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Home sweet second home

By Robert J. Shiller

Whenever I speak at finance and economics conferences around the world, I find that a great conversation starter with the spouses of the middle-aged business people who attend is to inquire about their vacation home. I then find myself entertained by stories of gorgeous ocean sunsets seen from the porch, views onto expanses of colorful wildflowers on mountainsides, and happy family reunions in beautiful seclusion (as well as problems with the plumbing).

Years ago, I never asked about vacation homes. They never seemed so much on people’s minds. Purchases of second homes for pleasure were confined to the rich, and thus did not seem quite so much of a conversation topic for the rank-and-file business people that I meet at such conferences.

But now the world is undergoing a second-home boom: an increasing number of people are buying vacation homes in beautiful and fun places that are within a few hours’ flying time from their first homes and jobs. Their second homes are a retreat where they will spend only a fraction of the year, and recently pristine mountain ridges and ocean cliffs are being dotted with new homes to meet the demand.

A study by the National Association of Realtors (NAR) indicates that 13% of all homes purchased in the United States in 2004 were vacation homes. This does not include buyers who purchased homes as investment properties, mostly to rent out. According to the NAR, investment buyers account for another 23% of home sales, bringing second-home purchases to 36% of the total. Some of the US counties with a high proportion of vacation homes are seeing price increases that rival, if not outstrip, the booming metropolitan areas. For example, according to the Case-Shiller Indexes, home prices in the fashionable Cape Cod vacation area in Massachusetts soared 184% from 1997 to 2005, compared to the 131% increase in nearby Boston over the same period.

America is not alone. Europeans are buying gemütliche Alpine ski chalets, glamorous condominiums with Mediterranean views in the South of Spain, and, increasingly, villas in picturesque sites in Turkey, Hungary, and Croatia. Australians are buying oceanfront properties at the Sunshine Coast and the Whitsundays.

Japan’s vacation-home boom of the 1980’s has largely fizzled with its collapsing stock market and urban land market. But even there, the market for vacation homes remains hot in places like Karuizawa, Lake Kawaguchi, and Hakone.

Being able to afford a vacation home in beautiful surroundings may mean a lot to some people. Indeed, sometimes the talk that I hear about these properties seems to integrate them into the true meaning of life. After all, where do we imagine that philosophers and poets and gurus live? In one of these captivatingly charming places, of course, and not as tourists in hotel rooms.

Most people who couldn’t possibly afford such a vacation home probably don’t miss it. Craving one seems to be a desire, like fine wine, that one discovers only when one has substantial wealth. So, as global economic growth continues, and as household incomes rise in today’s most populous emerging countries, demand – and thus prices – for vacation homes in beautiful places, either at home or abroad, will most likely soar.

There is reason to worry about this. Real GDP has been growing at around 3% a year in many advanced countries, and twice that or more in some emerging countries. Properties in beautiful places are likely to be what economists call “superior goods” – those goods that account for a higher proportion of consumption as incomes rise. With fixed supply, rents on these properties should increase at a rate equal to or above the rate of GDP growth. Prices could increase much faster at times.

On the other hand, in some places, a speculative bubble is fueling today’s boom in vacation-home prices. The vacation-home boom appears psychologically tied to the urban home-price bubble in many of the world’s “glamour cities,” and prices of these vacation homes are similarly vulnerable to a significant drop in coming years.

Moreover, there are plenty of ways for the construction industry to offer untold millions more people the opportunity to call some beautiful place home, simply by building more high-density and high-rise vacation apartment buildings there. Many of the single-family vacation mansions or low-density apartment buildings that are being built today will likely eventually be sold, torn down, and replaced with higher-density megastructures, boosting supply and thus easing pressure on prices of the remaining low-density vacation homes.

Such higher-density construction must be the best possible outcome, for it will please the most people. Most vacationers seem to derive a sense of excitement from the presence of many other vacationers around them. Large numbers of people contribute to a holiday atmosphere and attract entertainment and sports industries. But, for many of those who imagine relaxing in a place that offers a quaint life of undisturbed beauty, there is a strong risk that prices will rise out of reach in future decades. No economic strategy can change that, even if it produces spectacular GDP growth. dt-ps

Robert J. Shiller is Professor of Economics at Yale University, Director at Macro Securities Research LLC, and author of Irrational Exuberance and The New Financial Order: Risk in the 21st Century.

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