Mechanism of the Real Estate Cycle

Here's an interactive graphic exercise on the boom/bust cycle!

Economic depressions have historically followed periods of great productivity increases due to improvements in technology, transportation, communication, etc. The worldwide depression of 1873, which so influenced Henry George, followed the completion of two momentous projects: the transcontinental railroad, and the Suez Canal. Before the Great Depression, assembly-line manufacturing processes deeply lowered the costs of automobiles and farm machinery, leading to huge productivity increases. In the 1980s and 2000s, information technology and globalization contributed to big productivity gains. (1) Henry George observed that these "improvements in the arts of production" tended to lower the prices of manufactured goods, buildings, and services but raised the price of the land needed to produce these things. As we have observed, land rent tends to take an ever-greater portion of overall income in a growing economy. According to George, a point is inevitably reached when more and more workers and capital owners simply cannot afford the price of land. Production begins to stop.

In George's analysis, economic downturns begin when land prices are too high. However, this part of the theory frequently fails to jibe with history. In the 1920s, real estate values started falling before the crash of the stock market. And the Crash of 2008 was precipitated when a sudden decline in real estate values left many mortgage-holders "under water" having borrowed much more than their lands and houses were now worth.

How could a decline in land values bring about a recession? To understand this, we'll have to take a closer look at the roles of credit and public investment in the land market and examine the economic mechanism of sprawl.

While it is true that land is fixed in supply, it does not follow that the supply of land for particular uses must be constant. Mason Gaffney notes that

There are dozens of stages of more intensive use: from hunting and fishing to trapping, from lumbering to tree farming, from that to sheeping to beef cattle, from grazing to feeding, to farming small grains to maize, to horticulture, to irrigation, to vines and groves and orchards, to country estates, to subdivisions and housing, to low-rise apartments, to commerce and industry, to high-rise condos and offices and hotels, with many stages of intensity along the way. (2)

In a modern economy the conversion of land to a more intensive use usually follows improvements in public infrastructure. Timber or farm land becomes viable when there is a railroad or highway to get products to market. Residential subdivisions spring up after streets, sewers and public water service is provided. Increased land values, and new construction, grow around highway interchanges or commuter-rail stations.

How Sprawl Unfolds

There is the basic public/private investment dynamic that creates sprawl development. Owners hold land in low-intensity uses (or even idle), as a long-term investment. Center-city areas are either overly expensive, or rundown and unattractive. Center-city sites are sometimes held for extremely long periods. They become so rundown that they become bargains, and their owners hope to strike it rich when the down-and-out area finally gets gentrified.

In the meantime, however, new construction is needed to bring people, jobs and economic activity to a metro area. To stimulate this, infrastructure is extended to new areas. Land values soar in those areas, and the owners profit. New development is financed with loans, usually with the land's appreciated value as collateral.

The key factor in this process isn't the affordability of land, but rather the availability of credit. Low interest rates and easy credit keep the demand for land high, and promise high returns to land speculators and developers. In effect, everyone with a home mortgage is a land speculator. Homeowners bet that the future advance in price or rent will replace the saving they never managed to do. Thus everyone is hooked, forced by the market to participate in the speculative game. Eventually people forget that there could be any other way of doing business.

Speculative bubbles always burst but there are strong reasons for people to persist in denying that truth. The over-riding incentive during an economic boom is to repeat what has been working so far. So, new public infrastructure is provided to new subdivisions. Demand for new suburban construction is high, subsidized by the streets, police and fire protection paid for by the taxpayers, and by tax policies that favor home mortgages over other kinds of debt. But, as land values keep rising with the expanding bubble, things get riskier. Lenders cut more corners, loaning greater sums to less secure borrowers. Sooner or later, the next level of subsidized sprawl development will fail to find buyers.

Two pervasive trends in the 2000s have been the proliferation of "McMansions" and of luxury condominiums. Many of the former are now in foreclosure, and many of the latter stand empty. The buildings still stand, but if their market value is lost, then economically they are just as destroyed as if a wrecking ball had hit them. (3)

Remember that for sprawl development to work, land such as farm land at the edge of a city must be made easily convertible to higher-intensity use by the provision of public infrastructure. Cities borrow to provide this infrastructure, betting that the new construction will increase their tax base. Since the economy is booming, these new developments always seem like good investments. Eventually, though, the latest wave of land, made newly ripe for development, will not find buyers. At that point, developable land has been oversupplied; there is a glut of it on the market.

If demand for a product DVD players, say fell off because the market had been oversupplied, one would expect prices to fall a bit, production plans to be changed to reflect the new level of demand, and a new equilibrium price to be reached fairly quickly. But this is not what happens with land. When land values reach their peak, they tend to fall quickly and dramatically. The difference is that land has been used as collateral at every step in the process and it was used as collateral at its speculation-enhanced price. If newly-developable land at the edge of town cannot find buyers, this creates a series of reverberating effects. The city has borrowed a bunch of infrastructure money, but now it will get no new tax base in return. There are no jobs for the construction workers who expected to build the next development. People who lose their jobs cannot afford to keep paying on their mortgages, so they default, and the banks lose lots of asset value. The recession is under way and it started with an oversupply of land on the market.

A Constant Burden

So we see that, due to the interaction of land and credit markets, a drop in land values tends to initiate a recession. However, that the speculative premium in land value is a constant burden on the economy. How do labor and capital resist advances in land value, when they must have land in order to produce? By ceasing production. Of course, this doesn't happen all at once, but marginally bit by bit. What does this mean in real life? Labor and capital decline to buy or rent land at the high asking prices. Some will rent or buy less land, and use it more intensively. Some will sleep on the street, or sell from the sidewalk. Some will retreat to little patches of marginal land. Some will buy as much land as ever, but thus use up funds they otherwise would have used to improve it, becoming withholders themselves. Some will organize and pass counterproductive rent-control laws. The economy-wide net result will be less production, more unemployment.


  1. Curtis, Mike, "Henry Ford Caused the Great Depression", Georgist Journal #107, Spring, 2007.    (Go back)
  2. Gaffney, Mason, "Reverberations", Georgist Journal #119, Spring, 2012.    (Go back)
  3. See Gaffney, Mason, After the Crash: Designing a Depression-Free Economy, 2009, Wiley-Blackwell, pp. 189-90.    (Go back)