Monday, December 26, 2005
Second Home
A fascinating trend from an economic perspective is the growing popularity among consumers to purchase a second home. Whether it is being used as a vacation cottage, it is rented out or is merely an alternative to one’s primary address, the purchase of a second home is typically viewed as a Status Good. Additionally, this trend runs exactly opposite to the Theory of Marginal Utility and it thus makes the discipline of Real Estate the great exception to the general rule.
In every society, from the Marxist to the Capitalist, there is a fairly sizeable minority class which always has a surplus of cash from income or an ability to borrow sufficient for its expenditure to have stimulative effects on the general economy. Whereas in past historical times this minority class consisted mainly of the royalty and the aristocracy, it now comprises something like 25% to 30% of the population of a developed country. Because the education system in advanced countries is as egalitarian and selective as it has ever been in history, and because the skill requirements of a modern advanced economy are higher than ever before, this minority class tends to be clearly divided from the remainder of the population in terms of intelligence, educational attainments and cultural tastes.
With extra spendable resources at its disposal and a fairly higher degree of education, knowledge and experience, it comes to a point where this minority class focuses its energies and resources to the acquisition, holding, perusing, renting and reselling of consumer items which are out of reach of the remainder of the population at large. As such, these items have a distinctive connotation denoting a higher status within society – if none other than in the minds of the beholders, and are called Status Goods. A second or subsequent home is possibly the crown jewel of all consumer goods and the quintessential status symbol.
More specifically, a Status Good is a purchasable item which becomes fashionable enough to have an effect on consumer spending, sufficient to produce a significant boost to the general economy of a nation, or a region, or a culture. The main motivation driving its purchase and use is that of denoting high status in society. Because of its desirability the price of a Status Good is able to carry a high profit margin and thus new providers enter the scene quite quickly with competitively high prices. This explains the recent development of resorts areas throughout the world. Here in British Columbia, for example, Whistler is already a world renown ski resort and site of the 2010 Winter Olympics. The real estate development of Whistler and Blackcomb Mountain in this past decade has seen land prices multiply exponentially from an average of CAD $75,000 in 1995 for a standard residential lot to CAD $750,000 in 2005. Anyone who owns an interest in land in Whistler these days definitely fits the foregoing definition of Status consumer.
As stated before, the purchase of a second or subsequent home runs exactly opposite to the Theory of Marginal Utility. “Marginalism” is the economic line of thought that postulates the notion that what is most important for decision-making and to determine economic value is the marginal or last unit of consumption or production. For example, one automobile is very useful for getting around. An additional automobile might be useful in case the first is being repaired, or for spare parts, but it is not as useful as the first. A third automobile has even less utility than the first two. Given the price of cars, one would not expect many people to own three cars because the benefit they receive on the third car would be unlikely to exceed the price. In essence, “marginal utility” is the additional benefit that a consumer derives on an additional unit of a commodity output. Such additional output is said to have economic value if the additional benefit exceeds the price of the output. The concept grew out of attempts by 19th-century economists to explain the fundamental economic reality of price.
More specifically, a Status Good is a purchasable item which becomes fashionable enough to have an effect on consumer spending, sufficient to produce a significant boost to the general economy of a nation, or a region, or a culture. The main motivation driving its purchase and use is that of denoting high status in society. Because of its desirability the price of a Status Good is able to carry a high profit margin and thus new providers enter the scene quite quickly with competitively high prices. This explains the recent development of resorts areas throughout the world. Here in British Columbia, for example, Whistler is already a world renown ski resort and site of the 2010 Winter Olympics. The real estate development of Whistler and Blackcomb Mountain in this past decade has seen land prices multiply exponentially from an average of CAD $75,000 in 1995 for a standard residential lot to CAD $750,000 in 2005. Anyone who owns an interest in land in Whistler these days definitely fits the foregoing definition of Status consumer.
As stated before, the purchase of a second or subsequent home runs exactly opposite to the Theory of Marginal Utility. “Marginalism” is the economic line of thought that postulates the notion that what is most important for decision-making and to determine economic value is the marginal or last unit of consumption or production. For example, one automobile is very useful for getting around. An additional automobile might be useful in case the first is being repaired, or for spare parts, but it is not as useful as the first. A third automobile has even less utility than the first two. Given the price of cars, one would not expect many people to own three cars because the benefit they receive on the third car would be unlikely to exceed the price. In essence, “marginal utility” is the additional benefit that a consumer derives on an additional unit of a commodity output. Such additional output is said to have economic value if the additional benefit exceeds the price of the output. The concept grew out of attempts by 19th-century economists to explain the fundamental economic reality of price.
As it relates to real estate, therefore, the usefulness of a second or subsequent home should diminish and, in accordance to the Theory, so should its price, so that second or subsequent homes should not possess economic value and, thus, demand for them should be minimal to none. Clearly, this is not the case in that real estate is not viewed as a disposable commodity but, rather, it is perceived as an appreciation-generating vehicle - a real capital asset.. As proven empirically, second homes as Status Goods are a vital component of consumerism, in that they stimulate demand and production and, thus, economic growth.
Luigi Frascati
Real Estate Chronicle
