When you pay a lot of money for something, you hope to get a lot of value in return. Despite the housing downturn and the number of cheap houses it has left in its wake, there is still plenty of expensive land left. According to the Global Property Guide, an online real estate investor's guide, New York might have slipped from the second-most-expensive city in the world in 2008 to the sixth most expensive in 2009, but an average 120-square-meter (1,300-square-foot) apartment in the central business district will still cost you a hefty $14,898 per square meter.
So why are people willing to pay a fortune to live in certain places? And what are they getting in return for their money? According to a recent working paper from University of Michigan economist David Albouy, there's a great deal of value to be found in those high prices.
[See a slideshow of the 10 pricey cities that pay off.]
Economists look at every asset as having an "amenity value," which measures the amount of satisfaction the asset brings to its owner. For example, your home has an asset value that is worth much more than the roof it puts over your head. The land where you live brings with it a certain quality of life: How nice is the weather where you live? How close are you to the coast? How many cultural and recreational opportunities are nearby? These quality-of-life factors contribute heavily to the amenity value of a city, and they help explain why housing costs are so high in some places.
Another big component of a city's amenity value—trade productivity—is essentially, how many goods does the city produce that other people value? The San Francisco area has Silicon Valley. New York has Wall Street. But productivity boosters can come in other forms, such as universities that produce an educated workforce, easy access to water or other transportation, or proximity to natural resources. How do these factors create amenities? Residents of highly trade-productive cities tend to enjoy higher wages. What's more, businesses flock to these cities to enjoy the advantages. As incomes and employment go up, so do housing costs.
It's important to note that amenity value is not the only driver of a city's housing costs, just a very important one. It takes some finessing to figure out exactly how amenities make cities pricey. Drawing from data on wages and housing costs in the country's metropolitan areas, Albouy used statistical analysis to make an educated guess about the amenity values of these cities.
The question of why some cities become great places to live and work is like asking which came first: the chicken or the egg? Did jobs and cultural opportunities follow the people who started living in these cities, or do people move there because of the jobs and cultural opportunities? Albouy says the answer to the riddle is clear: "People are following the amenities."
Here are the top productive and valuable cities and some reasons why they give their residents such a premium for the price:
San Francisco. With the fourth-highest quality of life and the highest trade productivity on Albouy's list, the San Francisco area—which includes Silicon Valley—comes in first on the list of most valuable cities. There are high wages, but even higher housing costs. Albouy found that housing costs are pushed so much above the wage level because San Francisco residents enjoy a premium beyond income, such as great weather, a thriving local arts community, and lively neighborhoods. But the business aspects of San Francisco outshine even the quality of life. Albouy says it's often thought that small cities where workers earn lower wages, like Boise, Idaho, are where businesses should start because costs like hiring and renting a building are so low there, relative to cities like San Francisco. But low prices also mean low quality. "Boise is a terrible place to do business, and the low wages are a sign of that," he says. Compared to Boise, "San Francisco has a highly productive workforce," he says.
Santa Barbara, Calif. With a population of 400,000, the Santa Barbara metro area has the second-highest quality of life and third-highest trade productivity. Why do California cities appear so high on this list? Santa Barbara is a perfect example of how built-in advantages boost a California city's amenity value. Albouy found that, generally speaking, the number of days of sunshine a city has each year, the higher its land rent. Santa Barbara's Southern California locale gives it plenty of sun. Another good predictor of land rent: proximity to a coast. Santa Barbara's beaches—the city has been dubbed the "American Riviera"—are very likely another reason it has such a high quality of life.
Updated on 6/29/09: An earlier version of this article incorrectly stated that a 120 square-meter apartment is 373 square feet. It is about 1,300 square feet.