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Resi Wrap - Consumer Surplus and Serendipity Alpha
April 2023

Friends of ResiShares:

This month’s housing news flow was heavy on dissecting and describing the current housing shortage. The WSJ published an article about the nebulous definition of the housing shortage, given the impossibility of estimating demand when household formation itself changes for both endogenous (I can’t afford to move out of grandma’s house b/c the rent is too damn high) and exogenous (I don’t want to move out of grandma’s house b/c I like it) reasons. An extreme example of this definitional challenge would be to assert that we clearly have a national shortage of 5,000 square foot beachfront mansions, because I would rather live in one of those than my existing house (no offense to my neighbors, who are lovely).

One fun thing about writing a newsletter is that you get to pound the square peg of reality into the round hole of theory without having to worry about your econ teacher giving you a bad grade. With that, some fun examples about consumer surplus in the housing business.

How many of you recognize this chart from college?

The basic idea is that the blue “supply” curve slopes up, because when prices are higher, more marginal producers with higher costs “knock in” to the market and add more supply. Demand, contrarily, is downward sloping, because higher prices discourage the more marginal consumers (those with less money or those who value the good or service less dearly) from buying.

The “Consumer Surplus” describes the extra value or utility that the consumers most willing and able to pay receive because the market-clearing price is lower than their tipping point. In other words, if I am willing and able to pay $40,000 for a Subaru, but the market clearing price at which the curves intersect is $25,000, my consumer surplus is $15,000 (as someone whose financial resources have changed since high school, but whose taste in cars has not, Subarus offer me a deep well of consumer surplus).

The shape of the curve is an important descriptor of market dynamics. In the classic graph above, the supply curve steepness tapers off as it goes higher. This is because at some price level, there is a virtually infinite supply of producers able to produce a car with substantially similar features to a Subaru (anyone thinking of “investing” in NFTs should consider this first). Similarly, the inverted-S shape of the demand curve describes many markets, in that there is a price at which all or most buyers simply exit and find a suitable substitute.

Housing feels...different.

The demand curve can become distorted for a variety of reasons. In 2005, for instance, housing was often seen as a speculative instrument, not dissimilar from meme stocks or cryptocurrencies. People bought multiple homes without any intention of inhabiting them or renting them to a tenant, instead hoping to simply hold for leveraged appreciation and resell. When the marginal buyer of a home was this type of speculator, the demand curve becomes temporarily vertical. That is, the demand for homes is equal to whatever the banks are willing to finance with ninja loans, at any price the sellers make available, beause the speculators believe that they will be able resell higher. Ironically, this would suggest that for the most aggressive speculators in some markets, consumer surplus is effectively infinite (I always value a home more than I paid for it, because I presume I can resell for a profit regardless).

What about the supply side? If you are a consumer that wants to live in any one of the handful of Bay Area cities with top quality public schools, the inability to build new homes in any of them means that the supply curve is effectively vertical instead, in that the only supply will come from homeowners who die in place or are willing to move out of the region. Even extremely high prices don’t necessarily spark new supply, because the “supplier” is just an existing resident that would have to find a new, equally expensive home to remain in the area. With a vertical supply curve, it is the producer surplus that becomes near-infinite (accruing mostly to those homeowners willing and able to move, and bringing their newfound wealth to Austin, Boise, and Bozeman as they did during Covid).

Once you look for these examples, you find them everywhere in housing.

Serendipity Alpha

This very good (but very long) think piece called “The Age Of Average” came our way via Real Estate Twitter, but was making the rounds this month in a variety of specialized social networks. For those who don’t read it (which I get, because it’s long, but you should, because it’s quite good), the essay laments the convergence of all products and aesthetics to a market-optimized average quality.

All homes feature natural light and gray LVP floor tiles. All new multifamily developments are four-story, stick-framed buildings with the same floor plan. All cars are some version of a Hyundai Santa Fe (or an Acura RDX, or a Honda CRV, but I repeat myself). All aspiring beauty influencers look like Kim Kardashian (seriously - read the article - it’s fascinating).

I suppose it’s fine for the author to take a critical view of this trend towards sameness, as that tone probably appeals best to the artsy folks who like to read longform essays. At the same time, I couldn’t help but think, “isn’t that the point?” The vast majority of everything trending towards a market-optimized average is precisely what a free-market economy is supposed to deliver. This very boring sameness maximizes society’s “aesthetic utility” (probably not a word, but we’re going with it anyway) at minimal cost. This is the flip side of The Long Tail; the mass-appealing animal attached to The Long Tail gets fatter and more cohesive over time.

What it seems like the author is truly lamenting, then, is the loss of a very specific kind of consumer surplus, which we’ll call “serendipity alpha” (speaking of making up words - yet another reason newsletters are more fun than econ exams). Serendipity alpha is a mashup of aesthetic utility as a public good with transactional utility. It’s the value you get when you trip over buried treasure. It’s the value you get from the enjoyment of driving past a restored classic car, an undiscovered mountain vista, or a row of Victorian homes, whose very existence in the world is a result of some level of economic inefficiency. It’s the transactional utility (this one actually IS a word) of feeling like you got something of value for free, and feeling smart and lucky for having done so.

Like all forms of alpha, the market does not sleep in its quest to internalize it and charge money for it. It will only get harder to find. The best things in life may be free, but if someone can figure out how to charge for them, they will!

What is interesting about housing, however, is that it is one of the few markets in which this consumer surplus can be directly monetized by consumers. If a home buyer discovers a home for a lower price than they value it, they instantly lock in consumer surplus. If the demand curve for the hedonic characteristics of that home should shift over time to raise its market clearing price and destroy the consumer surplus, the homeowner can actually sell the home for a profit.

This is much less likely to happen with Subarus.  

For the adventurous among us in the real estate business, however, buying an abandoned home in Japan would seem like a good place to start looking for it in the meantime.

Unless we just ruined it…

The Turn

Big news today for those of us who refused to believe the doom and gloom: The Case Shiller Index ticked up this month. For those of you not as fascinated by home price index mechanics as we are (poor unfortunate souls), the Case Shiller index reports on significantly lagged data and is quite easily predictable. Corelogic (who owns Case Shiller) called this a few weeks ahead of time, so no big surprises here.

Our view at ResiShares has been consistent: the supply/demand imbalance in housing is such that prices must ration demand at the limits of affordability. All that policymakers can do until that imbalance is corrected (over the course of years, if not decades) is influence which type of cash and credit buyer profile gets to buy a home first. Recent attempts at directly building these sand castles of good intention are instantly overwhelmed by the ocean that is the US real estate market. Potential regulatory changes that harness the market’s power to create new supply are much more promising.

Supporting this market is an ultra-low inventory (again, highly predictable given the mortgage burnout bred from the past 10 years (and past 10 months) of interest rate policy. Migration patterns to warmer, cheaper, and prettier places, sparked by remote work, also stress locally undersupplied regions. Despite the western states’ dominance of this immigration, a sharply bifurcated market has emerged, in which the western states are seeing prices fall while the eastern states are seeing them rise. As a Bay Area resident who watched prices in Q1, 2022 spike 20-30% YoY over its already nation-leading level, my speculative explanation (not the view of ResiShares) is that this underperformance of western markets is simply a return to normalcy from an artificially high print, and will soon level off (if it has not happened already).

The Rest Of Resi

Only one item this month for us to highlight.

As parents, we try to teach our kids that new toys are more fun to play with when we share them with our friends.

We have built a new toy, available on our website at We invite you to play with it as much as you like and hope that it delivers you all large heaps of consumer surplus and serendipity alpha.