10 Pricey Cities That Pay Off

Posted by Leslie Bauer on Thursday, July 9th, 2009 at 11:56pm.

by Matthew Bandyk

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 (373-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.

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:

1. 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.

2. 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.

3. Salinas, Calif. The Northern California city of Salinas isn't nearly as big a business mecca as nearby San Francisco, yet it has the eighth-highest trade productivity of the areas Albouy examined. Again, the California climate is a big contributor to this city's high quality of life (the third highest on the list). But it's not just the sunshine and access to the coast that make Salinas and other California cities so amenable; their summers don't reach the same brutal temperatures as other warm parts of the country such as Arizona or the Southeast. Albouy points out that very hot weather tends to reduce the productivity of businesses and thus drive down value -- possibly because high temperatures limit the ability to work. Salinas strikes the right balance of comfort.

4. Honolulu. It's no surprise that Albouy finds Honolulu to be an especially nice place to live, and its high housing costs show just how nice people think it is. It has the highest quality of life of any metropolitan area on Albouy's list. That quality of life compensates for trade productivity that is lower than in cities such as Washington and Philadelphia, which don't have as much amenity value overall.

5. San Diego. This Southern California city has the seventh-highest quality of life and trade productivity that's on par with Philadelphia. San Diego's high value in Albouy's study is probably a product of not only its location but also the presence of many institutions of higher learning, with the University of California-San Diego, the University of San Diego, and San Diego State University all located within the city. Albouy found a strong relationship between the city's quality of life and the share of residents who have college degrees. College students and graduates "support the local arts, and they support walkable, cool downtowns," he says.

6. New York. Of course, the business capital of the country has great trade productivity, trailing only San Francisco. The large number of high-paying jobs, a unique culture, a highly educated workforce, and a coastal location are all major amenities for New York. But the city rates lower for quality of life than cities like Portland or Washington and far below the aforementioned California cities. New York has the 39th-highest quality of life of all cities. As much as New Yorkers love their city, the sometimes cold climate appears to make it less valuable.

7. Los Angeles. Los Angeles lands in the top 10 despite having a lower quality of life than any of the other California cities on this list. It's sandwiched between Wilmington, N.C., and Grand Junction, Colo., by that measure. But L.A. has the fifth-highest trade productivity, ranking just above Boston.

8. San Luis Obispo, Calif. The San Luis Obispo metro area, with a population of 246,681, sits between Los Angeles and San Francisco and thus shares many of the advantages of both cities. It has the fifth-highest quality of life. Why don't more people live in smaller California cities like San Luis Obispo? Albouy says that his study does not take into account building regulations that might make it difficult for the supply of housing to increase, and thus keep housing prices up. "California would have a lot more people if you can build more houses there. And that would probably be good for the country," he says, because more people could benefit from its high quality of life.

9. Boston. Like New York, the only other East Coast city to rank highly in value, Boston's weather lowers its quality of life far below some of the other cities on this list. It has the 30th-highest quality of life in Albouy's ranking. But also like New York, Boston has significant trade productivity -- the fourth highest on the list. These cold-weather cities boost their value by offering well-paying jobs and very productive businesses. Innovation stemming from the high level of education among Boston's residents is just one reason the city is so productive.

10. Naples, Fla. This city on the southwest coast of Florida has the eighth-highest quality of life. But it ranks 10th in amenity value because it's not very productive. A larger population tends to mean higher trade productivity, since businesses can draw employees from a bigger base. Smaller metro areas like Naples, which has a population of 251,377, are at a disadvantage.

Copyrighted, U.S.News & World Report, L.P. All rights reserved.

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