Friday, December 5, 2008

Neighborhoods, Disorder, and Real Estate Values

Bad neighborhoods equal bad real estate performance. Most real estate professionals would agree with that statement, but a lot of us feel uneasy saying it, because historically bad neighborhoods have been defined by red lines on maps and linked to the resident’s income level and race. I have touched on this topic a few times before (here and here), but a recent study summarized in The Economist reminded me this is something I wanted to write about in more detail. What exactly constitutes a bad neighborhood, and how does a bad neighborhood hurt real estate values?

My view is as follows:

  • A bad neighborhood is a neighborhood where there are visible signs of decline and disorder. These signs include poorly maintained buildings, landscaping, and infrastructure, graffiti, litter, and indications of criminal activity (e.g., drug dealing and use, prostitution).
  • Responsible people (which I’ll define in a very limited sense as people who pay their mortgages and rent when due) do not like to be around disorder.
  • The aversion of responsible people to disorderly neighborhoods results in less demand for housing in those neighborhoods, resulting in lower values.

I came to this view via Wesley Skogan’s Disorder and Decline and George Kelling’s Fixing Broken Windows, both of which should be required reading for real estate investors, appraisers, and lenders. The latest research provides additional support for the idea that disorder leads more disorder, creating a self-reinforcing downward spiral.

Is approaching real estate investing or lending in a disorderly neighborhood more cautiously really just redlining in disguise? After all, aren’t such neighborhoods typically lower income, and aren’t the residents typically minorities?

One of the findings in Skogan’s research which really struck me was the fact that minorities and low income residents hate disorder in their neighborhoods as much as wealthier and white residents do. The income level and race of residents is not the cause of disorder, and they would be happy to be free of it. If you want to eliminate disorder in a neighborhood, you do it by allocating public funds to maintain and police the neighborhood properly. It’s true that minority and low income neighborhoods often get the short end of the stick when it comes to resource allocation. That’s a public sector problem that will not be fixed by private investment.