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I have noticed that property prices near popular areas are much higher than what could be deduced by construction costs only. For example, in Finland, I can find a new 35.5 square meter row house in Oulu for 86600 EUR. This is about 2440 EUR per square meter. Based on my understanding, this 2440 EUR per square meter is about the cost of constructing a new house.

As far as I know, salaries in popular areas are not much higher than in non-popular areas. Also, for example, the Helsinki region is near Estonia, a source of cheap labor. So, based on this, the cost of constructing a new house in Helsinki should be about the same as in Oulu. So, the cost of a new house on leased land should be 2440 EUR per square meter near Helsinki (but the total cost of ownership would be higher because of the rent payments for leased land).

However, I found that a new 34.5 square meter apartment in leased land costs 148695 EUR in Helsinki. This is 4310 EUR per square meter.

Also, a city near Helsinki, Espoo, has plenty of unbuilt land. As a matter of fact, there is agriculture in Espoo! This all shows that there should be plenty of land to build apartment buildings on. Thus, a house on non-leased land should cost about 2440 EUR per square meter, because a fair price for land on areas where there is plenty of land is approximately 0 EUR per square meter (well, it is actually the opportunity cost, but it is very close to zero).

However, a 35 square meter new apartment on non-leased land costs 169490 EUR in Espoo. This is 4840 EUR per square meter.

I don't understand how these prices can be so high. Surely, the market economy means that when new houses can be sold for 4310-4840 EUR per square meter and the land should be practically free, there should be a lot of people trying to earn profit by constructing houses and paying 2440 EUR per square meter and selling them for 4310-4840 EUR per square meter. This should continue until there are so many new houses in the market that the price falls to a bit above the construction costs.

So, what explains these high property prices in popular areas?

I recall a quote "The market can stay irrational longer than you can stay solvent", which kind of describes this situation. The high property prices here are not something which has occurred only in the very recent past; the situation has been on for more than 10 years.

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    Supply and demand explains high house prices in popular areas. That said, why do you say there's plenty of land worth close to 0 EUR? If the area is actually that popular, the land seems like it should be quite valuable. Clearly, there are reasons (e.g. proximity to work, shops, friends, culture, etc...) why people prefer to live there and are willing to pay for it. Even if the land is currently unused, it may still be valuable, as it represents a parcel that could be built upon. Finally, local zoning limits what you can build, so not every farm can be turned into a 50 story apartment tower. – Zach Lipton Jan 10 '16 at 16:48
  • You are underestimating the demand side of the equation. – CQM Jan 11 '16 at 21:03
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House price developments:

Finnish house prices have been climbing for several years, with nominal house prices increasing by about 150% from their 1993 trough (see Figure 1). The pace of this sustained increase exceeded that of consumer prices and housing became significantly more expensive in inflation-adjusted terms. In 2012 house prices adjusted by the private consumption deflator (hereinafter referred to as "relative house prices") were 84% above the level of 1993. (Source)

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Price to income ratio in Finland:

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Various reasons of high housing prices:

1) Household debt developments:

The sustained increase in house prices was mirrored in the accumulation of household debt. Private sector debt (households and non-financial corporates, but excluding the financial sector) reached 184% of GDP in 2012 (est.). (Source)

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2) Structural housing demand and supply factors:

The comparison of valuation ratios with their historical average provides first-order information on potential housing market mispricing. However, these need to be interpreted in the context of any important structural shifts affecting housing demand or supply. For Finland, important factors include a booming population in the Helsinki area on the one hand and restrictive land allocation procedures and lags in the construction sector on the other hand. (Source)

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However in London (From Economist):

The London phenomenon is due to a restriction of supply at a time of soaring demand. In the north of England, slow economic growth, low population growth and plenty of new construction mean that there are lots of homes and not all that much demand for them. In London and the south east, by contrast, tight planning rules and a shortage of land mean that relatively little new housing is being built, even as a booming economy and spectacular population growth create lots of demand for it.

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(Source of above graph)

Also, this article explains causes and consequences of high housing costs of another such area (California).

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"The market can stay irrational longer than you can stay solvent" does not actually describe what's going on.

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I live 200 miles away, and in a town a short ride away, purchased a 3 family house (3 apartments in the building) which was $180,000 after renovations for 3000 square feet, or $60 per square foot.

I don't know your area, but I know that NYC is not a fad, not a bubble. It's never been cheap, and with today's technology, never will be. (Give me a new mode of transportation that will put me in midtown in 20 minutes from a couple hundred miles away, and this all changes, of course).

The city where I bought is depressed, but isn't likely to get to more than 50-100% the current price level to reach an equilibrium.

In the end, there are cities around the world that defy the averages. Those in demand will command prices that the average families can't afford, and those shunned, will keep a lower than average cost until something fundamentally changes in that area,

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