All market pricing is a function of supply and demand. One of the reasons many house price bubbles get started is due to a temporary shortage of housing units. This is a particular problem in California because the entitlement process is slow and cumbersome. Supply shortages can become acute, and prices can rise very quickly. This does not mean land is scarce. It means that the supply of dwelling units is experiencing a temporary shortage. It may seem like a minor distinction, but it is very important. New dwelling units can be created; land cannot.

In most areas of the country, when prices rise, new supply is quickly brought to the market to meet this demand, and price increases are blunted by the rebalancing of supply and demand. Since supply is slow to the market in California, these temporary shortages can create the conditions necessary to facilitate a price bubble.

The fallacy of running-out-of-land plays on this temporary condition to convince market participants that the shortage is permanent. The idea that all land for residential development can be consumed ignores one obvious fact: people do not live on land, they live in houses, and land can always be redeveloped to increase the number of housing units. Basically, builders can build "up" even if they can't build "out."

If running-out-of-land were actually a cause of a permanent shortage of housing units, Japan and many European countries where there is very little raw land available for development would have housing prices beyond the reach of the entire population (Japan tried it once, and their real estate market experienced a 64% decline over a 15 year period until affordability returned).

Since prices cannot remain permanently elevated, it becomes obvious that the amount of land available for development does not create a permanent shortage of dwelling units.

Over the long term, rent, income and house prices must come into balance. If rents and house prices become very high relative to incomes, businesses find it difficult to expand because they cannot attract personnel to the area. In this circumstance, one of two things will happen: businesses will be forced to raise wages to attract new hires, or business will stagnate and rents and house prices will decline to match the prevailing wage levels.

During the Great Housing Bubble, many businesses in the most inflated markets experienced this phenomenon. The effect is either a dramatic slowing of population growth or net outmigration of population to other areas. Several California markets saw an extended period of outmigration. These problems are caused by a shortage of dwelling units, but it has nothing to do with the amount of land.