Zoning and Market Pricing of Housing

The question of the effects of the supply restrictions in zoning on housing prices has erupted among leftist urbanist bloggers again. On the side saying that US urban housing prices are rising because of zoning, see anything by Daniel Kay Hertz, but most recently his article in the Washington Post on the subject. On the side saying that zoning doesn’t matter and the problem is demand (and by implication demand needs to be curbed), see the article Daniel is responding to in Gawker, and anything recent by Jim Russell of Burgh Diaspora, e.g. this link set and his Pacific Standard article on the subject.

This is not a post about why rising prices really are a matter of supply. I will briefly explain why they are, but the bulk of this post is about why, given that this is the case, cities need to apportion the bulk of their housing via market pricing and not rent controls, as a matter of good political economy. Few do, which is also explainable in terms of political economy.

But first, let us look at the anti-supply articles. Gawker claims that San Francisco prices are rising despite a building boom. We’ll come back to this point later, but let me note that in reality, growth in housing supply has been sluggish: Gawker links to a SPUR article about San Francisco’s housing growth, which shows there was high growth in 2012, but anemic growth in previous years. The Census put the city’s annual housing unit growth last decade at 0.8%. In New York, annual growth was 0.5%, as per a London study comparing London, Paris, New York, and Tokyo. In contrast, Tokyo, where zoning is relatively lax, growth was 2%, and rents have sharply fallen. The myth that there is a building boom in cities with very low housing unit growth is an important aspect of the non-market-priced system.

Jim’s arguments are more interesting. He quotes a Fed study showing that housing vacancies in the most expensive US cities have not fallen, as we’d expect if price hikes came from lack of supply. (In San Francisco, vacancies went up last decade, at least if you believe that the Census did not miss anyone.) This is too not completely right, because in Los Angeles County, as noted on PDF-page 18 here, vacancies did recently fall. But broadly, it’s correct that e.g. New York’s vacancy rate has been 3% since the late 1990s, as per its housing surveys. But I do not think it’s devastating to the supply position at all. The best way to think about it is in analogy with natural rates of unemployment.

Briefly: it’s understood in both Keynesian and neo-classical macroeconomics that an economy with zero employment will have high and rising inflation, because to get new workers, employers have to hire them away from existing jobs by offering higher wages. There is a minimum rate of unemployment consistent with stable inflation, below which even stable unemployment will trigger accelerating inflation. In the US, this is to my understanding about 4%; whether the recession caused structural changes that raised it is of course a critical question for macroeconomic policy. A similar concept can be borrowed into the more microeconomic concept of the housing market.

There’s also the issue of friction, again borrowed from unemployment. There’s a minimum frictional vacancy, in which all vacant apartments are briefly between tenants, and if people move between apartments more, it rises. For what it’s worth, the breakdown of 2011 New York vacancies on pages 3-4 by borough and type of apartment suggests friction is at play. First, the lowest vacancy by borough is 2.61%, in Brooklyn, not far below city average. Second, the only type of apartment with much lower vacancy than the city average is the public housing sector, with 1.4% vacancy, where presumably people stay for decades so that friction is very low; rent-stabilized units have lower vacancy than market-rate units, 2.6% vs. 4.4%, which accords with what I would guess about how often people move.

So if high rents are the result of supply restrictions, and it appears that they are, the way to reduce them should be to relax zoning restrictions. If this is done, then this allows living even in currently expensive areas without spending much on rent. Urban construction costs are lower than people think: New York’s condo average is $2,300 per square meter, and London’s is not much higher, entirely eaten by PPP conversions; Payton Chung notes the much higher cost of high-rises than that of low-rises, but the cost of high-rise apartment buildings is still only about $2,650/m^2 in Washington, and (using the same tool) about $3,100 in New York, and at least based on the same tool, mid-rises are barely any cheaper. For US-wide single-family houses, construction costs are 61.7% of sale prices, but the $3,100 figure already includes overheads and profit. Excluding land costs, which are someone else’s profit, construction, profit, and overheads are 92.5%; so let’s take our $3,100/m^2 New York high-rise and add the rest to get about $3,300, which is already more than most non-supertall office skyscrapers I have found data for in other major cities. The metro area appears to have a price-to-rent ratio of about 25, and with the caveat that this may go down slightly if the city gets more affordable, this corresponds to a monthly rent of $11 per square meter, at which point, a 100-m^2 apartment, sized for a middle-class family of four, becomes affordable, without subsidies, to families making about $44,000 a year and up, about twice the poverty line and well below the median for a family of that size. If we allow some compromises on construction costs – perhaps slightly smaller apartments, perhaps somewhat lower-end construction – we could cover most of the gap between this and the poverty line.

But given that demand for housing at prices that match construction costs, there has to be a way of allocating apartments. Under market pricing, they’re allocated to the highest bidder. If there is a perfectly rigid supply of 2 million housing units and a demand for 4 million at construction costs, the top 2 million bidders get housing, at the rent that the 2 millionth bidder is willing to pay.

I do not know of any expensive city with low home ownership that uses market pricing: too many existing residents would lose their homes. High home ownership has the opposite effect, of course – Tel Aviv may have rising rents, and high price-to-income ratios, but since home ownership is high, the local middle class is profiting rather than being squeezed, or at least its older and slightly richer members are.

Instead, cities give preference to people who have lived in them for the longest time. Rent control, which limits the increase in annual rent, is one way to do this. City-states, i.e. Singapore and Monaco, have citizenship preference for public housing to keep rents down for their citizens. Other cities use regulations, including rent control but also assorted protections for tenants from eviction, to establish this preference. Instead of market pricing allocation, there is allocation based on a social hierarchy, depending on political connections and how long one has lived in the city. People who moved to San Francisco eight years ago, at age 23, organize to make it harder for other people to move to the city at this age today.

Going to market pricing, which means weakening rent controls over the next few years until they’re dead letter, is the only way to also ensure there is upzoning. Although rent control and upzoning both seem to be different policies aimed at affordability, they’re diametrically opposed to each other: one makes it easy for people to move in, one makes it hard. As I mentioned years ago, rent-controlled cities tend to have parallel markets: one is protected for long-timers, and for the rest there is a market that’s unregulated and, because so much of the city’s housing supply is taken off it, very expensive. In exchange-rate dollars, I pay $1,000 for a studio of 30 square meters, of which maybe 20 are usable, the rest having low sloped ceilings. In PPP dollars it’s $730, still very high for the size of the unit. If I put my name on a waiting list, I could get a similar apartment for a fraction of the price; to nearly all residents, rents are far lower than what I pay, because of tight rent controls. Stockholm at least has a relatively short waiting list for rent-controlled apartments, 1.5 years, for international visitors at my university; American cities (or perhaps American universities) never do foreigners such favors.

The problem here is entirely political. Cities have the power to zone. Thus, supply depends entirely on whether local community leaders accept more housing. This housing, almost invariably, goes to outsiders, who would dilute the community’s politics, forming alternative social networks and possibly caring about different political issues. It’s somewhat telling that ultra-Orthodox Jews in the New York areas support aggressive upzoning, since the new residents are their children and not outsiders; Stephen Smith has written before about the Brooklyn Satmars’ support for upzoning, and the resulting relatively low prices. In the vast majority of the first world, with its at- or below-replacement birth rates, this is not the case, and communities tend to oppose making it easier to build more housing.

There is a certain privilege to being organized here. We see the pattern when we compare how US minorities vote on zoning to what minority community leaders say. In San Francisco specifically, activists who oppose additional development have made appeals to white gentrification in nonwhite neighborhoods, primarily the Mission District. Actual votes on the subject reveal the exact opposite: see the discussion on PDF-pp. 13-15 of this history of Houston land use controls, which notes that low-income blacks voted against zoning by an overwhelming margin because of scare tactics employed by the zoning opponents. (Middle-income blacks voted for zoning, by a fairly large margin.) Polling can provide us with additional data, less dependent on voter turnout and mobilization, and in Santa Monica, Hispanics again favor new hotel development more than whites. In areas where being low-income or nonwhite means one is not organized, low-income minorities are not going to support restrictions that benefit community leaders.

The result is that organized communities are going to instead favor zoning, because it gives them more power, as long as they are insulated from the effect of rising prices. In suburbs with high home ownership, they actually want higher prices: my rents are their property values. In cities with low home ownership, rent controls provide the crucial insulation, ensuring that established factions do not have to pay higher rents. Zoning also ensures that, since the developers who do get variances can make great profits, community groups can extort them into providing amenities. This is of course the worst in high-income areas: every abuse of power is worse when committed by people who are already powerful. But the poor can learn to do it just the same, and this is what happens in San Francisco; TechCrunch has a comprehensive article about various abuses, by San Franciscans of all social classes, culminating in the violent protests against the Google shuttles, and in many cases, the key to the abuse was the community’s ability to veto private developments.

The risk, of course, is displacement. As the gap between the regulated and market rent grows, landlords have a greater incentive to harass regulated tenants into leaving. This is routine in New York and San Francisco. Community groups respond by attacking such harassment individually, which amounts to supporting additional tenant protections. In California, this is the debate over the Ellis Act. The present housing shortages are such that supporting measures that would lower the market rent has no visible short-term benefits, and may even backfire, if a small rent-controlled building is replaced by a large unregulated building.

So with rent controls, community groups have every incentive to support restrictive zoning, and none to support additional development. With market pricing, the opposite is the case. What of low-income city residents’ access to housing, then? Daniel mentions housing subsidies as a necessity for the poor. To be honest, I don’t see the purpose, outside land-constrained cities like Hong Kong and Singapore. If it is possible through supply saturation to cut rents to levels that are affordable to families making not much more than the poverty line, say 133% of the US poverty line, the Medicaid threshold, then direct cash benefits are better. In the ongoing debate over a guaranteed minimum income, the minimum should be slightly higher than the US poverty line, which is lower as a proportion of GDP per capita than most other developed countries’ poverty lines, as seen in the government programs with slightly higher limits, led by Medicaid.

Leftists have spent decades arguing for state involvement in health care and education – not just cash benefits, but either state provision, or state subsidies combined with some measure of cost control. There are many arguments, but the way I understand them, none applies to housing:

1. Positive externalities: Ed Glaeser has noted that if some people in a metro area get more education then there is higher income growth even for other people in the area. In health care, there are issues like herd immunity.

2. Very long-term benefits: if college is as expensive as it is in the US today, it takes many years for graduates’ extra incomes to be worth the debt. With health care, the equivalent is preventive care. When benefits take so much time to accrue, first some people face poverty traps and don’t have the disposable income today to invest in their own health and education, and second, the assumptions of rational behavior in classical economics are less true.

3. Natural monopolies outside large cities: hospitals, schools, and universities have high fixed capital costs, so there can only be sufficient competition in very large cities. The same is of course true of rail transit.

4. Asymmetric information: students and parents can’t know easily whether a school is effective, and patients face the same problem with doctors; short-term satisfaction surveys, such as student evaluations, may miss long-term benefits, and are as a result very unpopular in academia.

With housing, we instead have competitive builder markets everywhere, no appreciable benefits to having your neighbor get a bigger or better apartment, and properties that can be evaluated by viewing them.

The only question is what to do in the transition from the present situation to market pricing. This is where a limited amount of protection can be useful. For example, rent controls could be relaxed into a steady annual gain in the maximum allowed real rent. While market-rate housing remains expensive, public housing is a stopgap solution, and although it should be awarded primarily based on need rather than how long one has lived in the city, a small proportion should be set aside to people in rent-controlled small buildings that were replaced by new towers. None of this should be a long-term solution, but in the short run, this may guarantee the most vulnerable tenants a soft landing.

What this is not, however, is a workable compromise. Community organizations are not going to accept any zoning reform that lets in people who are members of out-groups. They have no real reason to negotiate in good faith; they can negotiate in bad faith as a delaying tactic, which has much the same effect as present zoning regimes. What they want is not just specific amenities, but also the power to demand more in the future; it’s precisely this power that ensures the neighborhoods that are desirable to outsiders are unaffordable to them. What they want is a system in which their political connections and social networks are real resources. A city that welcomes newcomers is the exact opposite. Expensive housing is ultimately not a market failure; it’s a political failure.

43 comments

  1. Matthew

    That’s funny: I also thought of the NAIRU when I read Jim’s article. He self-refutes at the end, anyway.

    So the question now is, how do you create a political equilibrium around reasonable market priced housing?

    Things like rent control or zoning are easier to organize around. There’s a boogeyman: the big bad landlord. Or the big bad apartment building that’s going to “change the character of the neighborhood” (in other words, allow people different-from-you to live nearby you). So you rally to the blunt political instrument that will strike down the immediate danger, damn the long term consequences.

    I guess you have to find some way of convincing the residents that there’s something in it for them. Appeals to high-minded principles like diversity and vitality don’t seem to be enough. People are jealous: a developer comes in and makes a profit easily, it seems. Nevermind that the whole situation was created by their obsession with exclusionary zoning. Even though many folks I know are older than zoning, they cannot imagine a world without it.

    Politically connected developers also have a vested interest in zoning: they can manipulate it to keep the riff-raff out of their market, leaving most of the jobs to themselves and their army of lawyers/friendly politicians. Laws that prevent the construction of significant buildings are not objectionable to developers who are able to pull a variance when they need it.

    That’s how it looks in Boston anyway. Community groups clutch zoning as a means of extracting concessions out of developers, who are big enough not to really care, and who are frequent donors to politicians. Mixed with groups trying to build or preserve some amount of “affordable” housing according to some weird, esoteric definition of affordable. If you are a small time developer then you are only allowed to build unaffordable 1 or 2-family homes, even if the demand is sufficient for an apartment building, because you won’t make it through the process otherwise in most cases.

    • Shane Phillips

      Just as a quick reply to your first question about building political support for rational zoning, I’ve recently been thinking that one of the best coalitions you could build would be a group that pushed for greater supply of market housing and also strongly defended and promoted renters’ rights. These groups are often antagonistic in most places, but I don’t think that needs to be the case. Renters are weak politically, but in many cities they’re actually the majority of residents so if they could be spurred into action to protect their own rights (including the right to not have endlessly-increasing rents due to a perpetually and deliberately restrained supply), they could actually change things pretty dramatically. Without a focus on renter’s rights, including things like evictions and abusive landlords, I think you’ll have trouble convincing many renters that a market-forces political objective is really in their interest.

      This idea is still far from fleshed out but I think it’s an important piece of the puzzle.

      • Alon Levy

        The problem with this is that, at least in New York and San Francisco, market-rate renters are a minority; the majority of renters are rent-regulated, so their incentives are mainly to tighten rent regulations to prevent landlords from evicting them.

  2. Joseph Musco

    Minneapolis is considering zoning changes that would allow granny flats (mother-in-law apartments, accessory apartments) to be built in existing single family residential zones.

    http://www.ci.minneapolis.mn.us/cped/projects/WCMS1P-126877

    The recent lengthy recession opened the eyes of a lot of home owners to the benefits of a little flexible income and is perhaps going to transform the view of tenant from “outsider” to “a friend of a the family who needs a place”. Building legal accessory apartments where single family homes exist is a step with the potential to satisfy homeowners, city planners, and renters. Commercial developers might not light it but the home remodeling/construction industry is a powerful player that would be supportive. The alternative to legalizing this type of unit in an expensive rent market is to have tons of unlicensed rentals pop up — see every other basement in Queens, NY.

    • Alon Levy

      There’s been a similar discussion of duplexes in Austin, but there, the NIMBYs kept viewing duplexes as something meant for outsiders, figuring that people would rent out both units rather than live in one unit and rent out the other. See for example here.

  3. betamagellan

    Although for someone occupying a home there’s no problem if your neighbor has a newer, bigger apartment, it is an issue if you’re a landlord—although I’m more familiar with this happening in commercial real estate, existing property owners often oppose new construction because it means extra competition for renters (which sometimes gets dressed up in anti-density character/“livability” arguments).

    Stockholm’s situation seems a lot better than Amsterdam’s—when I was looking for a studio the prices were similar with 2/3 the usable area (or similar area and 3/2 the price), and many of my acquaintances either live far off in the boonies or some kind of arrangement with their family. I didn’t look into social housing (don’t think my visa includes eligibility anyway), but a Dutch acquaintance who just returned to the Netherlands found out that he’d be stuck with a ten-year waitlist (shorter in the boonies, of course, where wait times are short and the prices make Texas look expensive). People here tend to plan their lives around their housing situation, which is a pretty untenable prospect for younger, more mobile professionals.

    Incidentally, the only Dutch city with a “normal” housing market is Rotterdam, which doesn’t have the same sort of aesthetic concerns of Amsterdam and has a more American-style downtown area.

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  5. Ben Ross

    Your political analysis excludes the possibility of organization on a class basis. Strong labor movements advocate for both rent control and increased housing supply. That is partly because they see that rent control won’t work if the gap between market and controlled rents is too big, and partly because they represent the people looking for housing just as much as the people already in the housing. Labor-governed cities regularly have big housing construction programs. The classic case is Vienna in the 1920s (see Gulick, Austria from Hapsburg to Hitler). New York in the LaGuardia era built lots of housing too.

    • Alon Levy

      Okay, so now the question is why this is no longer the case – why these cities no longer build housing in large quantities. For instance, Sweden had its Million Program, but no longer does. In Sweden at least, the answer is the same us-and-them issue: the Million Program enabled the working class to live in larger apartments in the same area; it was not about accommodating immigrants, or about making it easier for people from peripheral cities to move to the capital. The same was true of Depression- and postwar-era US urban renewal, at least insofar as it was aimed at white people (when aimed at black people, it was about removal from city centers rather than any provision of services).

      I do not know what the city-province politics in Sweden are like, so I don’t know whether the idea of state involvement in construction in the Stockholm area would be acceptable to voters in the north, or in Malmö. If it’s anything like Israel, it would not be. In Israel, the idea of new public housing construction in the Tel Aviv area gets opposition from power brokers in peripheral areas, who want the state to prioritize construction in their own already affordable regions as a way of investing in them, and make nationalistic arguments about settling the entire country. Presumably Tel Aviv could take charge itself and submit an upzoning plan for state approval, which the state would probably approve; but once the decision is made by local interests rather than national ones, the same us-and-them politics rears its head.

  6. Alon Levy

    A couple points that I did not make in the post for length reasons but that are equally pertinent:

    1. In California, Prop 13 is essentially rent control for homeowner property taxes, and has contributed to the intransigence of suburban homeowners. That said, in the New York suburbs, NIMBYs are equally opposed to letting in poorer people; they just happen to face very high property taxes funding the local schools. The effect has not been to get them to support upzoning, but to get a few to leave these suburbs and move back to New York.

    2. Although I’m focusing on zoning restrictions and on the community’s use of variance applications to extort developers, there are plenty of other examples of harassment aimed at tenants who are in the them-group. When used by the middle class against the poor, examples include limits on unrelated adults living together (because of group homes, students, and maybe also low-income immigrants), minimum dwelling and lot sizes, and parking minimums. San Francisco doesn’t just have NIMBYs who vandalize tech shuttles; it also has NIMBYs who fight microapartments.

    3. When I excluded land costs from the cost calculation, I also excluded the cost of buying out the existing apartments for infill. For example, if you’re demolishing a building and replacing it with one with three times the floor area, you need to add one third to the per-unit cost. This is why replacements of buildings tend to be so out of scale: to financially pan out, they need to raise the floor area ratio several times over, which means raising height by an even greater factor because of setbacks. (This also helps explain the negative correlation between housing stock growth and lifetime of a building: if you’re replacing buildings by buildings three times as tall, then 2% annual housing growth means buildings last \log_{1.02}3 \approx 55 years, whereas 0.5% growth means they last 220.) In the future, it is prudent to require new high-rises to make it easy to extend their heights, on the model of the Blue Cross Blue Shield Tower, which may raise average costs somewhat but avoid letting marginal costs go far above average costs.

  7. Adirondacker12800

    Excluding land costs, which are someone else’s profit,

    Which then has to be reflected in the price of the housing unit built on it. It’s the reason McMansions built on the periphery are cheap, the land under them is cheap. You can’t ignore the cost of the land and the existing building on it. Amortizing that cost is going to show up in your rent or mortgage payment.

    • Alon Levy

      There’s a very specific reason I made this exclusion: urban land costs depend on the profitability of development. If, through zoning restrictions, an apartment that costs $300,000 to build sells for $500,000, then the landowners will bid up the cost of land, and the cost to the developer will be not much less than $500,000. Allowing more development would lower the price, which would lower the cost of land per apartment; depending on what the elasticity of demand is, it’s likely that the cost of land would go down per unit of land area, too, reducing existing owners’ cut. In contrast, allowing more development would not really reduce the price of any other component of home price: at the scale in question, marginal construction costs are basically constant, with neither economies of scale or significant rise in cost as the building gets taller; financing, marketing, etc., are also largely unchanged. So the more expensive an area is, the higher the land share of the cost is. For American single-family houses, land is 20% of the cost, which is presumably an average of many cheap Sunbelt suburbs and a few restricted suburbs of expensive cities, where a house that costs $250,000 to build sells for $1,000,000 (and if it’s in California then it still gets taxed as a $250,000 property). In the cities, it’s much more than that. Those $2,300/m^2 New York condos sell for $10,000/m^2.

        • anonymouse

          But it’s easy to minimize the amount of land you need for a given amount of housing: just build upward. The taller your building, the less land each unit ends up using, and the less the land cost matters to the per-unit price. Of course, at some point, you have to pay more for the expense of high rise construction, but engineering (and economics) is full of those sorts of tradeoffs.

          • Adirondacker12800

            Land and the buildings on it are very very expensive in places like New York and San Francisco. That gets reflected in the rent or purchase price.

          • threestationsquare / Anon256

            @Adirondacker12800: It’s the other way around. Developable land is expensive in NYC and SF because they have strong zoning cartels that guarantee that you can charge a lot for housing built on the land. (Land with un-evictable rent-controlled apartments on it can be pretty cheap.) If more development were permitted citywide then land prices would fall.

          • Adirondacker12800

            Most of Manhattan is zoned for densities higher than what it has, Those pesky pesky incumbent residents don’t want to move. Same thing in other big cities, to outbid them makes anything that gets built expensive.

          • Alon Levy

            …is that actually true? I know that there are parts of Manhattan where the opposite is true, i.e. buildings are taller than present FAR limits (to say nothing of parking requirements north of East 96th and West 110th, because in Manhattan everyone needs a car).

  8. mclaren

    This is so obviously shockingly wrong that it seems remedial to even have to point out the utter wrongness of the entire economic argument. But (sigh) let’s run through once again, shall we?

    The essence of the argument here focuses on supply and demand. Unfortunately, out here in the real world, we know that significant parts of the actual economy don’t operate according to supply and demand. Or, to be more precise, significant parts of the actual economy operate according to a perversely inverted version of the law of supply and demand. Namely, the more supply there is, the higher demand goes, and the higher prices become.

    Let’s take a specific example: freeways and traffic. Supply and demand tells us that if we build more freeways, the supply of available roadways will increase, and the density of traffic will drop. What actually happens is the reverse. Urban planners have repeatedly found, to their incredulity, that when they build more freeways, traffic _increases_. And as a result, the more freeways you have, the worse traffic density becomes. So we get this paradoxical result that if you build twice as much freeway mileage as you had before, traffic stalls and travels twice as slowly as it before. The real way to reduce traffic is to eliminate the free market for freeway traffic and impose external controls, as in the diamond carpool lanes now being used in various high-traffic urban areas. Eliminating the free market for freeway traffic represents a recognition that the law of supply and demand has broken down. The market doesn’t work in this particular instance.

    We see the same process with health care. More doctors don’t reduce the cost of health care, they increase it. Likewise, real estate in desirable cities. The more housing you build, the higher prices become. Build enough housing, and eventually nobody but rich people can live in that city. Building housing makes cities unaffordable.

    Economists can’t wrap their heads around these kinds of paradoxes because they’re unable to understand that not all parts of the real world function in the idealized way described by Econ 101. In the real world, there is infinite (or effectively infinite) demand for some goods, and creating more supply creates exponentially more demand in a vicious feedback loop. That’s not true in the toy world of Econ 101, but out here in the real world, there is no substitute for your life. If you die, you can’t get another life — you’re done. So people are willing to pay anything, absolutely anything, to avoid dying when they get sick. There is no limit to what people are willing to pay. The only limit is what people are able to pay. Creating more doctors just creates more opportunities to charge people money for health care, which increases the cost of health care without limit. The way to reduce health care costs is not to let the “magic of the market” create more doctors and nurses and radiological technicians, but to eliminate the market entirely and deliver health care by a nationalized single-payer system.

    Likewise, building more housing in America’s most desirable cities doesn’t reduce housing costs, it just lets more people move to those cities who otherwise wouldn’t. Why wouldn’t you, as a resident of Keokuk Iowa where wages run $8 an hour and jobs are scarce, move to Seattle WA, where the minimum wage is $15 an hour and jobs are plentiful? Obviously you would if you could. And when Seattle builds more housing you do move. So do lots of other people. But the number of people who move is always exponentially greater than the number of housing units built. This increases the population density in Seattle by a far greater amount than anyone expects (it’s always greater than anyone expects, courtesy of the exponential feed-forward effect) and drives housing costs up. And because there is always limitless (or effectively limitless) demand for housing in desirable cities like Seattle, many more people always move to Seattle (or New York or San Francisco) than housing units that are built. The result? Rents rise without limit. As with health care, the only way to reduce the cost of housing in America’s most desirable cities is to impose external controls on prices. Left to themselves, the “magic of the market” will push housing costs and health care costs and traffic density in urban areas to infinity.

    The plain fact of the matter is that the free market doesn’t work in some areas of life. Economists are unwilling to admit this, but it remains a brutal reality: privatized fire departments just don’t work. Privatized municipal water services are a bust. Privatized police are a no-go. Privatized health care is a disaster. And letting the market set housing prices in our major cities is an equall huge disaster. But economists just can’t accept the fact that large parts of everyday life, from universal public education to fire suppression to policing, cannot operate according to the free market. Economists just can’t accept the shocking reality that the law of supply does not apply to much of everyday life, from housing to traffic control to water and sewer services to health care.

    • Alon Levy

      (Rescued from spamfilter; I have no idea why it tagged your comment as spam.)

      First, I question your analogies. Having more doctors would reduce the salary of each doctor. That’s why the AMA keeps the supply of doctors in the US so scarce, by restricting available residencies and refusing to recognize foreign doctors’ credentials. It may or may not reduce the overall cost of health care, depending on what the elasticity is; this doesn’t really matter, since the issue with housing is not to reduce overall spending on housing in the economy but the amount of money paid per unit of housing in rent.

      Second, you’re discounting elasticity. Housing, like other staple goods, tends to be inelastic, so that overbuilding by a slight amount causes prices to freefall, and underbuilding by a slight amount causes them to go up to stratospheric levels. For a quick-and-dirty example, Detroit was built for 2 million people and has maybe a third as many today, but its housing prices have dropped by far more than a factor of 3 – if I’m not mistaken, the median house price there is $13,000, which is around a tenth or less of local construction costs. The same thing is the case with food – a small increase in demand, such as what happened around 2007, can cause large increases in the price of food. The difference is that the large majority of productive farmland in the world is already under cultivation, usually intense cultivation, whereas urban land is not used to nearly its maximum extent.

      Third, there are a lot of reasons why education, health care, and to a lesser extent infrastructure don’t follow any rules of basic economics. They’re outlined at the end of the post, and none of them applies to housing.

      And fourth, the feedforward effect is only true in one specific circumstance: if the entire city is tightly zoned, and one small area is upzoned, then it signals that there may be upzoning in surrounding blocks, and then developers buy them up expecting greater profits. At close enough level of zoom, upzoning does not reduce prices because the swing in supply is too small to matter. But when an entire city has lax zoning, things behave exactly as basic economics would predict. In Tokyo, 2% annual growth in the housing stock, more than the city’s population growth, has led to falling rents; in Toronto and Vancouver, which also have fast housing growth, people bemoan high rents and rising purchase prices, but rents are neither high nor rising fast by US rich city standards. And in the American Sunbelt, the ease of building more suburban sprawl has kept suburban sprawl prices low, barely above construction costs. There’s a lot of demand for living in dense cities like Seattle; there’s also a lot of demand for the Texas sprawl. But in the Texas sprawl this demand translates to population growth, whereas in New York and San Francisco this translates to high rents.

    • Joey

      Your freeway argument doesn’t hold because freeways don’t charge for access. Congestion could be eliminated by setting toll prices right.

    • threestationsquare / Anon256

      We need to build enough housing in the economically-active cities that EVERYBODY who wants to can move there (at which point prices will of course stop rising). Anything less would be an injustice against the people in Keokuk, who have just as much right to live in the cities as the people who already do.

    • Lewis Lehe (@LewisLehe)

      “Let’s take a specific example: freeways and traffic. Supply and demand tells us that if we build more freeways, the supply of available roadways will increase, and the density of traffic will drop. What actually happens is the reverse. Urban planners have repeatedly found, to their incredulity, that when they build more freeways, traffic _increases_. And as a result, the more freeways you have, the worse traffic density becomes.”
      I have never seen evidence that building more lane-miles increases average traffic density on the network, only claims about traffic flow (veh-km traveled). What is your citation? What is the “magic of the market” for traffic density? There are not prices for road access nor any meaningful market provision. Finally, you should know that raising mobility is only a tangential part of transportation planning and engineering. Mobility is a subgoal to the real goal: is to supply simultaneous access to destinations, which building roads certainly accomplishes. It is kind of like an amusement park with lines at the rides: building more rides will not notably shrink the exiting lines, but it is nonetheless a net benefit because more people can enjoy rides. But it is more beneficial than in the amusement park case, because at their destinations people interact with each other positively. Hence places with high accessibility also have high office rents, wages, productivity per hour, and variety of interesting products.

      • Alon Levy

        The specific claim about traffic density is wrong (too strong, really), but the general issue about induced demand is environmental. Building more roads induces more driving, which raises overall environmental damage, e.g. pollution and accidents. Occasionally you see pro-car contrarians claim that building more roads will reduce these environmental problems, e.g. more free-flowing traffic means higher fuel economy for cars, freeways have lower accident rates; this is true per car or per vehicle- or passenger-km, but the growth in driving means that overall fuel consumption and accident rates grow.

        This driving-specific example has turned into general, and unjustified, disdain for arguments about increasing supply of other things. I suppose it works if you think the fact that people live in central cities is itself a social problem (and this was historically the impetus for suburbanization and separate-use, single-family zoning).

        • Andre Lot

          Traffic density is not a proxy for price equilibrium. The whole analogy on @mclaren’s post is extremely flawed. It is like arguing that supply and demand doesn’t work because if you start giving out free sandwiches from a food truck, the number of people waiting in line will exponentially increase in the short term.

          Moreover, one cannot possibly make the case for induced demand based on driving patterns looking at a small part of the infrastructure availability spectrum. This is easy to demonstrate with counterfactuals:

          1) if demand for traffic was infinite, we’d see backroads on rural areas and national parks filled all the time.

          2) With exception of some enthusiasts, most people will only drive so much as they find it feasible to attain certain lifestyle including locational decisions – even if cars were given out for free, and fuel cost $0.01/metric ton, most people would not spend their whole days driving aimlessly. On my free sandwich truck example, there is only so much people for whom going to the food truck is a feasible proposition, and there is only so much sandwiches this set of people can eat before filling their stomachs to the max. The marginal cost of water is minimal for most households on developed countries, that doesn’t mean people take 4-hour showers.

          3) There are several contemporary or relatively recent examples of massive road building programs that didn’t end up with “road filling up again in one year”. I could cite Spain, Portugal, Netherlands and Poland as examples of that.

          I actually dislike, a lot, these usual gratuitous attacks on whole disciplines of science like @mclaren’s. He is the one who apparently doesn’t know much about even Econ 101, which wouldn’t be any problem had it not devolved into calling the whole professional class as stupid.

  9. kaleberg

    Based on my experience with the New York City real estate market, builders aren’t building less expensive housing, because they can build and sell more expensive housing. The zoning rules really aren’t that tight in Manhattan. There are all sorts of high rise office buildings and apartments and more being built, but it doesn’t make sense to build for the $44,000 a year market. You can make more money selling to the $144,000 or $444,000 a year market. I think the situation is similar in London. There is a huge capital glut among the world’s wealthy, and they will buy just about anything you build in certain major cities. They are willing and able to pay a lot. There is no point in building for anyone of lesser means. When a new building goes up in Manhattan and doesn’t sell out at or near list price in short order, then I’ll be willing to believe that the high end market is saturated. We are nowhere close.

    • Alon Levy

      It’s an artifact of there not being enough new housing to go around. I forget who it was who first said that, if car manufacturers were only allowed to sell a thousand cars a year, they’d all be luxury cars, and then people might think that there’s no way the private auto industry would ever want to make cars for the mass market.

  10. threestationsquare / Anon256

    Great post. Now what do we do about it? Artificial housing scarcity in the cities with the most jobs seems to be strangling the Western World, and I’ve not seen any strategy that works well against the systemic causes you explain in this post.

    • Eric

      It’s strangling NY and SF, and probably London and Paris too. Is it a major issue in any other Western cities?

      • Alon Levy

        Stockholm, Vienna, Amsterdam… European countries tend to have huge income disparities between rich regions (typically the capital and its suburbs) and poor ones (often the entire country except the capital and maybe a few small cities).

        In the US, it’s a problem in not just New York and the Bay Area but also Boston, Washington, Los Angeles, and to some extent also Chicago. LA and Chicago have vast areas that aren’t expensive, but these tend to be poor and undesirable for most people. One of the factors that strength racial segregation in Chicago is the difficulty for black people of finding affordable housing outside black neighborhoods. Whites of course have the same difficulty, but avoid most black neighborhoods, so they either don’t move to Chicago at all or move to small apartments on the North Side.

        • Eric

          Vienna and Amsterdam have historical preservation considerations that can’t be blamed on greed by the current inhabitants. DC has a similar issue with its height limit. I don’t know about Stockholm, but it might have similar issues.

          In LA and Chicago, while whites will not move into the middle of a poor black neighborhood, they (particularly the young, gay, and/or childless) will move into the marginal regions between rich white and poor black neighborhoods, and gentrify those regions. This is a slower process, but it does mean that in the longer term the “acceptable” housing supply is not in fact limited.

          • Alon Levy

            The historical preservation argument is a standard one used by the NIMBYs. Even in Indianapolis, once a neighborhood started to gentrify, the early gentrifiers petitioned (and got) historic district status, making sure their early investments would pay off.

            Stockholm’s housing stock seems to be of similar vintage as the low-rise parts of Manhattan. The building I currently live in, at the outer end of central Stockholm, is from 1907, about the same as the Columbia dorm building I lived in.

            EDIT: I’m not sure about LA, but in Chicago, the racial issue is that the black areas are on the South Side and the white ones on the North Side, so in principle, the in-between zone is the Loop. In practice there’s some gentrification starting on the Near South Side, but this north-south division has slowed down the process, while simultaneously enshrining segregation.

          • calwatch

            In LA the primary gentrification is towards Hispanic neighborhoods, which is why you see Boyle Heights, Highland Park, etc. gentrifying, brought on by proximity to downtown and mass transit. Meanwhile the Blue Line corridor is not gentrifying, although there is a huge handicap in that much of South LA is in the flight path of LAX and as such is more undesirable than equivalent areas in the north. Even so, you would expect places like Inglewood or Willowbrook to do better. They don’t.

          • Yoav

            I think it is a problem with black/white division, because a single white person in a black neighborhood or a single black person in a white neighborhood would really stand out. That sure can feel not so nice.

      • Sascha Claus

        Munich and Hamburg have a housing shortage with nation-wide media attention and Berlin has one at least inside the old pre-WWII quarters. Berlin is trying to fight it with some populistic measures that are carefully crafted to avoid possible useful side effects.

  11. Pingback: Housing Is Expensive Because Everyone Wants it That Way
  12. Andre Lot

    I think a critical issue to be examined on the political arrangements is the extent by which many people become vested to their outer financial skin on keeping housing prices as high as possible.

    Being not a cyclical consumption good that is periodically exhausted – at least not on a human lifespan scale -, housing bubbles or cycles of appreciation can be very difficult to defuse back to their pre-heat levels, from a political standpoint. You can only sew together so much support for keeping housing affordable for newcomers while also preserving value of existing real estate holders. I’ll examine some of these circumstances that conspire against that, in no particular order, in a context of Western(alized) real estate markets:

    1. When housing prices increase across the board, it has become easier for homeowners to extract in cash the appreciated value and refinance. Details vary per country, but the process usually works – you end up with a lot of people who reap a windfall, and then increase their debt levels based on that windfall.

    2. Underwater mortgages, in its various national iterations, on the other hand, damage the short-term consumption. Serious projects that would increase supply enough to bring the overall real estate prices in a metro area down by a significant margin would also put many households on a financially perilous situation, possibly reducing their access to credit and creating all sorts of moral hazard involving underwater mortgage – especially in countries where there is no such thing as “declaring bankruptcy and walking away from the home giving the keys to the bank and being done with it”. Plug (1) and (2) and you have governments and pretty much all incumbents keen on not letting prices go down much.

    3. Unless you have a city where renters are an extremely large share of all residents (say, like Berlin with 84%), the short term interests of incumbent renters are on direct collision with newcomers (renters or homeowners). More people coming implies more competition for the housing stock. This will almost always affect more the population with lower incomes, and these pressures usually also come with other effects (more crowded transit, more trouble to put kids on the first-choice schools) that make it much easier for anyone with 2 politically-savvy neurons to explore and blame on the “new people” (whatever they might be)

    Then, you have the market interventions of all sorts.

    Here in the Netherlands we have an hybrid institution called the housing corporation. It is not a government agency, it is a sort of semi-public independent entity that operates on real estate markets with great autonomy without a profit motive but under commercially sound principles with targets for affordability. There are several dozen housing corporations in the country. They account for roughly 32% of all building stock of Netherlands.

    The model is not perfect, and has problems (such as very long waiting times in some cities/areas). However, it has a great advantage in that it focus on renting based on capital costs of what had been built already, not seeking to extract the every last eurocent based on present market value. But they are not aiming for zero-surplus either, as they use the financial surplus to then leverage their financial position and build more housing.

    But I’m not the model is entirely replicable elsewhere, because land development is subject to very tight and rather draconian general planning laws, which reduces the inherent developable premium value of empty land.

  13. Zmapper

    If the state has the power to give a beneficial regulatory regime, they also have the power to take away that regulatory regime. Therefore, I’m not convinced that centralized power is a good long-term strategy; even if statewide liberalized zoning could pass, political winds could shift in such a way that zoning rules are tightened for all. At least under the “let 1000 flowers bloom” philosophy it is possible (albeit empirically unlikely) that one city could structure their zoning differently than another city.

    Instead of the state telling cities what they must do, how could the regulations be written in a way that tells lower authorities what they can’t do?

    Consider the following verbiage as a rough idea: “It is prohibited for any city (etc) to restrict residential development except as a legitimate extension of police powers in response to clear and direct health, safety, and/or public welfare concerns, and only when said restrictions are the least restrictive means of addressing these governmental concerns.”

  14. Pingback: The (Zoning) Battle of Seattle | Thickly Settled

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