The Economics of Housing Supply

chart by Smallman12q

Housing economists Edward L. Glaeser and Joseph Gyourko have posted The Economic Implications of Housing Supply to SSRN (behind a paywall but you can find a slightly older version of the paper here). The abstract reads,

In this essay, we review the basic economics of housing supply and the functioning of US housing markets to better understand the distribution of home prices, household wealth and the spatial distribution of people across markets. We employ a cost-based approach to gauge whether a housing market is delivering appropriately priced units. Specifically, we investigate whether market prices (roughly) equal the costs of producing the housing unit. If so, the market is well-functioning in the sense that it efficiently delivers housing units at their production cost. Of course, poorer households still may have very high housing cost burdens that society may wish to address via transfers. But if housing prices are above this cost in a given area, then the housing market is not functioning well – and housing is too expensive for all households in the market, not just for poorer ones. The gap between price and production cost can be understood as a regulatory tax, which might be efficiently incorporating the negative externalities of new production, but typical estimates find that the implicit tax is far higher than most reasonable estimates of those externalities.

The paper’s conclusions, while a bit technical for a lay audience, are worth highlighting:

When housing supply is highly regulated in a certain area, housing prices are higher and population growth is smaller relative to the level of demand. While most of America has experienced little growth in housing wealth over the past 30 years, the older, richer buyers in America’s most regulated areas have experienced significant increases in housing equity. The regulation of America’s most productive places seems to have led labor to locate in places where wages and prices are lower, reducing America’s overall economic output in the process.

Advocates of land use restrictions emphasize the negative externalities of building. Certainly, new construction can lead to more crowded schools and roads, and it is costly to create new infrastructure to lower congestion. Hence, the optimal tax on new building is positive, not zero. However, there is as yet no consensus about the overall welfare implications of heightened land use controls. Any model-based assessment inevitably relies on various assumptions about the different aspects of regulation and how they are valued in agents’ utility functions.

Empirical investigations of the local costs and benefits of restricting building generally conclude that the negative externalities are not nearly large enough to justify the costs of regulation. Adding the costs from substitute building in other markets generally strengthens this conclusion, as Glaeser and Kahn (2010) show that America restricts building more in places that have lower carbon emissions per household. If California’s restrictions induce more building in Texas and Arizona, then their net environmental could be negative in aggregate. If restrictions on building limit an efficient geographical reallocation of labor, then estimates based on local externalities would miss this effect, too.

If the welfare and output gains from reducing regulation of housing construction are large, then why don’t we see more policy interventions to permit more building in markets such as San Francisco? The great challenge facing attempts to loosen local housing restrictions is that existing homeowners do not want more affordable homes: they want the value of their asset to cost more, not less. They also may not like the idea that new housing will bring in more people, including those from different socio-economic groups.

There have been some attempts at the state level to soften severe local land use restrictions, but they have not been successful. Massachusetts is particularly instructive because it has used both top-down regulatory reform and incentives to encourage local building. Massachusetts Chapter 40B provides builders with a tool to bypass local rules. If developers are building enough formally-defined affordable units in unaffordable areas, they can bypass local zoning rules. Yet localities still are able to find tools to limit local construction, and the cost of providing price-controlled affordable units lowers the incentive for developers to build. It is difficult to assess the overall impact of 40B, especially since both builder and community often face incentives to avoid building “affordable” units. Standard game theoretic arguments suggest that 40B should never itself be used, but rather work primarily by changing the fallback option of the developer. Massachusetts has also tried to create stronger incentives for local building with Chapters 40R and 40S. These parts of their law allow for transfers to the localities themselves, so builders are not capturing all the benefits. Even so, the Boston market and other high cost areas in the state have not seen meaningful surges in new housing development.

This suggests that more fiscal resources will be needed to convince local residents to bear the costs arising from new development. On purely efficiency grounds, one could argue that the federal government provide sufficient resources, but the political economy of the median taxpayer in the nation effectively transferring resources to much wealthier residents of metropolitan areas like San Francisco seems challenging to say the least. However daunting the task, the potential benefits look to be large enough that economists and policymakers should keep trying to devise a workable policy intervention. (19-20)

Inclusionary Housing and Equitable Communities


The Lincoln Institute of Land Policy has released a policy focus report, Inclusionary Housing: Creating and Maintaining Equitable Communities. The Executive Summary opens,

After decades of disinvestment, American cities are rebounding, but new development is often driving housing costs higher and displacing lower-income residents. For cities struggling to maintain economic integration, inclusionary housing is one of the most promising strategies available to ensure that the benefits of development are shared widely. More than 500 communities have developed inclusionary housing policies, which require developers of new market-rate real estate to provide affordable units as well. Economically diverse communities not only benefit low-income households; they enhance the lives of neighbors in market-rate housing as well. To realize the full benefit of this approach, however, policies must be designed with care. (3)

The report uses the term inclusionary zoning to refer to

a range of local policies that tap the economic gains from rising real estate values to create affordable housing—tying the creation of homes for low- or moderate-income households to the construction of market-rate residential or commercial development. In its simplest form, an inclusionary housing program might require developers to sell or rent 10 to 30 percent of new residential units to lower-income residents. Inclusionary housing policies are sometimes referred to as “inclusionary zoning” because this type of requirement might be implemented through an area’s zoning code; however, many programs impose similar requirements outside the zoning code. (7)

The report notes that

Policy makers are understandably concerned that affordable housing requirements will stand in the way of development. But a review of the literature on the economics of inclusionary housing suggests that well-designed programs can generate significant affordable housing resources without overburdening developers or landowners or negatively impacting the pace of development. (4)

The report is obviously addressing two of the most important issues facing us today — the housing affordability challenge that many households face as well as the increasing stratification of communities by income and wealth.

There is a lot of value in the survey of the academic literature on inclusionary housing policies that is provided by this report. At the same time, there is some fuzzy thinking in it too. For instance, the report states that, “As the basic notion of supply and demand suggests, the addition of new units in a given market will inevitably put some downward pressure on the cost of existing units. But the larger effect tends to be upward pressure on housing costs because new homes are primarily built for higher-income residents.” (12)

This analysis ignores the well-accepted concept of filtering in urban economics. Filtering describes the process by which occupants of housing units go from higher-income to lower-income as the unit ages, becomes outdated and is subject to wear and tear. If higher-income households move to the newest housing, then other another household, typically of lower-income, can move into the vacant unit. If the number of households remains constant, then housing prices should decrease as housing development increases.

Because the real world does not look like an economic model, many people think that new housing causes increased housing prices. But the cause of the increased housing prices is often the same thing that is causing new housing construction:  increased demand.

Take NYC for instance. In recent years, it issues permits for 10,000-20,000 or so new units of housing a year, but its population has grown by about 60,000 people a year. Combine this with the fact that new housing construction is both a sign and result of gentrification in a particular neighborhood, it is no wonder people think that housing construction pushes prices higher. While this is an understandable line of thought for the man or woman in the street, it is less so for the Lincoln Institute.

My bottom line: this is worth a read, but read with care.


Affordable Enough for NYC?


Real Affordability for All has released a report, Real Affordable Communities: Mayor Bill De Blasio and the Future of New York City. The report opens,

Across the five boroughs, the affordability crisis is growing every day. Today, low- and moderate-income New Yorkers continue to be priced out of their neighborhoods. The incomes of countless New Yorkers are not increasing while rents keep rising. The growing gap between lower incomes and higher rents is making New York City increasingly unaffordable.

Indeed, a recent study released by StreetEasy, The High Burden of Low Wages: How Renting Affordably in NYC is Impossible on Minimum Wage, found that a New Yorker earning $15 an hour could afford just one neighborhood: Throgs Neck in the Bronx.

“The extent to which rent growth has outpaced income growth in New York City means low-wage workers face three options: find several roommates to lower their personal rent burden, take on more than one job, or move out of New York City,” the study finds.

According to a close analysis of the most recent Census data, Bloomberg’s housing efforts generated a shortage of more than 400,000 affordable units for low-income New Yorkers. Low-income here is defined as a household earning less than 50% of Area Median Income (AMI). For a household of four, that means an approximate annual income of less than $42,000. (In 2012 New York City area median income was $83,600 for a family of four; the 2015 New York City area median income for a family of four is $86,300).

Overall, utilizing the 2012 census data, more than 700,000 low-income New Yorkers were left behind by Bloomberg’s housing plan. To tackle the affordability crisis, Mayor de Blasio has proposed preserving or creating 200,000 units of affordable housing. He wants to achieve that goal through mandatory inclusionary zoning and dense new residential development in various neighborhoods.

To succeed, de Blasio will need to avoid repeating the mistakes of Bloomberg’s housing agenda, and ensure that real affordable housing is created for the huge number of low-income New Yorkers who were not served by the previous administration and still struggle to survive. (1-2)

The Real Affordability for All advocates that “Low-income neighborhoods like East New York and the South Bronx will be empowered to offer a ‘density bonus’ to developers in exchange for real affordable housing below 50 % of AMI and for career-oriented union construction jobs for local residents at new development sites.” (7)

The report provides an example pro forma for one building to demonstrate that this plan is do-able. The report does not, however, indicate where the De Blasio Administration would find the $15 million in additional subsidies it would take for this one building to be built according to the Real Affordability for All guidelines.

At this point, the plan is more of a wish list than a serious proposal, but it does make clear that there is a deep need for deep housing subsidies among low- and moderate-income households.