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)

Micro-Units for Millennials

murphy bed

Construction Dive quoted me in An Emerging Megatrend? Developers Experiment with Microunits to Target Millennial Market. It opens,

As U.S. home prices and rents continue to soar, some developers are taking aim at a new target market — those willing to sacrifice square footage to be able to live near their work and area nightlife at a more budget-friendly price.

These microhousing units, also known as microapartments and microcondos, have most of the amenities of their full-size counterparts but typically range from around 350 square feet to 550 square feet, with some buildings offering up units at a relatively roomy 1,000 square feet. Many also come outfitted with furnishings specifically designed for the unit — folding beds, hidden storage and convertible pieces that do double duty, such as a dining table that also functions as a work desk.

However, the growing concept is seeing mixed results in the U.S. Is microhousing just a passing fad as younger renters look for an affordable stepping stone to a larger space, or does it represent a shift in what some Americans are looking for in a home?

The Draw of Smaller Spaces

Jam-packed cities like Tokyo are prime markets for these tiny units because the cost of land is at a premium, according to David Reiss, professor of law and academic program director at the Center for Urban Entrepreneurship at the Brooklyn Law School. Microunits are particularly appealing to single, young professionals who spend a lot of time working and hanging out with friends rather than entertaining in their own homes, he said.

The primary draw, however, is “location, location, location,” Reiss said. “When young adults are choosing between a small space in the center city or a larger space further afield, there will always be some who opt for the former.”

This hasn’t always been the case, according to architect David Senden, partner at international design firm KTGY. Americans used to put a premium on living space, but there’s been a “shift on the priority list,” and “location and has jumped to the absolute top,” he said. There’s also a growing desire for shorter commuting times.

However, whether the overall demand for microhousing is on the uptick is debatable. Some developers see microunits as the solution that will provide millennials with the opportunity to live in vibrant urban settings, as well as offer baby boomers or those looking to downsize a minimalist living space without having to give up the modern conveniences they’ve come to expect.

When Microhousing Is a Viable Concept

Reiss said population density  and high prices need to be components of any successful micro project . When prices, in both rent and homes, “outpace middle-class income,” as they have done in cities like San Francisco and New York City, then some people will give up square footage in order to stay close to their friends or jobs. “The microunit might present a very attractive trade-off of space and cost for that demographic,” he said. Reiss added that New York City is even amending its zoning laws to allow for more micro developments.

The State of the Union’s Housing in 2016

photo by Lawrence Jackson

The Joint Center for Housing Studies of Harvard University has released its excellent annual report, The State of the Nation’s Housing for 2016. It finds,

With household growth finally picking up, housing should help boost the economy. Although homeownership rates are still falling, the bottom may be in sight as the lingering effects of the housing crash continue to dissipate. Meanwhile, rental demand is driving the housing recovery, and tight markets have added to already pressing affordability challenges. Local governments are working to develop new revenue sources to expand the affordable housing supply, but without greater federal assistance, these efforts will fall far short of need. (1)

Its specific findings include,

  • nominal home prices were back within 6 percent of their previous peak in early 2016, although still down nearly 20 percent in real terms. The uptick in nominal prices helped to reduce the number of homeowners underwater on their mortgages from 12.1 million at the end of 2011 to 4.3 million at the end of 2015. Delinquency rates also receded, with the share of loans entering foreclosure down sharply as well. (1)
  • The US homeownership rate has tumbled to its lowest level in nearly a half-century. . . . But a closer look at the forces driving this trend suggests that the weakness in homeownership should moderate over the next few years. (2)
  • The rental market continues to drive the housing recovery, with over 36 percent of US households opting to rent in 2015—the largest share since the late 1960s. Indeed, the number of renters increased by 9 million over the past decade, the largest 10-year gain on record. Rental demand has risen across all age groups, income levels, and household types, with large increases among older renters and families with children. (3)

There is a lot more of value in the report, but I will leave it to readers to locate what is relevant to their own interests in the housing industry.

I would be remiss, though, in not reiterating my criticism of this annual report: it fails to adequately disclose who funded it. The acknowledgments page says that principal funding for it comes from the Center’s Policy Advisory Board, but it does not list the members of the board.

Most such reports have greater transparency about funders, but the interested reader of this report would need to search the Center’s website for information about its funders. And there, the reader would see that the board is made up of many representatives of real estate companies including housing finance giants, Fannie Mae and Freddie Mac; national developers, like Hovnanian Enterprises and KB Homes; and major construction suppliers, such as Marvin Windows and Doors and Kohler. Nothing wrong with that, but disclosure of such ties is now to be expected from think tanks and academic centers.  The Joint Center for Housing Studies should follow suit.

Inclusionary Housing: Fact and Fiction

photo by Bart Everson

The Center for Housing Policy has issued a policy brief, Separating Fact from Fiction to Design Effective Inclusionary Housing Programs. I am not sure fact was fully separated from fiction when I finished reading it.  It opens,

Inclusionary housing programs generally refer to city and county planning ordinances that require or incentivize developers to build below-market-rate homes (affordable homes) as part of the process of developing market-rate housing developments. More than 500 local jurisdictions in the United States have implemented inclusionary housing policies, and inclusionary requirements have been adopted in a wide variety of places—big cities, suburban communities and small towns.

Despite the proliferation of inclusionary housing programs, the approach continues to draw criticism. There have been legal challenges around inclusionary housing requirements in California, Illinois, Idaho, Colorado and Wisconsin, among others. In addition to legal questions, critics have claimed inclusionary housing policies are not effective at producing affordable housing and have negative impacts on local housing markets.

While there have been numerous studies on inclusionary housing, they unfortunately do not provide conclusive evidence about the overall effectiveness of inclusionary housing programs. These studies vary substantially in terms of their research approaches and quality. In addition, it is difficult to generalize the findings from the existing research because researchers have examined policies in only a handful of places and at particular points in time when economic and housing market conditions might have been quite different. Given these limitations, however, the most highly regarded empirical evidence suggests that inclusionary housing programs can produce affordable housing and do not lead to significant declines in overall housing production or to increases in market-rate prices. However, the effectiveness of an inclusionary housing program depends critically on local economic and housing market characteristics, as well as specific elements of the program’s design and implementation. (1, endnotes omitted and emphasis in the original)

The brief concludes that, in general, ” mandatory programs in strong housing markets that have predictable rules, well-designed cost offsets, and flexible compliance alternatives tend to be the most effective types of inclusionary housing programs.” (11, emphasis removed)

I have to say that this research brief does not give me a great deal of confidence that mandatory inclusionary zoning programs are going to be all that effective.  Indeed, the conclusion suggests that many ducks need to line up before we can count on them to make a real dent in affordable housing production. While this by no means should imply that they should be curtailed, we should continue to evaluate them carefully to see if they live up to their promise.

Property Tax Exemptions in Wonderland

 

Cea

NYU’s Furman Center has released a policy brief, The Latest Legislative Reform of the 421-a Tax Exemption: A Look at Possible Outcomes. This brief is part of a series on affordable housing strategies for a high-cost city. It opens,

Since the early 1970s, New York City has provided a state-authorized, partial property tax exemption for the construction of new residential buildings. In the 1980s, the New York City Council amended the program to require that participating residential buildings in certain portions of Manhattan also provide affordable housing. Most recently, New York State extended the existing program through the end of 2015 and created a new 421-a framework for 2016 onward. However, for the program to continue beyond December, the legislation requires that representatives of residential real estate developers and construction labor unions reach a memorandum of understanding regarding wages of construction workers building 421-a program developments that contain more than 15 units.

This brief explores the possible impacts of the new 421-a legislation on residential development across a range of different neighborhoods in New York City, including neighborhoods where rents and sale prices are far lower than in the Manhattan Core and where the tax exemption or other subsidy may be necessary to spur new residential construction under current market conditions. We assess what could happen to new market rate and affordable housing production if the 421-a program were allowed to expire or if it were to continue past 2015 in the form contemplated by recently passed legislation. Our analysis shows that changes to the 421-a program could significantly affect the development of both market rate and affordable housing in the city (1, footnote omitted)

The 421-a program operates against the backdrop of a crazy quilt real property tax regime where similar buildings are taxed at wildly different rates because of various historical oddities and thinly-sliced legal distinctions. Like the Queen of Hearts, the rationale given by the Department of Finance for this unequal treatment amounts to no more than — And the reason is…because I say so, that’s why!

The brief concludes,

Our financial analysis of the possible outcomes from the 421-a legislation offers some insights into its potential impact on new construction. First, if the 421-a benefit expires in 2016, residential developers would lower the amount they would be willing to pay for land in many parts of the city. The result could be a pause in new residential developments in areas outside of the Manhattan Core as both buyers and sellers of land adjust to the new market.

*     *     *

Second, if the newly revised 421-a program with its higher affordability requirements and longer exemption period goes into effect in 2016 without any increase in construction costs, the city is likely to have more affordable rental units developed in many parts of the city compared to what the existing 421-a program would have created. Condominium development without the 421-a program may still continue to dominate in certain portions of Manhattan, though the program appears to make rentals more attractive. (12)

The first outcome — lower land prices if 421-a expires — is not that bad for anyone, except current landowners. And it is hard to feel bad for them, given that they should not have expected that 421-a would remain in effect forever (and not to mention the rapid increases in NYC land prices). The second outcome — the new 421-a framework — sounds like better public policy than the existing program.

But one wonders — what would it take for NYC to develop a rational real property tax regime to replace our notoriously inequitable one, one that treats like properties so differently from each other. Can we escape from Wonderland?

Reiss on NY RE Regulation

Law360 quoted me in What’s Up Next In NYC Real Estate Legislation (behind a paywall). It reads in part,

New York City lawmakers have introduced a slew of new bills in recent months that could impact commercial real estate owners and developers with changes like new protections for rent-regulated tenants and more public review for zoning changes. Here are explanations and some experts’ thoughts about the proposed laws.

*     *     *

Fighting Alleged Double Standards for Regulated and Market-Rate Tenants

City Council members Mark Levine and Corey Johnson are drafting a bill to combat what they claim is a trend of property owners unfairly discriminating against their rent-regulated tenants, preventing them from taking advantage of amenities that market-rate tenants can enjoy.

The issue gained a lot of attention last year when news broke that Extell Development Co.’s project at 40 Riverside Drive might have two separate entrances: one for owners of its condominiums and one for those living in the affordable units.

The “poor door” arrangement, which has reportedly been used at several buildings around the city, sparked outrage from tenants, who argued that developers were abusing the 421-a subsidy program, which gives tax abatements in exchange for affordable housing.

Levine and Johnson’s new bill would alter the city’s rental bias code, which protects tenants from discrimination based on race, gender or age, to include rent-regulated as a protected status.

Under de Blasio’s plan for mandatory inclusionary zoning at all new development projects, the bill appears to be an effort to establish actual integrated communities, said Brooklyn Law School professor David Reiss.

“Mandatory inclusionary zoning is not just about affordable housing; to a large extent it’s about socioeconomic integration,” Reiss said. “I think this bill about double standards is really not about protecting affordable housing as much as it is about respecting socioeconomic diversity.”

*     *     *

Requiring Two Years of Experience for a Crane Operation License

In April, Manhattan Councilman Benjamin Kallos introduced a bill that would require crane operators to have at least two years of experience working in New York City in order to obtain licenses.

Industry insiders note that the licensing process is effectively controlled by a local union, and many are concerned that this new bill would give the union even more power, essentially blocking the use of any crane contractors that are not affiliated with it.

“There’s a spat between developers and unions, and the bill is firmly taking the side of the unions,” Reiss said. But he added that the real question is what is actually in the public interest. “What is the level of safety that we need?”

The Bloomberg administration had a more developer-friendly approach, creating a plan to allow operators to get licenses if they had worked in a similarly dense city before. But the crane operators’ union sued over those rules, and the litigation remains pending.