It is popular at the moment to bemoan the high cost of housing, and if I were a first-time home buyer I’d be bemoaning with the best of them. The press and social media are full of stories of people who can’t find anything in their price range or who have made multiple offers but always get out-bid. Surely the housing market is broken and needs to be fixed.
Looking at housing cost in isolation, however, tends to lead to shortsighted and inefficient responses. Instead, housing should be viewed as one part of the larger economic picture -- a picture that has lots of moving parts that are all interrelated. Rapidly rising housing prices are a signal that supply and demand are out of whack, and addressing that imbalance will produce better results in the long term than band aid solutions that address the symptoms but not the underlying issue.
In this post, I hope to examine housing affordability from a different perspective than most commentators and suggest actions that local governments can take which I think have at least a reasonable chance of being effective. And almost as important, I will argue against some commonly proposed solutions to the housing affordability problem which I think would be counterproductive.
Defining the problem
In very simplistic terms, housing is increasingly viewed as being unaffordable because housing costs are rising faster than incomes. The median household income over the past 20 years has risen approximately 69 percent. In contrast, data from the Zillow Home Value Index indicates that average home prices have gone up 106 percent in the same amount of time. This divergence between income and housing cost means that it is becoming increasingly difficult for a household to find safe, sanitary housing at a cost that is reasonable given its income (generally considered to be housing that costs no more than 30 percent of gross income). A recent assessment of housing conditions in Kansas City indicates that just over 30 percent of households cannot meet that standard. In my experience, that level of housing failure is typical in the midwest, but it is much higher in selected cities where many households have to choose between either paying a much higher proportion of their income for housing or tolerating dangerous overcrowding or unsanitary conditions.
The averages, however, hide a great deal of variability. See, for example, the accompanying chart showing the trend in average home price by metro area. The national press tends to focus on the cities that are at the upper end of the spectrum: San Jose (up 227% since 2000), Los Angeles (up 201%), Seattle (up 157%), Boston (up 123%), or Miami (up 150%). In much of the country, including the midwest, the increase in average housing price has been less dramatic: Indianapolis (up 62%), Cincinnati (up 54%), St Louis (up 66%), Omaha (up 73%), Kansas City (up 88%), or Oklahoma City (up 84%).
Why the stark differences? While there may be some differences in construction cost, the primary factor is almost assuredly differences in supply and demand. Housing prices are being bid up because the number of new households who want to move to San Jose (for example) is greater than the number of housing units being constructed. This suggests two obvious solutions: 1. Build more housing in San Jose (increase supply), or 2. Don’t move to San Jose (decrease demand). Although obvious, both solutions have some significant limitations.
On the supply side, building more houses is not as straightforward as it sounds. You can’t just build more housing units, you also have to build all of the things that support those new residents: new streets, new schools, new parks, new hospitals, etc. In a crowded metropolitan area, building a lot of new stuff typically means tearing old stuff down and increasing density for the new stuff. This gives the existing residents -- who elect the decision makers -- three major avenues of attack in preventing new housing units from being built: 1. It will raise my taxes; 2. I love the old stuff (for a variety of reasons) so please don’t tear it down; and 3. I hate density because it will ruin the character of our city and destroy my way of life! There is a kernel of truth in all three of these arguments, although in practice they tend to be wildly exaggerated.
On the demand side, there are some indicators that high housing costs are causing a significant number of people to migrate away from certain metro areas. The real estate brokerage firm Redfin recently listed the metro areas that had a high number of people leaving, and while it is hard to pinpoint why someone moves out of a particular city, it is interesting that six of the top ten cities were located on the coasts with high housing costs. From an economic perspective, however, causing people to leave an area that is economically thriving by not producing enough affordable housing is potentially damaging to the national economy. In addition, the out-migration process is not as painless as an economic model might suggest. Moving low- and moderate-income people out of a city where they had established lives means breaking social and economic connections that can be damaging to their long-term emotional and financial well being.
Another factor that is often obscured by comparisons with the median household income is that income growth is not distributed uniformly. For several decades, income growth has been skewed toward the top 20 percent of households -- and in particular, the top 5 percent. The remaining 80 percent of households have seen income growth that has just barely exceeded inflation, let alone kept up with an asset such as housing that has grown at roughly double the rate of inflation. Thus the real housing affordability issue isn’t so much that an engineer making $150,000 can’t afford a 5-bedroom house with a pool in the backyard as much as it is that a firefighter making $50,000 can’t afford a decent house at all.
A Different Perspective
One of my favorite blogs is the City Observatory written by Joe Cortwright. He routinely delivers thoughtful articles that often reflect a unique perspective on urban issues. He recently posted an article entitled “Who got trillions? We found the real speculators profiting from higher housing costs” . In that article, he notes that residential real estate gained $2.2 trillion in value in 2020 -- an amount more than 3 times greater than the total pre-tax income of the bottom 20 percent of U.S. households. What’s more, these capital gains on real estate go largely untaxed thanks to generous federal exemptions on gains from the sale of owner occupied housing.
So who’s benefiting from the run-up in real estate prices? According to Cortwright’s research, the beneficiaries share three characteristics:
They’re old. Households led by a person 55 or older own 56 percent of all residential real estate wealth in the U.S.
They’re white. Non-hispanic white households own almost 80 percent of all housing wealth.
They’re affluent. Households in the top income quintile own 59 percent of all housing wealth.
Okay, I confess -- I’m the greedy speculator profiting from higher housing costs. I’m old, white and modestly affluent and, sure enough, my friendly county appraiser’s office says that the value of my home has gone up by 32 percent over the past 3 years (not that I particularly trust my county appraiser). Given the likely demographics of my readership, the odds are fairly high that the category of greed speculator also includes you.
The fact of the matter is that we have created a system for wealth-building through real estate that significantly benefits a group of people who are probably least in need of financial assistance. What’s more, we have historically restricted households of color from participating in this system through deed restrictions, redlining and outright discrimination. In the words of the cartoon character Pogo, “we have met the enemy and he is us.”
All of this exposes one of the weaknesses of capitalism: it is easier to make money if you already have money. And the housing market is a perfect example.
What To Do
Assuming you live in a city that actually has a housing affordability problem (not every city does), there are several things that I think would be particularly productive over the long term. What I am going to suggest may not be as specific as you might want, but that is intentional. First, speaking in generalities emphasizes the general principles involved which is initially more important than the details. Second, the specific details will vary somewhat based on what is politically and legally possible in a particular jurisdiction. Finally, you need someone smarter than me to work out the details. Build a team of local housing experts that are willing to think outside of the box and experiment until you get it right.
Expand housing supply. First and foremost, cities with a housing affordability problem must build more housing. I don’t think any other solutions will be particularly effective if supply is so constrained that every real estate transaction ends up in a frenzied bidding war. In general, the best municipal tool for expanding supply is likely to involve changes to zoning regulations. Most cities have huge swaths of land that are limited to single-family homes on relatively large lots.
At a minimum, cities should make sure that their zoning regs include districts that allow one- and two-family dwellings at densities approaching 9 units per acre (roughly triple the density of a typical single-family neighborhood). These districts will not be appropriate everywhere, but they should be available. Changing demographics and lifestyles mean that there will be a growing demand for small homes with small yards. Not every household needs four or five bedrooms and not every homeowner wants a huge yard.
In addition, cities should seriously consider limiting the amount of land area that is limited to just single-family homes. Several cities have done this comprehensively but most cities will not have the political will to do it everywhere, so start in those areas that would most benefit from reinvestment. Unfortunately, even this limited step won’t be easy because most cities have historically treated single-family homes as a form of “sacred cow” that has been protected at all costs -- to the point where single-family residents view any non-single-family incursion into their neighborhood as a disaster of epic proportions. Done correctly, however, accessory dwelling units, duplexes or even triplexes can not only add to the housing stock they can be an economic shot-in-the-arm for a neighborhood that is struggling.
Although some doubt that building new housing -- which tends to be expensive -- will help expand the supply of affordable housing, most studies have concluded that it does. I believe that building moderately priced new housing would be more effective than high priced units because the “trickle down” process has less distance to go. Still, anything is better than nothing.
Find ways to reduce cost. Housing construction in this country is focused on custom production, which is fine in many respects but in my opinion it is not cost efficient. I’m no expert in construction management, but I have to think that there are opportunities for factory-based automation, bulk purchasing, assembly line production, and a controlled environment to boost productivity to a point where costs drop.
I’m not sure whether this would take the form of room size modules that would be stacked together on-site or smaller wall and floor components that would be assembled like legos, but both are currently being tried in numerous places. Whatever form ends up being dominant, I think there is a significant potential for innovation. What innovation will require of cities is planners and code officials that are open minded and flexible. They need not sacrifice long-term community value or life safety, but they do need to be open to unfamiliar solutions. Building code officials, in particular, are often pressured by architects and contractors to allow them to cut corners. This tends to lead to an overly rigid attitude in which new ideas are almost automatically rejected. Cities need to view themselves as a partner in housing innovation rather than an adversary.
Expand access to home ownership. To be clear, home ownership is not for everyone and there are other ways to build wealth. But owning your own home does have a variety of advantages -- including wealth building -- and it should be an option that is available to as broad a spectrum of households as reasonably possible. The home ownership rate in this country reached an all-time high in 2004-05 of just over 69 percent, but then plunged when the housing bubble burst, the country fell into a recession and mortgage rules tightened. The rate fell to as low as 63 percent in 2016 before bouncing back over the past several years. My point is not that the rate should necessarily be higher, but that some households who currently would have a difficult time qualifying for (or sustaining) a mortgage should be assisted in some way.
Home ownership is something that should be matched to certain phases of a person’s life. Young people just starting their career and likely to be moving as their job opportunities unfold should probably not buy a house or condo. Important career opportunities can often involve moving to a new city, and owning a home generally impedes that process. In addition, the elderly often stay in their home longer than I think they should. Home ownership requires a certain amount of either work or money to handle routine maintenance tasks and that can be a challenge for someone on a limited income who isn’t as mobile as they once were. On the other hand, an active person with a steady income and a lifestyle that would benefit from some extra space (e.g. kids, pets, hobbies, work-from-home requirements, etc) should consider home ownership even if they come from a background where that is not the norm.
The first thing that needs to change is that the transaction costs involved with home ownership need to decline. I can’t remember how many pieces of paper I signed the last time I refinanced my house, but it is clearly a process that has room for automation and simplification. Numerous “fintech” entrepreneurs are rapidly changing both the home buying and mortgage industries, hopefully for the better. The result should be that both realtor fees and closing costs should decline over time and that will make it easier for buyers who have a sufficient income stream but not much savings to be able to buy a home.
Secondly, there needs to be a new process for home buying that is tailored to households that don’t fit the traditional mold. A recent survey of millennials who had purchased their first home found that the biggest problem was the unexpected expenses that come with owning instead of renting. First time buyers are rarely purchasing a newly constructed home which means they are soon introduced to the reality that in an older home there is almost always something that needs to be fixed. Plus yard or common area maintenance costs that used to be rolled into the monthly rent are now separate costs that are easily underestimated. And if the goal is to expand home ownership to households that have historically been renters, then some type of assistance will be needed to avoid mortgage defaults due to a lack of knowledge about what to expect and a lack of financial cushion to absorb the unexpected costs that can easily occur.
I think that community based nonprofits might have a role to play in filling this need. Perhaps they can partner with moderate income buyers with some type of rent-to-own or shared equity mortgage to provide a financial buffer for at least the first few years of ownership. They might also be able to provide a shared set of tools and lawn maintenance equipment, or offer classes in simple home repairs. My point is that some basic and relatively low cost assistance early in the ownership process could be the difference between a moderate income household being successful at home ownership rather than another foreclosure story.
What Not To Do
When faced with a problem, government has the unfortunate tendency to turn to regulation. That is almost assuredly not the solution for housing affordability. Other than the possible exception of short-term measures due to an emergency situation, I can’t think of a regulation that would make housing affordability better, and most would make the situation worse.
Rent control, for example, seems like an effective response to rising housing costs but it almost always ends badly. Rent controls end up severely restricting the production of new housing which makes the problem worse in the long run and it introduces distortions into the housing market which create serious issues with fairness and equity.
Similarly, I am not a fan of inclusionary housing policies. These policies are generally based on the belief that rising housing costs mean that developers are making “excess” profits that can be tapped for creating moderate income units. There can be situations in which new housing developments can be exceptionally profitable, but the fault is almost always not with the developer but with zoning or other development restrictions that limit the amount of housing that can be built. A common approach is to require that the developers of new housing projects rent 10 or 20 percent of the units at a below-market (i.e., subsidized) rate. While this does initially increase the stock of moderately priced housing, in the long run it suppresses the amount of housing that is built which tends to increase housing costs for everyone but the few lucky households who snag the subsidized units. In addition, the subsidized units are not really being paid for by the greedy developer, they are paid for by the higher rents charged to everyone else in the development. In essence, a small subset of affluent households end up paying the cost of providing a small number of affordable units. In an equitable society, the cost of providing affordable housing should be borne by the entire community, not an unlucky few.
Finally, it is fairly common to blame the lack of affordable housing on so-called “property flippers” who buy inexpensive housing, make some level of improvements, and then sell the housing to upscale owners looking to move into a newly trendy area. Any attempt to regulate or tax this activity is another example of entrepreneurial capitalists being blamed for a much broader societal problem that the community is unwilling to face directly. Property flippers are simply good at identifying value in real estate before the general market does, and that is actually a good thing not a bad thing. While I’m sure there are some bad apples, my experience has been that most property flippers focus on housing units that are either already blighted or at least are approaching a blighted condition. They are often an early source of reinvestment in a declining neighborhood that badly needs reinvestment. Most communities would be better off increasing competition by training local residents to become successful property flippers rather than try to regulate them out of business -- see for example, organizations like the Incremental Development Alliance.
In summary, we live in a capitalist society (whether we like it or not) and housing is an asset marketplace much like any other marketplace. If there is a problem with the market, our first steps should be to reduce the forces which tend to warp the normal workings of supply and demand, not develop new regulations or fees which distort the market even further.
Thoughts? As always, share your thoughts and ideas by leaving a comment below or sending me an email at email@example.com. Want to be notified whenever I add a new posting? Send me an email with your name and email address.
“Household Income Quintiles”; Tax Policy Center; March 2020; https://www.taxpolicycenter.org/statistics/household-income-quintiles
“Charting 20 Years of Home Price Changes in every US City”; Nick Routley; October 2020; https://www.visualcapitalist.com/20-years-of-home-price-changes-in-every-u-s-city/.
“Fair Housing Assessment for Greater Kansas City, Section VII”; Mid America Regional Council; November 2016; https://www.marc.org/Regional-Planning/Housing/pdf/7-Disproportionate-Housing-Needs.aspx
“People Living in these US Cities Are Most Eager to Get Out”; Doug Whiteman; December 2020; https://moneywise.com/life/lifestyle/people-in-these-us-cities-most-want-to-get-out#:~:text=Here%20it%20is%2C%20America's%20most,out%20of%20state%20every%20year.
“Housing Constraints and Spatial Misallocation”; Chang Hsieh and Enrico Moretti; April 2019; https://eml.berkeley.edu/~moretti/growth.pdf