Housing – Supply Side and Affordability

To improve housing affordability, we need policies that ‘increase land’. Public transit and remote work might just do it. Plus – which cities are actually affordable may surprise you.

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Housing affordability, especially in urban areas, is an issue facing many countries and it appears to only be getting worse. We discussed in our previous article why certain demand (buyer) side policies such as government subsidies in the form of 30 year mortgages do not alleviate the affordability crisis. Moreover, as part of our deep dive into housing, we described why location and housing services stemming from the location keep house values elevated. Naturally, the next avenue to explore regarding housing affordability is what can be done regarding housing supply.

Upzoning

A common policy often mentioned in the context of increasing housing supply is upzoning. Upzoning and upzoning-like policies (i.e. reducing regulatory restrictions), focus on increasing the number of housing units that can be built on a parcel of land. For example, single-family zoned land permits only the building of houses for a single family on this land parcel. Upzoning would remove this restriction and allow for multi-family housing.

At Nominal News, we have discussed upzoning and found that most research shows there to be limited price response to upzoning. Given our previous discussion on the determination of house value, this fact should not be surprising. The key element that influences the value of a house is the location-based services and amenities it provides. But the value of these location-based services is captured by the land it is on. For example, in high-cost housing areas such as New York City, Albouy and Ehlrich (2013) found that up to 48% of the cost of housing is land value. In locations with fewer location-based services, land value can be as low as 11% of the total housing cost. Upzoning or the reduction of certain regulatory restrictions does not change the amount of land, but it does allow for more people to live on a parcel of land. However, since more people can live on this plot of land, it means that the total value generated by this parcel of land is higher (total value of land = number of people x location based services). Land capitalizes this additional value and the price of land increases. This means that even though we can build more housing units (apartments) on this parcel of land, the price will remain elevated because the land the housing unit is located on is more expensive. Therefore, we should not expect policies such as upzoning to significantly alter the true housing cost.

Research Results

Turning our attention to research on this topic, Albouy and Ehrlich (2013) found that these regulatory restrictions (measured using a unique index, designed by Gyourko, Hartley and Krimmel, which captures various local regulations such as zoning, court approval requirements, minimum lot sizes, etc.) do not influence pricing as much. Moving from an average regulated market (in the US, some examples of such markets are Buffalo, Minneapolis or Columbus) to a highly regulated market (New York, San Francisco – which are the most regulated markets), housing prices increase by 3% to 7%, holding all other factors constant. Unsurprisingly, Albouy and Ehrlich (2013) also found that people that own homes in high-priced cities prefer regulations, such as restrictive zoning laws and height restrictions, as it results in higher welfare for them. These homeowners value the regulatory restrictions more than any potential price appreciation of their land removing these restrictions would bring about.

On the other hand, physical restrictions, measured using the developable land index (an index that computes the total percentage land that is or can be developed)¹ constructed by Saiz, have a greater effect on housing prices. Moving from an average developable urban area that has 75% of its land developable (e.g. Detroit) to an area which only has 60% of its land developable (e.g. New York), increases prices by about 7% to 9%. Moving to the city with the least developable area, San Francisco, which only has 27% of its land developable, would increase prices by almost 30%, compared to Detroit’s prices. The above results suggest that the impact of physical restrictions is far greater than that of regulations. Upzoning and other deregulation would reduce prices to some extent, but it is not going to significantly alter the affordability situation in many urban areas.

Upzoning – Still Valuable

It is worth adding that increasing density and allowing more people to live in a particular area is often beneficial to the wider economy. This is driven by the fact that there are many productivity spill-overs when people agglomerate, such as learning from others, as they benefit from proximity to each other. Urban areas are generally more productive from an output perspective than non-urban areas. Thus, although upzoning may not impact affordability, it will still be optimal for the wider economy to have more people living in the high-demand cities.

Housing Productivity, Amenities and Wages

Since land regulations are often supported by local residents, Albouy and Ehrlich (2013) also looked at how they impact quality of life (measured in terms of amenities) and local wages. They looked at the notion of housing productivity, which is how efficient a city is in converting land and labor (i.e. construction work) into houses. Naturally, housing regulations and zoning restrictions reduce housing productivity. Albouy and Ehrlich (2013) found that housing productivity is negatively correlated with both local wages and quality of life metrics. That is, places with high wages and high quality of life have lower housing productivity. The authors are unable to establish causality (does higher housing productivity reduce quality of life), but the correlation on its own can explain why current residents in cities have incentives to prevent further housing development (keeping housing productivity low) by making it costlier via onerous regulations and zoning laws, as it may improve quality of life. 

‘Increasing’ Land

The key issue with why affordability does not improve with looser regulations (including upzoning) or demand side subsidies (such as mortgage subsidies discussed previously) is that due to limited land, land ends up capturing most of the impact of changes in government policy and land becomes more expensive. Thus, theoretically, it would be optimal to increase the supply of land. If we had more land in urban areas, housing prices would fall. Since creating land is currently not a feasible solution, we can think of other potential ways to ‘increase land’ in an urban area. 

Transit

One of the larger contributors to land value in urban areas is the access to local jobs and opportunities, since these features are often tied to land. Previously at Nominal News, we’ve discussed how public transit may increase access to and within an urban area. Public transit will actually increase land values, as it is an additional amenity that benefits everyone. But at the same time, public transit can connect areas that have relatively lower land values than other parts of a city. Thus, affordability, when factoring into account accessibility and commuting requirements, can go up. By improving public transit, we’re effectively increasing the land mass that has reasonable access to the job opportunities available in the city centers. Faster and more reliable transit, thus, can in effect increase available land.

Moreover, affordability discussions should not only include housing costs, but also commuting costs. When factoring in commuting costs, it turns out some cities that are considered to be unaffordable are actually the opposite. 

As the chart above shows, although places like New York have very high housing costs (accounting 30.8% of median household income), the city’s much lower transportation costs (14.4% of median household income) due to developed public transit results in an overall more affordable city. For poorer households, New York is surprisingly one of the most affordable places in the country: 

Thus, even though public transit may increase house values, by improving access to lower cost areas and reducing transport costs, it could significantly improve affordability.

Job Opportunity Access

Another way of potentially increasing affordability is de-linking the job opportunities from land. One such way is the development of working from home. Although working from home is not a solution for all job types, even a slight permanent shift of certain jobs that are concentrated in particular urban areas can reduce the land value in those areas. We witnessed some of these dynamics occur during the Covid pandemic, where high income urban areas saw significant housing price declines.

Recent analysis by Palim and Zimmerman at Fannie Mae has found that the share of individuals that work in a hybrid or fully remote setting and are willing to move further away from the workplace has increased from 14% in 2021 to 22% in 2023. This desire to move further away is even more pronounced with younger workers (18-34 years old), where 30% of them are willing to leave the area of their workplace. This survey suggests that there is a significant group of people that do not personally benefit from the amenities provided by urban areas and are only in these urban areas for the job opportunities. Interestingly, Card, Rothstein, Yi (2023) found that after accounting for cost of living, which, among other things, include housing and transportation costs, the real wages earned by a particular individual in high nominal cost urban areas are comparable to what they would earn in a low nominal cost area. The reason, therefore, individuals may still prefer high cost areas is that the amenities in these areas are more valuable to them.²

Remote work can spread the value derived from job opportunities to a much wider geographic area. Moreover, one of the key reasons people agglomerate is due to the spill-over effects from being in close proximity to others that do similar things. Although today these spill-overs only occur due to physical proximity, there is no reason to not attempt to figure out how to generate similar spill-overs using ‘virtual’ proximity or other methods. 

Remote work-based migration can also result in the development of the same valuable location amenities typically found only in large urban centers. Thus, the idea is to spread out the benefits of agglomeration to a wide area. This would result in improving affordability in most larger cities, but it may in turn reduce affordability in smaller towns and rural areas, as demand for these locations will grow.

Conclusion

The issue of housing affordability is a lively topic of discussion. Solving it does not seem easy, as we do not have any clear template or successful example of how to tackle this issue. 

In our three-part deep dive, we discussed:

• why housing is unique;

• what determines the price of housing; and 

• what we can do to improve affordability.

Regarding affordability, it turns out the implied working definition that focuses solely on housing costs may not be a good reflection of the affordability issue. Including transportation costs, it might even appear that the affordability issue is not as large as it is made out to be (or that it is comparable in all urban areas).

Regardless, most of the commonly suggested solutions, such as upzoning and densification, typically would not significantly improve the issue of ‘affordability’. People will be willing to pay a certain percentage of their income for housing and transportation in order to have access to the local job opportunities. Upzoning and other deregulation, however, is still worthwhile as it enables more people to live in an area, which benefits the economy as a whole (at a minor expense to current residents). 

Improving affordability means reducing the amount paid for the same value of services. Thus, other solutions such as micro apartment units or co-living (Saiz and Salazar, 2020) do not actually improve affordability but rather reduce the amenities one gets. Solutions that would improve affordability need to focus on ‘increasing available land’. Smaller undertakings such as repurposing industrial land and converting offices to residential areas (Saiz and Salazar, 2020) would improve affordability, but these solutions may be too small to make a dent in affordability. 

What is needed are large changes. Some of these can be done via government spending on improving public transit, as it both widens the available land for cities (and the jobs often located in the centers) and gives the option of a very low cost transportation. Separately, the cultural shift of remote work could significantly alter the affordability issues faced by cities, as it will de-link location from job opportunities. 

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Interesting Reads from the Week

1. Article: In reference to our piece today, an article talking about how high are development costs for ‘affordable’ housing. Interestingly, land costs are expressed as a dollar rate per square foot of “net residential area,” i.e. in-unit living space.

2. Article:

   Guy Berger
   goes over the latest jobs and employment report in the US for the month of January. Spoiler: it was “much stronger than expected”.

3. Article:

   Polymathic Being
   discusses the issues of recycling and how we should focus on reducing and reusing.

4. News: The Federal Reserve made the decision to keep interest rates at the current level of 5.25% and appears to have hinted that a March rate cut is unlikely.

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Photo by eberhard grossgasteiger.

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Unions, Strike Action and the Economy (November 14, 2023) – with significant union organizing and strike action occurring in the US, economic research suggests that unions do impact all workers, not just unionized ones. Moreover, unionization threats also have an impact.

The True Value of the Infrastructure Bill (November 20, 2022) – the US passed the Infrastructure and Jobs Act, which has significantly increased infrastructure spending. How impactful will it be and why more is needed.

1. For example, residential construction cannot be built on slopes above a 15 degree gradient, thus making such an area non-developable land.

2. To illustrate – suppose an individual spends 10% of their income on entertainment regardless where they live. In a high cost urban area, there might be a larger variety of entertainment than in a low cost urban area. Since variety is typically considered better, the personal value one gets from spending 10% of their income in high cost urban areas is greater than the value in low cost areas.