international analysis and commentary

Housing supply, demand and low-income families

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Home prices are on the rise, again. They are up over 20% nationally, and some cities – like San Francisco and Los Angeles – have experienced even higher increases. This is potentially good news, at least in the current economic environment: rebuilding household balance sheets could help unlock the strong consumer spending rebound that has largely been absent in the recovery, thus providing a major boon to the economy. But with rising home prices can come rising rents, which can exacerbate inequality and strain already-tight low-income household budgets.

One can think of rising home prices as a transfer of wealth from prospective homeowners, who tend to be younger, to current homeowners, who tend to be older. Rising rent is more pernicious: the average home-owning household has two times the income of the average renting household, so rising rent coupled with rising home prices results in what is essentially a transfer of wealth from low-income to middle- and high-income households.

Housing costs (either mortgage or rent in this context) are also a disproportionately large burden for low-income households. On average, households under $20,000 in income dedicate 40% of their expenditures to housing, while for households making over $70,000 it’s only 31%. The disparity for income is even worse: housing consumes over 60% for households under $20,000, compared to 35% for households between $20,000 and $70,000 and just over 20% for households over $70,000. Low-income households often spend more than they earn, making the percentage of income spent on housing higher than the percentage of expenditures spent on mortgage or rent.

Over the last ten years, rental costs have grown almost twice as fast as median income. Some actually find solace in this fact, as a sign that the current trend is unsustainable, and by definition has to eventually stop. But three factors suggest that rents will continue to rise at least for the foreseeable future.

First, housing is not like most other goods. When the price of a good goes up, usually people stop buying it, which provides a countervailing downward price pressure. But when the price of housing goes up, you still need a place to live. You can move to areas where cheaper housing is available, but professional, family, and social networks – not to mention the cost of moving – minimize this moderating influence.

Second, when the price of a good goes up, producers are pushed to increase supply, which pulls the price back down. Yet again, housing is partially an exception to this model. Natural terrain, environmentally-sensitive land, and unsustainable commute times prevent the increased demand from being met simply by building further and further away from the city core. Denser housing in the already-developed areas is the logical answer, but in most jurisdictions land use policies make this difficult. Regulations that limit a building’s height, footprint, and number of units prevent the supply from expanding to match the increase in demand. Many jurisdictions even prohibit homeowners from renting out guest houses on their property or converting garages or basements into separate units.

Third, rising home prices don’t necessarily translate into higher rents, but it seems likely that this time they will. To understand why, we need to look at the housing bubble of 2001-2006 , the last time home prices decoupled from rents.

Normally, prices are a function of the supply of the good and the demand for its underlying value – in the case of housing, a place to live. But demand for housing during the housing bubble was driven not by the value of housing going up, but rather by speculation, the belief that no matter how much you paid for a house, there would always be someone else out there willing to pay a lot more a few years down the line.

Note that it’s easy for this belief to get detached from the actual level of supply. This allowed home prices to skyrocket, rising on average 11% percent per year from 2000 to 2006, even as new houses were built and sold at a furious pace. The new supply just didn’t seem to matter because consumers had become convinced that housing is always a good investment (how that happened is a topic for another article, but economists, financial analysts, hucksters peddling financial advice to retail investors, and simple availability bias all deserve a share of blame). Then the bubble burst, and home prices fell a full 32% in less than two years.

Rent, on the other hand, is a better measure of the underlying supply and demand of housing. Because it is a service rather than a good, and as such can’t be stored for later resale, it is impervious to speculation. And while home prices bounced around over the last decade, rent maintained its slow yet steady rise.

The context of rising rent since the bubble crashed is another story. Housing supply isn’t expanding at anywhere near the rates it was prior to the recession. In fact, it’s quite likely that we’re now dealing with a housing shortage. During the 2001-2007 recovery the economy overbuilt houses relative to the long-run trend, leaving us with excess supply. But since the crash, housing construction has fallen so low – and remained depressed for so long – that the underbuilding we’ve experienced since the crash is about twice as large as the overbuilding during the bubble.

In other words, the long-run trend suggests that we should have more housing than we actually do. And this is particularly true in the rental market: a recent study by the Joint Center for Housing Studies at Harvard found that in the last decade, the number of renters with very low incomes (less than 30% of the local median income) climbed by a third, yet the number of affordable rentals remained unchanged. If this persists, rent will continue its upward climb and more and more low-income households will feel the squeeze.

So what can be done? Perhaps the most important step is to first acknowledge that the housing market, like any other, is largely governed by the principles of supply and demand. It would be difficult – if not morally questionable – to attempt to reduce the demand for housing, but it is certainly possible to promote additional supply.

This can be done in a number of ways. As stated earlier, many jurisdictions have regulations that prevent the expansion of the housing supply. Revising these regulations to be less restrictive could help ease the pressure on rental prices. Jurisdictions can also actively look for underused land to develop. Oftentimes these areas are underdeveloped as a result of legal issues, pollution, lack of transportation infrastructure, or absentee owners. Governments can play an active role in removing these obstacles.

Many cities are already taking these actions. San Francisco has about 40,000 affordable housing units in the pipeline, with many projects built on formerly industrial areas like old warehouse sites, and the mayor has pledged to ensure they are completed in a timely fashion. Aggressive efforts to relax zoning laws in Hollywood could more than double its housing supply.

These are not the only solutions to increasing the supply of affordable housing and keeping rental costs under control. But they can begin a more comprehensive national conversation, which, as it goes today, is relevant to the two-thirds of the country that own homes but not so much to the one-third that rents. These families tend to be lower-income, and they face very different challenges than current or prospective owners. While the next few years will benefit homeowners as property values rise, it may be at the expense of the less well-off.

 

The views expressed here are solely those of the author.