Magazine March 9, 2020, Issue

The Unbuildable American Home

A carpenter works on a new home in Las Vegas, Nev., April 5, 2013. (Steve Marcus/Reuters)
How regulations and land-use restrictions have made it too expensive to build

The United States has developed a split housing market. There are cities where homes have become extremely expensive, and others where home prices have stayed low. Look at it from the perspective of a young family: In the expensive cities, it probably seems as though homes have been spectacular investments for their parents, but now housing is overpriced and makes for a poor investment. In the cheaper cities, it may appear as though their parents’ homes haven’t been such spectacular investments.

So, for those young families, the American dream seems to be a one-time asset bubble. Now it’s done, and all they have are poor choices.

It is tempting to try to address these incongruities with a targeted patchwork of solutions: rent control so families aren’t priced out of their neighborhoods, down-payment assistance to help new buyers in expensive markets, government watchdogs to make sure buyers aren’t overextended. 

The problem is, much of the stress and instability that we see in housing markets today is a result of a tangled web of existing barriers, taxes, and subsidies: This family gets a big income-tax write-off, and that family doesn’t. This family in one city rents a home for $4,000 per month, and that family in another pays $800 per month for a similar home. This family cannot meet the standards for mortgage approval and pays $1,200 in rent on a home owned by that family, whose mortgage costs only $700 per month.

All of these inequities are the result of thinking of public policy in terms of favoring or protecting a certain group or a certain behavior. One policy is meant to favor renters, another to encourage homeownership, another to prevent a new bubble from developing. Broadly beneficial housing policy doesn’t need to favor or protect anyone. It also needn’t be concerned with what the “right” price is, or even whether housing is affordable. Broadly beneficial housing policy needs to be focused on favoring just one thing: free and open markets. This is true at both the local level and the national level. 

What Americans need is the ability to purchase shelter. Today, home purchases are bundled with tax subsidies. The government estimates that homeowners saved more than $200 billion in 2018 because of untaxed rental value, the tax deductions for mortgage interest and property taxes, and capital gains on owner-occupied homes. There ain’t no such thing as a free lunch, as Milton Friedman was fond of saying. A home with tax subsidies is worth more than a home without them, so its price will be higher. 

They are also bundled with the power to decide what homes your neighbors can or cannot build. A major reason the expensive cities are expensive is that whenever new homes are proposed, current residents are able to mount an endless barrage of complaints: The new units are too tall or too expensive, they cast shadows, they don’t match the existing character of the neighborhood, they will attract the wrong sorts of new residents, etc. If you want a house in those cities, you have to pay dearly for it. But that high value might collapse if you and your neighbors start letting developers increase the local supply of housing.

In both of these cases, you may prefer a house that lacks those high-priced endowments, but if enough of your neighbors prefer them, the price of your home will reflect it.

It is tempting to excuse the expensive cities by blaming high prices on geographical limitations to building. It is true that building can be more expensive in dense cities with more local amenities. That can explain the difference between a high-rise condo in downtown Atlanta and a modest apartment in the nearby suburbs. But the difference between a house in L.A. today and a similar house in Atlanta is explained by politics.

This is clear if you consider the reaction of local regulators in L.A. to new developments. If geography were the limiting factor, when a developer proposed a new 100-unit project, the planning commission would be ecstatic, and it would enter into quick negotiations to see whether the developer could squeeze in 200 units. Instead, developers today typically must engage in years of negotiations just to get permission to build 50 units loaded with mandates and fees.

What is in short supply is simply shelter. Instead of tweaking the bundle of subsidies, taxes, and gatekeepers, we should get rid of the bundle. Make the market for shelter simple again. 

The perception that homes aren’t affordable stems from letting the market for homes slip out of the realm of “free and open.” At the local level, housing markets are restricted by zoning laws and other regulations that prevent new units from being built. It’s in the cities with the least new housing that prices have shot up the most drastically. The New York, Boston, San Francisco, and Los Angeles metropolitan areas are outliers with regard to both low supply and high prices. They don’t even allow enough building to accommodate natural growth, let alone transplants.

I call these the “closed access” cities. Year after year, thousands of their residents—usually people with lower incomes—must pack up and move away.

In Phoenix, I have met many families who have been forced out of the California metropolitan areas. There were no options in Los Angeles for them to mull over and no units within their price range in the Bay Area. Their only option was to leave.

These differences in costs affect our expectations. The cities with $4,000-a-month apartments exist in a society that has the ability to rent similar apartments for $800 a month elsewhere. People in expensive cities notice that their friends and family who live in less expensive cities rent better, larger homes. Shouldering a $4,000 payment each month forces some renters and homeowners to lower their expectations about what they can afford.

The vast gap between housing prices in different cities creates a sense of unfairness. The owners of modest homes in, say, the Bay Area that now rent for $4,000 a month or that sell for a million dollars didn’t earn that wealth by creating something. Their profits are a direct result of policymakers’ preventing developers from building new housing units.

In short, we suffer from a lack of choices, though we know more choices should be available. That is what creates so much frustration.

In a free and responsive market, the market price is the affordable price. This is obvious in markets that have changed a lot over time. Take television sets. In 1950, they were much more expensive than they are today. Was there a television-affordability crisis? No. The cost reflected the incomes, culture, and technology of the day. Both consumers and producers were free to buy or sell televisions that were appropriate for them. So families didn’t buy 70-inch TVs. They bought twelve-inch black-and-white TVs and saved the rest of their income for goods and services that provided more value in that time and place.

Housing is different from televisions. Every family will always need exactly one roof over their heads. For families in dire circumstances, a home is a basic right we should help to provide. Yet most families who are providing for their own shelter have a remarkable range of available options.

The average home size in the United States has more than doubled since World War II, even though family sizes have declined dramatically. There is a huge difference between the size and cost of a Manhattan condo and that of a farmhouse a few hours upstate. We make countless substitutions tailored to suit our lifestyles and budgets: new vs. run-down, large vs. small, quiet neighborhood vs. bustling. 

With so many choices, it doesn’t make any more sense to ask whether housing is affordable than it does to ask why some people buy large TVs and some people prefer streaming Netflix on their iPad. Better questions are “Why isn’t there enough of the affordable housing we need?” and “Why isn’t affordable housing where we need it to be?”

The cost of a TV should be approximately equal to the cost of the similar TV next to it on the store shelf, and the cost of any home should be about the cost of building a similar home down the street. Some of those homes will be 600-square-foot studio apartments in the heart of a bustling metropolis, some will be 5,000-square-foot villas overlooking the ocean, and some will be 80-year-old, out-of-date, rural two-bedroom units. Whatever conditions homes are in, the key to making them affordable is to protect the right to build a new home down the street. That includes both the right to build it and the right to finance it.

Building homes that are “too nice” doesn’t make housing unaffordable. Here it is helpful to think about televisions again. As TVs get cheaper, we don’t just spend less and less money on twelve-inch black-and-white ones. Some families might spend more on TVs (in relative terms) than they would have in 1950, if they conclude that the new 70-inch ultra-high-definition TV, which might cost more, is a better value. It looks better, gets more channels, and plays music. If TV-makers decide to market 70-inch color units, the sticker price alone doesn’t make them less affordable. 

On the other hand, if the government allowed TV-makers to sell only a limited number of TVs, then they might decide to sell only the 70-inch sets. In that case, TVs would be less affordable—because of the lack of choices, not because the TVs happened to be expensive to make. Would limiting the number of TVs while insisting they all have to be twelve-inch black-and-whites make them more affordable? No. If the supply were limited enough, the families with the most money to spend would bid up the price. There would be a queue for $1,000 twelve-inch TVs, just as there are waiting lists today for glorified closets in San Francisco. This is why, ironically, blocking new housing because the units will be “luxury” units makes the housing problem worse. The blocking is the problem, not the condition of the units. 

Homes will also not be made affordable by the financial securities that fund them, or by the taxes and subsidies that apply to them. Consider again those twelve-inch TVs. If there were only a million TVs available, and families of means had bid the price up to $1,000 each, would they become more affordable if we created a new subsidy that offered a $200 grant and low-interest financing to first-time TV buyers? Those subsidies might change who can buy a TV, but there would still be only a million of them, and they would now probably cost more than $1,000. Public programs that make homebuying more accessible can create public benefits, but we should judge them on whether they increase choices, not on how they affect prices—either up or down.

If the price of existing homes increases to a level that is higher than the cost to build a similar unit down the street, then more new units will be built. If the price of existing homes decreases below that, few new units will be built. 

The irony today is that housing affordability is increasingly a concern, yet we are building new units at historically low rates. This is because policy interventions have made the prices of existing homes lower than the price of the potential new home down the street.

At the local level, the closed-access cities are the epitome of the problem. By harassing and taxing developers and builders, policymakers in these urban areas help elevate the prices of new homes above those of existing homes.

The financial crisis didn’t change the closed-access cities as much as you might think. Building has recovered and returned to a pace similar to what it was before the crisis. But it’s still an exceedingly slow pace.

To varying degrees, much of the rest of the country has the same problem—few new homes being built because they cost more than existing homes—but for the opposite reason. The national crackdown on mortgage lending has prevented millions of Americans from buying entry-level homes. This lack of new buyers has driven prices lower. In most U.S. cities today, mortgage payments compare more favorably with rents than they have for decades, but many potential buyers cannot qualify for mortgages under current regulations.

Where the crackdown on mortgage lending is most binding, the shifts in markets are extreme. Among homebuyers with the highest credit scores (over 760), mortgage originations did not really decline during and after the financial crisis. Today, in inflation-adjusted dollars, this group is borrowing more than in 2005. Lending to applicants who have FICO scores between 720 and 760—which is above average—is down 35 percent. Lending to those with FICO scores below 720 is down more than 50 percent. And, contrary to popular belief, lending to people with low FICO scores was not elevated before the financial crisis.

In major metropolitan areas where the median household income is around $50,000 or less, which have been affected the most by tighter lending regulations, homes are being built at less than half the rate they were before the financial crisis.

From 2002 to 2005, an average of 522,000 new homes were sold across the country each year for less than $200,000. In 2018, only 72,000 in that price range were sold, and the number is still shrinking. A country desperate for affordable homes is hardly building any.

On the other hand, new mortgage-lending regulations don’t affect corporate access to funding. Apartment buildings are being built at a higher rate than they were before the financial crisis, but they would need to be built at roughly double today’s pace to make up for the collapse in the construction of low-priced single-family units.

The best solution to the entire problem is greater access: freer and more-open markets, in both mortgage-funding and urban land use.

The financial return on owning a house should come mainly from its rental value, not from excessive capital gains. That should be enough to make owning a home worthwhile. If it isn’t enough, more people will choose to rent, rents will rise, and so will the rental value of homes and the financial return on homeownership.

Today, families are not necessarily choosing to be renters. Many are renters even though it would be worthwhile to them to own their home if they could. Rents are rising just about everywhere today because we have eliminated choices.

Solve the problem of access, and affordability will follow. Choices are the key to the goal of affordability and fairness. We need to make more of those choices legal again. 

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Kevin ErdmannMr. Erdmann is a visiting fellow at the Mercatus Center at George Mason University and the author of Shut Out: How a Housing Shortage Caused the Great Recession and Crippled Our Economy.

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