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Housing as a Commodity

I recently got a chance to read Ryan Avent's Kindle book The Gated City. I have a lot of respect for the author. I think he's one of the smartest people around when it comes to urban economics. I even interviewed him here on this blog back in 2009. As far as the book goes, it's very good, and I recommend it to anyone reading this post.

There are two points that I wish wish would have gotten fleshed out more in the book, and in discussions of housing markets more generally. I'll cover one today, and the other later.

A recurring argument amongst writers like Ryan Avent and Matt Yglesias and Ed Glaeser is that the housing market suffers from a supply/demand imbalance. More specifically, there isn't enough supply, and that's the reason why so many neighborhoods in so many cities are unaffordable. If only we could boost the supply of housing to meet the demand, we could bring down, or at least stabilize, rents.

(from M.V. Jantzen on Flickr)

This idea rests, first and foremost, on the assumption that housing is a commodity. Consider a different commodity market - wheat. If wheat prices are very high, one way to bring them down is to boost production and flood the market with more wheat. This works because wheat actually is a commodity. Every unit of wheat is more-or-less the same as every other unit, so the price is whatever price the market dictates.

Housing is different. There are many unique types and styles of housing, some of which are more desirable than others. When demand for housing rises in a neighborhood, rents will rise, regardless of the type or quality of the housing. A neighborhood might have century-old rowhouses, 70s apartments, and brand new luxury buildings. If demand is rising in that neighborhood, rents for all types of these units will rise.

But what if a neighborhood doesn't have any vacant land sitting around waiting to be developed? How do you increase the supply of housing when there's no place to build new housing? Basically, you have to knock something down and replace it with higher density housing.

Furthermore, let's imagine that a developer is proposing to level some not-so-great 60s style townhouses in an urban neighborhood. In their place, the developer is going to build a multi-level apartment complex with gym, pool on the roof, and ground-floor retail. Perhaps the developer is going to knock down 10 low-quality units and replace them with 50 high-quality units, for a net-gain of 40 housing units.

Even though the number of housing units in the neighborhood goes up, it's virtually guaranteed that the market rents for those new units are going to be higher than the rents for the old units. So the folks who might have been able to afford one of the 60s-style townhouses no longer can afford a luxury-apartment in the neighborhood.

From a developer's perspective, this is a no-brainier. The biggest cost in constructing housing is building the structure itself. The cost of making the units look cosmetically luxurious is marginal, but the price that people will pay for a "luxury unit" makes it more than worth it for developers.

For this reason, it's understandable why some people oppose development, and it's not so simple as sitting them down and saying, "don't you get it?! there's not enough supply to meet the demand in your neighborhood, and that's what's driving your rents up! Once we increase the supply of housing everyone will be better off."

The truth is that increasing the supply of housing units in a single neighborhood might not have its desired neighborhood-level supply/demand effect, because housing isn't necessarily a commodity. But city-wide, and metro area-wide, it might actually accomplish something.

Unless a developer is going to replace 10 low-quality units with 50 low-quality units, there's going to be a change in the structure of the neighborhood housing market that's different from the impact on the metro area housing market.

Avent argues in The Gated City that homeowners often engage in NIMBYism because they are conservative, risk-averse, and are cautious out of fear that the project might fail. To that I'd add that renters often engage in the same behavior, but they do it because they're afraid the same project might actually succeed.

Comments

Anonymous said…
I reckon that building brand new Luxury apartments brings down the rent for Luxury apartments of less recent vintage, which drives down rents for less swank places etc etc etc down the line.

Those not-so-great 1960's townhouses were probably themselves marketed as "luxury" 50 years ago...
Anonymous said…
It's definitely worthwhile to remember that apartments are differentiated products, but first commenter is right that there is still some demand substitution among apartments of different levels of luxury. Further, the nature of zoning and density regulations is still poorly structured to make exactly this problem even worse: by setting aside some lots for high density and preserving others as tiny rowhouses, zoning often forces developers to tear down now-affordable but still livable 50s era apartment buildings to replace them with new luxury apartments, which is clearly just going to push up rents. If on the other hand, you can convert a vacant lot (ideally) or handful of single family rowhouses into 50 new units, I think the net positive is so great it will still ease area demand a bit. Also keep in mind the simple solution of including a few low-income units in a new development.
Ethan Gach said…
Interesting post. I think the point about the marginal costs of luxurizing new apartment complexes is exactly part of the problem.

I'm not familiar with Japanese urban development, but my guess would be that in their dealing with super high population density, in say, Tokyo, they've found ways around simply replacing inadaquate capacity with a greater amount of ultra luxurious capacity.


Studios and economy apartments are great examples. The biggest reason, as you note, why someone moves into a given neighborhood in a city is the location. They want to BE there, whether because of the school, work, local businesses, people, etc. And yet that simple demand for lots of AFFORDABLE housing isn't met because of the conflicting incentives of urban development and renewal.
JRoth said…
I've tried to explain this to Yglesias a number of times. The first commenter's model is true as far as it goes, but - as the original post points out - it doesn't necessarily help in the neighborhood in question.

When a neighborhood becomes desirable, demand goes up, pretty much across all income levels (although not uniformly, but the variance is inconsistent). Building new high-end units (and that really is virtually all that gets built in already-thriving neighborhoods) doesn't pull the wealthy out of the previous high-end units in the neighb; it draws them from across the city (because the new units are the latest and bestest and in the hottest neighborhood). So every time you build 50 new luxury units, you're freeing up maybe 10 or 20 in-neighborhood units - it's a very slow effect.

Exacerbating this effect is that the luxury market is limited - there are only so many people buying million dollar apartments. There is an extent to which developers, once the luxury market is saturated, will move down the income scale a bit, but what they prefer to do is to move into other neighborhoods, even other cities.

So you have a neighborhood with 5,000 housing units of varying quality. Demand shifts, and now 6,000 people want to live there. First of all, 1,000 housing units is a lot to add in any existing, urban area. Second of all, there's no way the luxury market can bear that many new units. So what you see is maybe 500 new units, split between high end and top of the line, and they bring with them an additional 2-300 residents who weren't considering the neighborhood until these great new units were built.

You never catch up, and the fact that there are now a few hundred empty units scattered about the city doesn't help current residents who'd like to stay where they live now.

And don't think that higher density or looser zoning is some sort of panacea: once you're above a few stories, you can't afford to build anything less than luxury units. So if you want to build (relatively) affordable, market-rate apartments, you're looking at low rise construction. And if you're looking at high-rise, you're back to the luxury problem.
Jesse said…
Your hypothetical seems accurate, but I don't think it explains NIMBYism as well as Avent's, nor does it do much to my mind to argue against real-world development.

Here's why: rarely can I recall an instance of a new development being primarily opposed by the residents of the specific footprint where it's proposed - ie, those to be displaced. In fact, there are rarely many displaced people at all - here in NYC most of the new big developments tend to occur on open lots (often being used as parking lots) or they replace single-story retail. Not often do we see brownstones torn down for highrises.

And yet, there is a heated local opposition to almost every devlopment - from people who live near, but not in, the affected lot. Why? Your explanation about the 10 hypothetical renters makes sense for them - certainly the development would be bad for them - but why do so many people who live nearby also oppose it? They aren't being displaced; if they rent they should be relieved that a new development nearby will soak up some of the unmet demand for apartments like theirs; if they own they should be pleased that their neighborhood is in such demand. It just doesn't make sense unless as a sort of irrational conservative response, as explained by Avent.
Anonymous said…
I would agree with the final message here, even though like most people I'm not in NYC. I live in midtown Sacramento where the places are fantastic and the rent is low. Somewhere around the mid-2000's, when the Kings really started making noise about a new arena, there was a ballot measure, Q if I remember, that went down (didn't succeed). It was a massive development measure at public cost, new lofts, new arena new neighborhoods, etc. A lot of people around town shared the belief that what was already happening in downtown (massive renovations, cleanup, shiny, expensive apartments etc.) was going to move at an accelerated rate into midtown, raising rents and all that. Now, this will happen anyway, and it has, recession or no recession, there is land to build on (if only it's cleaned up, rezoned, etc.) and the recent midtown developments flopped (too costly compared to existing housing).
Everyone wanted to let midtown grow as it had. That is, in contrast to the money thrown at downtown (which always ended up being regarded as failure since... there was no affordable housing!). From a distant, disinterested (in living here) perspective, it may not make sense, but whenever the voters have a chance we usually reject shady development deals for similar reasons, not the least of which being that we would be publicly funding our raised rents. Never-the-less, within the next few years we'll be adding the outer-available(ish) areas such as the railyards, the bridge district, and township 9 to the city, and we'll see how that goes.
Eric said…
Interesting post. I would take some issue with your characterization of the housing market.

As a commodity, housing does work a little differently than a bushel of wheat. The main differences, as you point out, lay in the great degree of varying characteristics. Every housing unit is unique, and each is priced individually. Much is made of location, but amenities, size, condition all contribute to the price. It's probably more accurate to think of the housing market as a summation of millions of micro-markets.

But that it's similar in that a tight supply will raise prices, and a surplus of inventory will drop them. We see this in exurban tract developments, just as we see it in Silicon Valley.

And housing markets are related, and often substitutable. If prices are high, people will look at alternate locations, or share living quarters when they'd prefer not to.

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