Rating Middle-Income Housing Affordability
Many prosperous cities consider ever increasing housing prices as an unavoidable side-effect of their economic success. The Annual Demographia International Housing Affordability Survey conducted by Wendell Cox and Hugh Pavletich demonstrates that some cities can be economically successful and avoid over-charging households for their housing consumption.
The Demographia International Housing Affordability Survey rates housing affordability using the “Median Multiple”, average house price divided by average household income or Price-Income Ratio (PIR). In the 2019 Affordability Survey covering 90 cities of more than one million people, PIR values range from 2.6 in Pittsburgh, PA and Rochester, NY to 20.9 in Hong Kong! Why some cities manage to conciliate economic growth and housing affordability while others see their PIR number increases
years after years?
An already high or increasing Price-Income Ratio (PIR) should immediately signal to urban managers that they should take urgent correcting action after conducting a detailed diagnosis that would explain the high PIR figure. The Affordability Survey should be similar to the periodic health check-up taken by an individual: an abnormally high blood pressure indicates that urgent correcting steps should be taken.
An abnormally high PIR number provided by the Affordability Survey is not a diagnosis that would allow finding what is wrong; it is only an indicator that something is wrong in the real estate supply system. While a high PIR always indicates a discrepancy between housing supply and demand, a low PIR might not necessarily be an indicator of housing economics health. A city with a low PIR might have just known better days. Cheap housing might only indicate low demand from a dwindling population with decreasing income. PIR numbers should therefore always be related to demographic and economic growth. The Affordability Survey of 2019 shows that cities like Houston and Atlanta, for instance, have relatively low PIR of 3.7 and 3.5 respectively, while maintaining high economic growth and low unemployment.
Each city with a high PIR should, therefore, conduct a detailed study to identify the sources of this abnormality. Because the survey displays PIR numbers and households’ median income for more than 300 metropolitan markets, cities managers could look for inspiration at urban development practices among cities with low PIRs and high economic growth rate.
The Affordability Survey has been running now for 14 years. It constitutes, therefore, an outstanding time series to analyze trends and relate them to reforms in different cities. The main message of the Annual Demographia International Housing Affordability Survey is that unaffordable housing is not an unavoidable fatality linked to economic success. Some cities achieve high demographic and economic growth without abnormal housing inflation.
Unaffordable housing misallocates resources
We know that unaffordable housing causes a lot of hardship for households that do not yet own their home, in particular, the youngest ones. But abnormally inflated housing prices have also a negative impact on the entire economy, including on the households who already own their home and who might rejoice that their real estate assets are increasing much faster than general inflation.
High housing prices misallocate resources toward real estate at the expense of the rest of the economy. This misallocation could eventually significantly slow down economic growth and causes a housing bubble to burst, freezing investments in the entire economy. Japan, has not yet completely recovered from its asset bubble created in the 1980s.
Hsieh and Moretti, two economists, found that the high price of housing in some otherwise very successful US cities has a ripple effect, distorting the spatial allocation of labor nationwide1. They calculate that the cost of the misallocation of resources caused by unaffordable housing represented about 9.4 percent of US GDP in 2014. Housing affordability is therefore not a trivial issue.
Their paper demonstrates that the welfare of households already owning a house—who may feel that they benefit from climbing housing prices—is also significantly decreased in the long run. High housing prices, create an immediate hardship to low and median income households, but in the long term, every household—rich or poor—would eventually become poorer because the imbalance in resource allocation will decrease investments and the productivity of the entire country.
A high PIR requires a more in-depth diagnosis
High PIRs affect mostly economically successful cities. These cities create many new jobs, who in turn increase the number of households and their average income. More jobs and people with high incomes creates more demand for urban floor space. The need for additional floor space is generated by new housing demand but also by the demand for more services like schools, restaurants, gyms, etc.
The provision of the additional floor space is possible only if a city can expand out and up rapidly enough to accommodate the new demand without creating real estate price inflation. Unfortunately, in free metropolitan areas, this expansion is blocked by inadequate land management policies and arbitrary land use regulations, and by an absence of mechanisms to finance infrastructure and transport to respond to demand for new greenfield land development.
Politicians and planners in unaffordable cities are well aware of the problems created by unaffordable housing. However, often they are not effective in allowing the supply of floor space and land to increase rapidly because many of them firmly believe in three myths:
Myth #1: planners know how to allocate land equitably through the design of increasingly complex zoning regulations while ignoring price signals.
Complex new zoning regulations are fixing administratively the consumption parameters that should be left to the market; they create a regulatory straightjacket that allows only the construction of luxury housing for which the minimum requirements are not binding. It is the difference between the supply of land and floor price compared to demand that generates land prices, not the color of a zoning map.
Myth #2: Regulators can mandate the creations of new affordable housing units by obliging private developers to provide a share (usually 20%) of the housing units they build at prices fixed by the government below market; regulators call these “affordable housing units.”
The practice is usually called inclusive zoning and has become a common practice in many cities from New York City to Mumbai! Under-inclusive zoning, a fraction of the demand for luxury housing coming from a minority of wealthy households is supposed to generate the entire supply of housing units affordable to the middle class! The quantity of “below market” affordable housing created by this regulatory mechanism is so short in meeting the demand that the new units have to be allocated through lotteries. In New York City, the odds faced by potential beneficiary households to win the lottery is usually below 1/100,000! 2 Besides, of the obligation made to developers to produce units priced below market acts as a tax on the flow of new market produced units, and therefore progressively reduce their supply. Thus, the impact of inclusive zoning on the housing supply is to make housing more expensive for those who can afford it and gradually more scarce for those who rely on the program to access housing.
In spite of its obvious flaws, the inclusive zoning approach to the provision of affordable housing is increasingly popular with mayors and politicians because it appears to cost nothing to the taxpayer; in reality, with time fewer and fewer wealthy households are asked to pay for the housing units of the ever more numerous households requiring subsidies. Indeed, the “no free lunch” principle is at the “core of economics.”3
Myth #3: The compact city fallacy. A city can accommodate increasing income and population through densification of the existing built-up area; expansion into greenfield would result in “sprawl.”
Many regulations restrict densities and building heights arbitrarily. In some urban locations, removing these regulations would allow housing demand to increase densities. In the long run, this would be positive: creating new housing in areas where there is strong demand for it. However, the growth of housing supply generated by the densification of existing built-up areas is necessarily slow and limited. Existing low rise residential areas have to be acquired; their occupants relocated before developers can replace them with new taller buildings with more housing units.
Densification is desirable only when it is demand driven, i.e. if many households and firms prefer to locate in a specific part of the city. However, if regulations or a lack of infrastructure are preventing new greenfield developments, the densification of the existing built-up area is not any more demand driven. In this case, the densification is generated by the absence of a housing alternative, not by the preferences of households and firms for higher density urban location.
Any policy aimed at increasing the housing supply should, therefore, include two components: removing regulatory obstacles to densification and expanding urbanization into new greenfields. A misunderstanding of the structure of cities is usually the cause of the fear of sprawl. Cities do not have optimum densities. High accessibility areas that are centrally located have a higher density that distant suburban areas. Differences in densities reflect a spontaneous order created by markets. New greenfield developments will have much lower densities than more centrally located areas. These lower densities do not represent sprawl and do not indicate a wasteful use of land. Housing consumers are compensated for their longer commute by a higher consumption of land and floor area.
The way out of an affordability crisis
Politicians and planners have to stop believing in fairy tales consisting of thinking that smart zoning can allocate housing fairly between the wealthy, middle class and poor households. The only solution (except for the homeless) are solutions driven by market forces. A new school teacher finding a new job in a city is not helped when entering a lottery is the only way to access a house she/he could potentially afford. An alternative will be registering on a waiting list where she/he will stay for many years before obtaining a “below market” housing unit. The characteristic of markets is that there is constant flow in and out of the housing stock, allowing new entrants to find accommodation within at most a month of looking for the best choice offered by the housing market. The market solution also allows any household searching for a house
to select the best trade-off between location, floor area and density that would best optimize its welfare. The solution to unaffordable housing does not consist in inventing clever regulatory gimmicks or in designing massive subsidies to be paid by the taxpayer or by a few wealthy households. The answer will always consist of increasing the supply of land and floor space and removing any land and floor regulatory straight jacket. The tradeoff between housing standards, like housing sizes, densities, lot sizes, and location are always better left to the decision of the consumer, and not the whim of the regulator.
But increasing the supply of land requires having a financial mechanism to finance the infrastructure and transport systems that will make the new area of land developed accessible to the city labor market. A city cannot expand without disposing of a financial instrument to finance new infrastructure as the need arises for an urban extension. This instrument should be able to finance infrastructure including road, storm drainage, and sewers as well as urban transport network that would ensure that the new residents will be within a commuting travel time of less than one hour from the city labor market.
Even when politicians and planner have established a likely diagnosis and a strategy to solve the affordability problem, it is not easy to implement it. The distortions created by the regulatory repression of land and floor space supply generate a sort of pathological equilibrium. The reforms required to break this equilibrium will create potential winners and losers. The winners may not be aware yet of the impact of the changes while the losers are usually well aware of them and therefore resist them.
Universal resistance to change a damaging status quo may explain why some cities remain in a high PIR range for so long, even when the solutions are well known and accepted by all. For instance, in New Zealand, an otherwise exceptionally well-managed country, Auckland’ s PIR has increased from 5.9 in 2004, to 9.0 in 2018. The current government has explicitly declared that it will:
- Remove the Auckland urban growth boundary
- Free up density controls
- Fund new infrastructure through innovative infrastructure bonds
These measures constitute the best approach to create a market for housing units responding to the demand of the majority of households. These measures, even when forcefully formulated, require time to be implemented as representative branches of government have to pass new laws and design implementation guidelines. After the government has successfully passed these reforms, the international community will watch with great interest the impact it will have on Auckland’s PIR in the next few years. It is hoped that the example of Auckland will create a blueprint that could be used in other high PIR cities.
I have often compared very restrictive urban regulations with hard drugs and cities that practice them with drug addicts. Trying to remove their drug fix suddenly creates severe side effects because their organism is used to the drug and needs it, even as they are being destroyed by it. I guess that any reformer should approach urban regulatory reform in the same way as a doctor develops a treatment for a drug addict: a progressive withdrawal planned over the long term. The main lesson to be drawn is not to become addicted to dubious urban regulations in the first place. I wish planning professional associations, and academic institutions would contribute to dispelling the three myths described above that are causing so many urban dysfunctions.