Why Aren’t We Building Middle Income Housing?

Posted by Rick Jacobus on February 21, 2017

In a previous Shelterforce blog post, I argued that we cannot give up hope that the market will build middle-income housing. Granted, over the past decade, most new housing has been built in the luxury segment of the market, yet some argue that this isn’t a problem because the luxury housing naturally "filters" down and eventually offers everyone the benefit of lower rents and prices. I agree that refusing to build luxury housing (in the face of rising demand from wealthy households) will only make the housing problem worse for everyone else, but exclusively building luxury housing is no strategy for addressing the housing problems of low-income or even middle-income people.

For low-income residents in high cost areas, there is no substitute for public sector action to provide below-market rate housing, but for middle-income households, the market really should be able to provide appropriate housing without government subsidy. It is not doing that now, but we shouldn’t give up on the idea because ultimately it will bring more benefit to a wider segment of the population than luxury housing can.

So why doesn’t this happen?

This is a surprisingly complex problem that is made all the worse by the fact that everyone seems to expect it to have a very simple answer. In local policy discussions, I hear two grossly simplistic answers that I believe do more harm than good. Some people seem predisposed to conclude that we don’t build more moderate-income housing because of developer greed. Another group of people want the culprit to be unnecessary government regulation. Both explanations stand in the way of really understanding the problem and doing something effective to solve it.

Do Developers Focus on Luxury Housing Because They’re Greedy? 

Of course developers are motivated by profit, but I don’t think there is any reason to believe that real estate developers are any more (or less) greedy than producers in any other industry. Yet when you look at most other consumer goods, the market provides options at a range of price, and quality, points. In the auto market, working class and middle-income people don’t all drive 40-year-old BMWs and Mercedes, many buy brand new Ford Focuses and Honda Civics.

While some of the most profitable cars on the road are luxury cars, the Ford F-150 pickup truck and the Toyota Camry are also at the top of the list, and it’s not hard to see why. In 2016, Toyota sold almost 400,000 new Camrys and nearly as many new Corollas. Their best selling luxury car, the Lexus EX, sold only 50,000 units. Even assuming they earn a much higher margin per car, luxury models are not better investments because the volume is so much lower. 

It is pretty clear that the real estate industry would make vastly more money if it were to build more housing for middle-income households, even if the profit per unit were lower on those projects. So the problem can’t be as simple as greed, and acknowledging that should lead us to a new respect for the seriousness of the problem we face. By building too little middle-income housing, we are not only increasing everyone’s housing cost, we are significantly holding back the profitability of the entire real estate industry.

We have a lot of social problems that can only be addressed in ways that cost industry money or lower profits. We only have a few like this—where solving the social problem will make an industry more profitable.

So no, the problem is not greed. The development industry is not choosing to build only for the rich because that's better, they are behaving exactly the way we would expect any industry to respond to an artificial cap on their production volume. The same thing would happen in the auto industry: if we limited Toyota to only 100,000 cars per year, they might well choose to keep the Lexus and scrap the Camry, even though, at volume, the Camry is more profitable.

Real estate industry stakeholders often try to make the point that if we simply built more housing, it would benefit everyone. I think a lot of skeptics hear those claims and picture the industry building more luxury housing, and surmise that it would make little difference. But because the luxury market is a relatively small niche, and we are already close to fully meeting demand in that segment, any increase in the volume of development will necessarily involve moving down market to serve more middle-income households. I, too, remain cynical about whether this would significantly benefit low-income and very-low income people, especially if they are displaced from their neighborhoods to make way for all the new housing. This strategy is not a low-income housing one, but it seems like an appropriate housing goal on its own. Building more middle-income housing would make a very big difference to the millions of working-class and middle-income families who are currently cost burdened and, done right, could help take some pressure off the lower end of the housing market in a way that luxury building doesn’t.

Or Is Unnecessary Regulation the Problem?

In every American city where headlines regularly proclaim a housing shortage, there are vacant and underutilized lots that could accommodate new large-scale development. But if you make a map of where housing is being built, you'll see that building is highly concentrated in a few high-rent areas. For the most part, it costs the same to build a given type of housing project in any part of town, but the rents or sales prices are quite different from place to place. Building happens only in places where the market rent is high enough to cover the cost of development. When costs rise, the number of places where this is true gets smaller. Everywhere else are projects that would happen only if the cost of development were lower.

A recent Urban Land Institute (ULI) report included a map of Portland, Oregon, highlighting the area in which new housing development would not be economically feasible even if land prices were $0:

 

 

 

 

 

 

 

 

 

 

 

 

Above: A ULI report found that even with a land value of $0, development was not financially feasible across a large portion of Portland, Oregon.

 

Considering that in every part of Portland, people are likely complains about high rents, ULI finds that rents are too low to support development in a surprisingly large portion of the city. The above map largely explains the trend to build only luxury housing—it is only at the high end of the market that rents and prices are high enough to cover the minimum cost of developing a new unit.

There are certainly many elements that contribute to the high cost to build new housing (including developer profits, wages, materials costs, land cost, etc.) and for just about every element there are potential strategies for bringing the costs down. But one area that has received considerable attention is the cost associated with complying with local land use and building codes. They include direct costs associated with things like required fire sprinkler systems or minimum parking requirements, as well as indirect costs that result from the uncertainty and delay associated with public review and approval processes.

A recent paper by the American Enterprise Institute (AEI) argues that we could have more economical housing options if we simply changed local laws to allow developers to build them. This recognition is a common source of extreme frustration to certain local planning stakeholders who feel that simply removing those expensive requirements is the obvious and only necessary solution to our housing crisis. The AEI researchers, however, highlight the factor I think is key to any effective response:

“We have met the enemy, and he is us. Whether in the name of open space, neighborhood aesthetics, or avoiding overcrowding, we as voters have driven up the cost to develop housing to the detriment of workers who need economical housing.”

Regulation is not the problem, we are the problem. Once we accept this, the answer is not quite as obvious as many people want it to be. Just as it is overly simplistic to assume that developer greed is the problem, it is too easy to blame "unnecessary" regulation. We can’t hope to lump all regulation together and simply reduce the overall burden on development—we need a clearer way to more carefully pick apart the good and necessary from the bad and discriminatory rules. Here is where I think the analogy—and contrast—to cars is especially helpful.

The car market, like the housing market, is highly regulated. All of the rules about safety and fuel efficiency and all of the Lemon laws increase the cost of the least expensive car that can profitably be built. Yet somehow all of these rules don’t prevent auto companies from providing middle-market products. There is a clear reason for this and it has to do with the ways that housing is fundamentally different from cars.

Both auto safety and building safety standards exist to protect the consumer from producers who might otherwise cut corners. But in housing we have an entirely different kind of regulation. There are numerous design standards which prevent developers from building ugly and cheap looking buildings. You can see these rules as requiring new housing to be more "upscale." We don’t require all new cars to have heated seats, so why do we require housing to have expensive exterior finish materials?

It is uncomfortable to suggest that we should allow lower-quality development because it feels like suggesting that some people should have to settle for less. But offering a range of quality is exactly what makes new cars (and so many other consumer goods) accessible to a wider range of the population. (If this was all that was going on, I would have no trouble agreeing that we just need to get regulation out of the way. But, again, there is more to the story).

A home is unlike a car in one important way—it is fixed in a particular location, in a particular neighborhood. Unlike the value of a car, the value of a house is highly dependent on where it's located, which means it depends on the value of the other houses around it. If my neighbor has an economy sound system in his car, that does not keep me from having premium sound, but if my neighbor has "economy" urban design, or economy architecture, or economy building maintenance, that means I now have an "economy" experience in my neighborhood. 

We can’t address the cost of regulation without frankly acknowledging that the reason for many regulations is not to protect the residents, but to protect their neighbors. Parking standards, for example, prevent developers from offering consumers less expensive units with no on-site parking—and they do that in order to protect neighbors from the inconvenience of increased competition for street parking. Design standards protect neighbors from having to look at ugly buildings (and, perhaps more importantly, from having others judge their property as cheap by association). 

I don’t doubt that if we were to eliminate most building and planning rules, the market would be able to build much more middle-income housing. But I don’t think that wholesale deregulation is likely or even desirable. People have a legitimate interest in the quality of their neighbor’s property. We can (and should) reduce the degree to which neighbors can veto new development, but in a democracy we can’t (and shouldn’t) hope to eliminate their influence entirely. And the more we move to urban densities, the more the quality of our neighbor’s housing will impact the quality of our lives.

So What Can be Done?

There are many promising avenues for increasing the market production of middle-income housing. Sadly, most of them lack the "silver bullet" appeal of eliminating all regulation. I will highlight some of these approaches in a future post, but on the topic of regulation, I do think that confronting the class bias embedded in many of our zoning rules could make a big difference as one piece of a larger strategy.

One example is the issue of "articulated facades." A hallmark of "cheap" architecture is the large, flat, unadorned wall. In the 1960s and 1970s, builders built very simple rectangular buildings, with long flat unadorned walls. Today, many cities now require that windows be inset or pop out from the plane of the building. To my eye, these articulated buildings look vastly better, but they also cost a lot more to design and build this way. Requirements like these raise the floor on building quality as well as housing affordability.

I know how easy it is to call for lower standards in someone else’s neighborhood, but let me reassure you that I live on the front line of this question. I live in Oakland in a neighborhood of craftsman houses from the early 1900s. Sometime in the 1960s, the city allowed developers to tear down a significant number of these modest but nicely designed houses and build exactly the kind of inexpensive apartment buildings that are illegal in most of urban America today. The two apartment buildings on my block are totally out of scale with the rest of the neighborhood, they have less parking than would be required today, and they are frankly, really ugly. There is no doubt in my mind that they impact property values, and help explain why the City of Oakland imposes all manner of expensive design requirements on new apartment buildings today.

But this story privileges an upper middle-class point of view—it is the way you look at it if you are already a homeowner. You will never hear any of the homeowners on my block talk about it this way, but it is just as true that none of us would have been able to afford to live in our neighborhood if it were not for these ugly buildings. The presence of this modest quality housing has partly blunted the forces of gentrification in this part of Oakland. People can’t tell the same story about how the neighborhood is "up and coming" because it is obvious looking at them that these buildings are never going upscale.

Just as wealthier people have an understandable desire to protect their quality of life and the value of their property from "cheap" buildings, everyone else has a legitimate need to protect the affordability of their housing from the impact of "upscale" housing. If my neighbor chooses to upgrade to a car with leather seats, my car payment does not increase. But in housing, when my neighbor improves her house, I end up living in a neighborhood that may include higher rent or property taxes.

The problem may not be design standards so much as "upscale" design standards.  Some portion of our planning code involves inappropriately enforcing upper middle-class standards of quality on working class and middle-income consumers. The opposite never seems to happen, but maybe it should. If we want to maintain economically diverse cities, we have to plan and zone for economic diversity, and that means allowing different quality standards in different neighborhoods. 

For the most part, the tools of planning and zoning have been used effectively by homeowners at all income levels to create and defend zones of higher-cost housing, but they have rarely been used as tools to promote widespread affordability. One exception illustrates the potential: Portland banned McMansion conversions (where someone tears down a small house and builds a massive single family home on the same lot) but they explicitly allowed building new structures of the same total size if they were subdivided into multiple units. This kind of zoning rule explicitly promotes a more moderate-income neighborhood composition. That wouldn’t be the right approach in every place, but I would love to see more places thinking this way.

While the evidence clearly shows that for the poorest families, small areas of concentrated poverty cause real harm, it does not follow that every urban neighborhood has to include a perfect cross-section of all income groups. I have seen no data suggesting that working-class people are better off when they live in upper-income communities or under upscale design standards. 

If we take this perspective to heart, it is not at all obvious what to do. I am not suggesting that we designate certain neighborhoods for shoddy housing construction. Inexpensive housing today could look a lot better than the 1960s-era buildings on my block. We need to have standards, but the appropriate standards can be different in different contexts. One small part of our growing housing crisis may be the result of going too far down the path of adopting upscale design standards as universal standards. I would like to see planners and local policymakers feel more comfortable talking explicitly about the class identity of neighborhoods when they make decisions that impact the cost of market-rate housing.

Image: By rachaelvoorhees, via flickr, CC BY-SA 2.0)

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COMMENTS

Chris
22 Feb 17, 9:58 am

Rick, thank you for this. I think you’ve touched on a lot of important points here. One conclusion you’ve made, though, is one I’m struggling with. Here you say that a major part of why construction is expensive is the architectural requirements. While I think that is true, in part, I think it also factors in other regulatory requirements that aren’t often discussed: when a site is capped at units per acre, for example, developers aren’t incentivized to offer smaller units. Yet, in most cities at least a quarter of the population lives alone. In this case, designing better rather than bigger could help reduce the net cost of development while increasing your overall NOI. Similarly, minimum lot sizes are a clear issue. If you zone an entire neighborhood with a minimum lot size that equates to a 50- or 60-foot wide lot, how can a developer earn its required return on investment by building mostly smaller homes? Whereas if you allow lots that are much narrower, the developer can build both smaller homes and larger ones. As with the Portland ordinance, cities could require that a portion of lots be smaller to encourage smaller units with larger units, aiding in the housing diversity you discuss here.

Lynda Hauser
22 Feb 17, 6:58 pm

Very thought provoking, thorough and constructive article that could actually facilitate discussion of viable options to improve middle income housing. A couple thoughts to contribute. Free-market rather than more regulation. Balance. Creative solutions like pocket neighborhoods. Well-designed doesn’t have to be expensive. I never understand why anyone builds ‘ugly’. It’s not necessary. Great article Rick. Now if we can find a way to mobilize people who want to be part of the solution but are not yet plugged in…the sky would be the limit.

Rick Jacobus
23 Feb 17, 1:25 pm

Chris, thanks.  I certainly didn’t mean to suggest that design requirements are the main reason building is expensive.  Many of the things you mentioned and some you didn’t are much bigger factors.  There are a lot of people who think that excessive regulation is the whole problem but I think this one example shows that it is not whether you regulate but how you regulate (ie who the regulation is intended to benefit).  I also don’t mean to be anti design. Building more economical housing will require thoughtful design but it may be a different design than we have built into some of our codes.

Wanderer
23 Feb 17, 2:17 pm

This is a good piece, thank you. I sometimes feel perversely happy when I see, for example, ugly mixed use buildings in expensive places like Silicon Valley. I figure somebody’s built at least cheaper, if not cheap, housing.

I also agree on the “greedy” developers point, I’ve always thought it was silly to call developers greedy. Yes, the US provides housing mostly through private, profit motivated developers. It’s just like the way the US provides most other goods and services, like food, vehicles, computers etc. I guess this namecalling derives from the myth that homes—at least single family detached homes—are somehow special spaces that are outside the market.

One question with zoning and similar regulations is what elements of the regulation are really driving up costs. Parking requirements drive up costs—the developer has to either acquire more land or build a parking structure. Limitations on the number of units per site are costly, since they typically drive up the land cost per unit. Overdone public process requirements create costly delay and uncertainty.  I understand the argument about esthetics, but does that lead to requirements that significantly drive up costs?

Richard
28 Feb 17, 1:45 pm

Another point:

With cars and most products, regulations are based on results (survive a head-on crash at 30mph) while with housing they are based on a method (to survive a fire, buildings must have X number of fire escapes, sprinklers, firewalls).

In the case of a result-driven regulation, this leads the producer to find a technological or design efficiency that eventually brings the price down.  Cars are much safer today than they were 30 years ago, but adjusting for inflation they actually cost less.  The safety features today do not cost that much of the purchase price. 

When you prescribe a method though, you eliminate any possible innovation.  Particularly methods that require a certain amount of square footage are going to forever increase the price.  Having trash chutes in separate rooms separated by fire doors is one way to prevent the chute from catching fire and taking down the whole building, but it will always eat ~50 square feet per floor of the building. 

Parking minimums are the same way.  Instead of a result-based regulation: make sure you provide a way for people to get around, where you could easily build near a subway station and say they could walk, we have a prescribed method, often 2 covered spaces per apartment.  Those 2 parking spaces will always eat the same amount of space, there is really no way to make them any cheaper.

Curt Lyons
28 Feb 17, 2:43 pm

Great article. One important difference between cars and houses is, cars generally depreciate with age, especially luxury cars. So even expensive cars eventually filter down to people who could not have afforded them originally. When these cars are losing their prestige and appeal to the original owners, they are still viable used options for people lower on the income stream. Houses, if built out of reach, generally stay out of reach, and too often even the houses that use to be within reach are now out of reach. I know so, so many people who live in nice, but formerly modest older housing that could not sell their house and turn around and buy their same house. They couldn’t afford it. They are only able to live where they do because they were able to buy at a right-time-and-place period of time.

Jeff Kruth
1 Mar 17, 12:58 pm

A great read with some good breakdowns of complex issues. However, it’s slightly dissatisfying that the “what can be done” conclusion suggests different quality standards as a probable solution. This implies a market-based (and rather neoliberal) approach to cutting costs, as opposed to angling for more structural aims like strengthening community land trusts, focusing urban policy towards areas that the market will not serve, taking land off the speculative market and keeping it permanently affordable, and incentivizing rehab in low/middle income areas.

George Mattei
1 Mar 17, 4:02 pm

Hi this is a good analysis, but I think there is a missing element.  You note that real estate’s fixed location makes it different from the auto market.  True.  It impacts it in a way I think you missed.  If the demand is outstripping the supply, prices won’t go down, no matter how many regulations you eliminate.  This is because the highest bidder will win the purchase, and if there’s not enough housing, then even modest units will be quickly bid up to prices that are not affordable for the middle income population.

In many coastal cities the demand is so high you would have to build massive amounts of new housing, and the land’s just not there.  You can’t reduce real estate values in San Francisco unless you build probably hundreds of thousands of new units ONLY when there’s an equilibrium in housing prices will the reduction in aesthetic regulations make an impact.

Alan
3 Mar 17, 5:55 pm

Thank you for this insightful article.  Since the apartments were built in your Oakland area, there have been many innovations in design, materials and techniques that allow for greater appeal both for the resident and the neighborhood.  But, there is no getting around the math—a more affordable home without subsidies has to be smaller than a more expensive home, all other things being equal.  Fortunately, designers have been tackling this head-on with better use of innovative materials, space and light, but the building codes have not caught up.  If this is what people mean by “regulation” reform, then yes, we are ready for that.  If what people mean is a return to shoddy workpersonship and dangerous conditions, then, I hope no one wants to return to that.  Everything in material and design is in place to make another leap forward in urban housing—it is up to us a society whether we want to move forward.

Miriam Axel-Lute
6 Mar 17, 2:15 pm

Richard: I think your point about results-based vs method based is interesting and on point, but in terms of fire safety, for example, how would it apply for buildings that are not mass produced? You qualify for the results-based car safety things by doing crash tests. Each builder is not likely to want to build out and try to burn down a whole building in order to prove that a new approach is actually safe enough. What would innovation and results-orientation look like? Seems it would need a whole structure by which to test out different approaches.  As for the travel example, while I support your idea, it is worth noting that the people making the rules generally don’t care so much whether people have a way to get around as whether they will be parking their cars on city streets because not enough parking is available for them at home. (And the cost savings of building near transit is generally already counter balanced by land prices.)

Rick Jacobus
6 Mar 17, 4:27 pm

George,

You raise an important issue which I thought I had addressed but looking back I don’t think I stated it clearly enough.  The reason that the relatively modest cost of specific regulations might matter for overall affordability is not because I am expecting developers to pass on the cost savings in the form of lower rents.  Lowering the cost of building (through any number of means - many of which don’t require regulatory reform) makes a difference, instead, by increasing supply.  You are right, if we lower cost but build the same number of units, we won’t lower rents.

That is why I included that map of Portland.  There is in every market essentially a least expensive project under current conditions,  Anything we do to lower the cost of the least expensive project EXPANDS the land area in which projects are feasible.  It increases not the total supply of land but the supply of land that someone can economically build a project on.  I don’t agree that we lack land.  Most of it is not zoned in a way that allows multi-family development (and that is surely a bigger problem than design standards, etc) but even looking - regionally - at the land that is zoned to allow multi-family, there is a lot that we can’t build because the cost for the least expensive project is too high relative to the rents that would be paid in that location. 

I will say again, no amount of increased supply will get us to the place where we don’t need subsidized housing for an important segment of the population but as long as demand is outstripping supply, increasing prices will hurt everyone (and increase the amount of subsidy needed to make subsidized social housing work).  Unless you have a plan to decrease demand (lower pay, fewer jobs - the list is pretty unappealing) then we have to increase supply.  Partly we do that by building more subsidized housing but partly we can do that by doing all that we can to remove any expensive requirements that we can do without.

Richard
6 Mar 17, 7:12 pm

Miriam Axel-Lute:

Some regulations will have to be method based.  We just need to be careful in using too many of them, particularly when they specify a certain amount of square footage be sacrificed.  Requiring fire sprinklers in every large building is costly but probably a good idea.  Tons of extra fire doors and separated rest areas probably are not. 

Things need to be constantly reviewed.  Where things can be rolled back they should be.  If something better comes along, regulations need to be adjusted. 

Regulations need to be well crafted and avoid kneejerk reactions. LA had a regulation that required anything over 75 feet to have a helipad.  The regulation lasted for 40 years after being enacted in response to a deadly blaze in Brazil.  Helipads are fantastically expensive, and yet hundreds of surplus ones were built.  Even more buildings were not built because of the requirement.  Over the 40 years, not one of the surplus helipads saved 1 life.

Richard
6 Mar 17, 7:38 pm

George:

There is a finite amount of land, but policy can make use of that land inherently wasteful.  In LA for instance, large minimum lot side and onerous setback requirements mean that a lot of that finite land had to be consumed for every house.

LA, like a lot of suburbs, requires 5000 square feet of land to build a house. Lots have to be 50 feet wide, meaning the minimum size is roughly 100 feet long. It then specifies that a 20 ft front yard, 15ft back yard, and 5feet side yards.  So on a minimum sized lot of 5000 sqft, 2400 sqft is un-build-able.

Think about that, even after streets, parks, sidewalks, schools etc you have a certain amount of land for houses.  Then you take almost half of that land and insist that no one can build on it.  Of the land that is build-able, you have 2600 square feet committed to the first floor.  To build an average sized american house you need not even build 2 stories. 

If land is scarce as you say, zoning regulations should recognize that and allow construction of single family homes on smaller parcels of land.  1200 square feet is enough to make a 2-3 story home of decent size and have a yard to plant a garden or play catch with your kid.  Right there we could have 4 times as many houses than we do now.

Rick Jacobus
7 Mar 17, 5:50 pm

Thanks to everyone for all the great comments.

I submitted this response earlier but it didn’t seem to go through: 

Jeff,

I am not sure why you say “this implies a market based solution to cutting costs.”  I am not implying that.  I am stating it explicitly—in the very first sentence.  We absolutely need all of the “Structural’ strategies you list and no market strategy will eliminate that need but I am confused about why you (and you are not alone in this) would see making the market also work better as a bad thing.  Are we not going to have some form of housing market?  Saying that the market can do something is not the same as saying that it can do everything.

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