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)