Monday, June 13, 2016

Housing: Part 160 - Low end housing is profitable

I realized via a twitter exchange that there is a common misperception about housing development.

A tweeter said: "Why would anyone invest in building low/moderate income housing when returns from luxury are better?"

I realized that this is a common refrain among people who want to stop urban development, and it is completely wrong.

The reason developers only want to build "luxury" apartments in the Closed Access urban cores is because the market rental rate in those areas is extremely high because of the housing shortages imposed by people like our tweeter who don't trust market development.  In every city that isn't full of obstructionists, the landlord market is highly weighted toward the low end.  That is because, at market rates, low end real tenant real estate is more profitable than high end real estate.  One reason it is more profitable is because high end homeowners can capture a lot of tax benefits, so they bid the prices of high end real estate up, lowering the returns available to landlords.  The way this plays out is by increasing the demand for housing among high end owner-occupiers and lowering the demand for housing among high end renters, with the end result that there just aren't that many high end renters in cities that aren't defined by housing obstructionism.

This is such an obvious and overwhelming fact to anyone who doesn't live in the Closed Access cities, it's funny that Closed Access obstructionists can repeat this without the incongruity being obvious to everyone immediately.  I must admit that it hadn't quite hit me so clearly until just now.

Just because developers don't like to build units where market rates are $4,000 and rent them for $1,500 because local activists insist on it doesn't mean that $1,500 units aren't profitable where $1,500 is the market rate.  Everywhere outside the Closed Access cities, landlords build sub-$1,500 units like mad.  It's their bread & butter.

I guess I could add this to my list of differences between Closed Access and Open Access cities.  In Closed Access cities, locals say, "Why would anyone invest in building low/moderate income housing when returns from luxury are better?"  In Open Access cities, nobody would think to say it, and if you said it to them, they would say, "Wha?"

And, I noticed that I hadn't posted as many graphs on this as I thought I had.  Here is a graph of zip codes among various MSAs.  The x-axis is median home price on a natural log scale.  The y-axis is the median Price/Rent for that zip code.  At the low end of the price range, it appears that most of the increase in home prices in zip codes where there is an increase in rent comes from the knock on effect of rising price/rent.  This effect declines until home prices reach around $500,000.  In fact, this appears to be the main reason why low priced homes in the Closed Access cities rose faster than high priced homes.  In other cities, where rents were not rising so sharply, there was only a small difference between price appreciation of high priced and low priced homes.

In any case, the relationship, at the zip code level, is systematic.  You can see this simply by going to Zillow and comparing rents vs. mortgage payments or prices of homes at the bottom end to those at the top end.  Prices will vary by much more than rents.


  1. Another excellent post. The solution is elimination of property zoning. I think developers prefer to build luxury housing the way Ford prefers to sell Lincon Continentals. But they still need to sell Escorts!

  2. Yep. Thanks, Benjamin.

    That sort of thinking also feeds the narrative about the subprime boom. Lenders were stuffing the pipeline with these toxic mortgages because they profit from the fees and high rates. It's the sort of thinking economists should be trained to oppose, but it turns up even in the academic reviews of the period. As Scott Sumner laments sometimes, it seems like economists turned their brains off in 2007.