Why we don't build more houses?
I don't fully grasp the housing crisis we have. In a few words, it means that houses and rent prices are so high because there aren't enough houses to accommodate this demand.
Economists recommend that only solution seems to be building more houses. So why is this not happening? Because prices on houses and rent only seemed to go up.
We learn in finance the the higher the ROE > Cost of Capital, the more participants will want to enter the industry until this ROE falls. So what seems to be the issue and why not more people are building houses considering the ROE (prices on houses, rent, etc.) is quite high?
It is an authorization thing? Lack of workforce? Lengthy process to build a house? Lack of interest? Lack of capital?
Real estate is illiquid, development even more so. Essentially there is a whole supply chain related real estate than simply higher roe>cost of capital. There is a long and tedious process pretty much anywhere to get permitting. You need to buy the land first, which is another long process. Get the contractors in place, raise the equity, architects, building materials, labor, construction time, and then you need to make sure the homes sell for profit by the time you do end up constructing them which could be years down the line depending on jurisdiction. This is a lot of uncertainty in a market where interest rate moves can make or break a deal.
While it might seem like a lot, there are actually very few players in this space compared to other industries because of the above barrier to entry, which in turn, results in significantly more risk/reward trade off, especially if you are a smaller player in this space. But then being a smaller player, your equity raise ability is going to add even more timeline to the transaction.
Development returns can be outstanding, but not many people want to lock their capital up that long. That's why you see a lot of people that want real estate exposure just buying REITs or investing in liquid mortgages (a lot of these mortgage REITs and buyers can result in returns in the 50%+ range when they buy the assets with the 20x+ leverage they get and then securitize them).
It’s actually much simpler than this.
Real estate values and rent go up in areas people want to live. It turns out, in areas people want to live in, real estate has already been built (yeah there may be some old buildings, but there’s probably already real estate there, thus not really creating new supply).
Where the housing shortage comes into play is that no one wants to build in areas that people do not want to live since you can’t push rent there since no one wants to live there.
Over time, values in nice areas will continue to climb, and builders will start building (not luxury) in less desirable areas as the shortage comes to fruition. It’s all supply and demand.
People will jump in to say “NIMBY zoning”, which is certainly true but only part of the issue. Actually, there are a number of drivers of the housing crisis:
First (and often ignored), people in Western countries today are less efficient users of housing than they were generations ago. The average household size in the US today is about 2.5, down from about 3.5 in 1950. This means that Americans need more housing units per capita than they did in the past, which, other things equal, means they need to spend more per capita on housing than previous generations did. But today’s housing units contain fewer people and are “used” less. Decades ago, there was a common humorous trope about the wife or daughter taking forever to get ready in the morning while other family members waited impatiently to use the bathroom. But you don’t really hear people joking about that anymore, since the ratio of bathrooms to people has increased. But bathrooms are expensive, so this change has come with a price tag.
Second, the economy has shifted so that good jobs are increasingly located in major urban areas, driving up the price of housing in those areas. There are actually a lot of places in the US where housing is cheap, but there aren’t many good jobs in those areas anymore.
Third, restrictive zoning limits the number of new housing units that can be built in many of the areas where they’re most in demand. This is a huge issue and much discussed.
Fourth, in many regions, developers of new residential projects of any significant size are forced to make a substantial fraction of the new units “affordable housing units”. Affordable housing, in this sense, is simply rent control for new construction. These are money-losing units that often kill deals if they’re mandated in sufficient numbers. Many projects not currently being built would actually get built if all of the units could be market-rate.
Fifth, regulations on building construction (building codes, energy codes, etc) have pushed up the cost of construction. This means that homebuilders’ margins are often tighter than you might think, even in areas where housing costs have gone way up and demand is high. I’ve priced out some of these deals in expensive areas recently and seen this firsthand.
This is a fairly accurate summary.
Re: point #3, I would submit that it is not just a limitation on the "number" that is the primary issue; it is the restriction on "density" that most matters.
Very thoughtful and insightful post.
I do think this is a little reductive. Certainly this happens, but not often enough to drive production one way or another. Usually affordability mandates are offset by tax abatements or subsidies or density bonuses, at least the ones I've seen. Which brings it back to more of a zoning/land use/NIMBY issue than one of affordability per se.
Very market dependent, obviously, but I am seeing more and more "inclusionary zoning" units being required in urban markets ranging from Florida to California. Or at a minimum, a payment in lieu if you don't include affordable units on-site. In some cases, as you note, these can be offset by subsidies/abatements. However, in the markets I am more familiar with, these is no benefit to the developer for including affordable units in their project - it's a pay to play essentially. We had a project a few years ago that the municipality required 20% of the units to be affordable, and yes, they subsidized it with TIF, but not nearly enough to offset the financial impact of the requirement. I'm all for finding ways of delivering mixed income buildings, but I wish more municipalities found a way to make it cost neutral for developers, rather than an additional cost to the project.
The only thing I have to add is that when affordable housing units are required, there are tools that anyone can use to offset that lower pricing
Only counter is that household statistical surveys are very bad at measuring household compression. I would wager there has actually been some household compression over the years as people fill into apartments. I don’t know a young person without roommates. Even those who own their place rent out and add extra rooms. Additionally, a lot of areas in cities were historically slum bunker zones with extremely high density. It’s a combination of supply limitation that then creates distortions in the workforce: a manual laborer might take a much lower wage, but they need to afford rent so require higher salaries.
There are a lot of reasons. A lot of them are explained very eloquently by others on this thread.
But in some respects I'd challenge the notion that this is a universal problem. Housing is being built in some municipalities. In some places in Texas or Florida, lots of housing has been built and prices have declined as a result. To a large extent it's a question of permitting, zoning, and land. Building in Texas or Florida is made easier, in many ways, because there aren't any physical constraints on where to go. It's a big plain, or swamp. by contrast, the parts of the NYC metro area where people want to live is already extremely densely settled. Ditto most of the Northeast. Ditto southern California (which has some real fire risk, too, of course).
Also consider risk. Real estate development takes a long time and is, comparatively speaking, extremely risky. Not a lot of people want to tie their money up for that long, with that amount of risk and uncertainty, when there are easier ways to make a buck.
So many factors as the people above have said:
Cost of construction has risen significantly. We're talking 100-150% increase in costs in some areas and thats just materials. Labor is a completely different issue in itself.
Once you factor in all these issues, the ROE for development might not be there. Thats typically why developers have to build larger subdivisions with cookie cutter mansions because those projects have a easier timeline/pathway to approval.
The younger generation always complains their parents had it better, but here is the thing. Sure their parents were generally able to afford a single family home with a white picket fence on one salary but the average starter home size back in the 1980s was about 1500 sqft and now its about 2500 sqft. This goes back to my earlier point, its more cost effective for a developer to build one 3000 sqft home then two 1500 sqft homes.
Bcuz human being are selfish creatures. NIMBY and Karen down the street won’t want new homes to glut the school district and create traffic for her.
Sensible, neither would I, seeing what my childhood neighbourhood looks like today.
Also worth noting that while economic forces will 'create' more labor and materials to respond to higher prices (and the new supply drives prices down in turn), this does not hold for land as it's finite. When the price of land doubles, the economy can't create more of it (like it does with labor/materials). The owner of land will just increase the asking price until competing developers bid it up to a number that gives the developer the bare minimum of acceptable return. With the whiplash of interest rates, the value of land is still too high for it to be developed, as land owners are stuck on yesterday's prices.
This is a small piece relative to others mentioned, but land values are an important piece.
The approval process it too localized and boards are run by neighborhood NIMBY boomers with a significant % of their NW in home equity. In places like Austin where its run by the city they've added a ton of supply and rents/prices have decreased substantially. Add to that in many markets the cost to build (not just materials/labor, but also all the local permits and associated fees) make it tough to generate profit selling reasonable priced housing. In my market the local fees and permits alone can run a few hundred thousand to develop a small multi unit apartment building.
Based on my extensive, up-close interactions with NIMBY boomers at local boards, I don't agree that their primary goal in opposing development is to maximize their home equity. This is one of those things that people think is true because it's logical in the abstract, but it doesn't explain the NIMBYs' actual behavior.
Property values generally vary by municipality. "Nice towns" with "good schools" tend to have relatively similar property values (controlling for property quality) throughout the town, or at least throughout the school district. Thus you'd expect property owners to exert relatively similar effort to oppose any new development within the zone that determines their property's value.
But that isn't what they actually do. What they do is what's suggested by the NIMBY acronym: they intensely oppose development in their own backyard, moderately oppose development in their neighborhood, and can't be bothered to show up to oppose development located four miles away. Based on this behavior (and on their actual statements), I think a better model of their motivations is that they like the existing views, density, and traffic patterns of their immediate surroundings the way they currently are, and don't want them to change.
It's exactly that. They don't want it to change. Everyone loves all of the changes that happened in the generations before them (hint: that beautiful pre-war brownstone wasn't a greenfield development!) but as soon as it comes to their time they want it frozen in place.
I once sat through a zoning board meeting where we were replacing an old warehouse that had zero stormwater systems with a modern apartment building an a serious infiltration and detention system. The city had a problem with flooding during high rain events, something our development was going to unquestionably improve on. We still had 12 people all claim our building was going to make the flooding worse because there were going to be more people there (?!). They just didn't want things to change.
The idea that they don't want more nearby development because it will lower property values doesn't even make sense when you look at the numbers. The only way that could be true is if new developments were exclusively low quality trailer parks. Which from a numbers perspective just don't make sense in developed areas because the land is too expensive.
NIMBYs care almost exclusively about their quality of life, so as you and others have said. It is about the traffic.
I've heard another reason is existing homeowners are against it as it lowers the current overall value of housing in an area. Just basic economics that by adding more supply, the prices as a whole go down. Current homeowners don't want to see the $500K house they have all of a sudden go down to $350-400K. It's understandable as they may have scrimped and saved up years to get their home.
I've read that that it may even affect the area economy and that Canada is an example of this. Unfortunately, once real estate becomes extremely high, the industry becomes a large contributor of the economy. It employs lots of people and brings in a lot of money. Lowering housing prices could potentially bring about a crash.
Final point: it also becomes a political issue. Both existing homeowners and large real estate companies exert a lot influence on the politicians/regulators, keeping the prices high.
Supply is only added once the land is purchased, creating a new data point for a land sale at $500k. How could the developer buy the house for $500k, go through development, to sell it for $350-400k? Better yet, why would they sell at $350-400k if they could sell for $500k?
It's called "density". If you don't understand the basic concepts being discussed, maybe your time is better spent listening and learning.
This isn't true. Economics doesn't work like that on a local basis. If you doubled the number of homes in a town sure. But the types of impacts we are talking about here are a tiny fraction of the overall number that already exist. Plus new development homes in places that are already developed have to be of a much higher quality level to justify the land costs. So they tend to end up driving up the cost of the surrounding properties.
The only real examples of prices coming down or staying the same with development is in Houston. That area has very lax development regulations and has persistently been in a housing unit oversupply since the early 80s when the overdevelopment boom started. That has more to do with a systemic market reality of ease of development that attracts fee only developers than it does with an impact of a NIMBY development.
We don’t build more houses due to a combination of factors. High construction costs, limited land availability, and complex zoning regulations make it challenging. Developers face lengthy approval processes and opposition from local communities concerned about overcrowding, traffic, or changing neighborhood character. Labor shortages and rising material costs also hinder construction. Additionally, economic uncertainties and high interest rates can deter investment. Environmental concerns and sustainability goals sometimes limit new developments. Solving the housing shortage requires streamlined regulations, incentives for builders, and investment in affordable housing to meet the needs of growing populations.
Another thing for people to keep in mind - we don't build enough single family homes because that industry was hollowed out due to the GFC. Horizontal developers, homebuilders, subs, labor....there was a ton of work one day, and then new home starts fell off a cliff. I work with three individuals who came from the homebuilding industry and had to find a new line of work after '08/09. And those people never really re-entered the industry.
Given the current political rhetoric I think this is a super important topic that few understand completely, myself included. The simple answer is that local governments do not allow new homes to be built.
Most of the post here capture the major pain points, but I would like to add extreme emphasis to deleterious effects of zoning, US building codes, and munnicipal bureaucracy. Fundamentally, cities are structures that increase human efficiency. From a theoretical perspective, it should be significantly cheaper to live in a city than out on the land.
While our buildings are much more complex, and it is true that household size and therefore efficiency of use has significantly decreased, I would argue that technological progress has far outpaced increases to housing quality. Yet nearly every city in the western world is currently experiencing a severe housing crisis. Why?
Because cities do not allow new homes to be built. Most of my research surrounds California cities, but broadly, most American metros are highly fragmented. Southern California has more than 190 municipal governments, each has its own city planning, transit, PD, accounting, etc., literally hundreds of fully staffed mini governments. Highly contrary to popular belief, the modern growth of government bloat is almost entirely driven by the municipal level, with some being at the state level and actually a decrease at the federal level since 1945. Look at FRED data for All Employees, Federal, State, Local, it is insane.
In California's history there were many years where population growth exceeded 30, even 50% in one year, yet housing prices remained relatively flat in large part because anyone could throw up a structure with virtually zero oversight relative to today. Of course conditions were much worse (aka consumption and therefore prices were much lower), but it is really only after the widespread adoption of restrictive zoning prices that housing prices begin to increasingly outpace wages. Even in the Gilded Age, housing prices stayed consistent with wages.
This was then exacerbated by newfound stability of consumer mortgage instruments. Interest rates have plummeted, allowing greater consumer debt burdens, and this new stability (initially FHA, Freddie, Fannie) paved the way for increasingly small down payments. Pre FHA, down payments were typically ~50%. and home loans were primarily reserved for the upper class. So in essence, these tools provide massive demand side subsidies to an artificially supply constrained market. == Massive price increase.
The negative impacts of land prices are also severely underestimated. Housing affordability is really a land affordability crisis. Rent all land has gone up immensely, as supply of industrial, retail, and hotel has also not kept up with population growth. Unlike any other input except maybe electricity or water, land is a primary input in most every business. Two of largest expenses for every business in your city are likely rent and wages.
So what happens when land rent increases by 3%? Employees pay more of their salary to housing and so wages must increase, but now groceries cost more because employees cost more. And now those same employees need more money to pay for their groceries. In a sense, yes that is just inflation, what's the big deal?
The big deal is that housing should theoretically be a depreciating asset. The $ cost of housing relative to wages should decrease overtime. In essence, the housing market is extremely extremely overvalued. Thankfully, the underlying land of most buildings can still appreciate as it is not even remotely close to its highest use. It is up for debate, but if every city threw off the reigns to housing and allowed free flow of labor (immigration), it would surely crash the entire market into a deflationary spiral.
All this is to say that the housing/land market is the primary reason (and a little wealth inequality) that it does not feel like you are living in the most wealthy, global hegemon that has ever existed, because old people own all the homes, so they are more active in local politics, and they don't like change, especially to the built environment, so instead of living in godlike, heaven akin metropolises, the tech capital of the world is almost entirely a bunch of stucko plaster ugly ass row homes. Granted, we still have it better off than every other generation that has ever lived, but it is up to young people to build their own future.
In my opinion, the actual solution to this requires a fundamental change to property rights whereby rights of the owner to put there property to its highest use are much higher. But this must be paired with a Georgist land value tax. The issue with land value tax is that it is hard to decide what the right rate is and avoid corruption in the process. This requires a market mechanism to solve. My proposal would be to have a by right bidding system for ownership. If my home is worth 1M and I pay 2% tax on the property, someone at any time could submit a bid for 2M, and once they do I am forced into a legal agreement where I would either have to pay 2% on 2M, or sell to the bidder. And of course placing a bid means you must buy if the seller decides to sell, it is kind of like an options contract. With this in place, it would quickly where base tax should sit to optimize redevelopment.
If you believe in markets at all, then all you really need is public transit, utilities, etc. and can more or less get rid of city planning besides theses concerns. I think it is more likely that population collapses as people are forced to spend more and more time in education, until eventually we have mostly free time, but fun to think about.
so close....then you lost it on this insane bidding system.
Seriously the first part above was great.
I would add that homes were never really an investment. What has happened in the last 3- years has just been financial gearing as interest rates dropped from 7-8% to 2-3% in 2010. Housing used to be intrinsically risk, owners for multifamily had to pay premiums for good buildings and not have them cashflow with debt for 5-10 years. Actually the prior IRS incentives to push people to own and operate multifamily real estate. ....I've lost steam. People were able to buy homes and not put work into them and just make 12-20% irr.
Yeah you’re totally right, tons of IRS incentives for real estate as well during this same time frame.
Long term, housing just cannot be an investment asset. It’s a Ponzi scheme in the sense that no new value has been created, it’s price only appreciates because of artificial scarcity. By definition, if housing is outpacing wages, eventually you have a problem and people can’t sacrifice any more of their paycheck to housing. We’re at or at least very near that point.
Land value + Bidding is just me theorizing about the optimal economic mechanism for putting land to its highest use. Land value tax alone is a great mechanism and something empirically supported by all modern applications. The bidding system is my own theory and I agree with you in the sense that I think it could be problematic. But aside from its other implications, housing and land value would certainly plummet.
Many good answers in this thread, I'd add we could easily open 10s of millions of homes/apartments up and never have a housing crisis again. Simple way to open up housing, remove illegal aliens, foreigners/greencard/temp can only own 1 property (or can't own at all), curb immigration, or better yet, begin shedding immigrants. skilled immigrants can WFH in their home country, unskilled immigrants shouldnt be taking up housing near cities. Building more will never solve the problem as the population grows by a 1mm+ every year due to regulations and crowding.
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