The following post examines the current housing market in the first of a series exploring the root causes of the American housing crisis and how public-private collaboration can chart a different course.
Housing is integral to social justice and economic opportunity, and it is the foundation for education and public health. In the U.S. the public sector regulates, enforces, and in some cases delivers housing in an attempt to uphold shared values and standards, address community needs, and drive economic prosperity. Over the past 20 years federal, state, and local governments have spent billions of dollars to provide housing stability to the under-served. Despite these efforts, access and affordability in the U.S. housing market have fallen sharply over time, and are likely to decline further amid the coronavirus pandemic and recession.
Even before Covid-19, the housing crisis threatened the economic prospects of an increasing number of Americans. Tragically, the impacts of housing shortages are felt most sharply at the lower rungs of the income ladder; for every 100 extremely low-income households, there are only 36 affordable rental homes on the housing market. Housing instability affects an ever-greater number of Americans — not only the 38 million people who live in poverty as of 2018, but the 38 million “cost-burdened” households who spend more than 30 percent of their income on housing, and the millions more who survive paycheck to paycheck.
Public officials across the country have discovered that no amount of housing subsidy can incentivize the market to work for the benefit of their communities, or meaningfully address the housing challenges they face. As the nation grapples with simultaneous public health and economic crises, improving housing access and affordability means getting down to brass tacks.
Can a free market ever provide all of the housing needed in our society? Why is it that the public and private sectors are unable to achieve efficiency and fairness? The answer lies in the structure of the housing market and the housing development process itself.
The housing industry evolved from a local activity where land was abundant and neighbors worked together to build homes, to a land-constrained environment with a highly specialized and regulated industry. The permanent, physical nature of real estate combined with local health and safety regulations have shaped a housing industry that develops, finances, designs, and builds one project at a time, with all construction work done on site by local contractors. Architects, developers, financial institutions, contractors, and others compete to maximize profit and minimize risk in housing creation.
Housing development is generally divided into market rate projects, financed by the promise of future renters paying full price, and so-called “affordable” projects, which rely on government subsidy to produce a home that is attainable at below-market rent. Yet market rate and affordable housing developers must work with the same available land and the same pool of industry participants — architects, engineers, contractors, etc. — to build their projects at the same industry rates. Affordable housing is actually more expensive to produce than market rate because the developer must pay additional costs associated with obtaining public subsidies and managing legal and financial compliance. Amid soaring demand in growing urban areas, per-door build costs for affordable apartments now range from $500K to $1M.
The implications are alarming. First, the industry is supply-constrained and can build only a fraction of the housing needed to meet demand in fast-growing areas such as Los Angeles and the Bay Area. Second, supply constraints mean higher building costs and a strong incentive for the industry to produce for the highest end of the housing market: luxury housing. Third, whether it’s private capital or public subsidy, the more money available to build housing in a given market, the higher the cost for this scarce resource.
Many believe that construction innovations such as modular construction and panelized building systems save time and money, thus providing a solution to the upward spiral in housing costs. But traditional modular builders are wedded to the incentives of the real estate market. They have their own labor and material costs, profit requirements, and competitive pressures. Modular firms match their prices with conventional offerings like on-site framing and tout the speed advantage of modular technology, while their developer and general contractor customers simply pocket any savings that result. Rather than making housing more affordable, modular technology has functioned as a replacement input into an industry that historically has invested next to nothing in research and development.
Moreover, competition among modular providers actually discourages housing innovation, as a glut of commodity-priced modular solutions race to build the lowest quality product at the highest possible price. In our new era of Net Zero, climate resilient, and public health conscious development, this is no room for a race to the bottom in efficiency, performance, and durability.
Contrary to popular and convenient opinion, the current housing market isn’t broken, it’s working perfectly as designed and in a very efficient manner. No one in this business will innovate to disrupt themselves. And if all the money in the world won’t fix housing, then perhaps we shouldn’t be trying to fix it at all. Perhaps we need to create a new housing paradigm that leverages innovation to drive down costs, reduces the need for subsidies, and creates new wealth.