The Tragic Economics of Urban Housing

If a market is highly competitive and has no irregularities, basic economic principles suggest that economic returns will be competed down to zero. Essentially, no provider of a good should be able to raise its price above that of other providers without losing consumers because no one would unnecessarily pay extra for the same product. Unfortunately, in the real world, markets for goods and services are manipulated in favor of special interests on a regular basis. In recent decades, one of the most egregious examples is the rigging of American urban housing, a particularly galling exploitation whose collateral damage afflicts the well-being of America’s lower and middle classes. Decades of cronyism, aided by the good intentions of policies meant to alleviate the situation, have made much of urban America affordable to only the wealthy, with grievous results.

Housing prices, like all other prices, are set by supply and demand: at a certain price, a certain number of people and firms are willing to sell housing units, and a certain number of people are willing to buy them. If the supply of housing on the market increases, the quantity of housing sold increases and the price of housing decreases. If the demand for housing increases, both the price and quantity of housing sold increase.

And demand for housing, particularly in America’s urban metropolises where populations have risen for decades, has been skyrocketing. In the post-industrial, knowledge-based economy, in which education is more and more important to getting a well-paying job, cities across the country are rising in importance. Cities offer easy scaling up of businesses and easy connection to other knowledge centers: density boosts productivity. New York City is famously unaffordable, but home prices and rents have also been spiking in places like Denver, Nashville, and Atlanta, and generally across cities with a sufficiently high population of the college-educated. Demand to live in these hip, high-wage areas has consistently increased while less-educated, rural counties slowly depopulate.

Turning to the shady nature of urban housing markets: in economics, the term ‘rent-seeking’ refers to the process of trying to generate financial returns for yourself in a market through non-market processes (in other words, “gaming the system to make more money than you’ve earned“). This process primarily works through influencing government regulations in a way that privileges certain firms or people over others.

Housing markets are “gamed” by supply constraints. The first type of supply constraint is the closing off of existing units from the rest of the market. For example, in 2014 in San Francisco, 172,000 out of the city’s 376,940 housing units fell under a policy called ‘rent control,’ which is in place in several major cities. Rent control is exactly what it sounds like: the government, instead of the free market, decides what the price of housing will be for some units, forcibly setting lower prices than the market rate. Rent control is a seemingly intuitive concept that can be popular with the general public: it purports to offer housing security to low-income people from unforgiving market conditions and vicious landlords. However, rent control is widely shunned by housing policy experts across the political spectrum for amplifying rent-seeking behavior.

Rent control means that some people who are lucky (or well-connected) get access to below market-rate apartments, but it also means that the supply of housing for everyone else decreases, which means that everyone else, including the low-income people who didn’t manage to get a rent-controlled apartment, face higher prices. Furthermore, under rent control, landlords have a permanent incentive not only to pass on upkeep on their apartments, but also to make life miserable for rent-controlled tenants to get them to leave so they can make more money by replacing them with tenants paying the market rate. This situation is worsened by underfunding of housing regulation and compliance inspectors. Rent control also reduces the incentive to build new housing, which is the root problem, because landlords will have to reserve some units for below-market prices. Governments can do useful things like shifting prices through subsidies and taxes, but most outright command-and-control regulations in most markets are frowned upon for a reason — they cause more problems than they solve.

The other type of housing rigging is rent-seeking restriction on new construction. Across cities nationwide, landlords (and their suburban equivalents, homeowners associations) have used their political power to hugely increase the scope of land-use regulations. The phrase “land-use regulations” alone is enough to put one to sleep, but they are absolutely crucial: they determine the zoning of residential areas, businesses, and public utilities. They determine how high buildings can go, how many apartment units can be put in a building, and myriads of other details about urban planning. By structuring regulations as to minimize new housing development, landlords are able to artificially push up rents on their units — and all other market-rate units in the nearby area. San Francisco, again, serves as a particularly dire case study; across the vast majority of the city, buildings are not even allowed to go higher than four stories tall. From 2010 to 2014, San Francisco’s population increased by 45,000 people, while the number of new housing units built, almost all of which were one-or-two-bedroom apartments and condos, was a mere 7,500. During that time, the median home price in San Francisco increased from about $750,000 to $1,075,000, and there is no end to the imbalance in sight.

Sadly, landlords are often aided in their battles by the most unlikely of allies: urban left-wing activists. Traditionally, urban progressivism has focused on causes such as cultural and historical preservation, ‘tenant’s rights’ (often rent-controlled tenant’s rights), and environmental conservation. Some activists have used the rhetoric of their longstanding causes to justify blocking high-density housing across the country, arguing that increasing density changes the character of neighborhoods, pressures existing tenants, and worsens pollution. All of those causes are important, but low-density housing that makes cities only affordable for the wealthy, plus token low-income people who will perpetually struggle to get by and evade eviction, does not actually help with any of them. Increasing height limits alone would greatly increase affordability without going against any of those campaigns.

The effects of such obstructionism are clear: across the country, the more liberal the city is, the more exorbitant the housing is. It is imperative that policy-minded progressives realize the consequences of this dynamic and convince their colleagues that the current strategy of blocking development serves the landlord class while it hurts virtually everyone else. Even the much-vilified tech companies, which also resent paying out huge amounts of money in office rent every month, are not rent-seekers and are actually on the same fundamental side in this debate as average citizens.

The consequences of this dynamic are simply disastrous. The greatest victims are the usual suspects: low-income people are being gentrified out of urban areas and the middle class, if not already depleted, is next. In the Bay Area, commute times for low-income workers are rising steeply as these people are pushed further and further from urban cores. Long commutes waste thousands upon thousands of hours and take parents away from their already socioeconomically disadvantaged children. Blacks and Latinos have already been effectively shut out of many urban areas due to the legacy of redlining policies that forbade them from buying housing in white areas. Because they are disproportionately low-income, rising rents hit them the hardest.

As economist Thomas Piketty famously articulated in his book Capital in the Twenty-First Century, inequality has skyrocketed in recent decades as returns to capital outpace economic growth. What Piketty missed, at least in his initial analysis, is that “surging house prices are almost entirely responsible for growing returns on capital.” When housing prices increase, the people who already own houses (higher-income, older people) gain wealth in housing equity, while people who are attempting to buy homes for the first time (lower-income, younger people) face higher initial deposit costs and mortgage rates. Higher wealth and income inequality transmits inequality in living standards and access to public goods, like high-quality public schools. The inequality perpetuates itself.

There are many intractable issues in the United States, and urban housing should not be one of them. Overwhelming evidence points to a straightforward way to alleviate the problem: increase urban housing supply by overthrowing the rent-seeking cartels that control it. The economics of the situation are clear; what is needed now is action.

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Andrew Granato, a junior studying economics, is a staff writer at Stanford Political Journal.