Supply & Demand Economics strikes again!
In case there is a paywall of sorts:
If the government tightly limited the production of sneakers, thereby triggering a bidding war over scarce athletic footwear, few would question whether the state’s deliberate suppression of shoe manufacturing was implicated in rising sneaker prices. In the shoe market, people find it intuitive that limiting the supply of a widely sought good increases its price.
And this same intuition holds for most other markets. If a drought decimated wheat harvests, leading to a shortage of grain and rising bread prices, few would have trouble discerning that the latter was a consequence of the former.
But in housing, this comprehension of the relationship between supply and affordability breaks down. A 2022 study from political scientists in the University of California system found that a majority of Americans do not believe that increasing the supply of housing makes it more affordable. And this perception was not unique to homeowners, who have a material interest in maintaining housing scarcity, but also prevailed among renters, who bear the brunt of America’s housing shortage. The researchers presented survey respondents with a wide array of different question wordings and arguments, and still only between 30 and 40 percent agreed that increasing the supply of housing units would improve affordability.
This widespread confusion is understandable. If you see a lot of new housing being built in your area, you wouldn’t necessarily be wrong to prepare for a rent hike. But the reason why new construction sometimes correlates with rising rents is not that housing is a good unlike any other, such that the more of it you create the more expensive it becomes.
Rather, the reason is that developers build new housing in response to rising demand. When a bunch of tech firms open up headquarters in Austin and create lots of high-paying jobs there, more high-skill workers will move into the city to take those jobs. Those workers will demand housing, and developers will respond by increasing construction.
But you can’t stop the yuppies from coming by blocking that construction. So long as high-paying jobs are being created in your city, high-income workers are going to move there. If there is no new “luxury” housing to absorb them, they will simply outbid less affluent residents for the housing units that already exist. Thus the less new housing that gets built, the faster rents will rise in a booming city.
And yet owing to the myriad restrictions on housing development in most U.S. cities, supply-chain bottlenecks, and other factors, new housing construction rarely ramps up fast enough in response to rising demand to reduce rents; rather, it merely slows the pace of rent increases. Therefore, if you see new housing being built in your neighborhood, you have some cause for expecting a rent hike when your lease is up.
If new construction sometimes augurs rent increases, however, it does not cause them. Evacuations often precede hurricanes. So if you live in a seaside town and see your neighbors all packing up their things and leaving at once, that’s a decent indication that a hurricane is coming. But it would not be rational to respond to this observation by imploring your neighbors to stay put lest they cause wind speeds to surge above 75 mph.
To be sure, believing that new housing construction can trigger rent increases is not as irrational as thinking that evacuations cause hurricanes. There is a coherent theory of how the former could occur: Shiny condo towers attract higher-income people into a neighborhood, which leads to the opening of stores that cater to upscale tastes, which attracts more high-income people into the neighborhood, which pushes up demand for housing there and, thus, rents. In practice, though, there are a good number of studies showing that this “induced demand” phenomenon does not actually happen, even at the hyperlocal level.
At the level of a city as a whole, meanwhile, there is no ambiguity in the empirical literature: More housing leads to more affordability. People will not move to a new city just because they heard that there’s a condo tower there with a sick roof deck. It is plausible that, in some circumstances, affluent people already living in a city might move to a new neighborhood because its housing stock has become more desirable. But to the extent that this happens, it would have the effect of reducing demand for housing in other parts of the city. As a result, there is overwhelming empirical evidence that expansions in housing supply slows rent growth at the municipal and regional levels.
In fact, Americans are seeing the power of new housing construction to push down rents right now.
Between 2020 and 2022, America witnessed a huge run-up in rental prices. This spike in housing prices was long in the making. Over the past decade, Americans formed 15.6 million new households but built only 11.9 million new housing units. As the millennial generation aged out of living with roommates (or parents), demand for housing was always poised to surge far past supply in the early years of this decade.
But the pandemic exacerbated matters. The rise of remote work abruptly increased Americans’ demand for floorspace. Many laptop workers who’d previously been comfortable living with roommates decided they needed their own one-bedroom apartment; many of those in one-bedrooms decided they needed a two-bedroom apartment to accommodate a home office; many with a two-bedroom decided they needed a house, etc. Meanwhile, as remote workers trickled out of urban centers into suburbs, beach towns, and other amenity-rich (but previously somewhat job-poor) areas, rents in those places suddenly surged.
But now, rent growth has returned to its pre-pandemic norm with prices advancing at an annual pace of between one and 3 percent, according to real-estate data firm CoStar Group. In June 2023, asking rents were just 1.1 percent higher than they had been 12 months before. Given that wages grew at a far faster clip over that same period, a rental home was more affordable for the typical worker this June than it had been a year earlier.