The housing market in the United States is grappling with a multifaceted crisis, characterized by distinct problems each stemming from different causes and requiring unique solutions. These issues range from the potential for homes to be larger or nicer, to the availability of homes in better locations with more amenities, and the fundamental affordability challenges driven by an acute shortage.
One significant facet of the crisis is the potential for homes to be larger or nicer. This problem has been chronically exacerbated by low productivity within the construction sector. More recently, the situation has been made more acute by the mortgage crackdown that began in 2008. While addressing this would not lead to earth-shattering improvements, it would offer marginal benefits that are nonetheless meaningful.
Another critical aspect involves homes being situated in better locations with enhanced local amenities. Across the country, metropolitan areas are hampered by arbitrary limits on urban development, which obstruct the realization of locational amenities that city-building could otherwise create. Similar to the first point, resolving these limitations would yield incremental improvements in lifestyle and quality of life. Some of these improvements could be particularly significant for equitable human development, given that cities often serve as valuable hubs for households with lower incomes.
There appears to be a disconnect regarding the development of urban housing. While some cities have been reforming their urban land-use rules, the process of comprehensive city-building was interrupted for a century. A more organic development path would have involved a complex progression of development, depreciation, and the distribution of families across neighborhoods based on their needs and incomes. This would have naturally resulted in a diverse array of neighborhoods with varying values, ages, and structural characteristics, including relatively affordable, dense neighborhoods that might have emerged from the depreciation of older, high-tier areas. The absence of this intricate network of interconnected neighborhoods has led to a situation where expensive, million-dollar condos can coexist with significant homeless populations, surrounded by single-family neighborhoods. This dynamic fuels complaints about gentrification, misattributing the problem to development rather than a century of obstructed growth.
While a complete set of solutions for the complex task of city-building remains elusive, any effective approach must acknowledge that the cost of freezing the structural form of 20th-century cities extended beyond a mere mathematical loss of potential locational value. It represented a profound interruption of equitable quality-of-life improvements, as cities were prevented from fulfilling their purpose for their most crucial constituents: households with below-average incomes.
Furthermore, the crisis encompasses the potential for more homes to be built in cities that possess regional amenities. New York City, historically, has offered value to aspirational individuals globally. Even today, despite narratives of "superstar cities," many densely populated areas of New York City are home to households with relatively low incomes. These residents remain in the city despite the high costs because of the unique amenities available to lower-income households, amenities that have been deliberately excluded from development in many more recently developed metropolitan areas. Figures illustrate that New York City differs from Los Angeles in two key characteristics: a substantial number of very dense neighborhoods with low incomes, and a significant number of very low-density neighborhoods with relatively high incomes. In most cities that have grown significantly since the era of zoning regulations, there is a minimal to non-existent correlation between density and income. However, in cities that developed organically before zoning, density and income are negatively correlated, as most urban amenities function as inferior goods.
The most significant affordability challenge, even in cities with regional and agglomeration value, is directly linked to an acute shortage in the technical sense of the term. Since 2008, ironically stemming from the mortgage crackdown related to the most benign aspect of the housing crisis, this shortage has become a nationwide phenomenon. When supply conditions, whether due to zoning or lending obstructions, deteriorate to a point where numerous families must constantly make difficult decisions about whether to downsize, they resist this pressure. Under such acute conditions, these families opt to pay more to avoid downsizing or displacement.
It is precisely under these acute conditions that nominal spending on housing escalates to uncomfortable levels. In metropolitan areas like New York City and Los Angeles, this has become a permanent fixture, largely attributable to local zoning regulations. Until these rules are revised, a substantial number of households will face displacement annually, with many willing to incur significant costs to avoid becoming part of that displaced group. The impact of this process on rents and prices far outweighs the effects of regional amenities for high-income newcomers and local amenities for low-income residents.
Figures comparing Phoenix and New York City, using price-to-income ratios, illustrate the scale of various price effects. These include the impact of regional amenities (comparing affluent areas in NYC versus Phoenix), cyclical inflation (comparing affluent areas in 2005 versus 1999 or 2022), local amenities (comparing dense, low-income areas of NYC with non-dense areas of NYC), and the effect of a perpetual shortage (comparing non-dense, low-income areas with non-dense, high-income areas). These factors do not directly correspond to the four points outlined earlier but represent a separate analysis of price determinants.
By 2022, the resistance to displacement, driven by a perennial shortage, began to inflate prices even in lower-income neighborhoods in both Phoenix and New York City. This phenomenon was previously absent in Phoenix before 2008. However, in Phoenix, as long as single-family rental housing is not prohibited, thereby allowing for the adequate creation of all forms of housing, this condition is expected to be temporary. Rental homes will likely be constructed in exurban areas, gradually accommodating pent-up household formation and resuming interrupted migration to Phoenix.
In the interim, the average American is compelled to allocate an uncomfortable portion of their income towards housing expenses. The notion that increasing the housing supply would not elevate the aggregate value of residential real estate is a point of contention, with some housing advocates for dense urban living and certain supply skeptics surprisingly aligning on this view. Both groups appear to err by underestimating the true cost imposed by the housing shortage.
Supply skeptics have adopted the unsubstantiated belief that housing expenditures have not significantly deviated from historical norms. This perspective is demonstrably ahistorical. The widespread public outcry and the disruptive financial crisis of 2008 were partly fueled by the collective understanding that the Case-Shiller index had become distorted due to a lending bubble. However, this understanding was incomplete. A lending boom, which was a component of the factors contributing to cyclical inflation, was identified as part of the issue in Figure 2. The Case-Shiller index's distortion was more accurately attributed to factor number 4 (perpetual shortage) and the cyclical impulse in cities like Phoenix, where numerous families, disillusioned with factor 4 in Los Angeles, accepted regional displacement to areas like Phoenix where new housing could be permitted.
Understanding the profound impact of this error has been the central focus of extensive research. Yet, the emergence of individuals who, after experiencing such a crisis, assert that "actually, there's not much going on here. Cities have always been expensive" demonstrates a level of audacity that is difficult to comprehend. This is not the prelude to a productive debate; rather, it signals that any such debate would likely be futile.
Conversely, some housing advocates recognize that increased development in cities correlates with higher valuations, reflecting progress and value. However, they tend to underestimate the magnitude of the shortage premium, leading them to misinterpret factor 1 in Figure 2 as the primary driver for factor 4. This oversight leaves them ill-equipped to counter the skeptics' claims, as they concede to the anti-empirical assertion that increasing supply will inevitably raise aggregate real estate values.
Larger, more densely populated cities are indeed associated with higher housing costs, increased incomes, and greater spending relative to those incomes. While this statement is factually accurate, it is not the sole truth. Thirty years ago, this might have been the predominant factor. Today, it represents only a small fraction of the overall picture. Figure 2 aims to provide a clearer perspective on this complex dynamic.
Figure 14, from a recent paper titled "We are not as wealthy as we thought we were," presents an estimate of aggregate home prices relative to incomes (the green line) and the portion of home prices attributable to construction, location-related amenities, and cyclical fluctuations (the dark line). The chart clearly shows a significant cyclical surge prior to 2008, which, while substantial, included a component of displacement from the Northeast and coastal California, driving demand booms in Arizona and Florida. After adjusting for mean-reverting cycles, the dark line remains remarkably stable, consistently hovering around three times income under various conditions.
When families opt for locational or regional amenities, they largely trade off structural value. The decision is not between a large home in a suburban area and a similarly sized condo in a city center. Instead, it involves choosing between a spacious house and a much smaller condo. While families may spend slightly more in some instances when exchanging structure and space for public and locational amenities, this is generally offset by other factors. Of the three times income that American families would typically pay for housing under non-shortage conditions, approximately half a times income can be attributed to some form of locational amenity, whether it be luxury condos in a downtown area or row houses near a subway line.
If American cities were to enhance their capacity to provide greater locational value, and this value were to double, the total real estate value would not necessarily rise to 3.5 times incomes. It might increase to approximately 3.1 to 3.2 times incomes. This explains why the Case-Shiller index remained relatively flat for a century: families tend to adjust at the margin to maintain stable nominal housing expenditures.
The yellow line in Figure 14 is superimposed on the dark line and represents the recent phenomenon of a scarcity premium – factor 4, as previously discussed. This premium arises from supply conditions, initially in coastal metropolitan areas and subsequently across the nation, so severe that families pay exorbitant rents to retain their established locations. These are personal reasons that prevent them from moving in a housing market that continually diminishes their perceived wealth until some eventually do. The yellow line, in fact, understates the severity of the problem, as it is a net figure derived from two opposing factors: (1) housing inflation resulting from the supply problem, which has effectively doubled the value of the average urban American home, and (2) a disincentive factor that is not fully detailed in the provided text.
