Affordable Housing & Economics

Affordable housing is an important issue across the country, and one that’s easy to think of here in high-growth Austin, Texas. House prices and rents have risen dramatically, especially in central Austin, causing families to move further out, and many musicians (who are so integral to our culture, here in the “Live Music Capital”) to flee the city entirely. For many low-wage workers it can mean even tighter times, less money for everything from groceries to gas to saving for their child’s college education.

Solutions for the affordability issue tend to fall into two different categories: some are economic solutions that attempt to address the root causes of unaffordable housing prices, and others are solutions that focus on direct provision of affordable housing. I’ll talk about this second category in an upcoming blog post, as there is a lot of excellent work being done; but in today’s post I want to focus on root causes and some examples of policy attempts to address the issue at that level.

Let’s kick off the discussion with an example from New Zealand that may seem extreme here in the U.S.: they recently banned most foreigners from buying a home in New Zealand. Housing prices have almost doubled since 2007 in Auckland, the country’s largest city, and foreign ownership in central Auckland has risen to 22%. The associate minister of finance put the rationale this way: “We believe it’s the birthright of New Zealanders to buy homes in New Zealand, in a market that is shaped by New Zealand buyers, not by international price pressures.”

For many Americans, that may sound like draconian government intervention and a violation of market principles. But is it really? First, the common belief that “free (i.e. unregulated) markets are good for society” is not accurate. Rather, economics says that competitive markets with no significant externalities are good for society, as they maximize output and growth, minimize consumer costs, and provide competitive wages. Many real estate markets do have several of the attributes of competitive markets: in large markets there are generally a lot of sellers and a lot of buyers, and there is a lot of information available to consumers about prices (through MLS systems) and about property condition (due to legislated requirements that sellers disclose all information they have about property condition).

But most real estate markets are also influenced, often heavily, by government action, some of which is consciously taken in order to influence the market. Interest rates, determined to a large degree by the Fed’s rate, make an enormous difference in the price a buyer can afford. A buyer who can afford a $200,000 mortgage when the rate is 6% (a typical pre-Great Recession rate), can afford a 25% bigger loan when the rate is 3.75% (a rate common for many recent years), thus boosting prices. Lending requirements also have a large effect, as we all observed in the runup to the Great Recession, when loosened restrictions, combined with opaque financing tools (e.g. CDOs), boosted prices by shifting risk from lenders to investors and the public.

City and regional governments play a big role as well. A decision to build a highway from an urban area to outlying areas will increase property values in those outlying areas. Municipal incentives to bring more employers (and thus more people) to town will have a similar effect, especially when the engendered growth happens more quickly than the housing supply can adjust. And the motivations and needs these goverment entities must balance are often skewed against affordability: buyers immediately become future sellers, and those that can afford rising property taxes thus have an incentive for prices to increase.

Finally, we must not forget that housing is an essential good for everyone. This provides both an obvious political reason to keep prices in check, and also another strong economic reason to do so: necessity goods intrinsically have low price elasticity, meaning they are the most susceptible to abuses of market power that increase prices beyond competitive-market rates.

Going back to the example of New Zealand banning foreign real estate ownership — it is not clear at this point whether that policy will have the desired effects on affordability. But recognizing the myriad ways that policy already impacts housing prices makes a compelling case for trying ideas like this. Foreign ownership of real estate is increasing in the United States as well, with Texas near the top of the pack, where foreign purchases as a percent of the total leapt from just 2% to 15% in the years between 2008 and 2016. Just how much this factors into the rising cost of housing we don’t yet know, but we may find ourselves at some point dusting off examples like New Zealand’s as we search for new answers.

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