Facebook has recently pledged $1 billion to fighting the housing affordability crisis in California and other areas in which they operate. Apple has recently committed $2.5 billion. Google, Amazon, and Microsoft have all thrown their name into the ring, as well, providing various levels of assistance and funding to address the problem.
We’ve also got politicians of all types opining on the issue and regular folks caught in the middle of it all.
While bringing these funds in certainly can’t hurt, it isn’t going to solve the problem. The problem is certainly NOT that there isn’t enough money coming into these markets. Evidence of this can be seen in the absurdly low cap rates where affordability is the worst. Take San Francisco, where cap rates are between 3 and 4 percent in strong parts of town.
For those newer to real estate concepts, let me help you out. The technical term in real estate for a 3 percent cap rate is “Bat-$*#@ Crazy Expensive!”
A 3 percent cap rate means investors are willing to pay $33 in price for every $1 in NOI. Let that sink in for a moment.
This tells us that investors are more than willing to pump as much capital as possible into these markets. Foreign investors especially love San Fran, L.A., Seattle, and New York. So, the problem is certainly not a lack of funding that commitments from these companies will address.
This Is What’s Actually Going On With Affordable Housing (or Lack Thereof)
What is the problem then?
The problem, like many others that may seem complex, really comes down to simple economics: our old friends supply and demand.
Case Study: California
With the growth of Silicon Valley and all the ancillary economic expansion that has come with it, the demand for housing has risen alongside it.
In a normal, well-functioning market, this increased demand would lead to a rise in housing prices, expressed through both higher home values and higher rents. Do a quick Google search on home prices and rents in Palo Alto, for instance. Then, pick your jaw up off the floor and come back to this article.
Twelve-hundred-square-foot housing approaching $2 million? Yep. Rents of $6,000 per MONTH for a 670-square-foot, one-bed apartment? You betcha.
These higher prices should serve as a signal to real estate developers that there are strong profits to be had by entering the market and building more units. Farmers and other landowners would be enticed to sell or partner with developers to realize these profits. The additional units would then serve to increase the supply of housing and pricing pressures would ease as the number of available units increase and renters can shop around.
The problem is that real estate is not a well-functioning market. And California’s real estate market is as bad as it gets.
Through a combination of political cronyism, nosiness, busy bodying, nimby-ism, and well-intentioned but ill-informed politicians taking action, California has created a highly restrictive system where increasing the supply of housing units is extremely difficult, expensive, and time-consuming. This slows down the rate at which housing can be added and makes the only economically viable developments projects that target the highest end of renters and buyers.
Laws and regulations in the name of preserving “open space,” “smart growth,” “urban growth boundaries,” and the like have the effect of drastically reducing the supply of land for building.
According to the L.A. Times:
“The California Code of Regulations—the compilation of the state’s administrative rules—contains more than 21 million words. If reading it was a 40-hour-a-week job, it would take more than six months to get through it, and understanding all that legalese is another matter entirely…
“But California’s state building code is also especially restrictive and deserves scrutiny from policymakers concerned about housing affordability. By itself, this section of the California Code of Regulations contains 75,700 restrictive terms (e.g., “shall,” “must” and “required”)—more than some states’ entire codes. The residential housing subsection alone has nearly 24,000 restrictions.”
And that is just the state code. You’ve also got local municipalities layering on the requirements.
State and local governments have made it impossible for otherwise willing landowners to sell to developers. Those developers that can secure sites are faced with a multi-year process full of hearings, paperwork, fees, fines, and aggressive NIMBY neighbors standing in their way.
When you make it that difficult to create new housing, it shouldn’t be hard to understand why prices are unaffordable. (Refer to the sources section at the end of the article for further support for this thesis.)
The Outlook Across America
It’s not just California, either. All of the places with the most severe affordability problems in the country are highly correlated with the most restrictive housing policies.
Basic economics teaches us that to reduce the price on something, you need to either increase the supply of it or reduce the demand for it. I don’t think anyone wants to destroy all of the jobs in California, thereby reducing demand for housing. Probably also not the best idea to put half of the population on busses and disperse them around the country.
So, we’ve got to focus on supply.
The solution to the problem will come from answering the question: How can we most quickly and efficiently increase the supply of housing to meet the demand and bring down prices?
The Impact of Increasing the Supply of Housing
Let’s do a quick thought experiment to drive home the point. Suppose for a moment that I could waive a magic wand and instantly create 50 million move-in ready new homes and apartments that were easily accessible to the main population centers in California. Before you think it, my magical powers also allow me to create the roads, electrical grid, and other necessary infrastructure, too.
What would happen to housing prices in that scenario? They’d plummet.
How can we replicate this concept in the real world? By removing as many barriers as possible to developers and landowners who want to use their time, resources, skills, and funds to supply the market with more housing.
It would look something like this:
- Restore property rights by drastically reducing the amount of restrictions on buildings, allowing property owners rather than politicians and NIMBY busybodies to decide what to do with the land desperately needed for housing. Allow farmland and land surrounding dense population centers to be developed in a manner decided by market forces. This requires massive reductions in zoning restrictions, lifting limits on lot sizes and densities, setbacks, parking, building materials, and the like.
- Streamline the approval process for new development. Remove any sort of requirements that don’t directly impact safety. Stop giving people and organizations who should have absolutely no say in what happens to someone else’s property a strong voice in deciding what can and can’t be developed. Reduce the number of agencies, paperwork, red tape, and bureaucrats involved in the process. The process should be measured in weeks, not years.
- Remove all rent control laws, which serve to reduce the existing supply of rentals and disincentivize owners to improve the rental stock.
- Relax immigration policies and remove tariffs and trade barriers, so that labor and materials for construction projects can come down.
In short, the way to solve the affordable housing crisis is extremely simple but nearly impossible politics-wise. Get out of the way of the entrepreneurs and real estate developers, so they can do what they do best: create high-quality and attractive living spaces for the people who need it.
Do you agree or disagree with my take on the housing affordability crisis?
Let’s discuss in the comment section below.