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Take a Walk on the Supply Side: New Evidence on Housing Construction and Rents

Jason M. Barr  (@JasonBarrRU)                     November 29, 2022

The price of housing just keeps going up and up and up.

In many urban neighborhoods, one can’t help but notice the rise of luxury apartment buildings. To the casual observer, it must be that they are driving up the cost of housing. But is this a confusion of correlation with causation? Naturally, the buildings they replace are more expensive, but what about their impacts on their respective neighborhoods? Do they cause their prices to rise as well?

Supply versus Demand

To the economist, supply is supply—if you build more housing, it must be that prices will fall. But the typical person will respond, “I don’t believe it. I see life getting more expensive each day and it must be from the rich boxing out the poor.” But as I teach my students in Economics 101, if you observe price movements, you cannot infer anything about what’s driving them since prices reflect the intersection of supply and demand. Changes in either one or both can be the cause.

The problem is that in vibrant cities, housing markets are in a perennial wrestling match, where demand is the 300-pound giant on steroids, while supply is the skinny guy in khakis and a cardigan. We can’t see the supply benefits because they keep getting body-slammed by demand. If we really want to know the impact of new housing, we must figure out a way to identify what economists call the “pure supply effect.” In other words, how does one “surgically” extract supply and remove the demand side to look solely at how new construction affects rents?

Identification

In the last few years, several economists have directly attacked this problem in some clever ways. And what they find, collectively, is that yes, more housing—even at the upper end—produces improvements in other people’s lives, all else equal. Greater supply means lower prices, plain and simple.  But let me stress the “all else equal” part. The statistical methods isolate the supply effect holding constant or controlling for local demand. In this sense, these economists implicitly measure what would happen to prices in the absence of new construction.

All the research discussed below does, in fact, find that new construction is associated with “gentrification” in that this construction is then followed by an increase in neighborhood amenities like restaurants and cafes. But the evidence also suggests the new construction takes place in neighborhoods that are already on the upswing. Developers strike when they see the writing on the wall. “Gentrifiable” neighborhoods draw new construction, leading to more restaurants and a sprucing up of the housing stock, which then attracts more construction, and so on.

This research also suggests that the benefits of new supply are highly localized. If a building appears, the small reduction in rents tends to be within walking distance. If new buildings are relatively rare, it’s that much harder to discern this because of the larger tidal forces of gentrification and urban growth.

Treatment and Control

This crop of research uses so-called event studies. The basic idea is to identify a “treatment group”—that is, a neighborhood gets a new building—and compare it to a “control group”—a neighborhood that does not—to see if there is a difference in outcomes, in this case, apartment rents.[1]

Vital is that treatment is either randomly administrated or independent of the larger demand for housing. This is important because if developers build where housing prices are appreciating, it will seem both to the naked eye and statistically as if the developments are driving the price increases.  If price increases draw more development, we can’t determine how supply affects rents properly. This two-way relationship needs to be “cleaved.”

San Francisco

One way to overcome this measurement hurdle is to look for random events that take old buildings offline and put new, larger ones in their place. Dr. Kate Pennington, in her paper, “Does Building New Housing Cause Displacement?: The Supply and Demand Effects of Construction in San Francisco,” uses a very clever way to identify a the supply effect.[2]

Her method is to find buildings destroyed or highly damaged by accidental fire (excluding ones that burned by suspicious circumstances, such as arson).  The fire is thus unrelated to housing prices in the neighborhood. Between 2003 and 2017, she found 158 fires, and 47 were so severe they required the construction of new apartment buildings.

Based on this strategy, when a new project is completed, Pennington found that “monthly rents fall by $22.77 – $43.18 relative to trend, roughly 1.2-2.3% for people living within 500 m [1640 feet] of a new project.” In other words, demand may be causing housing prices to rise overall, but the new building is reducing that rise for people who live close by.

New York City

Permits versus Occupancy

Dr. Xiaodi Li, in her paper, “Do New Housing Units in Your Backyard Raise Your Rents?,” studies the case of New York City. She measures two variables related to new construction. First is the year that the building received its initial construction permit. Next is the year when the certificate of occupancy is issued, and the building has been cleared to receive tenants. The idea is to look at the impact of building openings, conditional on, or holding constant, the time since the permit was issued.

The permitting year, presumably, captures the fact that developers start a new project after seeing significant local price appreciation. But a building’s opening time after that is essentially random—due to many factors outside the developer’s control, such as waiting for banks to approve loans, weather, lawsuits, supply chains, architectural and engineering issues, and so on. She finds that within 500 feet (152 m) of the new building, for every 10% increase in the housing stock, rents decreased by 1%.

End of Subsidies

While Li’s paper finds evidence for a net supply benefit, a paper by Divya Singh and Luis Baldomero-Quintana does not. In their paper, “New Residential Investment and Gentrification,” the authors use a similar data set as Li and look at new construction in New York City. Their primary strategy is to identify the supply impact that came from New York’s tax subsidy program changes.

In July 2008, New York altered the law that made new-construction tax subsidies (“421a”) less generous in many parts of the city. Public discussions about the changes had started as early as February 2006, and it took about two years to make its way through the legislative channels. During this time, developers, seeing a more expensive future, rushed to get building permits before the expiration date. This flooding of the market, one would expect, should lead to a net supply effect.

To better isolate the supply from demand, they take a two-step procedure. For each rental building in New York, they “drew” a 150-meter (492 feet) radius around it and then determined if there was a vacant parcel inside the enclosing circle. They then use the presence of a vacant lot or not to predict if there was “rushed construction,” near the building. Then they used this new predicted supply measure to see if the “rushed construction” impacted prices. The idea is that the presence of a vacant lot in a neighborhood is likely to be a random event, unrelated to gentrification, and based on the personal history of the landowners.

However, they find that rental buildings that experienced a 1% increase in the rental stock within 150 meters (due to “rushed construction”) were subject to a rise in rents of 1.8%, on average. This suggests that new construction prompted by the changes in the law pushed faster gentrification than what might have happened otherwise.

Helicopter Views

In a previous blog post, I discussed statistical work that I performed on supply and rents in New York. While my statistical method is not as cutting-edge or sophisticated—and has a broader geographical scope—it does suggest that supply does matter across New York City.

My strategy was also to use a two-step procedure. First, I predicted the changes in the number of units based on the historical restrictiveness of zoning across community districts, given that zoning restrictiveness is independent of current price changes. I then used my new measure of supply to see how it affected prices. I find that a 1% increase in units is associated with a 0.7 to 1.1% reduction in median rents across community districts.

At an even larger scale, research in Germany by Andreas Mense, in his paper, “The Impact of New Housing Supply on the Distribution of Rents,” predicts housing supply “shocks” based on summer rain patterns. Low rain summers mean more housing supply by the end of the year since construction can continue with fewer interruptions. Since rain patterns are essentially random, they can be used to create a random measure of supply. In this case, he finds, “adding one new housing unit to the stock for every 100 rental housing units offered on the market in a given month reduces rents by 0.4–0.7%.”

Housing Supply in Brooklyn
New Gentry City: New Housing in Brooklyn. Clockwise from upper left: 470 Dean Street, 1458 Flatbush Ave, 10 Montieth Street, 325 Kent Ave.

Chicago

The above research looks at new construction, but let’s flip the coin on its head. What happens to neighborhood rents when housing is removed from the market? Dr. Hector Blanco explores this in his paper, “Pecuniary Effects of Public Housing Demolitions: Evidence from Chicago.” The federal HOPE VI program incentivized the demolition of high-rise housing projects in the 1990s and 2000s, 20% of which were in Chicago, offering an interesting laboratory to see how this impacted rents.

The treatment group was neighborhoods in which public housing was demolished. Then, based on a statistical algorithm, Blanco created a “synthetic” control group, using neighborhoods within Chicago that were very similar in terms of racial and ethnic characteristics but did not see public housing demolitions. He looked that the difference in price changes between the two groups and finds “that house prices increased by up to 20 percent over a ten-year period in census tracts near the demolitions.”

Minneapolis

Another pair of papers use a similar strategy of comparing “near” buildings—those within a small radius of new construction, to “far” buildings—those beyond the radius border. The key assumption (backed up by evidence) is that the effects of new construction are very localized but that general demand impacts, as well as housing characteristics, are similar in a larger neighborhood area. Thus, researchers can compare rents in a small radius to rents just beyond this to see what would have happened if the new building was not completed, particularly when the new building is a “pioneer, i.e., the first building after a long hiatus in construction.

In the case of Minneapolis, Anthony Damiano and Chris Frenier, in their paper, “Build Baby Build?: Housing Submarkets and the Effects of New Construction on Existing Rents,” compare rents of units within 300 meters (984 feet) of new construction to a comparison group 300 to 800 meters (985-2624 feet) away. On average, they find no effects on rents. But they then look at neighborhoods of different income levels. They find that in high-income neighborhoods rents dropped by 3.2%. In the medium-income neighborhood, there was no impact. But in the low-income neighborhoods, they found that rents rose by 6.6%, on average. This suggests that in the high-income neighborhoods, there was only a pure supply effect since there would be no gentrification. In the low-income neighborhoods in Minneapolis, it seems that new construction promoted more upgrades to the housing stock that drove rents upward.

Across the U.S.

Brian J. Asquith, Evan Mast, and Davin Reed, in their paper, “Local effects of Large New Apartment Buildings in Low-income Areas,” investigate the impacts of new construction across eleven major cities—Atlanta, Austin, Chicago, Denver, Los Angeles, New York, Philadelphia, Portland, San Francisco, Seattle, and Washington DC—and specifically in low-income neighborhoods (below the median for the city) with pioneer buildings that are presumably gentrifying.

Like Damiano and Frenier, they use the near-far approach for treatment and control, respectively, where their “near” buildings are within 250 meters (820 feet) of a newly constructed apartment building, and the control is 251 to 600 meters (821- 1969 feet).  They found that new buildings lower rents in nearby buildings by 5 to 7% relative to the trend.

Research on Housing Supply.
Summary of Research Discussed in this Post.

Displacement

A few of the above papers also investigate the issue of displacement. For San Francisco, Pennington tracks the out-movers from a neighborhood with a new building to see where they went. She obtained the address histories of 1.24 million people who lived in San Francisco between 2002 and 2017. She defines displacement as the process where the out-movers leave their current neighborhoods for one with lower income. The idea is that higher-housing costs due to gentrification pushes them to look for housing in a cheaper location.

She finds that when a new building is randomly built because of a fire, “On average, an additional project reduces displacement risk by 17.14% for people living within 500m.” In short, she found that new construction makes displacement less likely.

Asquith et al. investigate in-migration by tracking individuals’ addresses over time. They find that new construction decreased the average neighborhood of origin income of in-migrants by about 2%. Additionally, the new construction also increased the share of in-migrants who are from very low-income neighborhoods by about three percentage points, suggesting that new buildings allow low-income people to “filter up.”

In short, while higher-income people move into newly-constructed buildings, they do not find that is also generates a wave of high-income displacers. This is consistent with other research, which finds limited displacement in gentrifying neighborhoods.

The Big Picture

Social science research, however, can be a messy affair. Each project uses varying data sets, with different locations, sources of rent information, new construction measures, neighborhood boundaries, and different times. Each also uses different statistical steps or techniques, which depend not only on the nature of the data but also on researchers’ choices. This is why not all research comes to the same conclusion.

For this reason, we must look at the body of scholarship to see general patterns. To the best of my abilities, I have collected a series of studies that well-represent the latest crop of work being done by economists. And when you look at this corpus, the majority concludes that new supply reduces prices compared to what it would have been otherwise.

Pennington and Li found this in San Francisco and New York City, respectively. Blanco saw that the removal of supply raised prices in Chicago. Asquith et al. estimated that supply increases reduce rents in dense low-income neighborhoods in eleven U.S. cities. Barr and Mense find similar results, though at much larger geographic scales.

On the other hand, Damiano and Frenier and Singh and Baldomero-Quintana see a reduction in prices from new housing in higher-income neighborhoods but a positive effect in lower-income ones. In these cases, the speed of gentrification outpaced the supply effect, on average.

Policies for an Affordable Future

It’s important to reiterate that all these studies focus on gentrifying urban neighborhoods. For good or for bad, non-gentrifying, low-income communities tend not to get new construction. But one thing is clear: You can’t help low-income people by restricting supply. Neighborhoods tend to gentrify because they have good transit and are already close to other exciting places and employment centers. Not building will not stop gentrification—though it might slow it down. So how do you allow for improvements in both neighborhood quality and affordability at the same time?

Vacancy and Quantity

Any housing affordability policy must come from a citywide program, given that all neighborhoods are part of an interconnected urban system. But a review of the above literature suggests some ideas.

The first must come based on neighborhood housing vacancy rates. If the new construction reduces vacancies, this is good. Residents at nearly all income brackets will have more choices and with less pressure on landlords to raise rents.

If new construction, however, lowers the vacancy rates, this is an important indicator that supply cannot keep up with demand. Reducing zoning restrictions and providing more construction subsidies can incentivize more construction. All neighborhoods should have average vacancy rates—in good times—between 7 and 10%. Lower than that can mean rising prices and above that can potentially lead to disinvestment or foreclosures.

Filtering

Another takeaway from these papers is that low-income household affordability generally comes not from new construction for low-income residents, but rather from the filtering process. As a higher-end building comes online, it “frees up” units for those in the lower income brackets. The best way to help the poor is to flood the market with middle-income housing and let the rents in the lowest-income areas fall as a result. The research consensus here suggests that higher-income housing can help the middle and lower classes through this process. We should not fear new housing when it helps to increase neighborhood vacancy rates.

Vouchers

Housing vouchers—subsidies given directly to renters—can be a helpful way to reduce housing expenses for the lowest-income residents. With vouchers, the government pays the landlord the difference between the rent and 30% of a household’s income. But vouchers can only work well if there is sufficient vacancy. In a tight market, if a landlord has many applicants for a vacant unit, she is likely to go with a non-voucher applicant.

Rhetoric versus Reality

The rhetoric on new buildings in gentrifying neighborhoods tends to be spun as us-versus-them–in some form of “They are destroying our neighborhood.” Residents blame “greedy” landlords for jacking up rents. They blame newcomers for displacement and changing the character of the community.

If you took this argument—however species—back in time, great cities like New York would never have become great. They rose to global metropolis status because the real estate market was flexible enough to accommodate all comers. This must remain so.

Yes, we live in different times, where there’s much greater global wealth and mobility, but the fact of the matter remains: new supply helps keep prices in check. The body of evidence presented here shows that it does. We should not fear new construction but encourage it even more.

 

Research Discussed

Asquith, Brian J., Evan Mast, and Davin Reed. (2021). “Local effects of large new apartment buildings in low-income areas.” The Review of Economics and Statistics, 1-46.

Barr, Jason, (2021). “Housing Gotham (Part II): Supply and Prices in the 21st Century,” Skynomics Blog, December 13.

Blanco, Hector. (2022). “Pecuniary Effects of Public Housing Demolitions: Evidence from Chicago.” Regional Science and Urban Economics, 103847.

Damiano, Anthony, and Chris Frenier. (2020) “Build Baby Build? Housing Submarkets and the Effects of New Construction on Existing Rents.” Center for Urban and Regional Affairs Working Paper, University of Minnesota.

Li, Xiaodi. (2022) “Do New Housing Units in Your Backyard Raise your Rents?.” Journal of Economic Geography, 22(6), 1309-1352.

Mense, Andreas. (2020). “The Impact of New Housing Supply on the Distribution of Rents.” Working Paper.

Pennington, Kate. (2021) “Does Building New Housing Cause Displacement?: The Supply and Demand Effects of Construction in San Francisco.” Working Paper.

Sing, Divya, and Luis Baldomero-Quintana. (2022) “New Residential Investment and Gentrification.” Working Paper.

—

[1] My summary of each paper is, by necessity, very brief. All the researchers do a lot of additional statistical work to check the robustness of their results and discern possible mechanisms for price changes. My summaries are just the “big ticket” conclusions. Readers of this post are urged to read the papers for more details.

[2] Note that my literature review here does distinguish between those papers that have already been published and went through the peer review process versus those that did not. All papers were written by Ph.D. economists or as part of their Ph.D. dissertations and are of high-enough quality to merit inclusion in this post.

by Jason Barr 3 Comments

Mitchell Bites Lama: The Unintended Consequences of a Housing Program

Cristina Scofield, Mary Beth Combs, and Jason M. Barr                   October 26, 2022

The post-World War II period was a time of massive government intervention for cities. Public housing was meant to replace the “slums” with affordable and clean shelter for the poor. While land deeds, federally-backed home loan programs, and highway building allowed members of the white middle class to buy free-standing homes in the suburbs.

But the lure of cheap land and the ability of Americans to fully embrace a car-based lifestyle worked too well. Central city areas, like Manhattan and the Bronx in New York, saw the flight of the middle class. Manhattan became a borough of the ultra-rich and ultra-poor, while the Bronx was for the poor and minorities who were boxed out of the suburbs through zoning and racial discrimination.

To counter the unintended consequence of “White Flight,” the New York State government enacted the so-called Mitchell-Lama (ML) housing program to encourage developers to build middle-class housing in central cities. Little did they know that they were setting themselves up again to generate a new set of unintended consequences that would reverberate long into the future.

The Mitchell-Lama Program

In 1955, the New York State legislature passed the Limited Profit Housing Law, which included a provision for the Mitchell-Lama (ML) program. ML has funded the majority of affordable units out of all the supply-side programs in New York City.

Under the provisions of ML, developers get financial incentives (such as low-interest mortgages and/or real estate tax benefits) in exchange for the construction of affordable rental and cooperative housing units aimed at middle- and moderate-income tenants. Current statutes reflect a minimum 20-year “affordability period” in which profits are limited, income caps are placed on tenants, and properties are subject to regulation and oversight by government agencies.

But the affordability period has varied over the years. The original period at the time of adoption as 35 years, after which owners could engage in a “buyout,” but which also carried many financial stipulations and costs. In 1959, during Governor Nelson Rockefeller’s administration, the buyout clause was changed dramatically, reducing the minimum affordability period to only 15 years and eliminating the stipulations on buyouts to encourage the construction of affordable housing.

Mitchell-Lama Apartment Buildings in New York City

Updates

In 1961, all laws regarding government-aided middle-income housing (including Mitchell-Lama) were consolidated into Article 2, Section 35 of the Limited Profit Housing Companies Law of the State of New York. This section, which is in effect today, allows for voluntary dissolutions (colloquially, “buyouts”) after 20 years. To exit the program, owners must have paid off all principal and interest of the original mortgage. Once out of the program, the landlord loses the tax benefits but is no longer under government supervision and can charge market rents.

In the case of Mitchell-Lama cooperative apartments (co-ops), a different dissolution process is required to convert the coop to market rate. Originally, two-thirds of co-op residents had to vote for privatization for a coop to leave the ML program (and thus waive Mitchell-Lama tax benefits). A 2021 New York State bill signed by Gov. Kathy Hochul, however, raised the co-op dissolution requirement to 80% of residents as part of an effort to retain the affordability and availability of these properties. Upon a successful vote, privatization follows. Residents remain owners of their units but must begin to pay market-rate real estate taxes. Many co-op owners, however, sell their units, often for a significant profit. For example, Southbridge Towers, located in Lower Manhattan, was one such Mitchell-Lama co-op that voted to privatize; residents who sold their apartments saw profits in the hundreds of thousands of dollars.

Overall, the program in Gotham has generated about 140,000 housing units (New York has nearly 3.7 million units). Since the turn of the millennium, buying out has been alluring as the prices of market-rate units have skyrocketed. In 2004, there were 125,000 units (53% in co-ops). There are fewer than 96,000 ML units today, and about 70% are co-ops. So, rental buildings have been more likely to exit.

The Location of Mitchell-Lama Buildings in New York City Color Coded by the Number of Class C Violations from 2017-2021. Source: here.

Incentives

It’s easy to see the incentives for favoring a buyout.  Once landlords get through the regulatory red tape, they are free to raise rents and operate outside the auspices of government oversight, opening the door to higher profits. These landlords can also sell their buildings for big gains. Or, in the case of co-ops, unit owners can sell out and receive huge windfalls.

But this leads us to wonder if the buyout opportunity might not lead to some perverse incentives in terms of building maintenance. Are landlords purposely neglecting buildings as they near the buyout date, either to displace rent-regulated tenants to make room for market-rent-paying tenants or with the intention of selling an empty building for a big profit?

There’s certainly some anecdotal evidence. In 2010, the New York Times reported on 1520 Sedgwick Avenue in the Bronx. It was bought by private investors after it exited from Mitchell-Lama. The article reported that “[s]ince the new owners took over… in the fall of 2008, the number of violations has jumped to 598 from 82, an increase of more than 600 percent, according to the Department of Housing Preservation and Development.” Life for tenants became miserable, as the new landlord sought to replace them with those who would pay higher rents.

But is this a larger, more systematic problem? To answer this question, we turned to the data.

Buyouts and Building Maintenance: The Evidence

As a stipulation of government oversight, all Mitchell-Lama buildings are subject to inspections by the NYC Department of Housing Preservation and Development (HPD). HPD publishes the results of these inspections online at NYC OpenData. HPD inspectors enforce the Housing Safety Code, issuing violations of different classes in varying severity. In particular, Class C violations are “immediately hazardous” and refer to issues with lead-based paint, window guards, pests, mold, and heat/hot water violations.

We looked at the incidence of housing safety code violations in Mitchell-Lama properties over the years to see if there was any correlation between the arrival of the expiration of affordability and the incidence of building neglect.  To this end, we performed a statistical (regression) analysis, looking at the drivers of Class C violations for ML properties. (Sources and results here.)

In the first set of analyses, we compared ML buildings to large non-ML rental buildings, controlling for building characteristics, locations, and the number of inspections citywide. We found that overall, Mitchell-Lama properties have, on average, 1.69 more yearly violations than comparable regular market-rate rental properties (regardless of rental or cooperative status).

The Buyout Window

In another analysis, we looked at the number of violations of the ML buildings within a 10-year window around the benefits expiration year, controlling for building location and characteristics,  and the number of total inspections citywide. The data show average increases of 3.5 violations in the year immediately preceding expiration, 2.5 violations in the year of expiration, and 6.35 violations in the year immediately following expiration.

While these numbers may seem small when taken separately, it is important to remember that this means a three-year period would see an average of 12-13 new Class C violations. Within the span of one year until expiration to four years after expiration, there is an average increase of 21.4 new violations. The incidence of up to 12-13 violations within the three-year period and 21-22 violations within five years around expiration is troubling. One Class C violation might mean an entire family is without heat in the middle of winter. Twelve of these violations within a concentrated period make a building virtually uninhabitable.

In short, the data strongly suggest that the buyout opportunity is driving owners to neglect their proprieties to replace low-income tenants with higher-paying ones.

Coefficient Estimates for Additional Number of Class C Violations, on Average, versus Years Till Mitchell-Lama Expiration. Source: here.

The Policy Implications

Given the evidence, new housing code compliance incentives must be implemented, particularly for ML properties.

Inspections

In addition to traditional code enforcement inspections, both annually by HPD and those requested by tenants, New York City could gravitate to a model where inspections are based on predictive algorithms that use data from tax assessors’ offices, utilities, public works, and other sources to identify housing-related health risks and to prioritize properties for inspection and coordinated service provision. And in this case, being close to expiration for an ML property is a risk for tenants.

A recent study of a neighborhood in Boston found that risk-based inspection using a machine learning model resulted in an 1.8-fold increase in the number of inspections that identified code violations.  Beyond these inspection measures, New York also could increase the number of inspections of buildings owned by repeat offenders, such as setting the timing for a building’s next inspection based on how many violations were discovered at its last inspection.

Capital Reserve Funds

Similar to the rules already in place for New York City co-op boards, non-co-op ML building owners could be required to create a capital reserve fund to cover future significant repair and replacement costs.  In addition to regular maintenance of roofs, elevators, fire escapes, and fire doors, building owners should be required to hire a professional architect or engineer every five years to determine a capital budget that looks ahead as far as five years.

Fine structures

HPD violations may result in civil penalties imposed by the Housing Court if an owner fails to comply with the violation and certify the correction or if the owner certifies the correction falsely.  The degree to which these fines are levied and enforced has been questioned by others researching housing code violations.

New York Times reporter Kim Barker shows that the fines are too small to create an incentive for building owners to comply, particularly if they are planning to sell the building after they force the current owners (either through neglect or harassment) to move.  Often the millions of dollars in profit earned by converting and selling at market rates far exceeds the relatively small fines levied against building owners who do not correct code violations.

Stories of landlords who try to drive tenants out of regulated apartments are legend: “In the 1980s, one moved in drug dealers and prostitutes to harass tenants. One landlord legendarily roamed the halls with snarling pit bulls. Several earned tabloid nicknames, such as Dracula Landlord and Reptile Landlord.”

If building owners who want to marketize a building are more likely to neglect the building and/or harass tenants , then fine structures should be reconfigured to incentivize compliance better.  A fine system could be tied to a percentage of the sale price of the building and is based on the number of violations per year in, say, the five years immediately before the sale of the building.

The Future of Middle-Class Housing in New York?

More broadly, Mitchell-Lama housing is becoming a “dying breed.” The real problem is the discrepancy between market prices and the benefits generated by being in the ML program, even with generous subsidies.

While the ML has provided housing for hundreds of thousands of New Yorkers, it raises bigger questions about its overall sustainability. The spike in building class violations that we found around the expiration dates provides evidence of the program’s structural problems.

Going forward, New York needs to devise or revise its methods for encouraging middle-class housing. Back in 1955, when they were writing the law, they did not think of or care about one simple fact: incentives matter.

by Jason Barr 1 Comment

Frictions and the City: Housing Affordability and Redevelopment in New York (Part II)

Jason M. Barr    August 31, 2022

New York City suffers from a housing affordability crisis.

The fundamental problem is that there are too few homes to keep up with the demand, particularly in the middle- and lower-income areas. The rich get the units they want because their money incentivizes developers to provide them. Besides, the places where global jetting setters have apartments are where zoning regulations are the most generous, mainly because of Manhattan’s long history of welcoming density.

A Century of New Housing

A review of new housing over the last century shows that new construction across Gotham in the 21st century has been underwhelming compared to past decades. The last era of big supply increases ended circa 1965. The Roaring Twenties was the best period, where the city was averaged close to 100,000 new units per year. 85% of Gotham’s housing was built before 1975.

Since 2010, just 11% of the roughly 2,100 census tracts in New York City have provided 80% of its new housing units; most of these tracts are close to the city center. In other words, only a few census tracts are doing most of the “heavy lifting.” Hardly a way to end an affordability crisis.

Let’s say that each census tract “pledged” to add its fair share of housing by increasing the number of units by 10% over the next five years—through new construction, conversions, accessory dwelling units (ADUs), etc.—that would add 365,000 units, more than what has been added to the city in the last 15 years (see the figure below). This kind of fairness would be a huge boost to affordability.

In this blog series, I aim to uncover the nature of the frictions to new housing in places where high-rollers are not interested in putting their money—the places where housing is desperately needed but is not being supplied.

Norwood, The Bronx

In a previous post, I looked at the Norwood section of the Bronx. By many measures, it is a successful dense working-class neighborhood with excellent parks, easy access to public transportation, and a strong retail corridor. Yet, a review of the housing stock shows that the neighborhood is frozen in time, with 95% of its residential structures built before 1965! This is a waste, given that Norwood has all the attributes for more transit-oriented housing.

So, what are the main frictions? First is the costs of new construction relative to the residents’ income. Because it is a working-class neighborhood (far off the gentrification path), the income that households can pay for housing is quite limited. The median household income of Norwood is $40,000. Using 30% of gross household income as a benchmark would suggest that the typical household should pay less about $1,000 monthly for rent (the actual median rent is $1,600).

But because of its current density, land values are relatively high, coming in at around $430 per square foot of land. This, combined with the fact that average construction costs for a new apartment building run around $300 per square foot, means that the return on investment on new construction would not generate a sufficient return to attract redevelopment. From an investment perspective, buying an existing apartment building is more profitable than building a new one.

More Frictions

But say the construction costs were lowered, for example, through generous subsidies or reductions in the costs of labor, materials, or building methods, this would not solve the problem. In Norwood, there is a “land shortage.” Most apartment buildings have rent-stabilized tenants. As a result, it’s nearly impossible to empty an old building to tear down. Given the construction economics, a developer would likely need to combine two or more lots and have the tenants in both buildings leave voluntarily, a near impossible task.

A large part of the reason they don’t want to leave is that vacancy in the neighborhood is so low, thanks in large part to rent stabilization and the lack of new construction. Where would they go if they left? Rent stabilization creates a Catch-22—tenants can’t leave because there is nowhere to go, but there is nowhere to go because tenants don’t leave. The rental vacancy rate in the Bronx is now 0.78%!

But let’s say the government came up with a plan to facilitate the movement of people to other buildings nearby, you still would not have solved the problem, because of the zoning regulations. In Norwood, nearly all the residential properties today are required—by law—to be five stories or less. There is no way a developer could buy a low-rise building and construct, say, a 10- or 12-story one in its place (with twice as many units). The rules forbid it.

With all these frictions, is it any wonder that no new housing has been provided in decades?

Rosedale, Queens. This suburban community has expensive housing and is close to the train, parks, and shopping, but restrictive zoning prevents densification to satisfy the demand.

Rosedale, Queens

But Norwood is just one type of neighborhood. New York is nothing if not a city of neighborhoods. To explore the kinds of friction in a suburban community, comprised mostly of one- and two-family homes, we can look at the Rosedale section in Queens. This is a very different place than Norwood. Rosedale is literally at the edge of the city, sharing a border with Nassau County, one of the world’s largest bedroom communities. The median household income, about $93,000, is over twice as high as Norwood.

The neighborhood has about 25,000 residents covering 2.1 square miles (5.4 km2), with a density of 19 people per acre (compared to 120 people per acre for Norwood). About 80% of its residents are Black or African American, with 9% Hispanic and 5% White.

Amenities

The neighborhood has a suite of local amenities. The 90-acre (36 ha) Brookville Park is on the western border. The Long Island Railroad (LIRR) stops at the northern edge. Because it is a small neighborhood, most residents can walk to the station. The rail line runs parallel to Sunrise Highway, a six-lane “highway” with traffic lights. The Greenacres Mall is just on the Nassau side of the border, and JFK Airport is also a stone’s throw away.[1] The southern part of the neighborhood is bordered by a deep channel, onto which backyards abut. Several houses have docks for personal boats.

There’s plenty to offer, but, by my estimate, it has barely grown its housing stock. In 2002, there were about 6,210 units, and in 2021, that figure was close to 6,850—a 10% growth in two decades, an annual rate of about 0.05%. Nearly 90% of properties are one- and two-family homes (and about 5% are apartment buildings). Nearly half of the homes are for two or three families, suggesting a relatively high demand for rental units.

The median price of a one-family home is $610,000. This puts the house price-to-income ratio at about six—considered double the “affordable threshold” of three. In this sense, the typical middle-class household in Rosedale also suffers from an affordability problem.

The Economics of Redevelopment

Since Rosedale is a middle-class neighborhood of free-standing homes, the problem of redevelopment is not rent stabilization. So, what are the frictions?

To see, we need to investigate if it’s economically feasible for property owners to densify. What is the “optimal” density given the income and costs of construction and land? If the optimal density is greater than the current density, it suggests, in this case, that the key friction is either zoning or land assembly.

To this end, I “costed out” various types of redevelopments on the assumption that a developer would buy two typical adjacent lots of 4,000 square feet and combine them to make one relatively large lot (in Manhattan, nearly all the residential lots of this size have 5- or 6-story apartment buildings). I looked at both rental buildings and condominiums (the data, assumptions, and analysis can be found here).

The results suggest that from an economic point of view, the neighborhood has too few housing units. Rosedale has the demand to support garden apartments and low-rise multifamily buildings. That is to say, the revenues from new construction would more than pay for the costs. My analysis also shows that condos would be more profitable than rentals.

Greetings from Rosedale, New York City

The Zoning

Seeing how the neighborhood “wants” more housing, why can’t it get it? A look at the zoning regulations gives some clues. All the residential buildings fall into an “R3” district, with 60% as “R3X.”

R3X

With the R3X regulations, no structure is legally allowed to have a floor area ratio (FAR) greater than 0.5. This means for a typical 4,000 square foot lot (372 m2), there can be no more than 2,000 square feet (186 m2) of space. In addition, there is a height limit of 35 feet (11 m). The house must be set back at least 10 feet (3 m) from the street, and the rear of the home must be at least 30 feet (9 m) from the property line.

In addition, R3X has “contextual zoning” rules which require pitched roofs after 21 feet (6.4 m), further restricting the flexibility of construction.[2] At least one spot of off-street parking is required per dwelling unit.

While the other R3 districts—in this case, R3-1, R3-2, and R3A—have slightly different rules, the broad parameters are the same. No residential structure in Rosedale can have a FAR greater than 0.5, nor can it rise more than 35 feet (11 m), and it must provide off-street parking.

All these regulations mean that it’s illegal to have anything more than a one- or two-family house. In short, nearly 90% of the neighborhood property owners must keep their homes exactly the way they are. More than half of the structures are over the allowable floor area ratio, and nearly all the rest are so close as to make it economically unfeasible to tear them down and replace them with anything except a ballooned-up, more modern version of what’s there now.

The neighborhood is mandated by law to be frozen in time.

Zoning as Blunt Instrument

What’s even more perverse is that amenities surround the neighborhood. The LIRR station is within walking distance (or is a short bike or bus ride away). The western part is bordered by a park, and the eastern part is next to a mall.

The zoning codes makes no distinctions regarding land values and access to these amenities. Lots near amenities will have higher land values, reflecting the benefit to residents. And higher land values suggest a higher demand for that location. Being close to a rail line, for example, is valuable, which means that densifying is the rational thing to do.

However, in Rosedale, it’s illegal for land values to dictate density because the entire neighborhood has the same set of FAR regulations—all of which “force” one- or two-family homes on residents, regardless of whether this is economically rational or not.

A Century of Housing Construction in New York City. During the 1920s, the city regularly built over 80,000 units per year. Today, that figure is closer to 20,000. Sources: here.

What’s To be Done?

Upzone Rosedale

As I have discussed elsewhere, the first thing to do is to permit the allowable FAR to tick upwards based on the demand and land values. The minimum rezoning throughout the neighborhood should be increased from 0.5 to 1.0, with a corresponding loosening of height limits, plot coverages, and off-street parking requirements.

The zoning regulations should also consider the location of amenities and provide higher FARs on these blocks. Upzoning the corridor along the LIRR and Sunrise Highway seems a no-brainer. If city regulations truly had transit-oriented design (TOD) in mind, this area could be rebuilt as a mixed-use walking neighborhood centered around the train stop.

Likely, the MTA/LIRR owns a significant amount of land along the train lines. A master plan should allow the MTA to lease lots to developers now used only for parking ; this way, the MTR can profit from the density and plow the money into improving service. For that matter, the greater the density along the corridor, the more riders and the greater the revenue.

A Streetcar Named Sunrise Highway

More ambitiously, how about a streetcar line that runs along Sunrise Highway from the city to deep into Long Island, and parallel to the LIRR? Again, the blocks along the highway could be converted into apartments for thousands of people in what could be one of the world’s longest TOD corridors (to build along Sunrise Highway would hardly impact Nassau County’s homeowners, though the Nimbyists would immediately cry foul.)

Legalize ADUs

Another no-brainer is to allow homeowners to create Accessory Dwelling Units (ADUs). An ADU is a small additional unit, say a converted garage, basement, or porch, that has separate living space and entrances and is suitable for one- or two-person households. ADUs provide additional income to the property owner and housing options for the very old, young adults, or the single. There are nearly 2,000 single-family homes in Rosedale—imagine each one had an ADU!

Land Value Insurance

One of the biggest obstacles to change is the fear of change—the fear that homeowners will find their house values plummeting as the neighborhood redevelops. Ironically, a densifying community will see increased land values which would help existing property owners. For example, residential land values in Norwood are around $430 per square foot as opposed to $150 for Rosedale, even though Norwood’s median income is less than half of Rosedale’s.

One possible policy is to offer land value insurance to residents. As I have discussed elsewhere, homeowners could take out an insurance policy that would pay out at the time of selling if their land values declined because of rezoning.[3]

The point is that some form of insurance can mitigate fears that partly drive Nimbyism and opposition to rezonings.

Can We Get to Affordable Housing? Think VEAM

The road to affordability, however, begins with systematic thinking. Right now, Nimbyists dictate what happens because they are trying to protect what they have. Parochialism is the order of the day. Residents see changes as a zero-sum game–one neighborhood benefits at the expense of another.

Incentivizing massive redevelopment begins with the idea that all neighborhoods must be ready to chip in their fair share of housing. It also means that people who fear change must see some compensation if they are harmed–to reduce their reluctance of change.

But a big problem is that different government agencies frequently act independently, without any sense that a city is system of inter-connected parts. For example, the Department of City Planning oversees zoning, while the MTA, Department of Transportation, and the Port Authority oversee transportation (each separately from each other). Planning, zoning, and transportation are barely connected, despite the fact that housing and mobility are two sides of the same coin.

While I will have more to say about this in future posts, the road to a better, more affordable city begins with recognizing what I call the VEAM Principle. First is the Value of Land–higher land value places should have more allowable density since land values represent the value of geography. Second is Externalities. Planning polices should reduce shadows and congestion, for example, without imposing undue burdens on what can be built. Third is Affordability. If a neighborhood has low vacancy, it must be upzoned and encouraged to build more units (even above its “fair” share). Affordability cannot come from ad hoc policies and expanding the rent stabilization program. Lastly is Mobility. More housing requires more mobility, which means investments in rail, pedestrian and bike lanes, and driving congestion fees.

If the city truly considers these four elements at the same time, Gotham will get that much closer to solving its affordability crisis.

 

Continue reading Skynomics Blog posts on New York City real estate here.

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[1] Rosedale, however, is on the landing path of airplanes. Giant steel birds descend over the houses. It’s a bit unnerving to see it for the first time.

[2] Why the government dictates architectural practice is beyond me. Sure, things like building scale matter, but if a city is going to add a restriction, it should allow a dispensation somewhere else (such as higher lot coverage). Dictating style alone only serves to make housing markets more expensive. IMHO, when the government forces architects to recreate older styles, it makes the neighborhood look more inauthentic.

[3] The program could not insure against the value of both house and land, since house value insurance would incentivize owners to under-maintain their homes.

by Jason Barr 5 Comments

Frictions and the City: Housing Affordability and Redevelopment in New York (Part I)

Jason M. Barr       June 13, 2022

New York’s resurgence in the 21st century has led to a housing affordability crisis. More than half of the city’s renters pay above 30% of their income for housing. Of this group, one-third are severely rent-burdened, spending more than half of their income on rent. And, of those earning less than $25,000 per year, 85% are severely rent-burdened.  Furthermore, between 2009 and 2019, there was a 59% increase in people living in the city’s shelters.

Now that the pandemic is abating, housing access and costs are worsening. All these problems exist despite a ten-year housing affordability plan implemented by Mayor De Blasio in 2014.

Why the Crisis?

If you ask people why housing is so expensive, you will get different answers. To many, the affordability problem is a result of gentrification and the rise of skyscrapers along Billionaire’s Row. If you were to poll economists, they’d likely point to overly restrictive zoning, which often prohibits densification. To others, the problem lies with the city government, which does not do enough to encourage or build low-income housing. And yet, to others, the fault lies with “greedy” landlords who allegedly gouge their poor tenants.

While all of these might be true to some extent, the bottom line is that the demand for housing across the income spectrum is greater than the market’s ability to supply it. New York has nearly 3.6 million housing units, so one can’t pin the problem on a single cause.

In a fluid housing market, however, rising prices should lead to a rise in housing supply which would moderate price increases. To the degree that there are “frictions” or barriers to creating new housing, housing is under-supplied, particularly in lower-income markets, where the returns to new development are smaller.

Aim for the Middle

The best way to make housing affordable for lower-income residents is to add an abundance of units in the middle range. Middle-class households, who move into the new buildings, will generate higher vacancies in the older ones, reducing their rents and making them more affordable for those of more modest means.

What barriers to new housing prevent supply from keeping up with demand, especially in the middle range? This post—the first in a series on this topic—will explore the economics (or lack thereof) of urban densification with a particular focus on one neighborhood in the Bronx, Norwood.

The Norwood Section of the Bronx. The neighborhood is surrounded by parks and has easy access to mass transit (black lines are subways). The neighborhood appears a likely candidate for transit-oriented design.

Norwood

This neighborhood remains far off the gentrification path that, in theory, could house a larger population because of its easy access to parks, mass transit, jobs, and retail. A stroll through the area reveals a building stock virtually frozen in time, with 85% of its residential structures built before 1940.

Norwood is a middle- to low-income neighborhood in the north central Bronx. It consists of mostly low-rise buildings built out between the arrival of the subway after 1904 and the Great Depression. About 70% of its residential structures are four stories or less. And another 25% are five- or six-story apartment buildings.

It is surrounded by parks:  Van Cortlandt Park to the north, Mosholu Parkway to the west, the Bronx River to the east, and the New York Botanical Garden to the south. In the center is the Williamsbridge Oval with recreational facilities.

The Montefiore Medical Center complex along Gun Hill Road is the neighborhood’s largest institution and employer. There are two retail corridors, one along Gun Hill Road and the other along Jerome Avenue. There is easy access to two subway lines—the D train and the elevated 4 train—and there’s a Metro North commuter rail stop on the eastern border.

The neighborhood has about 40,000 residents with a gross density of about 110 people per acre (similar to Greenwich Village). In terms of ethnic and racial composition, it is diverse. About 63% of residents are Hispanic, 20% are Black, 10% are White, and 10% are Asian. Immigrant groups include those from Albania, the Arabic-speaking world, and the West Indies. The median household income is $36,800, less than the median for the Bronx, which is $41,900. 96% of households are renters.

TOD?

While, like all urban neighborhoods, Norwood has its share of problems, it strikes me as a vibrant place that should have more housing for low- and middle-income residents. This extra housing would ease the rental burden by lowering rents from increased supply and benefit those who can take advantage of its local amenities.

Given its excellent parkland and easy access to mass transit, it seems a prime candidate for transit-oriented design (TOD), where denser housing is built adjacent to parks and rail lines. Since the neighborhood is far from Manhattan, it is precisely the kind of neighborhood that could, and should, remain affordable for those in the lower-income brackets.

And yet, virtually no new housing has been built in decades. Why not?

I reached out to Lev Mavashev, the Founder and Managing Principal of Alpha Realty, a real estate brokerage firm specializing in mid-market multifamily properties, to get his take on Norwood’s lack of redevelopment. His response, “It’s a supply-constrained market.  There just isn’t much to develop on. Most properties in Norwood are your typical rent-stabilized multifamily buildings.  And the sites that are available for development are constrained by zoning.”

Well, let’s see what the numbers say.

Mosholu Parkway, The Bronx. This strip of parkland is a abutted by blocks of 5- and 6-story apartment buildings constructed in the 1920s.

The Economics of Redevelopment: A Case Study

As a case study, let’s take the blocks of apartment buildings that face Mosholu Parkway, a large strip of green land with a parkway in the middle. The buildings are all five- and six-story apartments, and there is no reason why they couldn’t be redeveloped to house 10-story or even 15-story structures (say with setbacks).

In this case, what would the economics be of tearing down an older low-rise apartment building and replacing it with a medium- or high-rise that could accommodate more people. What would the return on investment (ROI) look like, and what are the major barriers preventing redevelopment?

Return on Investment

Let’s look at a hypothetical development’s return on investment (ROI). Here we define the ROI as the net operating income (NOI) divided by the total cost of constructing a new building, ignoring financing costs to keep things simpler. The NOI is the total income from rent minus the expense of operating the building, including real estate taxes.

The idea is to look at the four major pieces of the puzzle: (1) the costs of buying the land and creating the new building, (2) the expected income from rent, (3) the net operating income (the profit), and (4) the return or profit rate.

The Cap Rate

We need a benchmark to see if a project is worth going forward. In this case, we can use the so-called capitalization (cap) rate, which is the building’s current net operating income divided by its market value. In other words, if an investor buys a rental property, the market price will be adjusted relative to the operating income to give a satisfactory return.

For the average multifamily property in the Bronx, the current cap rate is about 6%. That is, on average, investors expect at least a 6% return (though this varies above or below 6% based on the neighborhood). If new a development produces an ROI greater than the cap rate, it makes sense to redevelop the property, and if not, it’s more profitable to retain the older building.

To make matters as simple as possible, as a hypothetical exercise, we will pick an existing structure, tear it down, and redevelop the lot. We’ll look at three scenarios: (1) replacing what’s there now with the same number of units, (2) creating a building with twice as many units, and (3) a more detailed scenario that looks at the return from building heights that range from six to 26 stories. (The information on the data sources, assumptions, and analyses can be found here). For now, we ignore the zoning regulations.

The Land

To redevelop a property requires buying an old building, having the tenants vacate, and then tearing it down. We can use recent sales prices of these buildings to get a sense of what the land would cost. In fact, one apartment building that recently sold along Mosholu Parkway has all the right elements for a hypothetical teardown/redevelopment.

This 6-story apartment building, completed in 1928, is on a lot of 15,000 square feet and has a total building area of 70,650 square feet (with a Floor Area Ratio of 4.71). In October of 2021, it sold for $12 million. It has 72 residential units (with no retail). It is a relatively large lot and could certainly accommodate a much taller building (in fact, in Manhattan, recent construction on 15,000 square-foot lots frequently rises 20 stories or more.)[i]

Land Cost: $12 million

The Construction Costs

With the property in hand (for now, we magically assume we can empty it. I’ll return to this issue below), we must tear it down and rebuild it. To give redevelopment a “fair shot,” I will assume a relatively low but typical range for construction costs (both hard and soft) of between $300-350 per square foot. Costs are determined by wages and materials, the quality of the finishings and appliances, and the amenities. For this project to work, we must consider one that is relatively modest in scope.

Construction Costs: $300-350 per square foot

The Income

Based on my discussions with real estate professionals, new construction in the Norwood section of the Bronx would likely have average monthly rents of $2,200-$2,400. Rents in the older buildings (most of which likely fall under rent stabilization) are between $1,500-$1,800 per month. The premium for new construction reflects tenants’ preferences for newer buildings.

Average Monthly Rents per Unit: $2,200-$2,400

Net Operating Income

Older buildings typically have expenses that run 35-45% of gross rental income because of aging equipment and less efficient designs. And they often pay full real estate taxes. Newer buildings with new plant and equipment, and more efficient heating and electric systems, will typically have operating expenses at about 25% of gross income (this includes tax abatements as well). Again, to give redevelopment the “best chance,” we assume zero vacancy.

Expenses Ratio: 25% (i.e., NOI is 75% of gross rental income)

 

Scenario I: A New Building the Same Size as the Old One

In this scenario, we tear down the old building and replace it with one that has the same size, height, and number of units (72). The advantages are a higher rental roll and a higher NOI from a more efficient building (and tax breaks). But the downside is the high construction cost. Here we assume the lower construction figure of $300 per square foot and the lower monthly rent of $2200.

Does the ROI hit the 6% threshold?

The answer is no. The best case for this project is an ROI of 4.3%

Total Cost (Land and Construction): $33.20 million
Total Expected Annual Rental Income: $1.90 million
Total Expected Net Operating Income: $1.43 million
Expected ROI: 4.3%

 

Scenario II: Replace with Double the number of units

But the low return for replacing the building may partly be due to the high land values. Therefore, we need to cost out a taller building. In this scenario, we assume there will be 144 units, and the building will be 12-14 stories high (ignoring the zoning, which currently prohibits this kind of structure).

Let’s assume that the average per square foot construction costs will be the higher $350, given the extra costs associated with a larger building. However, a taller building might increase the average rent if people on the higher floors pay more for better views. Again, to give this building a “fair chance,” we’ll assume average monthly rents on the higher end of $2,400.

Does it hit the 6% ROI threshold? The answer is no.

The taller building generates a high return, but it still does not pay to construct market-rate housing in this neighborhood.

Total Cost (Land and Construction): $54.4 million
Total Expected Annual Rental Income: $4.1 million
Total Expected Net Operating Income: $3.1 million
Expected ROI: 5.1%

 

Scenario III: The Search for the Profit Maximizing Building Height

The above two cases show that new construction does not pay. However, it’s only two examples. Maybe we are missing the sweet spot? To this end, I crunched the numbers to estimate the ROI for buildings that range from 6 stories to 26 stories. The idea is to find the building height that generates the highest return.

In this case, I needed to make additional assumptions about rents and construction costs. If you are interested, the details are here. So, what are the conclusions from this exercise?

First, no building would ever hit the 6% ROI benchmark. Second, the profit-maximizing building height is 15 or 16 stories.

Return on Investment vs. Building Height. This graph gives the estimated hypothetical returns for buildings of different heights along Mosholu Parkway in the Norwood section of the Bronx. Source: here.

The Frictions Takeaway

The takeaway from this analysis is that under a reasonable scenario where we have a large lot with a good location, the economics of densification do not pay in this lower-middle-income neighborhood in the Bronx. But if the city eliminated some of the main frictions to densification, much more housing could be supplied. It’s clear that the threshold to unleash new housing is not—from an economic point of view—that far away. If the city eliminates the current zoning restrictions,  you would still not likely see much development because construction costs are too high relative to the potential income, even if tax abatements are available.

What’s to Be Done?

The policy strategy, in this case, would be a two-fold plan. First, subsidize construction costs directly so that the developer of a lower- or middle-income high-rise building pays, for example, only a fraction of the hard construction costs per square foot. The lower the income of the residents in the neighborhood, the greater the subsidy. In this way, unlike tax abatements, the program can directly target the residents that need help the most.[ii]

The second element is upzoning. Right now, along Mosholu Parkway, for example, the allowable floor area for new construction is less than the actual floor area of the buildings. If a developer tore down an old building, by law, the new one would have to be smaller! Once new construction is subsidized, then the planning rules must increase the allowable units. In other words, subsidizing without upzoning is like someone stepping on a car’s gas pedal while the clutch is in park.

Rent Stabilization: The Catch-22

Another issue ignored above is that of rent stabilization. The rent stabilization rules limit the rent increases landlords can charge tenants and prohibit tenant evictions for those in good standing—great benefits to residents.

However, this limits a neighborhood’s ability to provide more housing. Specifically, it’s nearly impossible to evict tenants. And, even if the economics favored neighborhood densification, the time and resources needed to empty the building are so large they reduce the return, eliminating what slim incentives for redevelopment that might be present.

But tenants are rightly reluctant to move because they have few alternatives. Since there is limited new construction and low vacancy, where will they go? And if they did move, they’d have to pay more for rent.

Rent stabilization thus creates a Catch-22: Residents don’t move because there is no new construction, but there is no new construction because residents are not moving.

Jump-starting the Process

The government needs to act to pop a neighborhood out of its stasis. I think the best strategy for this is for the government is establish a new program where an agency or authority buys up large lots or assembles them from smaller ones, clears the land, and then auctions off long-term ground leases to developers who will construct more lower- and middle-income housing.

To the extent possible, the program can focus on areas of underdeveloped or industrial lots. The ground leases would state what must be built and what the rents will be. This way, the government buys the land and then resells the development rights, and if there is a resultant loss in land values (which there would not likely be), they can be directly absorbed by the government.

The government has the power over eminent domain and has planning rights to centralize, coordinate, and jump-start the growth in the housing stock outside of the center. It can begin this process through the selling of ground leases from land it purchases. Once the neighborhood starts to see a rise in vacancies from this new construction, the market itself, along with construction cost subsidies and upzoning, would do the rest.

Can We Get to Affordable Housing?

The only way to get out of the affordability problem is to create more units, especially in the outer boroughs, where gentrification is less an issue. Ironically, the best way to help poorer households is to boost supply for the lower-middle income range. Since new units tend to rent for a premium, higher vacancies in the older units will then reduce their cost and increase affordability.

New York City has vast areas primed for transit oriented design if the government takes the next steps of promoting development along the subway lines and parks. The Norwood neighborhood in the Bronx is one such place given its vast parkland and access to mass transit.

At the end of day, we must recognize that the free market for housing made New York City the world’s greatest metropolis and it will be the market that continues to provide housing for Gotham in the 21st century. As  real estate broker Lev Mavashev put it, “Developers need the government to be their partner. The government needs to incentivize construction and new development, not restrict it via red tape and regulations.”

The data support this notion.

 

Continue reading Skynomics Blog posts on New York City real estate here.

 

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[i] Land values are not exogenous in the sense that if allowable FAR was increased or tax abatements were removed, the value of land would adjust accordingly. Generally speaking, for multifamily residential, land costs are expected to be between 25-33% of the total per square foot costs.
[ii] I will leave for future work which type of subsidisies will affect the city budget less. At any rate, it seems that the real estate tax abatement program in New York, known as the 421a, is on its way out. It’s longer run impact on housing construction is unclear, especially if removal of the abatements reduces the price of land.

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