Not In My Black Rock
Investment funds are buying up houses. That's not why they're expensive.
Wall Street buying homes isn’t a big deal
Over the last couple of days, people on social media were ANGRY at big investment funds, especially Wall Street colossus BlackRock and its trillions, for buying large numbers of single family houses to rent them out. Threads like this were shared tens of thousands of times each. Is it a big deal? No.
Private equity firms have horrific reputations in the US, and not for bad reason: for example, employment in firms subject to their takeover shrinks 13% in the first two years (for publicly listed companies) and earnings drop 1.7% per worker on average. These firms have been buying houses for at least 15 years, if not more, and while do have a bad reputation for being especially bad landlords, their large purchases of homes in distressed areas after the Great Recession have also helped stabilize some of the worst hit housing markets in the US. The most important caveat is that the “hedge fund landlord” market is vanishingly small: they own, at most, 1% to 2% of all homes in the US - a third of what corporate investors in general owned, and just under one twentieth of all investor-owned homes (i.e. single family homes bought with the explicit purpose of renting them).
This comes in a context of crazy news reports of intense bidding wars, double digit percentages over asking, and even, in one case, a couple who offered to name their firstborn after the seller in exchange for the listing. A majority of houses are sold within weeks of being listed, and most of them by people who had never set foot in the house they bought. People are so mad because, of a limited supply of housing (more on that later), additional demand by the bottomless pockets of the titans of finance is simply no match for the humble everyman. While these greedy companies want to buy the houses and rent them, families want to buy them so it can be their main asset.
These kind of companies own, roughly, 300,000 single family homes. For context there’s 15,000,000 single family homes available to rent, and 80,000,000 single family homes in the country. It seems that, contrary to social media hysteria, the biggest owners of American homes are… American homeowners.
Additionally, it is possible that the housing markets BlackRock and the gang (including, confusingly, a fund named Blackstone) are targeting areas that were already primed for higher property values and rents - the idea is, after all, buy low and sell high. There are plenty of reasons why house prices are going up so much now specifically: 0% interest rates, weird material shortages (for example, lumber), milennials entering their home-buying years, and large savings gluts accumulated by the well off in 2020. I wouldn’t make an argument for a housing bubble regardless.
The economics of it aside (for now), “housing should be abundant and affordable” and “housing should be an asset that perpetually gains value” are not compatible statements, logically. If houses endlessly appreciate, it means they’re getting less affordable over time. And actually the people mad at bidding wars that end with every property scooped up by the wealthy are correct - they’re just mad at the wrong things. If more demand raises prices (which is their argument) then… would more supply lower them?
Why are houses so expensive in the first place?
There’s two stories here. The first is Econ 101 supply and demand. The other one is more complicated supply and demand. Econ 101 is usually a bad, limited way of understanding the discipline. However, it is more or less useful as a framing device here: if there’s not enough supply of something, the people willing (or able) to pay the most will get it. Normally, entrepreneurs would smell opportunity and make more of the thing. Why don’t they? Because the government doesn’t let them.
Initially, there would be a number of mitigating factors. For example, building a house in many places may be more expensive (for example, due to rough terrain) or the land under the house may be very costly. Plus, not all parts of the US have this kind of problem. While California or Connecticut have incredibly expensive housing, states like Mississippi or Maine just chug along. How desirable certain areas are is also important: many high rent cities have very attractive labor markets or a good school system.
But empirically, construction costs and land values simply can’t explain the large differences in housing prices between cities - Detroit, Seattle, and Los Angeles are more or less equally dense, but have very different home values. The difference seems to hinge on land use regulations (i.e. what you can build and where) that make building houses harder in cities that have enough land for them. The harder it is to build houses (legally), the more expensive houses are.
Consequently, most “standard” models predict that neighbourhoods where land is more expensive would have more dense housing, frequently built more recently, and that more valuable houses would have more investment in additions and alterations, to keep property values up and also for improved amenities (many valuable houses are also very old). But as seen on the chart above, this is not the case: alterations and additions are somewhat accurately predicted by housing prices, but new construction is not.
In most of the United States, the vast majority of urban land is used for single family houses. In fact, only about a quarter of all land in American cities can be used to build anything that’s not a big house for just one family. The division of land between uses has a very intuitive consequence, that to build more houses cities have to get physically bigger (i.e. sprawl) or replace existing buildings.
Zoning isn’t the only type of regulation that affects housing: people must also contend with things such as parking minimums (a required number of parking spaces to be built for every expected person in a building), heigh restrictions and lot size requirements (exactly what it sounds like for both). For instance, mandating large lots means fewer and larger houses, which are more expensive, while making buildings too short means they contain fewer homes. Finally, many places throw in additional steps as requirements, such as environmental impact studies, or public hearings where neighbors can state all of their objections to a proposed development.
The cost of housing is also directly linked to rent: renting a property must be at least as profitable (over time) as selling it, so higher property values mean higher rents.
To be fair, many cities (especially in Texas) don’t have any zoning at all - such as the fourth largest city in the US, Houston. But most of them do have some combination of parking mimums and lot size requirements by area that sort of occasionally work as de facto secret zoning. And some Northeastern cities have a different problem, that land is so scarce it pushes up building costs enormously, although they also don’t allow enough houses to be built in the first place anyways.
California is probably the most egregious case in land use regulation. Most municipalites barely zone any land for multifamily housing (duplexes, triplexes, or apartment buildings), mandate very large lot sizes, demand long legal processes for new developments, and impose onerous limits on building height, which results in the multifamily developments that do get build being much smaller. All of these means that building houses that people actually want in places they can live in (most egregiously, San Francisco and the rest of the Bay Area) is too costly compared to other types of housing.
Land use wars as class wars
People are somewhat reasonable, so if you explain this problem well enough, they’d probably want to change things. But instead, zoning and housing became fiercely debated topics in cities, with two distinct factions. On one side, you have local homeowners who steadfastly refuse to accept new housing in their area; on the other, groups that (for the reasons cited above), want looser regulations and more homes. The “anti more housing” group was named the Not In My Back Yard-s, or NIMBYs, while the latter called themselves Yes In My Back Yard, or YIMBYs. Why don’t the NIMBYs ever change their minds?
Firstly, they might actually have some (somewhat) reasonable concerns. I don’t think there’s anyone arguing for the abolition of ALL housing regulations. Additionally, opponents of new housing frequently cite complaints (going so back as to the most relevant Supreme Court case on zoning, Village of Euclid vs Ambler Realty, in 1926) are congestion on roads and other public services, noise pollution, increased traffic and traffic fatalities, environmental concerns, or historical preservation (going as far as laundromats). Though there’s also some very flimsy arguments like “changes to the character of the neighborhood” or shade in local parks.
The other reason is, they have money on the line. Lots of it. Remember all the people furious at BlackRock for buying up scarce houses and driving up their price? Well, the NIMBYs like this sort of thing because it makes their houses in desirable areas more expensive. In many cases, desirable areas also have good school systems (they are, after all, funded by property taxes), so parents are acting in the best interest of their children by not allowing more families into the area. This isn’t some fringe conspiracy theory, since when zoning became popular in the 1920s and 30s, this was an explicit selling point: well delimited land use would preserve the character of “desirable neighbourhoods” and ensure that property values didn’t go down.
NIMBYism is, thus, a form of rent seeking. In economics, a rent is a profit made in excess of the market value of a good, frequently because of (artificial or not) restrictions to its supply . To quote Council of Economic Advisors Chairman Jason Furman:
“While land use regulations sometimes serve reasonable and legitimate purposes, they can also give extra-normal returns to entrenched interests at the expense of everyone else (…) Zoning regulations and other local barriers to housing development [can] allow a small number of individuals to capture the economic benefits of living in a community, thus limiting diversity and mobility.”
In the end, many of the NIMBYs are either annoying busybodies that want to shoot down any proposal to put up new buildings for bizarrely irrelevant reasons, and/or blatant rent seekers trying to line their own pockets and hoard opportunities provided to them and their families by land ownership rents.
Land use wars as race wars
Zoning and urban regulation also have a nasty history of, to put it bluntly, racism. All the mentions of “desirable neighbourhoods” free of undesirables very obviously carried a skin color attached to each. While most US cities are zoned now, they haven’t always been: in 1916 only six cities in the entire country had zoning ordinances, but that number increased to 1246 just twenty years later.
The 1926 SCOTUS case Euclid v Ambler Realty was the most important for early zoning, but it wasn’t the first - that “honor” belongs to Buchanan v Warley (1917), in which the Court ruled that cities explicitly forbidding black people from buying houses in certain areas of town was unconstitutional. Private citizens were actually allowed by the Court, from 1926 until 1948, to sign contracts to not sell property to black people in an area - after all, they were private agents with private contracts. And some cities simply re-applied functionally the same laws with paper-thin veneers: Richmond, Virginia ruled that you couldn’t move into blocks where marriage with a majority of dwellers was illegal, which de-facto racialized zoning since Virginia would not allow interracial marriages until the Supreme Court ordered it to in 1967.
The most common use of zoning as a means of segregation was redlining, which was mentioned in last week’s post: most zoning was for detached single family homes, which are quite expensive, and the federal government simply declined to offer assistance to black homebuyers - if they could even get a mortgage in the first place. For example, sections of the Oakland map above have descriptions as delightful as “so graded because of the presence of two Negro families”, “There are only a few Negroes and Orientals, but the low class foreign element is large”, or “Unless one knows about the colored families living in the district, there is no means of distinguishing their homes from those of their white neighbors”. It does seem like a pretty unfortunate coincidence that most American cities decided to have three quarters of their land specifically dedicated to the one type of house you basically need a loan to buy at roughly the same time that the federal government decided to not give loans to minorities. Makes one wonder.
Currently, a surprising factor is that states like Connecticut and Oregon have most of their new housing built on poorer, less white neighbourhoods. This seems to occur for three main reasons: property values are lower, local leaders are more friendly to development, and locals are less likely to participate in the endless community hearings required. The fact that supply is limited means that more afforable homes are being fought over by rich bidders and lower income ones -and obviously the rich will win that one. Add to this the fact that most new housing is built in low income areas, and you have a perfect recipe for the much-maligned gentrification and for displacement of low income communities (frequently of color).
Conclusion
There is strong empirical evidence for land use regulations, on top of the other kinds that were brought up here, to increase housing prices and thus the cost of living in an area. And the political fight to increase urban density will be uphill, since there are many people with large amounts of money on the line. The fundamental issue at hand is whether houses should be affordable or whether they should be an investment, and it’s pretty safe to say that, through most moral frameworks, the former trumps the latter. And eliminating zoning is a solid step, but not the only one needed.
Unless steps are taken to increase the supply of housing and to make housing more affordable, rates of homeownership will decrease and the proportion of renters will increase, especially for younger people. Fortunately, some cities (such as Minneapolis or Berkeley) and states (Oregon) have taken steps to eliminate such burdensome regulations.
In addition, the current way of taxing property treats land and structures similarly - this would disincentivize more dense building even if cities were upzoned, since lots with more valuable structures (say, apartment buildings) would also pay higher property taxes but the same land value tax than a single family home. Plus, more dense zoning would increase land values in the densest neighbourhoods, providing even greater land rents to homeowners there and worsening the inequities mentioned above. A solution for this would be a land value tax, which taxes structures at a lower rate and land at a higher rate; this idea was first proposed in the 19th century by economist Henry George.
Finally, even with both of these solutions, many low income people would still be unable to afford a home. Currently, there are frequently onerous and unnecessary requirements imposed by multiple levels of government, painfully long waiting lists, and simply insufficient funding for housing assistance. Short of solving every single problem in the United States, there is a space to be filled by policies that complement the ones listed above. Housing vouchers for low-income people, rent assistance, or even just generalized income supplements, would ensure affordability when paired with reforms that aim to increase supply, but might worsen the problem by goosing demand for an inelastic good if more homes aren’t built.
Sources
Shoutout to my friend Julie (@notpretzel on Twitter) for pointing me towards sources for this post on her own substack.
Introduction
“Wall Street isn’t to blame for the chaotic housing market” (2021), Jerusalem Demsas, Vox
“Why You Should Wait Out the Wild Housing Market” (2021), Derek Thompson, The Atlantic
Zoning is bad
Schuetz (2018), “In whose backyards has D.C. built new housing?”
Glaeser, Gyuorko, & Sachs (2005), “Urban Growth and Housing Supply”
Glaeser & Gyuorko (2002), “The Impact of Zoning on Housing Affordability”
Mayer & Sommerville (2000), “Land use regulation and new construction”
Fischel (1990), “Do Growth Controls Matter?”
Furth & Gray (2019), “Do Minimum-Lot-Size Regulations Limit Housing Supply in Texas?”
Murray & Schuetz (2019), “Is California’s apartment market broken?”
Zoning is for rich people
Fischel (2004), “An Economic History of Zoning and a Cure for its Exclusionary Effects”
Halikias & Reeves (2016), “How land use regulations are zoning out low-income families”
Zoning is racist
Silver (2007), “The racial origins of zoning: Southern cities from 1910–40”
What to do?
Goodman & Zhu (2019), “The Future of Headship and Homeownership”