I have blogged on several occasions that the only solution to making housing affordable is to expand supply. This supply expansion has to combine both market and public housing supply. The former requires combining multiple policy levers and staying the course with those policies for a long enough time, and the latter requires large fiscal spending. The earlier posts in this series are here, here, here, and here.
John Burn-Murdoch in FT makes the same argument about increasing supply in general, and writes that the trickle-down effects work in the affordable housing market in developed countries.
But recent studies from the US, Sweden and Finland all demonstrate that although most people who move directly into new unsubsidised housing may come from the top half of earners, the chain of moves triggered by their purchase frees up housing in the same cities for people on lower incomes. The US study found that building 100 new market-rate dwellings ultimately leads to up to 70 people moving out of below-median income neighbourhoods, and up to 40 moving out of the poorest fifth. Those numbers don’t budge even if the new housing is priced towards the top end of the market.
He also points to recent research questioning the gentrification argument on squeezing affording housing supply,
Another argument is that building market-rate housing in a lower-income area leads to gentrification, with higher earners moving into a lower-income area and displacing the incumbents. But the latest research from Britain and the US shows that there is typically little, if any, outward displacement of incumbents. It is the incomers who have been displaced, priced out of wealthier areas by supply constraints. In other words, even if you think it’s inherently bad if high earners move into poorer neighbourhoods, the answer is to build more market-rate housing for those higher earners.
A new paper by Geetika Nagpal and Sahil Gandhi explicitly addressed the question of whether the relaxation of zoning regulations increases affordable housing or simply triggers the building of new luxury units by examining data on the effects of a 2018 FAR deregulation in Mumbai.
Leveraging granular panel data and exploiting variation in time and space, we find that the reform increased housing supply in treated areas by 28%, implying an elasticity of housing supply to the FAR of 1.59. The FAR relaxation increases the scale of development, resulting in higher investment in shared amenity space within the building. This increased public good provision facilitates an 18% decline in unit sizes, leading to a 29% decrease in apartment prices that allows lower-income households to access housing. We develop a structural model of housing supply and demand that incorporates the provision of amenity floorspace and shows that after the relaxation, average home buyer incomes are 3.18% lower. We use the estimated model to show that a further 5% rule-based relaxation would amplify the scale economies and increase the affordability gains from deregulation by 1.7%. Taken together, our results show that concentrating FAR relaxation can improve affordability.
In this context, I have blogged that affordable housing policy instruments should not only target supply but also specifically target the genuinely affordable housing supply. I argued this, especially in the context of large developing countries like India, where the baseline market conditions are very different from those in developed countries. In these countries, the demand-supply mismatch covers the majority of the population and their affordability gaps are much higher than in developed country cities.
The housing market in developing country cities consists of at least four segments. The first is the richest sliver, who can afford housing in the main parts of the major cities. Second are the higher income and upper middle class whose affordability is confined to outside the main core of the city, third are the middle and lower middle class who have incomes but enough to buy only at the margins of even the suburbs and face the genuine affordability problem, and finally those who cannot afford any market supplied housing and thereby end up in slums and squatter settlements.
The third and fourth categories make up the vast majority of the population, certainly over 80%. The affordability gap for the third group is very high, in orders of magnitude of their current affordability. As an illustration, assuming an annual income of Rs 6 lakh for these households and affordability of ten times annual income, the supply of Rs 60 lakh units will however be only at the margins of even the suburbs, if at all. The fourth group will certainly require some form of heavily subsidised housing or public housing in rental mode.
In this context, what's of relevance is not the unit size, but the price. Even within the price, it's the unit price declines that are of critical importance. And even when there are reductions, they have to be high enough to make any meaningful dent in the problem.
This is because the supply of market rate units will mostly serve customers with higher incomes and this market itself is large enough to absorb most of the incremental supply for long years. The trickle-down effect does not materialise in any meaningful manner in a finite time period.
There are several issues with drawing the general conclusion that FAR deregulation leads to an immediate and significant enough impact on affordable housing supply from the paper. For one, the paper does not discuss what constitutes affordability and the aforementioned market segments. I'm not sure about the meaning of the 29% decrease in apartment prices, since the relevant metric is either the price for comparably sized units or the unit price of housing (per sq ft price). It's impossible to have anything close to such a decline in apartment prices on the same or similar metrics. In absolute terms, given the existing affordability gap, an affordability gain of 1.7% from deregulation would be insignificant. Further, the 28% increase in housing supply in treated areas corresponds to just a 0.7% increase in aggregate housing stock added to the city each year, and tiny addition compared to the requirement. Or the 3.18% average income of the new buyers would itself be so small and confined to within the top income quintile. There are also important limitations to the data sources used in the paper.
Finally, the deregulation was itself limited to sites abutting roads that are more than 12 m (or 40 ft), which invariably rules out those localities that predominantly supply housing for those in the third and fourth categories. This also raises the point that a meaningful dent in housing affordability in large cities requires large deregulation and renewal in slums and lower-income localities. This is also important since the majority of land available in major cities would be those with less than 40 ft abutting roads. At the least, the land values in those places within large cities with more than 40 ft abutting roads would be much higher than in those with smaller abutting roads.
In the net, I'm inclined to conclude that such limited deregulation would end up only slightly lowering the prices, increasing the affordability, and improving the quality of housing supply aimed for the second segment, but would have only negligible impact on the third and fourth market segments.
On this point, Burn-Murdoch also points to the examples of Auckland and Minneapolis, both of which relaxed zoning regulations with impressive results in increased supply, and that too in a relatively short time period.
In November 2016, large areas of New Zealand’s largest city, Auckland, were rezoned to allow for higher-density building. The results were twofold: a boom in construction of multi-unit housing — predominantly at market rates — and the flattening off of rents in the city in real terms. On the eve of upzoning, median rents were 25 per cent higher in Auckland than the capital Wellington. Six years later, nominal rents had grown by an average of 3 per cent a year in the former and 7 in the latter, putting the two neck and neck. Adjusted for inflation, renting in Auckland is now no more expensive than it was in 2016, compared with a 25 per cent rise in Wellington.In the American Midwest, where Minneapolis has been building more housing than any other large city in the region for years, and has abolished zones that limited construction to single-family housing. Adjusted for local earnings, average rents in the city are down more than 20 per cent since 2017, while rising in the five other similarly large and growing cities.
He also points to a new paper by James Gleeson that points to the importance of increasing the housing supply in making housing affordable.
The latest issue of Works in Progress has an essay by Eleanor West and Marko Garlick on zoning reforms undertaken by New Zealand in response to an acute housing shortage and affordability problem.
When Auckland Council wrote its zoning plan in 2016, the National government successfully pressured the local government to allow intensification across its non-historic suburbs by threatening to use their powers to overrule the council. And then in 2020, the Labour government forced the five largest cities to allow six-storey buildings within walking distance of city centers, commercial hubs, and existing and planned rapid transit stops. But the biggest change came in 2021, when both major parties joined together to force local governments to allow three-storey townhouses in almost every neighborhood in the five largest cities – encompassing at least 57 percent of New Zealand’s population. But this may have been a step too far. Implementation of this most ambitious policy proved fraught, with some local governments strongly resisting the top-down directive. In the face of an upcoming election and the shifting sands of political incentives, the cross-party consensus broke down.
New Zealand shifted from a liberal zoning regime to a more restrictive one in the 1970s as local communities were empowered to control development in their areas. Like in the US and the UK, local governments imposed restrictions to contain growth 'out', 'up', and protect historic character areas and green areas with development controls. Simultaneously local consultation requirements were made more elaborate and it was made easier to appeal planning decisions in the courts. This down-zoning led to the zoned capacity for new housing in Auckland being cut by half.
Some of the zoning restrictions were idiosyncratic and unique to New Zealand,
There are ‘viewshafts’ that stop any developments that would block views of some of the 53 volcanoes in the region, including developments in the city center. One viewshaft over the central city, E-10, which makes sure Aucklanders can see Mt Eden from a particular point on a motorway, was estimated to block NZ$1.4 billion (US$800 million) worth of buildings.
As has been seen with the cases of Houston and Washington DC, local governments will permit increased supply if there are financial incentives to do so like additional tax revenues. New Zealand has a structural problem with creating this incentive.
Unlike local governments in the US, Denmark, and Australia, which tax a fixed percentage of a property’s value, New Zealand councils tax via a rating system. Councils determine the total amount of revenue to collect each year, and then each homeowner pays in proportion to their share of total property value. In other countries, more housing automatically brings in more revenue; in New Zealand, new housing only slightly reduces the burden on existing properties.
New Zealand's breakthrough in upzoning came with the Auckland Unitary Plan (AUP), under which 75% of residentially zoned lands were upzoned, mostly meaning that it now allowed townhouses and even apartments. It was a big success with a large increase in dwelling consents and permits for new housing doubling within five years.
The proposed National Policy Statement would require councils to allow at least six storeys of building in areas within walking distance of rapid transit stops, commercial hubs, and city centers in all major cities. It would also abolish minimum car parking requirements across New Zealand’s cities, which had required that new developments set aside large amounts of land for parking. Councils would need to justify character protections on a site-by-site basis, balanced against the need for more homes... The final policy was published in July 2020, less than a year later – uploaded to the internet with no fanfare, no announcement, no press release, to take effect the next month... Though the new upzoning policy avoided public scrutiny to begin with, it attracted plenty in late 2020 when the capital, Wellington – a city where historic-character areas protected 88 percent of land parcels in the inner-residential zone – began updating its zoning plan to reflect the new policy. Wellington was the first city to test the implementation of the new policy... In the end, character areas were reduced by 30 percent and upzoning was applied more widely than initially expected...The Medium Density Residential Standards (MDRS)... policy (passed in December 2021) was even bolder than the first, directing councils to set a new default minimum residential zone in the five largest cities of three dwellings, up to three stories. Essentially, both major parties wanted to permit townhouses and walk-up apartments almost everywhere... This policy would go much further than the earlier National Policy Statement, covering nearly every suburb in the country, rather than just constrained areas in city centers and around rapid transit stops... opponents stressed that the upzoning policies would add pressure to existing infrastructure and raised doubts that the central government could address the problem. A wave of conservative and anti-development politicians were elected to councils around the country in October 2022 amid growing dissatisfaction with the prospect of densification.
The MDRS has struggled to get implemented in the face of opposition from local governments and the collapse of the bipartisan national level support among the two main political parties. The essay points to how the New Zealand government could have embraced the strategy adopted by Houston (more later) by allowing the most vocal pockets of opposition to upzoning to opt-out of broad upzoning instead of implementing the entire policy nationwide.
The Works in Progress has a story on Houston which has been a remarkable success in urban planning, especially in overcoming local resistance to easing zoning regulations.
Real house prices in Houston tumbled along with local incomes during the late 1980s, when the local oil industry took a beating from a global oil glut. But, remarkably, house prices and rents in Houston have remained low, even as the metropolitan area population increased from 2.4 to 6.7 million and the economy returned to booming. By 2021, they were still 23 percent lower in real terms than their 1980 peak. By contrast, inflation-adjusted prices in New York increased by 147 percent and in San Francisco by 216 percent, rendering those cities increasingly inaccessible for those on lower and indeed even higher incomes.
This is what Houston did with its zoning rules
Houston’s Code of Ordinances – its planning rulebook – sets limitations like minimum lot sizes (how big a plot of land must be used for each residential property), how far the building must be set back from the street, requirements for the number of parking spaces that must be included with the development, and much else. Historically, this set of regulations, which require a lot of land for each property, combined with the city’s permissive attitude to building outwards, led to Houston’s characteristic sprawl.In 1998, a major change was made to the Code of Ordinances. The minimum lot size of a plot within the I-610 motorway which circles Houston’s inner suburbs was dropped from 5,000 square feet – about the size of a professional basketball court – to 1,400. This allowed landowners to divide (or ‘replat’) existing lots into much smaller parcels. The reform also changed the rules around property setback from the street, reducing the minimum required from 25 feet to as little as five feet. Whereas previously a landowner with a 5,000 square feet parcel would have generally been constrained to build one home, set back far from the street and with a lot of land surrounding it, now they could build three homes, for three times as many families...Builders had started putting forward more frequent applications for replats into smaller lots in the more central suburbs. Initially the city’s planning authority had considered these on a case-by-case basis... So, rather than continue to process large numbers of replat applications one-by-one, the city redesigned the Code of Ordinances to enable these replats by right, removing the need to apply for each individual replat... The reforms have survived to this day – 2023 marks the twenty-fifth anniversary of their implementation – and, as further evidence of their popularity, were even extended into the suburbs outside of the I-610 motorway in 2013, meaning they cover the entirety of the city’s 671 square miles.
It's outcomes have been impressive
The 1998 reforms, alongside Houston’s generally liberal approach to planning, helped to preserve housing affordability in the central neighbourhoods of the city, with the median townhome costing an estimated $313,000 in 2017, and the twenty-fifth percentile at just $156,000. Life is better for renters as well, with thousands of apartments available for less than $900 a month, unimaginable in many other cities within the US... Houstonians live in bigger, better housing than New Yorkers or Californians, and they do so much more affordably. Increasingly, they do so in pleasant, walkable environments... Indeed, what was once ‘renowned worldwide as the global citadel of carbon-based fuel extraction’ is now an ‘unexpected and almost entirely unheralded success story’ of urban renewal and better environmental planning... Houston, synonymous in many people’s minds with car-centric America, is now mid-ranked among American cities on the Foot Traffic Ahead walkability ranking, with its substantial improvement acknowledged in the latest report. In the 1990s it was the only major city in the United States without a rail system; it now has three light rail lines operating and two more planned.
Any local opposition to deregulation and easing of zoning laws was overcome by allowing homeowners associations (HOAs) covering small geographical areas to opt-out of city-wide zoning regulations or changes to those. This meant that nobody could hold hostage the easing of zoning regulations.
This opt-out system may explain why city-wide reforms were able to pass, and why they have had the staying power to last several decades relatively uncontroversially... Houston sets relatively limited rules about land use at the city level. Instead, many rules around land use are set within private ‘deed restrictions’. These are private agreements between landowners within blocks or small areas. When you buy a home in Houston, it may come with deed restrictions determining how you can use the land... If violated, deed restrictions in Houston can be enforced by the city at the request of neighbours, normally via their homeowners’ association, or HOA...Because these deed restrictions can specify if the lot has additional restrictions to the minimums set by the city-level code, Houstonian homeowners already had an institutional mechanism if they wanted to prevent new types of development near them, regardless of what happens in the citywide Code of Ordinances. If they didn’t want smaller lots to be permitted in their area, they could agree collectively via the HOA to add new deed restrictions. In 2001, new legislation was passed to make opting out even easier, by allowing local homeowners to petition the city to introduce a special minimum lot size (SMLS) even without going through the legal process of altering the deed restrictions... The petition needs to attract 51 percent support from local homeowners, or less than 51 percent support and no objections against... As a result, Houstonian homeowners who really don’t want new homes built near them don’t need to worry as much about the overall citywide rules. They have a much easier route nearer to home: they can agree with their neighbours in the HOA to alter the deed restrictions, or they can petition for a special minimum lot size... Houston’s system allows homeowners to opt out without bringing housing supply in other areas down with them.
And this has a self-regulating dynamic
What this means in a practical sense is that a Houstonian homeowner can opt to have more stringent restrictions on what gets built nearby, but it affects their own property in an obvious and direct way. If they want to set a minimum lot size of 5,000 square feet in their block, they can; but their own property will be worth less should they choose to sell it in the future. So they must decide: what’s worth more to me, the additional value to my property from the right to replace one home with two, or preventing my neighbours from having the same right? Different people come to different conclusions here. Houston allows them to, and it turns out many people don’t mind development next door as long as they have the same option. The benefits, and the costs, of additional regulation are therefore better aligned.
Another feature of Houston's zoning regulations is the sunset clause to private deed restrictions
Restrictions on land use in Houston typically have sunset clauses of 25–30 years. This is a smart workaround for the problem that many planning systems face, where stacks of rules, often conflicting or at least not designed to operate holistically, are added incrementally... Sunset provisions are used widely across legislative and regulatory fields, and they can be highly effective: states that use sunset programmes reduce their spending at the state level but increase the level of government services provided, suggesting that the sunsets help to weed out bad policies while preserving good ones. Similar benefits were seen in London’s Great Estates, where lease renewal dates were strategically timed to permit rebuilding. Much like how the Houston opt-out system prevents individuals from imposing their own preferences on neighbours who don’t share them, sunset clauses do this for future residents. In other places, a restriction preferred by a few residents can not only be imposed on much larger areas, it is also imposed on them indefinitely, long after the residents with the preference are gone.
In another article in Works in Progress, Judge Glock examines the reasons for the growth in regulations that stifle the expansion of supply.
The best explanation for increasing regulation is that local governments and neighborhoods are less likely to see the gains from growth than they were in the past. Local governments used to get substantial fiscal benefits from a growing population, yet now they suffer fiscal costs. Local homeowners used to see the value of growth in terms of reduced taxes and increased land values, and now they see the increased taxes and worse services. States and local governments used to prepare infrastructure before growth happened, but now they let existing residents suffer crowding of roads and schools when new residents arrive.
The essay points to several examples of fiscal zoning (or sharing the benefits of new developments with local governments and local people) from across the world. It also points to a decline in fiscal zoning over time (restrictions on the local tax levy, reduction in sharing of revenues with the local government etc), contributing to rising opposition and NIMBYism in the US. He examines the reasons for increasing regulation,
One reason is that in most communities the ‘winners’ from increased development are always small. There are only so many plots that can be built up at any time. The vast majority of neighbors only see the negative consequences of someone else developing their land and try to prevent those individuals from developing, even if they could later benefit from developing their own land. These neighbors can indeed increase the value of their own property by limiting development options on others property, but the end result is lower total property values in a community.For much of the twentieth century, and in much of the United States today, the main way the developing plots compensated their neighbors was by providing extra fiscal revenue to the rest of the city. Although neighbors saw the costs of increased development, they also saw reduced taxes and increased services. Cities engaged in ‘fiscal zoning’ to attract the sort of development that brought extra funds and this was the impetus for increased local growth in general.
Glock's argument is to re-establish the fiscal benefits and make it obvious to residents that the costs of restricting new developments are much higher than its gains. This was the basis for the New Zealand reforms that we discussed earlier.
Interestingly, he points out that the vast majority of US cities and towns do not suffer from any supply shortages, and that regulations are a problem only in a few large cities - New York, San Francisco, Boston, Los Angeles, Seattle etc. He also points to research that shows that regulatory burdens increase the closer we get to the central parts of American cities. Most worryingly, while restrictive zoning and regulation were low or non-existent almost everywhere, they've been growing since the late 1990s.
One reason for the restrictions in large cities is that the marginal benefit from an additional dollar of investment is very small compared to those in smaller or less developed cities. In the former, the infrastructure and service delivery are very good, whereas the latter requires significant additional investments. To this extent the existing households in larger cities have lesser incentive in raising resources.
The researchers use the difference between the market price and the actual cost of construction, with the gap being a measure of regulatory burden (or a zoning tax). They estimate this zoning tax using a clever trick that calculates the difference between the value that an existing homeowner puts on having a bit more land (the intensive margin) and the value that a builder places on the same amount of land with the right to build on it (the extensive margin). The difference, a measure of zoning tax, would be higher in highly regulated cities. If it's higher, then the existing homeowner would be encouraged to sub-divide and sell out the land at the intensive margin to the builder. In cities with restrictive regulations, the builders would bid up the prices of the lands at the extensive margin till there were no unexploited profit opportunities left for builders.
In this context, building on the paper by Nagpal and Gandhi, it would be useful for researchers to undertake studies like this and this to determine the extent of zoning tax in Indian cities. Which Indian cities (or states) have the highest zoning tax and which have low taxes, and whether and how do these taxes vary within these cities?
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