Michael Hicks is the George and Frances Ball Distinguished Professor of Economics and the director of the Center for Business and Economic Research at Ball State University. His column appears in Indiana newspapers.
A shortage of local housing options is one of the more frequent concerns I hear from elected leaders in the Midwest. The lament is often too few executive homes, or a shortage of middle-income homes, or low-income housing. While all these concerns may be true, lack of housing is a symptom of a deeper problem that merits hard thinking. Let me explain.
Housing availability and home prices are the result of fairly straightforward market forces that reflect both the demand and supply for housing. In other words, the willingness of buyers to pay for a house in a particular location and the interest of builders to construct a house in a particular location determine the price and quantity of housing stock. There is abundant and readily available scientific research on home prices that dates back at least 40 years, but this is also common sense. Unfortunately, policy efforts often don’t reflect much common sense.
I’ve recently read about a mayor trying to remedy a perceived housing shortage by acquiring property and selling it cheaply to a builder as a way to boost the quantity of homes. Fortunately, such efforts typically fail, which is probably the best outcome for two fairly obvious reasons. First, again, inadequate housing is a symptom of deeper underlying problems that typically involve the demand for housing. Think about the common example of “we don’t have enough homes in the say, $175,000 to $250,000 price range for people who want to move here.” This is nonsense. Home buyers are really looking for value in a home, and the price is only part of the value consideration. As it so happens, you can scan the list of unsold homes in your local county sheriff’s sale. Find the ugliest property on a quarter acre lot, that would be worth more if a fire consumed it. Now imagine it in downtown Chicago. There it’d be easily worth between $170,000 and $250,000. The problem isn’t the house; it is the location of the house.
Four decades of technical research on home prices tells us that a third of the variation of home prices in a city are determined by school quality. And don’t believe folks who argue it is hard to measure school quality; housing markets do so with great effectiveness. Crime and the presence of disamenities, such as railroad noise or an abandoned factory, all reduce home prices. Crummy neighborhoods are easy to spot and readily show up in home prices. And that turns us towards the issue of supply.
Builders typically construct speculative homes based on their expectation of buyers. These expectations are almost wholly informed by the local characteristics: schools, parks, recreation and the like. Investing in speculative homes is risky business. Because the cost of building a new home is similar nationwide, the real challenge for the building is assessing the demand for housing in a particular neighborhood. Obviously local leaders can do some things to reduce local costs, but typically the problem is that homes aren’t worth the cost of construction due to low demand. Builders don’t like to construct a $250,000 home that ultimately sells for $210,000, because home buyers don’t like to buy homes that won’t grow in value.
So, when you hear someone say we don’t have enough houses in a particular price range, what that really means is that demand for this housing is so low that it isn’t profitable to build new homes in that location. The problem is never a house; it is always the neighborhood. And that brings us back to our hapless mayor and his doomed housing plans.
If the demand for housing is low, and builders won’t supply new homes because it isn’t profitable, the very last thing you would rationally do is to directly incentivize new homes. This would simply increase the supply of homes, reduce the market price of existing properties, and further worsen the housing problem. Yes, it really is that simple. The lesson of all this is, if you want to fix the housing problem in your community, make sure you work on your schools, neighborhoods and amenities (in that order).