PAI786: Urban Policy

1. PAI786: Urban Policy Class 6: Overview of Housing Markets

2. Urban Policy: Housing Markets • Class Outline • Housing Demand • Housing Supply • Landlord Decisions and the Neighborhood Effect • Filtering

3. Urban Policy: Housing Markets • The Housing Market Is Competitive • There are many housing sellers, none of which dominates the market, even in a given urban area. • But input markets may not be competitive. • Regulations, such as building codes, may matter, that is, they may influence market outcomes.

4. Urban Policy: Housing Markets • Housing Demand • Housing demand is driven largely by demographics. • But the link is not one-to-one; housing conditions affect household formation. • The size and types of housing vary with economic conditions. • The income elasticity of demand is positive and less than one.

5. Urban Policy: Housing Markets • Most Households Are Homeowners • There was a huge increase in homeownership after WWII. • Over 2/3 of households are now homeowners. • Renters are mostly in private, unsubsidized units. • Public units = about 2% of rental units • Subsidized units = about 4% of rental units

6. Urban Policy: Housing Markets • Housing Supply • Most housing is supplied by existing units. • New units are also built, of course, but the number of constructed units varies widely over time. • New units = about 2% of supply in a given year. • For single family houses, there are about 5 times as many sales of existing homes as of new ones.

7. Urban Policy: Housing Markets • Housing Supply, Continued • Many existing units are upgraded in any given year (more later). • Mobile homes and manufactured housing are a growing share of the total, particularly in rural areas. • They now equal about 20% of new housing units and almost 7% of total housing units

8. Urban Policy: Housing Markets • Housing Supply, Continued • Housing supply activities are quite varied. They include: • Downward conversion • Maintenance • Upgrading • Upward conversion • Nonresidential buildings are sometimes converted to housing (and vice versa).

9. Urban Policy: Housing Markets • Housing Supply, Continued • Housing maintenance/upgrading decisions are affected by neighborhood conditions. • A landlord increases housing quality, H, until the marginal cost of improvement equals the marginal benefit. • The marginal benefit is the price per unit of H, namely, P (or the expected P for upgrading decisions) • An improvement in neighborhood amenities raises P, and hence raises housing maintenance/upgrading.

10. Urban Policy: Housing Markets MC • Housing Supply, Continued • The maintenance/upgrading decision P{A,u′} P{A3,u′} P{A2,u′} H0 H1 H2 H3 H Start of year End of year with no maintenance

11. Urban Policy: Housing Markets • The Neighborhood Effect • The link between neighborhood amenities and investment leads to an important externality: the neighborhood effect. • One landlord’s housing improvements raise neighborhood quality, but the landlord only considers the impact on his own profits. • With this type of positive externality, landlords under-invest in housing, which implies that government subsidies have social benefits.

12. Urban Policy: Housing Markets MC • The Neighborhood Effect, 2 • The maintenance/upgrading decision P{A,u′} Marginal Social Benefit P{A2,u′}+NE P{A2,u′} Marginal Private Benefit H0 H1 H2 H3 H Start of year End of year with no maintenance

13. Urban Policy: Housing Markets • The Neighborhood Effect, 3 • A landlord sets MC=P, which is their MB, and therefore selects H2. • The social optimum is the point at which MC=P+NE, which is H3. • As a result, some kind of subsidy is needed to ensure that landlords make the socially optimal amount of investment in housing.

14. Urban Policy: Housing Markets • The Neighborhood Effect, 4 • The neighborhood effect has another important implication for policy, namely, that cities should concentrate their housing efforts in a few neighborhoods. • Building or rehabilitating housing has a spillover effect on nearby houses; this effect is maximized when many houses are built or improved in the same neighborhood. • The greater the housing improvement, the higher the P, and the greater the incentive for private landlords to fix up their units, too.

15. Urban Policy: Housing Markets • The Neighborhood Effect, 5 (review) • Concentrating housing programs in certain neighborhoods may have a cost, however, namely the displacement of low-income renters. • As P goes up and as landlords invest to raise H, apartment rents (PH) obviously go up, too. Some low-income renters in an improving (gentrifying?) neighborhood may have to move; in extreme cases, cohesive low-income communities may be broken up. • These costs must be weighted against the benefits of better housing, nicer neighborhoods, and larger tax bases. • Note that low-income homeowners do not lose—they receive a capital gain!

16. Urban Policy: Housing Markets • Abandonment • This analysis of landlord decisions also helps to explain housing abandonment. • This is a process that begins when a landlord’s revenue, PH, does not cover all his/her costs, even after picking the optimal degree of maintenance/upgrading. • Other costs include: • Property taxes, mortgage interest, heat and other utilities.

17. Urban Policy: Housing Markets • Abandonment, 2 • Note that in this case we are not talking about marginal costs, but instead are talking about total costs or average costs at the initial level of H. • Under normal circumstances, PH, covers a landlord’s costs, and even yields a little profit. • But if P drops significantly due to neighborhood decline (remember P reflects neighborhood quality!), then the landlord may start to lost money.

18. Urban Policy: Housing Markets • Abandonment, 3 • The steps in housing abandonment are: • Step 1: Stop maintaining • Step 2: Stop paying property taxes =legal abandonment • Step 3: Stop collecting rents (and paying utility bills) =literal abandonment • Step 4: The city takes legal title

19. Urban Policy: Housing Markets • Abandonment, 4 • Abandonment interacts with the neighborhood effect. • Abandoned buildings are a negative amenity, as they are unsightly and may be a haven for criminal activity. • Thus abandoned buildings drive down P, which not only drives down maintenance but may also push rental revenue below costs, causing abandonment in other buildings. • Hence, abandonment can be a powerful accelerant in a cycle of neighborhood decline.

20. Urban Policy: Housing Markets • Abandonment, 5 • In the old days, the city sometimes sold the buildings it acquired to the highest bidder. • Professional “milkers” were often the highest bidder so the process of abandonment would start all over again. • Now cities usually try to incorporate buildings they acquire into their housing programs • State or federal aid is used to rehabilitate the buildings, • The buildings are sold to community groups for a nominal fee, or • The buildings are demolished.

21. Urban Policy: Housing Markets • Abandonment, 6 • Finally, property taxes sometimes contribute to abandonment. • A building’s property taxes equal its assessed value, determined by an assessor, multiplied by a property tax rate, determined by elected officials. • A building’s market value is the present value of the stream of net rents it is expected to generate. • In many cities, however, assessed values are not updated very often, particularly for rental property.

22. Urban Policy: Housing Markets • Abandonment, 7 • The lack of frequent re-assessment • Benefits building owners when rents are rising, • But it keeps their costs high when rents are falling. • Thus, a landlord in a declining neighborhood may be expected to pay property taxes based on an assessed value that far exceeds market value; if he cannot pay, he may be pushed into abandonment.

23. Urban Policy: Housing Markets • Abandonment, 8 • Another form of abandonment can be seen in the market for single-family housing. • Mortgage problems lead to abandoned housing when: • Homeowners have no equity in their home and cannot pay their mortgage, so they simply walk away. • A lender forecloses on a home (i.e. takes title because the homeowner has not made its mortgage payments) and then does not sell the home right away. • More on this type of abandonment in a later class.

24. Urban Policy: Housing Markets • Housing Markets Are Characterized by Filtering • By one definition, filtering is a change in the income of the household living in a unit. • By another definition, filtering is a change in housing quality over a household’s life cycle. • Housing units filter down; households filter up. • We focus on the first definition.

25. Urban Policy: Housing Markets • Filtering, 2 • Housing can be maintained, but often declines in quality over time. • For high-quality housing, supply increases usually come through construction. • For low-quality housing, supply increases usually come through filtering.  

26. Urban Policy: Housing Markets • Filtering, 3 • Some people claim that filtering ensures adequate housing at the bottom of the income distribution. • In fact, however, there is no guarantee that the housing that filters down is adequate, in size, quality, or price, for the poorest households. • Moreover, filtering does not guarantee that housing is provided in acceptable neighborhoods. • Overall, filtering provides a great deal of housing for low-income households, but it does not automatically provide enough—or the right kind.

27. Urban Policy: Housing Markets • Filtering, 4 • A recent paper by Stuart Rosenthal (Syracuse economics department) sheds some light on filtering using the American Housing Survey, which tracks housing units (and the people in them) over time. • By focusing on housing turnover, Rosenthal finds that houses do, indeed filter down. • Rental housing filters down (that is, the income of the occupants declines) at a rate of 2 ½ to 3 percent per year. • Owner-occupied housing filters down at a rate of 0.5 percent per year. • The rate of filtering varies significantly across regions, with much less filtering down on the coasts.

28. Urban Policy: Housing Markets • Filtering, 5 • Rosenthal concludes that: • “These findings suggest that filtering is a viable long run source of lower-income housing, and especially so given that rental housing is the traditional home of the poor.” • “[T]o the extent that long run rates of house price inflation differ across locations, filtering rates will differ as well and this can have sharp implications for the desired form of housing assistance at the local level.” • These findings lead Rosenthal to conclude that housing vouchers, not new housing construction, are the best policy option in most circumstances. We will return to this issue in the next class (and in our first case).