In a well-functioning free market economy, consumers expect to buy the goods they need at a reasonable, stable price, which can be defined as one that comprises the costs of production, distribution, and retailing, and the profit taken by the producer. As long as the price of a loaf of bread remains more or less stable over time, consumers are satisfied to pay it. But when the cost of gas at the pump spikes because of external forces that are invariably beyond the control of any local market, or even national governments, let alone consumers, there is typically an outcry, then grudging acceptance.

Housing is different in that it is considered both a commodity and an investment. Home buyers who lament the high cost of buying into a market are more than happy to see their property appreciate in value once they have done so, the faster the better. The wealth is by no means evenly distributed, however. Younger home owners, especially those that live in areas that have not seen high price growth, have less housing wealth than their counterparts of thirty years ago. And younger households that live in pricey areas have large mortgages. The biggest wealth gains from real estate tend to be among the older cohorts.

This is part of the argument made by a pair of economists in the US, who pose the question: what if we stopped looking at housing as an investment and saw it entirely as a commodity? In that case, if housing markets delivered homes at what the economists call the minimum profitable production cost (MPPC), just as makers of toothpaste and producers of milk do, we would have a well-functioning housing market. The MPPC comprises the cost of the land where housing is built, the construction costs, and the builder’s profit. Put another way, when market prices equal the full social cost of producing the housing unit, the market is functioning well.

In the majority of cities in the US, and in Canada, where housing demand and highly elastic supply intersect, housing prices are in fact well within minimum profitable production costs. In some cities, Detroit being an example, housing prices are well below the MPPC, because of an abundance of cheap housing that no one wants any more.

However, a transformation has occurred since the 1970s, the authors of  “The Economic Implications of Housing Supply” argue, resulting in a transfer of property rights from land owners to “wider communities” which have chosen to reduce the amount of new building allowed, resulting in the development of “inelastic supply” in some of the most successful cities.

Cities like San Francisco, which turns out to have a lot of similarities to Toronto in this scenario. In San Francisco, housing supply is constrained by limited land availability and land use regulations. It is what the authors call the “political economy of land use” that accounts for the divergence between market prices and fundamental production costs.

The development of inelastic supply in some of our most successful metropolitan areas is a relatively recent phenomenon. As late as the 1960s, building was lightly regulated almost everywhere. Much housing was built in all high demand areas, including coastal California and New York City. However, there has been a great transformation since the 1970s, in which property rights have essentially been reassigned from existing land owners to wider communities, which have chosen to substantially reduce the amount of new building. This change reflected the growing power of anti-growth political movements and environmentalism more generally.

Land is very expensive in San Francisco, while at the same time the city is a highly desirable location, with high economic productivity. But that high productivity has not led to more homes and more workers, but just to higher home prices and an inelastic supply. This has come about because of a transformation in which property rights have been reassigned from property owners to wider communities, which have chosen to reduce the amount of new building in certain areas. Typically hurdles used by municipalities to delay development include requiring zoning changes, minimum lot sizes, development charges, and a waiting period for building permits.

On the street, existing home owners in high-value areas are often opposed to new development because greater housing supply could decrease the value of their property, while forcing them to live with the inconvenience of construction. Developers, on the other hand, are often perceived as the only ones deriving significant benefits from new housing, and they do not typically live in the area where it is happening.

A current example that illustrates how complex it can be to create new housing in Toronto is taking place in a neighbourhood which has actually been designated for higher density. Nevertheless, local residents opposed to “density creep” went to the Ontario Municipal Board (OMB) which has ruled that the proposed development of eighty stacked townhouses on Keewatin Avenue in the Yonge and Eglinton area, must be scaled back. The developer told CBC news that the ruling was a surprise, because the townhouses would have brought much needed low-rise housing to Toronto, something that planners have approved.

The outcome illustrates how decisions made by majorities or their proxies in one area can have a negative impact on potential beneficiaries of a new project who do not live within the area where the project is being debated. Many of those who had already bought into the Keewatin development are now left stranded.

An example of the great transformation the authors speak of, this NIMBYist approach is unlikely to be reversed unless a way is found to compensate existing residents for the downsides of development, which may include more crowded schools and roads and costly new infrastructure.

At the same time, constricted housing supply causes a “potentially profound distortion” in urban labour markets and productivity, as people are unable to move into more desirable cities, like Toronto and San Francisco. According to the authors, this has a serious effect on the nation’s GDP, so that it seems to them “virtually certain” that GDP would rise if San Francisco were to build more housing and allow more population to shift there from less productive centres. The conundrum is that more expensive markets like San Francisco (and Toronto) tend to be more regulated and have more inelastic supply.

As for the environmental argument, in which advocates of land use restriction tend to emphasise the negative “externalities” of building, including higher greenhouse emissions, this too can be short-sighted, say the authors. Denying builders permits to build in one place “likely” creates an environmental impact elsewhere, as the builders will simply build there instead. So, if restrictions on building in California induce more building in places like Texas or Arizona, where artificial cooling is more necessary, the negative environmental impact could be even greater.

They conclude that these negative externalities are not large enough to justify the costs of regulation, which they view as a form of “implicit tax” on development. There would appear to be welfare gains from reducing some of these restrictions, and that will require policy changes at a higher than local level.

If Housing Were More Commodity, Less Investment, Could We Solve the Supply Problem? by Josephine Nolan | Condo.ca