How to Fix San Francisco’s Housing Market

Want to live in San Francisco? No problem, that’ll be $3,000 (a month)–but only if you act fast.

In the last two years, the the cost of housing in San Francisco has increased 47% and shows no signs of stopping. Longtime residents find themselves priced out of town, the most vulnerable of whom end up as far away as Stockton.

Some blame techie transplants. After all, every new arrival drives up the rent that much more. And many tech workers command wages that are well above the non-tech average. But labelling the problem a zero sum class struggle is both inaccurate and unproductive. The real problem is an emasculated housing market unable to absorb the new arrivals without shedding older residents. The only solution is to take supply off its leash and finally let it chase after demand.

Strangling Supply

From 2010 to 2013, San Francisco’s population increased by 32,000 residents. For the same period of time, the city’s housing stock increased by roughly 4,500 units. Why isn’t growth in housing keeping pace with growth in population? It’s not allowed to.

San Francisco uses what’s known as discretionary permitting. Even if a project meets all the relevant land use regulations, the Permitting Department can mandate modifications “in the public interest”.  There’s also a six month review process during which neighbors can contest the permit based on an entitlement or environmental concern. Neighbors can also file a CEQA lawsuit in state court or even put a project on the ballot for an up or down vote. This process is heavily weighted against new construction. It limits how quickly the housing stock can grow. And as a result, when demand skyrockets so do prices.

To remedy this, San Francisco should move from discretionary to as-of-right permitting. In an as-of-right system, it’s much more difficult to stop construction. As long as a project meets existing land use requirements, city planners have to issue a permit. And although neighbors can sue based on nuisance, they don’t have any input in the actual permitting process. As-of-right permitting would go a long way toward defanging NIMBYs and overzealous planners.

Yellow equals a height limit of 40 feet or less than 5 stories.

Yellow equals a height limit of 40 feet (less than 5 stories). Credit Business Insider.

 

But even if San Francisco opened up the permitting floodgates, height limits, floor-to-area ratios, zoning designations, and minimum parcel sizes all prevent land from being put to its best use. Land use restrictions like these can increase the price of housing by as much as 140% over construction costs. Relaxing–if not abolishing–these types of restrictions would be hugely beneficial.

But for as much as regulatory reform would help, there’s another way of encouraging supply to catch up with demand. And, interestingly enough, it involves raising taxes.

Tax the Land

The more you tax something, the less of that something society produces. Raise taxes on income and you discourage labor. Raise taxes on capital and you discourage investment. Raise taxes on property and the same logic applies; the higher the tax rates the greater the burden on new construction. But property taxes aren’t just a tax on buildings, they’re a tax on the land underneath as well. Separate the two in favor of taxing land alone, and construction is not only unburdened, it’s encouraged.

A pure land tax would amount to fixed overhead for each assessment period. This would encourage landlords to use their holdings as intensely as the market would bear. Holding a valuable parcel vacant or underused would become prohibitively expensive.

In San Francisco, where land is incredibly valuable, a land tax would encourage  denser development.

In San Francisco, where land is incredibly valuable, a land tax would encourage denser development. Credit Ascher, Kate. (2011).

 

There are a few different proposals for implementing land taxation. The most aggressive approach calls for a 100% fee on land values and the abolition of all other taxes. A slightly more moderate proposal favors an 80% land tax to allow for some margin of error in assessment. The most realistic plan would be to retire San Francisco’s property tax in favor of a land tax and make the change revenue neutral. Considering the city’s property tax rate is barely over 1%, a revenue neutral land tax probably wouldn’t deliver the sun, the stars, and the moon like it would at much higher levels. That said, it would still be an improvement over the existing property tax.

Fix the Market, Not the Price

Neither rent control nor inclusionary zoning will fix the housing crisis. Both amount to price controls. Both drive up the price of market rate construction. Both create a gap between subsidized and unsubsidized housing. And as long as San Francisco can’t set its own immigration policy, there will never be enough subsidized housing to go around. It’s simply not a scalable solution. But that doesn’t mean there’s no room for a safety net.

Housing vouchers are like food stamps for….well, housing. They put resources directly in the hands of those who need them while avoiding the negative side effects of price fixing. It’s welfare that doesn’t try to mandate a price, but instead ensure that the least well off can pay whatever that price might be.

Funding via a land tax would tie the amount of revenue available for vouchers to the state of the housing market. When housing costs increase, it’s not the buildings themselves that are becoming more expensive, it’s the land that they’re sitting on. Houses aren’t wine, they don’t typically improve with age. The actual ground they sit on, however, can become more valuable if more people want to move into a neighborhood. If a sudden surge in demand sends land prices through the roof, a land tax would ensure that funding for vouchers would increase as well.

Funding through a land tax would also prevent vouchers from becoming a subsidy for landowners. Pumping other sources of revenue into housing might simply make the market more competitive and allow landlords to charge higher rents. A land tax would limit this by moving resources from landlords on one end of the market to tenants on the other end without increasing the total amount of dollars chasing housing. Regulatory reform would also limit any price increases from a voucher system since an increase in demand would better stimulate an increase in supply. The extra supply would then put downward pressure on prices.

Slowing down–let alone turning back–the rising cost of housing will require a massive amount of new construction. Relaxing land use rules will clear the path. Changing the tax code will hurry things along. And rethinking the social safety net will ensure that no one gets left behind.

The benefits of the market in both infrastructure and urbanism

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Alain Bertaud, a senior research scholar at the Urbanization Project, has had a long career in urban planning, and many of his writings have a market urbanist flavor. He is currently working a book called Order Without Design, and last year he published an excerpt from that book called “The Formation of Urban Spatial Structures: Market vs. Design.” In the article he offers a compelling case for letting the market determine building sizes and uses, but he argues that infrastructure provision must be left to the state. I agreed wholeheartedly with the first portion of his paper, but find that his arguments for the market in land use contradict his arguments for the state in infrastructure.

Bertaud eloquently explains the knowledge problem facing urban planners who seek to regulate efficient land use patterns. Because economic growth is such a complex process that’s dynamic over time, he explains that top-down design will fail to keep up with changing land use needs to the detriment of economic growth. He cites Hartford, Connecticut as an example. The city developed a large insurance industry, but as it became profitable for American insurance companies to outsource clerical work abroad, fewer Connecticut residents find employment in the industry. However, in a futile effort to maintain jobs, urban planners have refused to update land use regulations to permit new employment opportunities. Rather than succeeding in keeping historical sources of employment in place, urban planners have prevented economic diversity that can hedge against a downturn in a specific industry.

Bertaud describes price mechanism that allows the market to identify land’s highest value use:

Markets …  recycle obsolete land use quasi-automatically through rising and falling prices. This constant land recycling is usually very positive for the longterm welfare of the urban population. In the short term, changes in  land use and in the spatial concentration of employment are disorienting and alarming for workers and firms alike. Responding to the disruptions caused by land use changes, local governments are often tempted to intervene in order to slow down the rate of change and to prevent the recycling of obsolete land use. However, the long-range effects of maintaining obsolete land use through regulations are disastrous for future employment levels and for the general welfare of urban dwellers.

While Bertaud waxes romantic about the power of the market in allocating land use and supporting economic growth, he makes two primary arguments for why the private sector cannot provide road networks. First, he asserts that private sector is incapable of assembling the necessary rights-of-way to build major thoroughfares.  Second, he makes an externality argument. He says that because roads can improve accessibility and increase land values, it’s “impractical to allocate and to recover its cost from beneficiaries since not only road users but also landowners benefit from better accessibility.”

To the first point, it’s false that the private sector is incapable of constructing a road network beyond local access streets. In fact, several major roads in the United States have been financed, constructed, and maintained by private companies that collected tolls. By constructing these roads in existing easements, these companies didn’t need to resort to eminent domain. Private U.S. companies built turnpikes in an era when road building was much less efficient than it is today, and more importantly tolls had to be collected by humans in tollbooths, rather than electronically, requiring more overhead than a toll system would today. Turnpike companies sought investments from landowners near the road who stood to gain from road construction, demonstrating that mutually beneficial exchange can happen even in the face of the externalities that Bertaud describes. Aside from roads, private enterprise has historically provided canals, streetcars, and elevated rails demonstrating the powerful incentive that people have for identifying opportunities for cooperation even when the benefits to buying and selling a good aren’t fully captured by the consumer and producer. Bertaud points out that, unlike regulators, the price system can effectively make tradeoffs between land uses. Similarly, the price system could determine resource allocation between different types of transportation, but instead this role is delegated to “designers” in developed countries today.

History demonstrates that privately built and financed roads are in fact possible, but Bertaud is likely correct that they would not be possible in developed countries today because government infrastructure spending and regulations have largely crowded out private investment in the industry. Those who assume that roads must be built by the government rely on market failure arguments to assert that the private sector fails to produce the efficient amount of infrastructure. Bertaud writes, “to build an effective, citywide circulation network, a city needs to connect privately-built roads, linking various neighborhoods and allowing travel speeds consistent with the efficient functioning of labor markets.”

It’s possible that the free market would fail to reach some optimum level of travel speed as identified by technocrats, but it’s key to note that government’s infrastructure building record is rife with failures. The political process results in bridges to nowhere and costly mixed-traffic streetcars. Robert Caro provides a detailed account of Robert Moses’ trangressions against the people of New York for the cause of his infrastructure building mania, but neighborhoods across the country were irreparably damaged by highways with relatively little recognition of the damage wrought by government road building. Unlike state road designers who can raze entire neighborhoods for the sake of infrastructure, privately built roads would not likely be built through densely populated neighborhoods.

Government infrastructure planning is subject to many of the same problems that Bertaud points out plague government land use planning. If neither the market nor government can reliably provide the “efficient” amount of infrastructure in the right places, which sector does it better is an open question that won’t be answered without developed countries’ governments drastically curtailing their involvement in infrastructure. Those who argue that the market cannot provide the level of infrastructure deemed efficient by econ 101 models make an unfair comparison to idealized models of how the public sector provides infrastructure rather than looking at the infrastructure that government actually delivers. Infrastructure provision presents private sector challenges because it isn’t bought and sold according to the textbook example of perfect competition. But starting with the assumption that government can identify and execute an optimal infrastructure plan whitewashes publicly provided infrastructure failures.

Thanks to Anthony Ling for pointing out the article.

How Land Prices Obviate the Need for Euclidean Zoning

Yesterday, Reason TV released a video comparing Houston with more heavily regulated East Coast cities, explaining that Houston’s relatively lax land use regulations contribute to its housing costs that are much lower than in other large cities. While the video paints an exaggerated picture of Houston as a free market paradise in spite of its codified sprawl, Todd Krainin makes some great points about Houston’s land use tolerance. For example, the city’s tin houses that save on construction and energy costs would be illegal in many cities that have tighter restrictions on building codes.

In the video, the former mayor of Victoria, TX makes the great point that in spite of the absence of Euclidean Zoning in some Texas cities, residents don’t need to worry about heavy industry cropping up in their neighborhoods. “Economics dictates that you’re not going to put a rendering plant next to a residential subdivision,” he says. He’s referring to rent gradients that lead to land near amenities being priced at higher rates than land farther from amenities. Owners of low-value land uses don’t choose to pay high prices to be near these amenities. While there are occasionally legitimate nuisance cases in which housing and industrial uses impose externalities on each other because of their proximity, in a free market these cases would be very rare because it doesn’t make sense for industrial uses to take place on the land that people are willing to pay premium prices to live on.

While city planners make the case for Euclidean zoning by saying that they are protecting residents from living near industry, zoning often results in the exact opposite outcome. Valuable property in cities including New York and San Francisco that is zoned industrial gets surrounded by residential neighborhoods over time as the city grows. Planners’ inability to keep codes up to date with evolving cities means regulations require industrial uses adjacent to residential ones, mandating inefficient land use and creating industrial blight near homes. In Washington, DC, recent rezoning of industrial uses near Union Station and Navy Yard has created rapid fire gentrification. Without zoning, industrial uses would have gradually move from these valuable sites, allowing for housing and retail to enter these neighborhoods slowly allowing for filtering prices over time.

In Bushwick, warehouses abut apartment buildings.  Image via Real Estate Weekly.

In Bushwick, warehouses abut apartment buildings. Image via Real Estate Weekly.

In Los Angeles, the problem of cementing the location of industrial uses has reached an extreme. Torrance, CA, a city where the median home sells for over $600,000, is home to an oil refinery, located about two and a half miles from the coast. A few miles northwest in El Segundo, where the median home is worth $860,000, a Chevron refinery occupies 1,000 acres of beachfront property. This isn’t because these companies enjoys refining oil surrounded by residential neighborhoods or find it particularly profitable to do so, but rather because its unlikely that they could ever receive the necessary approvals to open a new refinery elsewhere.

In some cases, such as developing world mega cities, it’s more likely that industrial uses would locate adjacent to housing than it is in the United States because of different transportation systems. In these cases, people with progressive attitudes might argue that zoning would protect residents of cities like Karachi, and Lagos from living near polluting industry. But even in these cases, using zoning to prevent the market from allocating land use is likely to hurt cities’ most disadvantaged residents rather than making them better off.

True, developing world residents accept risks when they live near factories, including the small potential for a catastrophe such as a factory fire in a residential neighborhood. However everyone accepts risk in their daily lives in their efforts to make a living and pursue happiness. Those with low-incomes in the U.S. and even more so in the developing world accept greater risks than those with higher incomes because risk reduction is a normal good whose demand rises with income. Individuals must make risk-risk tradeoffs in their lives, including the decision to live near a factory in exchange for shortening a difficult and dangerous commutes or in turn for saving money on housing to have more resources for other essentials.

In the United States, legally separating industrial uses from residential land uses at time zero is unlikely to result in a significant change from a market outcome because owners of industrial property will want to locate on cheap land far from where people live. In those cases where industry and residents choose to locate next to each other, it’s worth considering that the people involved are making the best choices given their circumstances. Given that cities grow and evolve, it’s likely that industrial-zoned land will end up adjacent to higher value uses, leading regulations to achieve the opposite of their intent. In those rare cases when economics do not naturally separate residential from noxious uses, the court system is well-equipped to mediate cases as they arise.

Parking is not a public good

Writers at Salon, Slate, and Time have criticized new San Francisco-based apps that allow users to purchase access to a parking spot as another driver is leaving it. The apps MonkeyParking, Sweetch, and ParkModo provide a platform for drivers to let others know when they’re leaving a spot, and reserve the spot until the another user bidding on the spot arrives to pull in. As of last week, the future of these apps is unknown since San Francisco issued a cease and desist order based on the city’s rule against auctioning or leasing public parking spots. All three writers express outrage that the apps’ creators and users are profiting off of government-owned parking spots. At Salon, Andrew Leonard writes:

Monkey Parking’s solution intended to generate profit off of a public good by rewarding those who are able to pay — and shutting out the less affluent. 

One problem with this line of reasoning is that parking is clearly not a public good. It is both perfectly rivalrous and easily excludable. Unlike a public good, the price system provides the right incentives for suppliers to provide the optimal amount of parking based on consumers’ willingness to pay. While Leonard uses the term public good, he may mean simply a good that the government provides, and he argues that entrepreneurs should not be permitted to profit from these public services. While this argument provokes a populist sense of unfairness, Monkey Parking should be evaluated against the current problem of under-priced curb parking rather than against the assumption that city governments are currently pricing curb pricing appropriately.

City governments systematically undercharge for street parking, especially in cities like San Francisco where land is very valuable. These apps are able to profit because the city charges prices for parking below the level that drivers are willing to pay. Without an app that lets drivers pay for the knowledge of parking spot availability, parking spots are allocated by drivers’ time spent driving around and looking for a spot.

Curbside parking spots, typically the most conveniently located and most accessible spots on a block, are often priced lower than nearby garage spots. Because these spots are desirable, they are often full. Drivers circle their destinations looking for available curb spots, paying for the cost of the spot with their time and wasted gas rather than in dollars as they likely would in a free market. Donald Shoup, the expert on all things parking, estimates that 30% of downtown urban traffic congestion is caused by drivers who are cruising for parking. In just one Los Angeles neighborhood, Shoup estimates that drivers waste 47,000 gallons of gas, or 730 tons of carbon annually just looking for parking spots. The cost of the cruising phenomenon in terms of drivers’ time and in greenhouse gases across cities and around the world is clearly immense.

Slate’s Will Oremus argues that allocating parking spaces based on drivers’ willingness to pay for them is regressive:

As if it weren’t enough that middle-class San Franciscans are getting squeezed out of their housing, now they get to worry about some tech tycoon outbidding them for their parking spot. These are public, metered parking spaces, mind you, paid for by taxpayers.

Keeping the price of parking below the market-clearing price is not clearly beneficial to low- or middle-income people as these authors assert. If a low-income person is running late for an important appointment or has a heavy load to carry to his destination, he will likely be thankful for the opportunity to pay a premium for a conveniently located, available spot. The app allows people to trade money for time and convenience, and people of all income levels may or may not want to make this tradeoff in a given situation. Under-priced curbside parking is a subsidy to all drivers, regardless of their income. In San Francisco, low-income residents are less likely to have access to cars than high-income residents, so providing under-priced parking likely subsidizes high-income residents more than low-income residents.

Rather than prohibiting these parking apps, San Francisco policymakers have the opportunity to make them irrelevant. Their program SFPark is already implementing reforms based on Shoup’s recommendations. 8,200 of the city’s curbside parking spots have sensors that indicate whether or not they are occupied. These sensors provide data on when parking spots are occupied, and the meters for these spots are set with the goal of maintaining 15% availability to eliminate cruising. The prices are capped at $6 per hour, so they may not reach levels high enough to maintain 15% availability, creating an opportunity for MonkeyParking to allocate spaces based on price.

Meters

Image via San Francisco Examiner

By expanding SFPark to more of the city’s curbside spots and allowing parking prices to go as high as necessary to maintain 15% availability, San Francisco policymakers would capture the parking apps’ potential revenues for the city. For those concerned that charging market-clearing prices for parking hurts low-income residents, this new revenue source could be used to provide a tax credit for low-income people. However, it’s unclear to me why the price of parking should be artificially low to benefit low-income people as opposed to all other goods. Allocating parking based on pricing rather than by queuing allows people to plan their travel based on the true cost of their trip. Setting parking prices at a market-clearing rate would create an incentive for people of all income levels to consider taking transit, biking, or walking to their destination, and would allow anyone to have the availability of conveniently located parking spots at their destination when the it’s worth the price to them.

DC streetcar: Worse than nothing

On Tuesday, DC’s city council passed a tax reform package that will cut funding for future streetcar construction. These cuts come as the H Street streetcar delays continue to mount, and much of the commentary supporting the streetcar has shifted from touting its transportation benefits to its economic development role. As Stephen has explained, the benefits of streetcar over bus depend heavily on streetcars having dedicated lanes, which most of DC’s streetcars wouldn’t have.

Earlier this spring, I was in a bike accident that cemented my opposition to DC’s streetcar. Because the streetcar tracks cover the right two-thirds of H Street’s right-hand lanes, bicyclists typically ride between the two tracks. This creates a situation in which the sudden need to swerve or a brief loss of concentration puts cyclists at a risk of catching their front tire in the track, causing an over-the-handlebars accident when the front wheel comes to a sudden stop. In Toronto, streetcar tracks are a factor in nearly one-third of serious bicycle accidents. While I can say I’ll now go to great lengths to avoid riding on H Street, DC’s lack of good east-west bike routes make it unrealistic to expect all cyclists to avoid the streetcar tracks. Avoiding tracks will be much more difficult for cyclists under DDOT’s plan to eventually construct 22 miles of tracks.

Aside from creating a hazard for cyclists, this streetcar will only provide effective transportation for people visiting H Street retail destinations from the adjacent residential neighborhoods. It does not connect residential neighborhoods to job centers. While some have argued that it’s designed to serve tourists rather than District residents, the streetcar line doesn’t pass by any sightseeing, I don’t think that H Street’s retail is a common destination for tourists. Passengers using the streetcar to travel east from Union Station have to navigate a large parking garage to board the streetcar in the middle of a pedestrian-hostile overpass.

Passengers coming from Union Station will board the streetcar on an overpass outside of a parking bride. Image via Fulertography.

Passengers coming from Union Station will board the streetcar on an overpass next to a parking garage. Image via Fullertography.

Its poorly planned route will, however, cause delays for bus riders and drivers as the streetcar comes to a stop behind cars turning right, cars that don’t park close enough to the curb, or inevitable breakdowns. The H Street corridor has the one of the city’s busiest bus routes with an average of over 15,000 riders each weekday. Unlike the streetcar, the X1, X2, and X9 buses actually connect residential neighborhood’s to job centers and they serve passengers who live farther east in Anacostia. The streetcar will reduce the effectiveness of these valuable routes by adding to delays and reducing frequency as a result.

While streetcar construction has coincided with rapid-fire gentrification on the H Street corridor, those who attribute these changes to the streetcar’s presence discount other policies and trends that happened simultaneously. In 2006, then mayor Fenty implemented the Great Streets Initiative, a grant program that provides up to $85,000 to small businesses businesses renovating space on corridors designated for the program. H Street was the first corridor designated as part of the Great Streets Initiative and the only corridor eligible for small business grants until 2013 when the program was expanded to include several additional corridors. Hstreet.org explains:

DMPED [Office of the Deputy Mayor for Planning and Economic Development]  received an initial capital authorization of $16.6 million to provide development assistance, multiple property owner grants, technical assistance, loans and credit enhancements to projects like those happening on H Street. DC Council also authorized DMPED to issue up to $95 million in tax increment finance (“TIF”) notes or bonds to support retail projects within six retail priority areas along the initial GSI corridors. Up to $25 million out of the $95 million was authorized on H Street NE.

Staff at DMPED were not able to provide data on grant recipients before 2012, but for 2012 to the present, they provided data for each grant issued. Since 2012, H Street businesses have received nearly $2 million in grants for facade improvements and renovations. This is about a third of all of the grant money that the program has awarded in that time period. It’s clear that between 2006 and 2012 H Street businesses received millions of economic development spending, including a $5 million subsidy for Giant supermarket. These grants factored into dozens of entrepreneurs’ decisions to open businesses on the H Street corridor rather than another neighborhood in the city.

Furthermore, the pattern of redevelopment in the Atlas District suggests that these grants may have played a more important role than the streetcar. Typically, neighborhoods experience residential gentrification first, and the commercial gentrification bringing new shops and restaurants follows. As developers sometimes say, “retail follows rooftops.” However, the Atlas District experienced the reverse order. The bars and restaurants on H Street didn’t spring up to serve a new affluent neighborhood population or people moving to live near the streetcar line; rather a dedicated shuttle bus from Chinatown brought bar patrons from other neighborhoods in the city out to H Street for the first years that new bars were opened their doors on the corridor. In the 20002 zip code, home values held fairly steady from 2009 to 2012, indicating that demand for residential property didn’t surge until well after the commercial corridor began to gentrify. Home values in this zip code closely follow the city’s trend from 2005 to the present, whereas other zip codes, like 20009, show home price spikes that can more likely be attributed to a change in the neighborhood’s desirability, rather than the city’s general growth.

Of course, H Street’s gentrification is far from an objective policy success. The Great Streets Initiative grants that encouraged building renovations were tailored to benefit new businesses coming to the neighborhood, rather than existing businesses that served long-time residents. But even given the questionable policy goal of gentrification, it’s unclear that the streetcar can take credit for economic development. The streetcar will make commuting more difficult for X bus riders, and if tourists want to take the streetcar, they’ll have a difficult time reaching its western terminus from Union Station. Still not carrying passengers five years after construction began, the streetcar is a very expensive bike trap.

How Affordable Housing Policies Backfire

Affordable housing policies have a long history of hurting the very people they are said to help. Past decades’ practices of building Corbusian public housing that concentrates low-income people in environments that support crime or pursuing “slum clearance” to eliminate housing deemed to be substandard have largely been abandoned by housing affordability advocates for the obvious harm that they cause stated beneficiaries. While rent control remains an important feature of the housing market in New York and San Francisco, even Bill de Blasio’s deputy mayor acknowledges the negative consequences of strong rent control policies. In the U.S. and abroad, politicians and pundits are beginning to vocalize the fact that maintaining and improving housing affordability requires housing supply to increase in response to demand increases.

While support for older housing affordability policies has dissipated, the same isn’t true of inclusionary zoning.  From New York to California, housing affordability advocates tout IZ as a cornerstone of successful  housing policy. IZ has emerged as the affordable housing policy of choice because it has the benefit of supporting socioeconomic diversity, and its costs are opaque and dispersed over many people. However, IZ has several key downsides including these hidden costs and a failure to meaningfully address housing affordability for a significant number of people. Shaila Dewan of the New York Times captures the strangeness of IZ’s popularity:

New York needs more than 300,000 units by 2030. By contrast, inclusionary zoning, a celebrated policy solution that requires developers to set aside units for working and low-income families, has created a measly 2,800 affordable apartments in New York since 2005.

DC’s City Center includes 92 affordable units. Image via Foster and Partners.

Montgomery County, a Maryland suburb of DC,  has perhaps the most well-established IZ policy in the country. After 30 years, the program has produced about 13,000 units. Montgomery County is home to over one million people, 20 percent of whom have a household income of less than $43,000 annually. While this is an extraordinarily high income distribution relative to the rest of the country, this makes the county’s median apartment rental of nearly $2,300 out of reach for many more people than even an aggressive IZ policy can serve.

While Montgomery County’s IZ housing does not reach a large percent of its population, it has provided many more units than other cities’ programs have. Washington, DC’s IZ law was passed in 2006, requiring developers to set aside 8-10% of units as affordable in all new projects with more than 10 units. As of the most recent 2012 report, DC’s IZ program has yet to reach a single beneficiary. The IZ units that have made it to market are sitting empty. This is in part because IZ units, priced to be affordable to those making between 50% and 80% of the Area Median Income, are not the most cost effective choice for many people in this income range, potential beneficiaries of owner-occupied IZ units may not be able to qualify for a mortgage. IZ units tend to be one- or two-bedroom apartments. Low- and moderate-income DC residents may be able to find housing that is much more affordable than what IZ provides by living in a larger apartment with a roommate(s), in a group house, or with family. By attaching these affordable units to new, often luxury buildings, IZ siphons affordable housing resources to the type of housing where it will buy the least.

Evidence on the benefits that mixed-income housing provides for low-income people is mixed, but it’s hard to deny that inclusionary zoning beneficiaries win a lottery. They live in new construction in desirable neighborhoods, housing that would cost several times as much at the market rate. However, IZ’s effects are not limited to beneficiaries, and its costs are not fully borne by developers. Because developers will lose money on the IZ units they build, this cost has to be made up in the market rate units in order for the project to go forward. This adds to construction costs and also incentivizes luxury units that can better absorb the cost of the IZ units relative to more affordable construction. While providing affordable housing to a few lucky low-income people, IZ also makes housing less affordable for everyone who doesn’t receive the benefit by reducing housing supply and skewing the market toward luxury housing that can subsidize the affordable units.

IZ appears free to everyone except developers because it’s not paid for out of city budgets. But ultimately housing consumers share in the cost of IZ units through a hidden tax. By making new construction more expensive, IZ also reduces the rate at which the prices of older or less desirable housing filters down to the point that it becomes affordable to low- and middle-income residents. Putting affordable housing in new construction ensures that it will benefit fewer people than the same amount of resources otherwise could. IZ supporters emphasize the importance of neighborhoods that are socioeconomically diverse but ignore the opportunity cost. Low-income people may be well-served by putting resources toward living in a diverse neighborhood, but this competes against many other places their resources could go, including investing in a business, pursuing education, or prioritizing nutritious food.

As economist Ben Powell explains, IZ can be designed not to have an effect on market-rate housing prices if developers are allowed to voluntarily trade the provision of IZ units for density bonuses. In that case the bonuses must be high enough to offset the cost of the below-cost units. However, as Stephen has pointed out, IZ creates an affordable housing lobby that opposes upzoning without affordability requirements. Eliminating IZ would put all housing affordability advocates on the same team. The same amount of resources currently providing for IZ units could be levied as a transparent tax and transferred to low-income people as cash rather than as luxury housing. This would also allow for resources to be distributed based on need, rather than giving a few households a jackpot.

The Use of Knowledge in Urban Development

This post was written for an essay contest on the question “What would Hayek say today?”

Hayek and other Austrian economists demonstrated that government ownership of the means of production is a sure route to poverty, but today, central planning remains the norm in one crucial area: cities. In the United States, the Supreme Court determined that cities could designate sections of city land for specific types of development in the landmark case Euclid v. Ambler. Since then, land use regulation has expanded to include heights limits, parking requirements, and design guidelines across the world’s great cities. Urban planners and politicians determine the rules for the location and types of development permitted within their jurisdictions, and ultimately have veto power over major projects designed in the world’s great cities. If Hayek were alive today, he would focus on applying his work on the knowledge problem to city planning.

In the United States, progressive city planners began promoting restrictions on building height and density with the objectives of promoting light and air in the early twentieth century. At the time, these objectives were considered important for public health.  Property owners and policymakers soon realized that zoning tools could also be used to protect home values by preventing the construction of low-cost, high-density housing.

Today, property owners support a wide range of policies designed to limit housing supply and increase the value of their assets. These policies include minimum lot sizes, density limits, and parking requirements. While a large economics literature describes the regressive effects of zoning, these policies remain nearly ubiquitous in the Western world. They owe their persistence to powerful public choice incentives that lead policymakers to favor their current constituents over the unrepresented people prevented from moving into their municipality or neighborhood by restrictive land use regulations (Schleicher, 2012).

While the institutional landscape favors the continuance of restrictive zoning, land use regulations are not well-suited to shaping city design. Urban development is an information gathering process based on dispersed and tacit knowledge of entrepreneurs, like other market processes. As Hayek describes in “The Use of Knowledge in Society,” even if city planners have the best of intentions, they are incapable of accessing the information that would guide land and building resources toward their best uses in a free market (1945).

Unlike private sector developers, city planners do not experience profit and loss, leaving them without the single tool that can best direct the allocation of resources within a city over time. Israel Kirzner clearly explains the centrality of profit and loss in the market process:

The only difference between one market day and the following one was that plans made for trading during the latter day are based on estimates of prices learned through the market experience of the previous day. Agitation in the market was caused by rapid changes in plans made by the various participants as market experience steadily spread more information and repeatedly indicated fresh opportunities for profitable trade. When one superimposes upon this already complicated picture a particular pattern of unforeseen changes in initial commodity-endowments and in individual tastes, things become far more complex (1963).

With access to this powerful learning tool of profit and loss, property owners, developers, and consumers will improve the allocation of a city’s land over time with each day providing opportunities to buy, sell, and redevelop. This process leads to a city that relentlessly improves meeting consumers demands as entrepreneurs see individual opportunities to profit. Because this tool is available only to those with access to the profit and loss mechanism, city planners will never be able to equal the urban development success that a free market can. The absence of profit and loss feedback and the disperse nature of knowledge that leads to profit opportunities are the reasons that efficient resource allocation is impossible under central planning, as Hayek detailed in “Socialist Calculation: The Competitive Solution” (1940).

Urban theorist Jane Jacobs identified the same problem in city planning that Hayek revealed in economic planning. In her 1961 classic The Death and Life of Great American Cities, Jacobs even used language similar to Hayek’s, explaining the “the knowledge of the particular circumstances of time and place” (Hayek, 1945) as “locality knowledge” (Jacobs, 1961). Neighborhood residents have insights into the best use of the land in the few blocks that they traverse daily, but planners cannot access this disperse information because even the most well-intentioned planners are not omniscient.

Jacobs’ ideas have profoundly influenced urban planners, particularly within the Smart Growth and New Urbanist movements. These planners have absorbed Jacobs’ criticism of traditional zoning regulations that limit urban density and prevent mixed use neighborhoods. Traditional zoning leads to cities in which walkable development patterns are illegal and to the collapse of the emergent “sidewalk ballet” that she observed in New York’s Greenwich Village (Jacobs, 1961).

However, in those branches of urban planning where Jacobs’ observations on the benefits of dense, mixed-use neighborhoods have permeated, planners typically fail to realize that she espoused the potential for emergent order within cities when homebuilders, shopkeepers and residents are free to act in their own self interests. Rather, today’s progressive planners seek to mandate the type of development that Jacobs herself preferred as a matter of taste through regulatory tools such as urban growth boundaries, parking maximums, and public transit spending.

Smart Growth and New Urbanist city planners typically attempt to correct past government failures with new government regulations and programs. They fail to recognize that the key to allowing emergent order in cities is deregulation, permitting landowners to build the type of development that consumers demand (Washington, 2010). In Law, Legislation and Liberty Volume 1, Hayek demonstrates the importance of allowing individuals to rely on their own knowledge for decision making:

A condition of liberty in which all are allowed to use their knowledge for their purposes, restrained only by rules of just conduct of universal application, is likely to produce the best conditions for achieving their aims; and such a system is likely to be achieved and maintained only if all authority, including that of the majority of the people, is limited in the exercise of coercive power by general principles to which the community has committed itself (1978).

By attempting to engineer cities to fit their vision, planners of all persuasions violate this principle of liberty and, in doing so, prevent individuals from seizing mutually beneficial exchange opportunities to improve city design.

If Hayek were alive today, he would draw a parallel between markets and cities as dynamic processes, demonstrating the errors that city planners make when they attempt to build Jacobs’ emergent urban vision through regulation and fiat. Mises, Hayek, and Kirzner convincingly show that economies are not mechanistic and economic growth cannot be conducted from the top down. Likewise, cities are not machines; they are dynamic marketplaces that provide the spatial component of entrepreneurial activity (Ikeda, 2012). Attempting to direct urban growth from the top down limits a city’s ability to facilitate exchange and learning through the market process.

Today, federal government issues such as monetary policy, fiscal adjustments, and national economic development receive more attention from free market scholars than land-use regulation. However, it’s hard to overstate the impact that land use regulations have on individuals’ lives and on productivity growth. Researchers at the Santa Fe Institute have established that urban scale is related both to economic growth and to efficient use of public and private infrastructure (Bettencourt and West, 2010). Similarly, Harvard economist Edward Glaeser’s extensive body of research shows that urban density is vital to economic development and that without freedom to build, housing costs rise prohibiting opportunities for productivity growth (2012).

In a free market, cities will continuously move toward an equilibrium in which they are best suited to meet the needs of their residents, but land use regulations put a stop to this process. Because cities provide the spatial component of entrepreneurial learning, preventing these marketplaces from improving over time comes with a high toll in economic growth. Like markets, successful cities grow, but they cannot be made. Today Hayek would be writing about the importance of the urban development process that provides the space where entrepreneurship takes place.

The Value of Walkability

Last week DC Streetsblog reported on a new survey from Kaiser Permanente. The survey covers Americans’ attitudes toward walking and their self-reported walking habits. While a substantial majority of people believe that walking has health benefits ranging from weight management to alleviating depression, the survey found that most people walk less than the 150 minutes per week that the Centers for Disease Control and Prevention recommends. The Streetsblog coverage attributes a lack of walkable infrastructure to low walking rates, although it’s not clear to me that the survey explicitly supports this conclusion. However, past research demonstrates that people who live in neighborhoods where they are able to complete errands on foot do, unsurprisingly, do walk more than those who don’t.

While people may not cite walkabilty as an important consideration in choosing a house, choosing a home involves weighing many factors, from size, price, distance to work and other amenities, aesthetic, and countless others factors. Consumers rely on tacit knowledge to weigh many of these factors because they can’t consciously enumerate all of them in making a decision of where to live.

For this reason, revealed preference theory is a more reliable tool than survey data for observing how consumers value one attribute of a complex good like housing. Building on a past project, my colleague Eli Dourado and I are studying whether or not consumers do pay a premium for greater neighborhood walkability. Using a fixed-effects model, across all metropolitan and micropolitan statistical areas in the United States, our preliminary results indicate that, on average, Americans are willing to pay a premium of about $850 for a house with one additional point in Walk Score. Because of the many restrictions that limit walkable development, consumers have to pay this premium for the scarce supply of houses in walkable neighborhoods.

This finding also indicates that, in a world with fewer regulations limiting the supply of walkable development, the free market would provide a greater supply of walkable neighborhoods because developers have opportunities to profit from doing so that are currently prevented by regulations. In a freer market, more people would have the opportunity to live in neighborhoods where completing daily errands on foot is feasible. These findings don’t tell us what, if any, public health improvements would be seen from more people living in walkable neighborhoods, but they give us a clearer picture of the value people place on walkability than survey data does.

Market suburbanistsoften cite survey data finding that most people prefer detached, single family homes to living in multifamily housing. They also often say that revealed preferences back up these surveys because most Americans live in single family homes. Indeed, this is true, even in the largest cities. However, looking at the housing choices that Americans make while ignoring both regulations that limit the potential choice set and without considering the prices consumers pay is misleading, like saying Americans prefer Fords to BMWs because there are more of them on the road.

An understanding of consumers’ complex decision process in selecting a home cannot be accurately gleaned from either survey or Census data; rather, this information should be observed based on the price that emerges between buyers and sellers in the market. While, all else equal, most people might prefer a large detached house with a big yard, in weighing the many factors like proximity to amenities, price, and house size, we find that people are willing to pay a premium for walkability.

While I’m not prepared to make any claims about health benefits from permitting more walkability, it is clear that people are willing to pay a premium to live in more walkable neighborhoods and that in a freer market, more walkable development would be provided.