What follows from the idea that new construction raises rents?

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What follows from the idea that new construction raises rents?

Matthew Yglesias

13 - 16 minutes

I think the YIMBY movement, reflecting its origins in the very progressive jurisdiction of San Francisco, demonstrates a bit too much interest in arguing with obscure leftist professors and activists and ought to focus more on the concerns and ideas of normal people.

In my dramatic upzoning proposal for D.C., I throw anti-gentrification activists a huge bone (the ability for low-income neighborhoods to opt out), but that’s mostly because it’s a cheap concession to make in D.C. The real policy challenge is developing a proposal that will reassure people who park their car on the street and who worry that more housing will lead to more parking scarcity. “I’m selfishly worried about my parking space” isn’t a great article to submit to the Journal of Obsessive Economics Haters, but I think that in practice, people who are selfishly worried about parking are a bigger obstacle to reform than Marxist geographers, and it’s probably worth paying more attention to them.

But there is one idea in left-NIMBY circles that I think is worth talking about.

The notion that new development actually causes rent increases in nearby areas is a staple of activist rhetoric. I’ve mostly dismissed this argument as opportunistic — it’s a useful thing to pretend to believe if you’re trying to extract certain concessions from developers — but Clayton Nall, Chris Elmendorf, and Stan Oklobdzija did a recent survey where they find that 30 to 40 percent of the national population shares this supply skepticism view. Interestingly, the researchers kicked the tires on people’s more general intuitions about this and found that in other markets, they tend to believe in supply/demand economics. I’ve twice tried to write articles addressing supply skepticism by noting developments in the automobile market, but people aren’t supply skeptics about cars.

So I want to take a different tack today and think about the implications of living in a world where allowing more construction does lead to higher prices.

You’d be saying, in essence, that a new building would generate more demand than supply, which if taken really literally suggests that cities can unleash a kind of perpetual motion machine for economic growth, where supply begets demand which begets supply which begets even more demand. That seems like it’s probably false — but more importantly, if it’s true, that seems like something we’d want to know about! We should take the Supply Skepticism hypothesis seriously, in part because I think it’s probably capturing something correct.

Jerusalem Demsas, writing about Supply Skeptic research, posits that skeptics are essentially confusing cause and effect — construction tends to happen when prices are rising, so it seems like it is causing the price increases:

    Why is housing different? Perhaps because the supply argument seems to defy lived experience. People look around their community and sense that a lot has changed. They see new homes and developments cropping up, even as prices keep rising. This eyewitness account results in people thinking that these new developments either do nothing to alleviate rising prices—or worse, actually cause prices to increase.

Disentangling cause from effect with a mix of opportunistic data-spotting and clever math is something that economics as a profession has gotten very interested in, so a bunch of young economists have tried to look at this empirically and have generally vindicated traditional theory-based supply/demand arguments.

Probably my favorite of these is Kate Pennington’s paper “Does Building New Housing Cause Displacement?: The Supply and Demand Effects of Construction in San Francisco,” which looks at what happens when buildings burn down in a fire and then get rebuilt. She also constructs conceptually separate measures of displacement (when poor people move to poorer zip codes) and gentrification (when rich people move into a neighborhood). She finds “that rents and displacement fall differentially near new market-rate projects, while gentrification increases.” In other words, it’s true that new construction acts as a magnet for affluent newcomers. But it also deflects affluent newcomers from competing for the older nearby housing stock. So you get more gentrification but less displacement — a win-win.

In keeping with the theory that people are confused about causation, I think most people plausibly assume that what Pennington calls gentrification and what she calls displacement are the exact same thing. There is a bias toward zero-sum thinking that holds even though the point of new construction is very literally to create a positive-sum amount of housing.

That said, I am not entirely sure that evidence grounded in this kind of natural experiment fully incorporates the universe of possibilities. I lived briefly in the Columbia Heights neighborhood of D.C. at a time when it offered a pretty low quality of life. The only places to eat were a Subway and a dismal Chinese carry-out, and the local supermarket was a really gross Giant up by Newton Street where Thip Khao1 is now. But one reason that Giant was so gross was that at the time, several big apartment projects were underway directly adjacent to the metro station, and one of them was a brand-new Giant that represented the future of the company's investment in the neighborhood. I had already left the neighborhood by the time the metro-adjacent mixed-use projects were completed. But when they were done, the neighborhood became a much more pleasant spot featuring a nice supermarket, a Target, a bunch of restaurants, a gym, and other appealing amenities. It seems plausible to me that a rule requiring those metro-adjacent parcels to remain vacant would have suppressed local rents, even though it also would have reduced housing supply.

Note that on a technical level, the hypothesis here isn’t that the new housing raised rents — it’s that the new retail amenities on the ground floor of the housing raised rents. All else being equal, I’m sure it’s true that shorter buildings with less housing would have generated more scarcity while taller buildings with more housing would have generated less scarcity. But I think the most salient real estate projects are precisely the kind of transformational mixed-used projects that provide significant amenity benefits.

What’s odd to me about this debate is that “this new market-rate development is bad because it made the neighborhood more appealing and raised demand” seems like conceptual acid that could dissolve all kinds of policy ideas:

    Don’t renovate the crummy playground because a nice new playground will make the neighborhood better, raise demand, and lead to higher rents.

    Don’t recruit and retain excellent teachers at the neighborhood middle school because rising test scores will raise demand for living in the neighborhood and lead to higher rents.

    Don’t solve murders that happen on the neighborhood’s commercial street because solving crimes will deter shooters, make people feel safer, and lead to higher rents. 

Thinking back to my time in Columbia Heights, I noted that the vacant parcels were right by the metro station. At the time I moved there, the station itself was less than four years old. And it’s the station — and the broader opening of the Green Line — that explains why I was there in the first place. Moving to an unfamiliar city with a low-paying job and an affection for urbanism, my roommate and I sought out an affordable place that was near a metro station, which brought us to the 1300 block of Harvard Street. I think it’s unquestionable that the metro station increased demand for living in the neighborhood, and that increased demand helps explain why the big mixed-used projects were happening in the first place.

So is it bad to invest in transit infrastructure projects that raise neighborhood demand?

I would think the opposite. A lot of infrastructure projects don’t work out. But digging the central segment of the Green Line up from the Convention Center to the Shaw station, to U Street, to Columbia Heights, to Petworth, and then connecting it to the suburban stub running to Fort Totten has been a demonstrable success. You see it in the ridership numbers and in the increased demand for living near those stations, demand that was reflected in part in higher prices and in part in new construction. If they’d dug the tunnel and it didn’t increase demand for living near the stations, that would’ve been a sign of failure.

So what are you saying, Matt? You love gentrification and want to see the poor priced out everywhere?

No, but I am saying that our housing affordability solution can’t be to look at cheap neighborhoods and then decide they must be forever consigned to high crime, few parks, bad schools, and low-quality transportation infrastructure. Once you accept that improving quality of life is a legitimate goal for local government, then what you see is that induced demand due to mixed-use projects with nice retail amenities isn’t special. It’s just another example of how making a neighborhood a better place to live is good. But if a neighborhood gets better, demand will rise. The solution is to allow that demand to take the form of new construction rather than just higher prices.

I think it’s important to not be total denialists about the fact that new construction can increase neighborhood desirability because agglomeration benefits are an important part of the case for urbanism.

Traditionally, economics has focused more on agglomeration benefits on the production side — people in related industries benefit from being in proximity to each other. But with more work going remote, I think we will see interest in the consumption amenities side growing. I’m often struck by the fact that New York is more expensive than Boston or D.C. (this is true whether you look at the central city or the whole metro area), even though it has lower wages and incomes. You often see this kind of rent/wage anomaly in places with particularly good or bad weather. Miami and Los Angeles are more expensive than you’d think based on their incomes and Minneapolis is cheaper — that’s because people don’t like the cold.

New York is different. I think people like New York because it’s a bigger city.

Or rather, I think lots of people don’t like big cities at all and wouldn’t want to live in any of these plays. But among the set of people who find the big northeastern cities congenial, New York is seen as the best because it’s biggest and densest and has the most stuff.

D.C.’s population has grown nearly 20 percent since I first moved here, and I would say that not only have a number of specific neighborhoods developed better neighborhood-serving retail amenities as part of that growth, but the city as a whole has become a better place to live. When restaurants sprout up in a neighborhood they are mostly neighborhood-serving restaurants, but a few of them will be “worth a trip” standouts. We have more movie theaters than we used to, one of the only cities that’s true of. There are multiple places you can go to throw an axe with your friends.

Again, this is not a case where “adding housing raised rents” exactly. But I do think it’s true that the influx of real estate investment dollars (both more houses and more commercial real estate) has created more amenities and raised demand for D.C. living. It’s a mistake to deny people’s intuition that development can spur demand, because at the end of the day, we are trying to convince people to be less fearful of investment.

The important thing for everyone to keep in mind is that there must be some kind of limit to this process or else cities could easily generate infinite economic growth and prosperity. Or to put it another way, if induced demand effects were really large and common, then that would only strengthen the case for upzoning because it would imply cities could be creating infinite levels of prosperity.

Suppose we did a broad upzoning all across D.C., and that led to a huge spurt of new construction, and that new construction led to lots of new amenities, and those new amenities created so much new demand that even though the city added residents, marginal prices were higher than ever. Well, thanks to those higher prices, we’d see more construction than ever. That would mean even more new residents and even more amenities and even higher demand. Lather, rinse, and repeat as the city’s population keeps growing, leading to ever-more amenities and ever-higher demand.

It’s true that this growth escalator might generate some downstream problems of higher rent.

But it would also be creating incredibly large amounts of jobs and income, to say nothing of tax revenue that could be used to improve public services or give cash assistance to the poor. Any scenario where investment begets more investment is a scenario where you want the investment.

The fact that we don’t see any city anywhere doing this is good reason to believe that it won’t work because it’s not, as a rule, true that new development leads to higher rents. I think the boring truth is that this is only true in certain very particular cases, but those cases happen to be memorable precisely because a sudden spurt of growth and investment is unusual. But if it does happen, we should see it as good — just as other things that increase demand like better schools or new parks or safer streets or useful infrastructure are good.