The Answer Is Transaction Costs

All Housing is Affordable Housing

• Michael Munger • Season 2 • Episode 11

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Are housing regulations making affordable homes a pipe dream? We promise you'll gain a deeper understanding of how transaction costs and regulatory hurdles impede new housing development, frustrating both market responses and the dreams of potential homeowners. We'll explore how the very laws intended to protect affordable housing often backfire, pushing developers toward luxury projects instead.



Cans v. Bottles: https://twinmonkeys.net/an-advantage-to-canning-vs-bottling-lower-shipping-costs/#:~:text=Aluminum%20cans%20are%20cheaper%20to,space%20and%20reducing%20packaging%20waste

The Theban Plays: https://www.amazon.com/Sophocles-Oedipus-Colonus-Antigone-Editions/dp/B00HTJUCLW/ref=monarch_sidesheet_title

If you have questions or comments, or want to suggest a future topic, email the show at taitc.email@gmail.com !


You can follow Mike Munger on Twitter at @mungowitz


Speaker 1:

This is Mike Munger, the knower of important things from Duke University. Okay, so this week I'm in Montreal for the Freedom Week festivities sponsored by the good folks at Institute for Liberal Studies out of Ottawa. Big shout out to Matt and Janet Bufton. Shortages, especially housing shortages. A new twedge, a book in a week, plus this week's new letters and more Straight out of Creedmoor. This is Tidy C.

Speaker 1:

I thought they'd talk about a system where there were no transaction costs. It's an imaginary system. There always are transaction costs. When it is costly to transact institutions matter, and it is costly to transact institutions matter and it is costly to transact A shortage. Why are there housing shortages?

Speaker 1:

It's been estimated by the Obama administration that there's a shortage of millions of houses and apartments, and it's getting worse. Now there's four things that you need to think about for housing or, more generally, a dwelling where you live in an apartment. First is the location. Is it near jobs? Second, the size. Third, newness and quality of fixtures. Fourth, price. Now those four things trade off amongst each other in ways that can be pretty complicated.

Speaker 1:

A while back, I wrote an article that claimed that all housing is affordable housing. Now that's actually a controversial position because a lot of people think we need to set aside affordable housing, we need to subsidize it, we need to have price controls. My claim is that all we need to do is make it legal to build new houses. So if there's a shortage of something, that means that there are more people who want it than can get it at the current price. If there's scarcity, that usually means that consumers buy or use less because the price is going to go up. Producers make more if they're allowed to do so, because the high price signals that we need more of that thing and entrepreneurs come up with substitutes. Now, in housing, that system's not working because it's not being allowed to work, and it's not working for two reasons. First, prices are not being allowed to rise because we have a variety of controls that prevent prices from doing their job of signaling that we need more of these things. Further, entrepreneurs who are trying to find new ways to produce things or producers that just want to produce more housing are being thwarted by all sorts of rules about how expensive it is to build new housing. There's a lot of transaction costs that prevents people from building the houses that they actually want to build. It is effectively illegal in many places to build new housing.

Speaker 1:

Now, the truly odd thing is that, even though it's illegal to build new housing and a lot of people want to live there, the city government blames greedy landlords for raising the price. Well, if a lot more people want something than there is available of that thing, the price is going to go up. The monetary price can go up and I hope I've convinced you in this podcast the non-monetary price can go up. So remember, starbucks has surge pricing. Well, housing has surge pricing if you have a price control. So if you say that the price can't go up beyond a certain amount, there's a bunch of people who want that low-price apartment. They're going to queue up. They're going to try to-price apartment. They're going to queue up. They're going to try to make bribes, they're going to hold on to it for a long time and have illegal sublets, and so the effect of price controls is going to make it much more difficult for the market to do its work.

Speaker 1:

The housing advocacy group Up for Growth estimated that 23 US states used intentional restrictions to block more than 7 million new dwellings that would have been built without the regulations in those states. More importantly maybe, is the finding that, even for the units that were built, as much as 30 percent and sometimes more of the final cost was caused by regulatory uncertainty, waiting for approval or the submission of repeated traffic, environmental and other reports and having to jump through regulatory hoops. So a big part of the reason why even the housing that is built is so expensive is we put up a bunch of regulations that make it more expensive to build housing. We don't get anything for that. It's not a tax, it's just a way of slowing down the market response, and I think the strange thing about this is that many of the people who are doing that are on the political left. What's odd is that rich people can pay these costs and for that reason developers, if they do build anything, are much more likely to build expensive housing than affordable housing, which brings me to the next point that I think is interesting.

Speaker 1:

I've claimed that the essential step toward reducing the housing shortage was to make it legal to build new housing, and in fact I did an estimate for the break-even cost of a new apartment in the city of Raleigh, north Carolina, where I live, and by break-even I mean if there's no profits. So the developer just decided that they were going to break-even developer just decided that they were going to break even, so presumably this would have to be someone who was acting like a charity, because they're not going to get any return to all of the time that they spend and the money that they invest. Even if you just break even, it would cost $3,000 per month for a one-bedroom apartment that was new in Raleigh Raleigh's hardly the most expensive city that there is, but the barriers that have been put up to building new housing are so overwhelming that it's very difficult to build new housing. Because of the regulations. It's literally impossible to build new affordable housing.

Speaker 1:

Now, when I wrote that, I got some emails with an argument that I actually had trouble taking seriously because it seemed ridiculous. But when I check, it's actually true. There's a lot of people who are affordable housing advocates who claim and I'm not making this up that we should not build new housing because new housing is more expensive than existing housing and all it will do is drive the price up. We have to set aside affordable housing. We can't build new market rate housing. As I said, I had trouble taking that argument seriously, but actually there are a lot of people who make that argument, so let me try to address it First, just on the merits of housing.

Speaker 1:

Well, why stop with housing? Why not do it with cars? After all, new cars are much more expensive than used cars. Does it follow that we shouldn't build new cars? No, in fact, building new cars is what keeps the price of cars from going higher than it otherwise would. So that's not to say that new cars are cheap they're not. But building new cars means that the price of cars doesn't go up as much as if we made it illegal to build new cars.

Speaker 1:

Toothbrushes I have a toothbrush. It's pretty old. A new toothbrush is going to be more expensive than my old toothbrush. In fact, I probably can't sell my old toothbrush for much of anything. I can't imagine anybody wants it. But wait, new toothbrushes are more expensive than old toothbrushes. Won't that drive the price up? Well, no, not compared to outlawing the building of new toothbrushes. Obviously you want to allow the building of the new item in order to keep the price from going up even higher. Well, housing is no different. It is absolutely true that the price of new housing is going to be higher than the price of existing housing.

Speaker 1:

But all housing is affordable housing. If we build new housing, even for the wealthy. That means that there's going to be a lot less pressure for gentrification. What causes gentrification? Gentrification is caused by the ability of wealthy neighborhoods and, let's face it, that's mostly white people. So let's say it like it is rich white people who don't want to live near poor people and they have the political power to make that stick. People who live in poor neighborhoods don't have anything like that kind of political power. So since we can't build high-density, expensive housing in wealthy neighborhoods, they're displaced to poor neighborhoods. And then we say, oh, that's so greedy because of gentrification. No, the greedy people are the rich white people that won't allow high density housing in their wealthy neighborhood in the first place. Look, all housing is affordable housing. If we allow the building of new housing units in wealthy neighborhoods, that will reduce the pressures for gentrification and it will sharply reduce the amount of pressure on poor neighborhoods.

Speaker 1:

Now there's several arguments about this, what's called the supply skeptic argument. The supply skeptic argument says that building new housing won't help because it'll be too expensive. Again, I don't know why we don't apply that to cars, but fair enough. There's four categories of that argument. First, land. Land is so scarce in cities that any use other than immediately building affordable housing is going to take available land off the market and it will permanently prevent affordable housing from being built on that plot. Once we have an expensive house on it, it's not available for affordable housing. Second price New housing is more expensive than existing housing and so it's going to raise the average price, not lower it. We want affordable housing and so we want to lower it. That's no good Argument.

Speaker 1:

Three is an argument involving induced demand. Allowing more high-end housing to be built in response to big increases in people moving to your cities will in fact lower the price of high-end housing, but that's going to attract even more rich people in the next wave. That is, if we build enough housing for rich people to live so the price isn't skyrocketing, even more of these nasty rich people are going to move into our area. So in growing areas, price decreases from increased housing in a static sense will be more than offset by the additional high-end demanders that are moving in in a dynamic context. And the fourth argument even if building new housing in a neighborhood does reduce rents overall, it increases rents in the immediate neighborhood as previous tenants are displaced by gentrification and they try to stay in the neighborhood where they have connections.

Speaker 1:

Well, I'm not going to discuss these arguments at very much length, but I will put up a link in show notes to a paper that was written by three scholars from New York University's Furman Center, and let me quote from that paper. This paper is meant to bridge the divide between the arguments made by supply skeptics and what research has shown about housing supply and its effect on affordability. We address each of the key arguments that increasing supply does not improve affordability. Many of the arguments are plausible. We take them seriously, but we ultimately conclude from both theory and empirical evidence, that adding new homes moderates prices and therefore makes housing more affordable to low and moderate income families. Moderating price doesn't mean that prices won't rise at all, but they won't rise as much as they would otherwise. End of quote. So what this paper does is it takes seriously the four arguments that I just made. It tests each of them and in a way, each of the four has a kernel of truth in it.

Speaker 1:

But building new housing is better than not building new housing, in the sense that not building new housing will make the price go up by even more. So the difficulty is that we have a shortage, and remember a shortage requires that people who want the thing at the existing price are unable to get it, and so they're going to try to bid up the price. Able to get it, and so they're going to try to bid up the price. So if you look at the restrictions that are placed on new dwellings in neighborhoods, you'll see that they're amazingly complicated. So, for example, some of them if you wanted to build a new dwelling, setbacks, parking minimums per unit, square footage of the dwelling minimum, lot size, no snout houses. So let me say again, there's four things that are important about dwellings Location needs to be near jobs, the size of the unit, newness and quality of fixtures and the price.

Speaker 1:

We have a family friend who's kind of a moderate leftist. He mostly thought government was trying to do the best thing and was trying to help poor people. But then he was a manager of a large commercial real estate complex in Durham, where Duke is here in North Carolina, and it happened that the commercial real estate complex they actually had rental apartments the only place in Durham that had two and three bedroom units for under $1,800 per month. So a lot of people wanted a little bit more size. There weren't many two or three bedroom units and it was in an area of Durham that was near a lot of jobs. It was under $1,800.

Speaker 1:

What was the missing factor here? Well, newness and quality of the fixtures. So the point is, you can't have all of these things. Remember, the four things that I said were location, size, newness and quality of fixtures and price. Well, these apartments in the complex that he was managing they were cheap, they were large, they were near jobs, but they weren't very nice. They were pretty old. A lot of the appliances were old, a lot of them needed to be painted, some of the doors, things in the bathroom probably needed to be repaired.

Speaker 1:

Well, the city of Durham required that that complex update all of the appliances and refurbish all of the units because they were below and I'm making air quotes here code. We're not talking about electricity, we're not talking about safety issues. These are things, rules about the quality of the dwelling. Now, that was very expensive. The company was willing to do it. However, because Durham was growing very fast, these refurbished apartments now had rents of $2,500 or $3,250 per month and the result was gentrification.

Speaker 1:

Wealthy people moved into these apartments because poor people could no longer afford them. What caused it? The restrictions that the city of Durham imposed, saying that if you're going to have a large apartment, if you're going to have an apartment with good location, it also is going to have these expensive things of new appliances. All of the doors are fixed, it has to be painted, you have to redo the bathrooms. That means it will command a much higher price.

Speaker 1:

Now, was it the greed of the landlords? It was not. The price of those apartments was bid up by the many new wealthy, young people that are moving to that area. They see that apartment and they'll say, well, I'll pay quite a bit more for this. You've got three, four, five, seven people all bidding for the same now much nicer apartment, and the price is driven up. If the landlords had not raised the price, there would never have been an opening. It would have been impossible to get an apartment. So the result is that if you want people to have affordable housing and to be able to have it in a location near jobs, you're going to have to compromise either on size and maybe people are willing to live in a smaller place so they won't have as long a commute or you're going to have to compromise on quality, and there has been a move in many cities to try to force an improvement in quality, and I gave some of the list already.

Speaker 1:

I actually gave a talk not long ago about housing restrictions and said that setbacks and things like snout houses raised housing prices, and a woman was very angry and she said yes, but I don't like snout houses. I don't want to live in a neighborhood that has snout houses, and a snout house is a house where the garage is quite a bit out and forward of the house, so that if you look down the street, all you see is a bunch of garage doors. Well, it makes much more efficient use of the space on the lot and it means that the house is quite a bit cheaper. Ma'am, if you don't want to live in a neighborhood that has snout houses, you are welcome because you are rich to pay the extra that is required. But a lot of people are willing to live in a snout house because it's quite a bit cheaper and it's near good jobs. So the idea that, because you don't like it, other people can't have it is astonishing. And again, this is not a safety issue. This is an issue about we have rich white people forcing the poor to live elsewhere and then blaming landlords when it is the fault of these housing restrictions. So if you want to know what is the cause of housing shortages and high prices, well, maybe it won't surprise you to learn the answer is transaction costs. These are restrictions that are imposed by politics. It is a friction that is imposed by regulatory pressures, by people that just don't want poor people to live near them. Whoa, that sound means it's time for the twedge.

Speaker 1:

I'm going to go all cultural this week about Canada. First, how do you get a Canadian to apologize? Well, you step on her foot. I think that's hilarious because it's totally true. If you step on a person's foot up here, it's likely they'll say oh sorry. Second, what makes up 50% of Canada? The letter A. That's hilarious because A is a stereotype for things for Canadians to say. And of course, there are three A's and a C and N and a D in the word Canada. So 50% of Canada is the letter A. Finally, what does a Toronto building inspector use for birth control? Their personality, that one kills me.

Speaker 1:

Building inspectors are people who care very much about enforcing rules, and it is true that many of these rules are passed for political reasons. I'm a fan of law enforcement. I understand that they're just enforcing the rules, but I'm a little worried about the sanctimony. You're not protecting poor people. You are harming poor people by enforcing these building rules. Some of these building rules add a lot to the expense of the apartment. Rich people can pay it, poor people can't. And so the people who are building inspectors that are just outraged by minor violations and who force repeated, expensive delays and repairs are doing a great deal of harm to the very poor people they pretend to care about. Now I recognize they actually do in many cases care about, but they are mistaken. They're driving up the cost of housing for no good reason.

Speaker 1:

This week's letters we got two letters on the beer in cans and bottles, and it's interesting that each of them offers a different explanation for why bottles are more expensive than cans. First, cans versus bottles. Bottles are more expensive for many reasons More expensive to produce, more fragile, more expensive to ship. Think about the box you buy bottles in versus the box you buy cans in. Can box is very cheap and thin Think of a cereal box compared to the very sturdy bottle box. It's also quite a bit more efficient to ship cans because they weigh less. C from Montana. End of letter. And then letter two Hi, mike, I've worked for the largest beer company in the world and can confirm that consumers see more value in bottles versus cans.

Speaker 1:

So that could at least partially explain different pricing. Interestingly, consumers couldn't taste the difference in taste between our value core and premium beers, but the premium beers are priced two or three times more than the value beers. I guess tidy C Could it be signaling you want people to know you belong to a certain group and there's no easy way to get that info across, except, of course, for buying the right beer Prudently anonymous. End of letter. Well, so we have one claim that bottles are more expensive than cans because bottles are more expensive and another claim that people are willing to pay more for bottles and in fact the difference may even exceed the difference in cost. Now, both of these things are clearly true, so I'm not saying that one is correct, but it was interesting to get two different explanations from either insiders or experienced people who have looked at beer markets quite a bit. I do think it's interesting that people may not be able to tell the difference in taste. The thing is that it is a signal. If I'm drinking a cheap beer, then I'm the sort of person who drinks cheap signal. If I'm drinking a cheap beer, then I'm the sort of person who drinks cheap beer. If I'm drinking an expensive beer, then I'm the sort of person that drinks expensive beer. It's a strange thing that the price matters more than what's in the bottle. But there may also be other differences that are harder to detect. But thank you both for those letters.

Speaker 1:

It's time for Book of the Week. I want to expand horizons here a little bit. This isn't really a book, but a trilogy of plays, sometimes called the Theban Trilogy, by Sophocles, so it's more than 2,000 years old. You can find a lot of editions or performances online. I just read the three plays while I'm here in Montreal Oedipus Rex, oedipus at Colonus and Antigone. I was struck by just how much these plays are, forgive me, all about transaction costs.

Speaker 1:

Oedipus Rex is about triangulation, finding out information about who and what. All of it is about information being embedded and not available. So Oedipus is looking for information and a lot of people are trying to keep it from him for his own good. When he finally finds it out, well, I won't spoil the ending. Antigone is all about triangulation and transfer, the problem of negotiating agreements and delivering on promises. So it isn't so much about information, but it is a reneging on agreements and promises and cultural expectations. So it's a fascinating exercise in transaction cost. The theme of trust pervades all three. Now you can read these in the long afternoon, and you certainly could read each one of them in a short evening. I have to say, though, I've read the trilogy several times. This time I was surprised at how much I got out of the experience. Well, the next episode will be released on Tuesday, august 20th. We'll have a new topic, some letters and, of course, a new hilarious twedge. All that and more next week on Tidy C.