One Freshman Textbook Cannot Explain San Francisco’s Housing Markets

Who thinks $7,000 per month rents are “affordable”?

Mayor Daniel Lurie now says that it is necessary to foundationally change the character of many San Francisco neighborhoods – like the Sunset, Richmond, Cow Hollow, Noe Valley and others – in order to make the city more affordable. The Mayor’s cleverly branded “Family Zoning” plan would allow market-rate housing towers in many traditionally low-rise, single-family neighborhoods, particularly along neighborhood shopping streets.

But many residents are asking a foundational question: How do new market-rate housing towers, with rents and costs far above the budgets of most residents, make the city more affordable?

Mayor Lurie, and his active coalition of Yes In My Backyard (YIMBY) supporters, say that broad upzoning will bring greater affordability through the simple dynamics of supply and demand. But a growing body of economic research shows that housing markets are not so easily simplified and that in a city like San Francisco, more luxury housing will not lower costs for most, and in fact, could actually increase housing costs for many.

How could this be, many ask? Isn’t this just Economics 101? Doesn’t more supply mean lower costs, by definition?

It turns out housing markets are not so easily explained by freshman textbooks.

The most definitive recent study, just released by the Federal Reserve Bank of San Francisco, took a hard look at how regulations like zoning affected housing prices. Their conclusion, counterintuitive to many, was not at all.

The Fed’s comprehensive study concluded: “Differences in housing supply elasticities (regulations) across U.S. cities are small and quantitatively not important for explaining differences in house price and quantity growth.”

The authors find: “Contrary to prevailing beliefs and influential policy narratives, our empirical results consistently demonstrate that higher income growth predicts similar growth in house prices, housing quantities, population, and living space per person across more and less housing constrained cities.”

In short, housing costs so much in places like San Francisco largely because people make so much in San Francisco – and property owners charge what the market will bear.

The work of Professors Andres Rodriguez-Pose and Michael Storper of the London School of Economics, also found that high housing costs are driven by the cost of land, labor, competition from overseas buyers, and other issues separate from zoning. And the authors warned that just focusing on deregulation to make housing more affordable is problematic because it can actually backfire by increasing the cost of housing for working families by driving displacement and gentrification, in part by driving up land costs.

Likewise, in his oft-cited research, Professor Yonah Freemark found that in Chicago “upzoning increased prices of existing housing units” because of immediate increases in land values and that in the mid-term, at least, “no impacts of the (upzoning) reforms, however, on the number of newly permitted dwellings over five years.”

One of the foundational arguments of the YIMBY forces is that if we just “free” for-profit developers, now frequently private equity-backed, they will make housing less expensive. Please pause on that thought for a moment. Ask yourself, when was the last time Wall Street and private equity worked to make something less expensive? The idea that these developers will flood San Francisco with so much housing that they will “crash” the housing market is not supported by facts. The reality is they will pace construction to keep prices high. That’s exactly what Australian economist Cameron Murray has studied. Did he find savvy developers flooded markets with housing to lower prices? You know the answer. They did not, and will not. They ”throttle” construction to maximize profits.

And closer to home, Professor Patrick Condon in Vancouver, BC, argues persuasively that the massive upzoning being driven by the deregulation advocates is, in fact, the key driver of housing inflation. Vancouver has already done what California developers seek – allowed massive upzoning and pursued broad deregulation. The result? The highest housing costs in North America.

Why? Condon’s research shows the immediate effect of upzoning is to drive up land costs making both existing housing and any new housing ultimately built that much more expensive. And so what does the data indicate will happen if Lurie and his YIMBY supporters get their way? An immediate spike in land prices – which means a spike in both commercial and housing rents and an increase in the price of existing housing. (This is great for you, if you are a commercial landlord, or own a home that is now more valuable because the land under it is more valuable. But this upzoning is damaging if you are a small business, a customer of a small business, which now must raise prices to pay for higher rents or close, or in the market for a home or apartment.)

One of the data sets the YIMBYs often cite is the comprehensive study of over 1,000 US cities by the Urban Land Institute. They should read it with greater attention to detail. The study found that 3 to 9 years after loosening zoning restrictions rents did not decrease at all. Housing inventory did increase by slightly less than one percent. But the authors found key benefits went largely to high-income people and that without interventions, like supporting affordable housing, upzoning can backfire because of gentrification and displacement of lower-cost existing housing with the new upper income units.

And one hard reality Lurie doesn’t acknowledge is the findings of his own Planning Department, which predicts his plan will not make housing for working families more affordable, but the opposite.

The Nexus Study prepared by the Planning Department found that increasing the number of market rate units drove demand for affordable units. In short the increased supply of high-income people who can afford the high costs of these new units drove a demand for teachers, childcare workers, and other service workers and unless enough of homes were affordable it made housing more expensive for working families. (The study found that over 30 percent on-site affordable was required to provide adequate supply for the new demand for service workers and others. Lurie’s upzoning plan requires just one-third that need).

And while Lurie and his developer allies claim blanket upzoning is the answer to meeting the State of California’s Housing Mandates, they don’t acknowledge that San Francisco has already approved nearly 70,000 new homes and apartments in places like South of Market, Treasure Island, Pier 70, and the Hunters Point Shipyard. These neighborhoods, generally well-served by transit and close to jobs, are already zoned for dense housing and that housing is not getting built. Why? Because the impediment to new housing is not zoning – it is, as so many studies have found – the cost of construction, land, and capital. The Lurie upzoning plan does nothing to address any of these barriers – and in fact makes one of the barriers higher by raising the cost of land.

While potentially making the housing affordability crisis worse by increasing the cost of land, the Lurie plan takes away one powerful tool we once used to create more affordable housing. Upzoning is in every respect a transfer of value from the city to the property owners. The city “owns” the zoning and in the past, when we transferred value to property owners through upzoning, we asked for, and received, something in return – usually an investment in affordable units that could be up to 40 percent of the total built on a given site. Lurie asks for nothing new in return for his upzoning – it is an outright gift of land value to private property owners with no new value captured for the city’s taxpayers in return.

Perversely Lurie’s plan is also essentially “anti-planning.” He is giving a blank check to developers while basically saying – “you figure it out and let’s see if your luxury housing trickles down.” That is the opposite of what visionary mayors do. Visionaries plan how their cities grow. Look at Mission Bay and South of Market, where new housing and jobs have grown up next to new and improved transit. That wasn’t an accident – that was planned by mayors like Willie Brown.

In Lurie’s case, he says revitalizing downtown will be one of the key goals of his administration. Smartly, he says new housing there is a priority. But then instead of guiding new housing into downtown, he allows developers to put it on Taraval Street, Judah Street, or 24^th Street based on a discredited economic theory and the even less credible promises of developers.

Again, the developers and their SPUR and YIMBY supporters cry – “It is Economics 101!” Well great, run the numbers. If a new unit costs $1 million to build in San Francisco in the years ahead (which is a number I am rounding down) then a basic pro-forma shows the rent on that unit is going to be $7,000 per month or higher. In what world do people call that affordable? Of course the trickle-down theory is that in the future these units will ultimately become more affordable through depreciation – but housing in San Francisco is an appreciating asset, not a depreciating one.

And beyond all these studies we can simply ground truth. San Francisco just unwittingly conducted a real-world experiment that tested Lurie’s theory of housing supply and demand. In the past five years the city lost 31,000 residents while building nearly 20,000 new homes and apartments. Considering the average occupancy of a San Francisco residence is 2 people, that is the functional equivalent of creating 35,000 new housing units – or slightly more than what Lurie promises the neighborhood unzoning plan will create.

What happened? San Franciscans know the answer. Housing prices went up, not down.

So if blanket upzoning doesn’t work, why do it?

There could be lots of answers – but there is one obvious one. Building affordable housing costs money. And San Francisco faces crushing budget deficits.

Promising magic solutions? Well that’s free, at least for the politicians.