The Importance of Housing Supply
December 11, 2018
Authors: Josh Lehner, Oregon Office of Economic Analysis
Publishers: HFO Apartment Investor Newsletter
What Lurks Beneath
The economic expansion marches on, and our regional economy continues to hit the sweet spot. Job growth is more than enough to match population gains, and household incomes are setting all-time highs on an inflation-adjusted basis. However, problems remain underneath the surface of the strong economy. Most prominent is housing affordability, or the lack thereof.
The good news is housing affordability has largely stopped getting worse over the past couple of years due to the combination of increasing new construction activity and rising household incomes. However, there is no question that affordability is significantly lower than a decade or two ago. Overall, high housing costs are putting upward pressure on local businesses as employees need higher wages to make ends meet. High housing costs also squeeze household budgets, leaving less money to spend on food, clothing, entertainment and all other goods and services.
Lack of Construction Keeps Housing Costs High
The primary driver of today’s outsized housing costs is the fact that the economy has not built enough new homes relative to population growth and household formation. Strong demand in the face of lackluster supply is a classic recipe for rising prices. These issues are evident across much of the nation and are particularly pronounced in the Pacific Northwest. The Up for Growth National Coalition found that from 2000 to 2015, Oregon underproduced new construction by 155,000 units—equal to nine percent of overall housing stock. The same group found that Washington underbuilt by 225,000 units or 7.5 percent while Idaho fared somewhat better—underbuilding by 3.2 percent (22,000 units).
Filtering: A Misunderstood Process
Thankfully all is not lost. Worsening affordability does not have to be our new normal. It’s true that new construction is always expensive and aimed at the upper third or so of the market. Local residents can be alarmed by high rents and sale prices attached to new construction leading some to erroneously conclude that new construction does not help with overall market affordability. Luckily—this is not the case. The reason is at least twofold: first, high-end demand needs to be met. If it’s not, then high-income households compete with middle-income households for existing homes, helping to drive prices higher. Second, provided that overall demand is met, better affordability is achieved by a process called filtering.
Over time housing depreciates and becomes more affordable. This does not occur overnight. It is a long-run process. For example, apartments in the Portland region built in the 1970s rented for above average prices in 1980. Those same 1970s era apartments today rent for prices that are below average. Filtering is the single biggest mechanism to provide reasonably priced housing for middle-income households, or what is commonly
referred to as workforce housing.
But is The Process of Filtering Enough?
Now, a key question is whether or not filtering alone is enough to achieve better affordability. The answer is no—at least not when there is a supply shortage. Filtering does work, and it does help. However, to the extent that housing is underbuilt, filtering will be slower and take longer because there are not enough units to go around. The linchpin to the filtering process is to continuously add housing supply, particularly in popular and growing cities and regions. If a community builds more housing, they will experience more filtering and relatively better affordability.
Let’s segment the current Portland-area housing market into three equal parts based on prices. If one examines the most affordable third, or the lowest-priced third of all units, an interesting pattern is revealed that shows filtering in action. Currently, there are as many units in this most affordable third that were built in the 2000s as there are from the 1980s and the 1960s. Why? Because the Portland region built significantly more housing overall in the 2000s; one-third more units than during the 1980s and twice as many as in the 1960s. While 1980s era construction has better affordability overall today—it is 30 years old, after all—the total number of these relatively affordable units is the same as the number built last decade. This is due to filtering. If a community builds more housing, they experience better affordability.
While the lack of supply is a problem in today’s market, it is likely to last another generation if the region does not build more housing in the coming years. The wounds of the Great Recession and housing shortage will heal, but they will remain visible. The reason is this: the units that are currently filtering from more expensive to less expensive today are those largely built in the 1990s and 2000s. Fast forward to the 2030s and the small number of units built this decade means there will be fewer units to filter at that time.
Bridging the Underproduction Gap
One result of seeing stronger construction activity today and in the coming years would be to bridge this underproduction gap, helping to improve affordability for current residents and the next generation. As Up for Growth writes in a recent report, “the housing crisis should be among the most urgent and important social equity issues requiring attention,” given its impact on affordability, and access to economic opportunity combined with the benefit of stronger economic activity and associated higher tax collections funding public services.
People Are Not Going to Stop Moving Here
Given the Pacific Northwest’s strong regional economy and high quality of life, the number of households wanting to live here will remain large. We must maintain these strengths while shoring up our weaknesses. In order for all households to live here—not just high-income earners—we need to ensure an adequate housing supply EVERY year. This includes all types of housing, including so-called missing middle housing units like duplexes and townhomes which provide myriad benefits, from more walkable neighborhoods to less environmental impact, and a more efficient use of public infrastructure and transit. Worsening affordability does not have to be the new normal; it is a choice.
Josh Lehner is the State of Oregon Senior Economist. He can be reached at (503) 378-4052 or via e-mail at joshua.lehner@oregon.gov.