Addressing the shortage of affordable housing

As a prelude to discussing any remedy for the problem of the shortage of affordable housing, I need to lay a foundation with some basic economic theory and terminology: Economists take pains to distinguish between supply and quantity supplied and, similarly, demand and quantity demanded. Supply and demand are functions that reflect the ranges of amounts and prices at which willing sellers and buyers would be willing to transact. Think of supply and demand as the set of possible amounts that market participants would be willing to sell (suppliers) or buy (demanders), respectively, over a range of prices. Aggregated supply from all sources is directly related to price (i.e., producers supply a greater quantity at higher prices, and vice versa), while aggregated demand is inversely related to price (i.e., consumers demand a lesser quantity at higher prices, and vice versa).

When prices are “too high” we end up with an abundance of sellers relative to buyers, and hence a surplus of goods. On the other hand, when prices are “too low,” we end up with an excess demand or a shortage. In a well-functioning market, prices will adjust until any imbalance between the quantities supplied and demanded is eliminated. When this adjustment occurs, economists say that we’ve established an equilibrium price where the quantity supplied equals the quantity demanded.

So what’s going on with housing? Housing is somewhat idiosyncratic in that it’s not readily transportable and conditions vary from locale to locale. Still, in any given location, prices are free to adjust and do so based on supply and demand. Unfortunately, the resulting equilibrium price in too many places is a price that’s unaffordable for many critical workers in that local economy. Perhaps it goes without saying, but this problem is an extremely difficult one to solve; and unfortunately, many of the purported solutions end up helping a few at the expense of the many.

When it comes to the dearth of affordable housing, we typically have two avenues of attack. We can address affordability directly by subsidizing the affected populations, using income supports or by providing below-market housing. We do this currently with public housing and Section 8 support, which provides vouchers that recipients use to supplement rental payments. These programs suffer from the fact that they cover only a small portion of those eligible for these programs. It’s great for those who manage to get into these programs, but the vast majority of qualifying households are out of luck. Note that these subsidies to households serve to increase demand. As such, we shouldn’t expect such subsidies to lower housing prices generally (or price inflation) if they were to become entrenched.

The other major approach for addressing housing affordability works to increase the housing stock. I think it safe to say that virtually any economist would agree that you can lower the price of any good by increasing supply. Given that starting point, the solution to the problem of a shortage of affordable housing should be obvious: add to the residential housing stock — i.e., build more units. Easier said than done.

From a policy standpoint, we could have the government add to the housing stock by building new homes and apartments. Although we have some history of publicly operated housing, having the government bearing the primary responsibility for adding to the stock of housing units would be a significant departure from past practice. Instead, policy makers generally prefer to increase the stock of housing by incentivizing private builders and having them undertake the construction. In some form, this approach involves subsidizing builders. Such subsidies could come in the form of direct grants, tax credits, or below-market or tax-exempt financing.

Importantly, to incentivize builders in an effective way — i.e., to increase supply — requires changing the economics in the housing market to either lower builders’ costs or otherwise raise the prospects for their profitability. In many cases, however, subsidies directed at the builders/developers may seem like they should be stimulating supply, but they don’t do that. That is, they fail to alter the housing supply function because they don’t really change the economics for the builder.

To illustrate, think about a common arrangement –at least common in NYC, where I live — where a builder signs on to make a certain portion of his construction available for sale at a below-market price in exchange for a tax credit. Either the subsidy offsets that builder’s opportunity cost fully, or to the extent that the offset is incomplete, higher costs are passed on to the buyers of the other “non-affordable” units. Critically, if the subsidy is incomplete and the market doesn’t allow the builder to pass on the shortfall to the other buyers, the project won’t go forward.

In any case, a small portion of those who might qualify for these affordable units end up managing to secure them. While these subsidies are designed to ensure an acceptable return to builders and developers, they’re not intended to generate “excess” profit for them. (If they did, they’d be highly criticized.) Rather, they’re intended to make units affordable to the participating households. As such, the effect of these subsidies should be seen as stimulating demand in the same way that income supplements and rental vouchers discussed above do.

Given this incremental increase in demand, if these subsidies were to persist, the rest of us would face higher housing costs than we otherwise would have in the absence of these subsidies. This outcome works just fine for existing homeowners who enjoy higher property values, but it makes it harder for prospective first-time home buyers who aren’t lucky enough to get into the currently offered affordable stock.

If we really want to increase the pace of the expansion of the housing stock, we need to change the economics facing builders and developers, to enhance their prospect of profitability. Certainly, removing any tariffs on materials used in construction would be a promising start. (Currently, steel, aluminum, cement, concrete, and lumber are subject to tariffs.) Beyond that, in certain locations, zoning restrictions may be the most significant factor constraining new residential construction. The expansion of allowable sites for construction and the reduction of other regulatory requirements should foster a lower cost structure and thus enhance the prospects of profitability.

At least in theory, these regulatory adjustments should serve to increase housing supply and thus lower costs for the ultimate consumer. Getting there, however, requires overcoming massive NIMBY (not in my backyard) resistance and identifying those regulations that can be eliminated without compromising the safety or quality of the units being built. If we can accomplish that, we may have stumbled onto one of the most promising ways to increase the housing stock involving little or no subsidies at all.

Interestingly, Harris and Trump don’t seem to be terribly far apart as far as their intended housing policies go. Both are proposing similar support initiatives for builders and households, alike; both are looking to reduce regulatory red tape; and both are flirting with the idea of making federal lands available to builders of affordable housing. Critically, tariffs are really only being talked about by Trump, and he’s talking about raising them. Higher tariffs, of course, will do nothing to help in addressing the affordability of housing.