Understanding how housing markets really work is essential to crafting solutions to our affordability problems

Regular followers of City Observatory will know two things about us:  We’re keenly focused on the problem of housing affordability, and we like to treat Portland, Oregon (our local backyard) as a kind of laboratory for better understanding urban issues. Last week, we wrote about the city council’s decision to block Fremont Place, a proposed a 275-unit apartment building in the city’s fashionable Pearl District.  The council’s vote ostensibly turned on concerns as to whether the proposed building complied with the city’s greenway requirements, but also followed loud outcry from neighbors complaining about blocked views.

We thought the council’s decision to invoke its ability to override the city’s design review commission (which had ruled that the proposed development complied with city requirements) set a precedent that was likely to chill new development, and compound the city’s housing shortage (which the city council has, by vote, declared an emergency).

The isn’t yet fully resolved.  The council may reconsider the proposal, and is also facing other proposed large apartment projects. Some city council members are pushing back against the arguments that we and others have made about the likely adverse housing market effects of their decisions.

In comments at the city council, City Commissioner Nick Fish challenged our arguments

“There is a view that is getting some traction in the media,” says Fish. “I call it ‘trickle down housing,’ and the idea is that … if we continue to have 95 percent or more of our housing at the luxury level, that we will over time be a benefit to those people shut out of the market.  If you take the logic of what some economists have said,” Fish said. “what they’re really saying is the person who can’t find a luxury apartments to live in, is going to go out to 158th and Powell and displace someone who is a low-income unit run by Joe Weston. That is so preposterous on its face, that it is not worthy of our discussion.”

Essentially, Fish is arguing there’s essentially no connection between how many units we build for middle and upper income households, and the availability and price of housing for lower income households. We and other’s don’t share that view:  Willamette Week’s reporter, Rachel Monahan adjudged the the Commissioner’s claims as follows:

Fish, a consummate public speaker, is erecting a bit of a straw man here.

Willamette Week asked us to respond, and published our reply, which we’ve added here, in edited form.

The past five years wasn’t some random epidemic of greed; it was because we had a shortage of new housing, and in the face of rising demand, higher income people outbid lower income people for a slowly growing housing stock. We’ve lived through history that simply proves [Fish] wrong.

Also: Virtually everyone agrees that more market rate housing reduces rent increases and reduces displacement. Miriam Zuk and Karen Chapple run the Urban Displacement Project at the University of California, Berkeley: Their estimates show that adding two market rate apartments have about the same effect on displacement rates as building one unit of public housing.

Based on that estimate, to make up for the displacement effect of NOT building Fremont Place, Portland is going to have to come up with something like 130 units of affordable housing. Those are currently running in the range of $300K (and up), so that’s like $40 million worth of affordable housing you would have to build to offset the displacement from not building Fremont Place.

Rent increases in Portland have dropped from double digits a year and a half ago to negative today. The reason that has happened is because so much more market rate housing has become available in the past 12 months. And that’s producing vacancies all over town, and not just in high income properties, but in the existing older apartment housing stock.

In fact, the process of filtering in the housing market is how nearly all affordable housing gets built. Most housing gets built, at least initially, for middle and upper income households. As it ages, it becomes less desirable, and the original tenants move on, and the newer tenants typically are lower in the income spectrum.

In effect, the housing market works like a game of musical chairs: If there aren’t enough chairs, then some people get pushed out. In musical chairs, it’s the slow. In housing, it’s the poor. For a non-technical explanation of house this works, see this great infographic from Sightline Institute.

But this process of filtering doesn’t happen when you block the construction of new housing. If there aren’t enough new chairs added to the game, rich people end up in smaller, older chairs (houses) and the poor face shortages, rising rents and eviction. That’s why in some places the 1950s era ranch home is the affordable housing stock in a metro area, and why in other places (like the Bay Area and LA), tiny, aging ranch houses can command $1 million or more.

In the extreme case, when you can’t build expensive new housing in desirable areas, less expensive housing gets converted to more expensive housing. A recent example comes from Chicago’s North Center neighborhood, where an aging three-flat (a three story tri-plex apartment building) is being converted into a single family residence. If the family “deconverting” this house could buy a large, new home in the neighborhood, these three units would stay rentals. (Hat tip to Chicago Cityscape).

Filtering also works in weak market cities. When you build lots more new housing in cities that aren’t’ growing, the price of older homes falls so far that there’s no economic reason for their owners to invest in maintenance and repair. The older homes decay, and the lowest quality buildings in the least desirable neighborhoods are ultimately abandoned or demolished. That process is at work in the Cleveland metropolitan area, as Aaron Renn points out:

 If you keep building new homes but you aren’t adding households, then older homes at the bottom of the scale will be abandoned. And all up the stack homes are devalued. This helps explain why even many inner suburban neighborhoods are falling into serious decay.

So the process of filtering is really ubiquitous in housing markets. When there’s more housing supply than demand, housing filters down (as in Akron and Cleveland); when there’s more demand than supply (and you can’t build new high income units) housing filters up (as in Chicago’s North Center Neighborhood). The lesson for cities like Portland is that when you face a housing shortage, and if you care at all about affordability, you have to build all kinds of housing, including for upper income households. If you don’t, the ones who will pay the price will be the lower income households.

And one final editorial note: While some may ask why we inject ourselves into the middle of controversy, we’d stress this is exactly where City Observatory needs to be; bringing its analysis and the experience of a wide range of cities to bear in a timely and hopefully clear fashion and directly in the context of current policy debates We have great respect for the energy and leadership Nick Fish has brought to housing policy; but we will politely, but firmly speak out when our research points to a fundamentally different conclusion. This is an important debate to have, and we’re happy to participate. Our thanks to Willamette Week for putting the wonky details of housing econ 101 front and center as part of the public discussion.

Editor’s note: This post has been revised to correct the attribution of the quotation of Aaron Renn. Hat tip to Jason Segedy for sharing both the quote and its correct author.