Updated: Jun 14, 2022
by Tim Nadreau, Ph.D.
Intuition gets it wrong again…
There is a pervading notion that increased population leads to housing scarcity and drives housing prices through the roof. After all, look at densely populated areas throughout California, New York, Chicago, Seattle, etc. As a city starts to grow, housing costs increase. Yet, if we look at the data, you realize this doesn’t have to be the case—in point of fact the extremes show the exact opposite. Although they may co-move in some cases, housing prices and population are not correlates.
Theory in practice:
There are several instances in U.S. history where regulatory controls were enacted to curb demand. In the past, they have tried rent control to regulate housing prices, green zones to regulate urban sprawl, and zoning regulations to protect home values (e.g., preventing a landfill from locating in a suburban neighborhood). These efforts have roundly failed to achieve their desired goals as well as leading to a host of unintended consequences. Often the housing prices are driven up as a result of increased demand and stifled supply.
Well-meaning city leaders see the change growth is having on their region and, in an attempt to preserve the identity of the community, curtail supply through permitting, zoning, and regulations. Those policies increase costs for new home construction and those increased costs are passed through to buyers. Figures 1 and 2 below show how supply and demand shift over time. In Figure 1 demand, 𝐷1, shifts to the right as the region experiences growth. This usually occurs when a community with several amenities becomes a highly desirable place to live. This attracts entrants to the market resulting in increased demand, 𝐷2. Note that this shift has caused a rise in the price level as the market shifts towards a new equilibrium (𝑃𝑒 to 𝑃2). The quantity of homes purchased would naturally increase as well (𝑄𝑒 to 𝑄2).
Of course, Figure 1 assumes the supply is fixed at the original level, 𝑆1, and that demand will not grow beyond 𝐷2. This is not the case. Economies are dynamic and continue to change. Figure 2 shows how increased regulatory costs increase construction costs, shifting the supply curve to the left, exacerbating the price effect (𝑃2 to 𝑃3). Demand will continue to rise as well (𝐷2 to 𝐷3 ), causing a small net increase in home availability (𝑄2 to 𝑄3).1 The higher housing costs become untenable for residents. This leads to a crowding out effect where wealthy non-residents enter the market and bid up home values, ultimately driving out the residents (i.e., Gresham’s law applied to housing).
Figure 1: Initial Price and Quantity Movement from Increased Demand
Figure 2: Subsequent Price and Quantity Movement from Reduced Supply
Hard (to swallow) Evidence:
Municipal Governments from Palo Alto and Petaluma, CA, to Austin, TX have failed to understand that any and all regulations enacted to try and curb demand, ultimately only curtail supply. Ed Glaeser, Joseph Gyourko and Raven Saks (2005) have documented this in the U.S., and Gyourko and Molloy (2014) then documented the same finding in Australia. Data from Japan and the UK suggest the same findings. Houston and Tokyo have taken a very different tactic from other cities: neither city enacts any zoning or land use regulations. They ensure setbacks and other codes are followed but any land may be developed for mixed use. Below are the housing prices and population trends in Houston and San Jose. Mitchell Harvey of Stanford University and economist Tam Alex put it this way:
The empirical evidence and the economic theory are perfectly consistent on this point: if
you restrict how land can be used through strict zoning and planning laws, you will push
up production costs and restrict supply, in turn creating housing affordability problems.
This problem is not just about the cost of living, but also about inequality and social
mobility. We know that most of the growing inequality in developed nations is caused by
rising house prices. Inaccessible housing markets restrict job opportunities and
entrench systemic inequality among groups that cannot afford to get a foothold. This
problem will go away if the politicians and bureaucrats stop telling people how they can
use their land. The empirical evidence and the current literature tell us that deregulated
housing markets create affordable housing. We know how to solve this problem. We
have for a while.
The idea that increased demand and population growth must lead to increased housing prices may be dismissed by looking at the Houston, TX MSA data. Similarly, the idea that static populations, and stable demand leads to reduced prices and increased affordability may be dismissed by looking at the data from the San Jose, CA MSA. Table 1 and Figure 3 show that the population for Houston grew by 50% over the past two decades (4.8 million to 7.3 million people). During that same time the population in San Jose only grew 13% (1.7 million to 2 million people). Percentage changes in price and populations are somewhat deceptive here. Note that for Houston the populations grew by 2.5 million people, relative to San Jose’s 300 thousand. The real typical home price in the San Jose MSA was $710 thousand, as opposed to $157 thousand in the Houston MSA. Even with the much higher base price and much lower population, San Jose’s typical home price rose twice as fast as Houston’s. From 2001 to 2021 the price in the Houston MSA rose $52,011 in real terms (30% growth). In the San Jose MSA that number was $453,774 (59% growth). Even though Houston’s population was growing nearly 4 times faster than San Jose’s, San Jose’s typical home prices were growing twice as fast as Houston’s. Houston’s data shows that rapidly growing populations don’t imply rapidly growing home prices. San Jose’s data shows that fairly stagnate population doesn’t prevent rapidly growing home prices. So if population change and housing price change are not correlated, then what is going on?
Figure 3: Houston and San Jose MSA Populations and Real Typical Home Prices (2001-2021)
Source: Emsi 2021.4 and Zillow zhvi metro statistics
Table 1: Houston and San Jose MSA Populations and Real Typical Home Prices (2001-2021)
Source: Emsi 2021.4 and Zillow zhvi metro statistics
Supply Side Housing:
This all emphasizes the point that affordable housing is possible even in an environment of protracted population increase. It also illustrates that communities with almost no growth—San Jose’s population was growing at about 0.6% annually—can have rapid housing inflation, predominantly spurred by a heavy-handed regulatory environment. Someone might object that there were other underlining differences in the communities. One of the primary differences was that Palo Alto’s vision for addressing the problem was a “Zoning Ordinance Technical Manual” that defines, for example, precisely the difference between unenclosed and enclosed porches. Meanwhile Houston’s Development regulations read
“The Department of Planning and Development regulates land development in Houston
and within its extraterritorial jurisdiction, ETJ. The City of Houston does not have zoning,
but development is governed by ordinance codes that address how property can be
subdivided. The City codes do not address land use.”
~Planning and Development Regulations City of Houston
In short, Houston allows mixed-use and industrial-use development to take place wherever the developer can find the land. They have opted for affordable housing, increasing housing and population density. Palo Alto opted for unaffordable housing and large lot, single family homes. This is the trade-off that currently faces many regions in Idaho. If affordable housing is an objective of local governments, two clear paths forward are 1) increase supply at the same rate as demand, or 2) find a way to make the region an undesirable place to live and reduce demand that way. We don’t recommend the second strategy.
My Take: Growth, a Problem?
Many planners, city council members, and county commissioners are actively pushing against growth. They are concerned that the bucolic nature of their community is changing. But growth and change are challenges, not problems. They reflect that a community is doing something right and people want to be a part of that. This is not a problem—it is a badge of honor. The challenge comes in finding ways to propagate doing things well at a much larger scale. I recently had a city counselor tell me he wanted to put extraordinarily high taxes on second homes, vacation homes, and VRBOs, thinking this would induce owners of those properties to sell, thereby reducing the housing shortage. However, they may lead to the unintended consequence of forcing developers to allocate land to new hotel construction, as short-term living facilities will then be in short supply. This is exactly the type of problem that markets solve better than planners, and I would argue that the markets in Houston have succeeded, evidenced by the fact that the population there continues to grow. In fairness, the regulations in San Jose have worked as well. The people there didn’t want high density housing, they didn’t care so much about affordability, or making sure the class of houses for restaurant servers and police officers were available. They imposed large-lot single family regulations. It makes the region a highly desirable place to live with a great deal of housing scarcity. All of which translates into extremely high prices. The only question that needs to be answered is where on that spectrum the community wants to be, and in our democracy, the majority determine that location through their elected representatives.