The cities where housing is more expensive than you would expect

What the 'shadow' price of housing tells us about affordability.

August 20

The story of why the rent is so high (and why developers love to build luxury condos) begins with the price of land. (Check out Lydia DePillis’s story on why it’s so hard to find a cheap apartment in Washington.)

When you pay for a place to live, you pay for both the building and the location, and, as any real estate agent will tell you, the latter is far more important. When the housing market in a city heats up, it’s not the buildings that have suddenly become more desirable. It’s the location, the land values.

A couple of years ago, economists David Albouy and Gabriel Ehrlich made an interesting calculation. They obtained data on actual land values (collected from sales records) and combined it with information on local construction costs to estimate how much it costs to build housing in cities across the United States. Some cities had housing that was far more expensive than the cost of land, materials and labor would predict. Many were among the usual suspects, places such as Boston and San Francisco, where new housing projects are notoriously hard to see to completion.

The price of a house or apartment, the authors argued, is more than just the value of the land plus the value of the building. There’s a third, shadow price, which represents how difficult it is to get something built given local regulations. In highly restrictive places like San Francisco, regulations impede the supply of new buildings, and so raise the price of housing.

By these measures,  Washington and New York do not rank all that high, but that’s probably because the researchers looked at broader metro areas instead of focusing on downtown Washington or Manhattan, where it is far more difficult to build.

In the past couple of years, downtown Washington has seen a parade of new luxury housing projects. This makes sense in a place where high land prices eat into developer profits and so do regulatory costs. As long as there are enough rich people to snap up these new units, feeding the high-end market nets developers and their investors the highest returns.

These charts from CoStar, a real-estate research group, show average rents in the Washington area for both newly constructed and existing apartment buildings. The first thing to note: New construction is always more expensive to rent. This fact is true of comparison cities Baltimore and Las Vegas, as well. Newer buildings are nicer and have more amenities, especially in Washington, where they are mostly luxury apartment complexes. Still, Washington is different. Rental prices for new housing in Washington have been more or less flat for the past couple of years, while the rest of the market is still heating up.

One conclusion we might draw from these numbers is that the spree of high-end housing projects in Washington has been keeping pace with demand from affluent newcomers. Any less construction, and prices would have risen; any more, and prices would have dropped.

What’s concerning is the continued upward march of rents for everybody else. This is not to blame all the new construction. Had there not been any luxury apartments built in the past couple of years, we might have expected the affluent to bid up the prices of existing housing, which would have raised rents even more for everybody. And economists argue that over time those shiny new units will deteriorate and become more affordable.

It’s become pretty obvious, though, that protecting lower-income people from a price war with higher-income people is not the same thing as helping lower-income people obtain affordable housing. These days, the supply of new apartments in Washington has been satisfying demand from the affluent, but little else.

Jeff Guo is a staff writer for Storyline. He's from Maryland (but outside the Beltway). Follow him on Twitter: @_jeffguo.
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