Three Ways Housing Supply Actually Lowers Prices

The Wile E. Coyote Effect, Densification, and Playing Musical Chairs in Reverse

I’ve heard every version of how adding housing supply brings prices down — but I rarely see all the explanations laid out in one place. Leaning into being the change I want to see, I’ll try to fill in that gap here today.

For longtime housing advocates, none of this will be news. But like I said, there’s more than one way adding to the housing stock works to reduce overall cost and there’s value in documenting those mechanisms comprehensively. To make the case, I’ll walk through three metaphors I’ve tortured into the service of housing economics — these include a hapless desert predator, draconian pizza law, and playing musical chairs in reverse.

The Wile E. Coyote Effect

When Developers Oversupply the Market

Housing markets rise and fall with the larger economy. When the boom times boom, housing costs go through the roof. Developers respond to rising prices by building more housing — but, critically, they’re reacting to rising prices after the fact.

Even in places with supply-friendly housing policy, there's a lag between prices going up and new housing coming online. It takes less time to buy a house than it does to build one, after all.

When people claim that for-profit developers won’t supply new housing in the midst of a downturn, they’re kinda right.¹ Generally speaking, developers won’t start new construction in the midst of falling demand. They will, however, finish new construction that’s near completion, even if the market has started to turn. As it turns out, housing developers are almost as bad at predicting economic cycles as macroeconomists.²

Part of what’s going on here is that construction is just time-consuming. In the US, the average build time for a single-family home is 7-12 months. That figure for the typical apartment building is something like 12-24. When developers commit to building and the music on the most recent economic expansion abruptly stops, they get stuck holding the bag — and we all get new housing at a discount.

And, no, this isn’t just theory.

In 2016, oil prices crashed, leading to a downturn in major oil producing regions like Houston. As job growth slowed because of the downturn, housing prices declined as well. Part of that was because of a reduction in people’s incomes; but it was also due to the supply that was created from developers chasing rising demand prior to 2016. In Houston’s relatively permissive regulatory environment, that amount of housing was much larger than in other places with more restrictive housing policy. That boom-era construction, completed post-crash, helped underwrite Houston’s low housing costs for the next decade.³

On a more personal note, I benefited from the same phenomenon in Oakland, California back in 2021. For those who lived through the before times in the Bay Area, you might recall the feeling that San Francisco was bursting at the seams and that development was finally going to overflow in earnest just across the bay in Oakland.⁴ Well, history happened and tech went remote, but all of the apartment buildings that had begun construction in anticipation of workers and businesses arriving in downtown Oakland still opened up. The net result? Three months free rent in a brand new apartment two blocks from both transit and the best Sichuan food I’ve ever eaten.⁵

To maximize this effect, though, we need to actually let builders build. That means not only legalizing a broader range of housing types, but also shortening excessively long permitting processes. A developer sitting on land who’s stuck in permitting limbo when a downturn hits isn’t obliged to actually build anything. They may sell their land at a loss, but whoever scoops up the parcel will typically sit on the property until the rainy season returns. If we want renters and homebuyers to benefit from developers’ mistakes, we need to make sure there's as much housing under construction as possible — not just proposed and waiting for approval.⁶

Densification Demystified

How Building More Housing on Less Land Reduces Cost

Housing prices break down into two parts — the price of the actual house and the price of the land underneath. While the building itself is like a car or a refrigerator (a gradually depreciating consumer durable), land follows a different logic.

Land value doesn’t depreciate over time due to wear and tear. The more that a given piece of land provides access to, the more valuable it becomes.⁷ The same building, copy-pasted from New York to Topeka would be worth less; there’s just much less going on in Kansas than in Gotham and that difference is priced into NYC real estate.

So, when a property becomes increasingly valuable over time even as the house itself decays, it’s the land that’s becoming more expensive. In especially high-productivity regions, land value can make up as much as 67% of a property’s overall value.

As land becomes more expensive over time, developers tend to use less land and, instead, build more building. Rising land prices drive densification, encouraging people to build up instead of out.

At least when we let them.

Small Lot Supremacy in Hanoi | Credit: Brandon Fuller, Marron Institute

In the U.S. (and most other countries in the anglo-sphere), regulations discourage densification.

These include restrictions like minimum lot sizes, setback requirements, floor-to-area-ratios, and a host of similar regulations that prevent cost savings by replacing land with built square footage.

Now, I could try to explain in detail how these work to try and make the point I’d like each of you to internalize. But that would be a slog, and I’d lose most of you by the fifth sentence. Instead, I’d like to offer a pizza-based metaphor to get my point across.

For those of us who were once young and occasionally partook, an experience we all have in common is spilling out of the bar, club, or discothèque in search of something to eat. That frequently involves a certain kind of pizza joint that stays open at least ninety minutes past last call. Typically, such establishments sell pizza by the slice. This is convenient because we often only want a single slice. And if we’ve managed to keep an inebriated group of friends together long enough to make it to pizza, folks might want different things.

Imagine, though, that we passed a law that said you could no longer buy pizza by the slice — whole pizzas only. Also, they all have to be extra large. Now add to that a regulation that pizzerias are only allowed to add toppings starting a certain minimum distance away from the inside of the crust, leaving a band of unadorned dough on every pizza. Finally, imagine a rule that 75% of pizzas had to be plain cheese.⁸ That would not only be annoying and wasteful, it might also result in some people being priced out of getting any pizza at all.

In many places throughout the U.S., this is how we regulate land.⁹

Eight units replace a single-family home in Seattle; less extreme than the Hanoi example, but same idea (credit: Schemata Workshop)

Now, this isn’t a call to abolish all of these regulations entirely. There are some reasons for some of these regulations some of the time.¹⁰ But, mostly, they force us to use way too much land, increasing housing costs.

Here again, Houston makes an appearance. In 1998, the city reduced minimum lot sizes in the inner loop from 5,000 to 3,500 sqft; the city would later reduce that requirement further down to 1,400 sqft in 2013. According to research from Emily Hamilton, these reforms contributed to 80,000 units built on newly legalized small lots, helping sustain affordability.

But Houston isn’t the only city that ever chose to allow density.

Auckland, New Zealand underwent a major reform in 2016 that allowed significantly greater levels of density in areas previously restricted to single-family homes. The net result? Greater density and greater housing affordability — as expected.

So, that’s the second way in which building more housing — i.e. building more housing relative to the amount of land said housing sits on — helps keep prices down. But there’s a third way to think about housing supply, and this one involves everyone’s favorite furniture-based children’s game.

Musical Chairs in Reverse

How to Make Affordable Housing Out of Luxury Units (Just Add Time)

Filtering is the process through which new expensive housing gradually depreciates, thereby becoming more affordable to residents across the income spectrum. Historically, this is how most working-class housing has been produced in the U.S.; during periods of rapid growth, booms in housing construction would create “vintages” of new housing units that would gradually become more affordable as they aged.

Critically, though, this process happens over an extended period of time. Expensive new housing built today may take decades to filter down into middle or working-class affordability; so, for this effect to actually take place, a metro area needs to allow a constant stream of new construction. Kink the hose for a couple decades and it’ll take at least that much time for luxury housing to begin depreciating into general affordability once again.

That said, luxury development can have an immediately beneficial impact on prices as well.

Researchers have documented a moving-chain effect wherein new luxury housing is occupied by the wealthiest residents in an area, freeing up units the next rung down on the price scale. The next most affluent residents move into the now vacated units and the effect cascades down the income spectrum. And if it’s not sufficiently on the nose, this is where the musical chairs part comes in. Instead of playing a game with zero-sum mechanics, we can orient housing markets to be positive-sum. We can add metaphorical chairs to not only accommodate the people already playing, but also welcome any new folks who’d like to join in.¹¹

Now, it’s fine to talk about all this with metaphor and abstraction, but I’m a sucker for a real-life example. My favorite one of these comes from a talk by Bill Easterly and Laura Freschi entitled “A Long History of a Short Block”.

In their presentation, Easterly and Freschi detail the 400-year-long history of a single block in New York (pictured below). They chronicle the parcel’s beginning as agricultural land outside of what was then a Dutch Colony. It would later become a genteel upper middle class neighborhood in early 19th century New York before morphing into a place for light industrial production and sex work. Cut to the mid-20th century and artists and other bohemian types (what some might call first-wave gentrifiers) begin moving in, repurposing light industrial buildings back into living spaces. In more recent decades, the area has become home to the super-affluent and the local commercial space has filled up with luxury retail.

This story demonstrates two important things about filtering.

First, it's cyclical in nature. Over four centuries, this one little block has borne witness to wealthy residents and the working class trading places in successive waves.

Second, this kind of adaptive redevelopment is only possible to the extent it’s allowed. The organic, cyclical process Easterly and Freschi describe died off with the advent of modern land use regulations. As a result, the neighborhood has literally stopped growing — i.e. no more successive waves of development increasing the housing stock — and the super affluent have become entrenched in a neighborhood that’s been frozen in amber since the 1970s.

Big picture, letting developers build for the top of the market is actually important. Whether it’s providing expensive units today that become modest homes in twenty years or easing competition for existing units right now, it all boils down to the same insight: increasing the housing supply for rich folk is still increasing the housing supply; and directly, or indirectly, expanding the size of the pie benefits everyone across the board.

Coda

This post isn’t meant as a polemic about how the market™ will solve all our housing problems if only we’d get out of the way. There’s 100% a role for public action — whether that means subsidies, direct housing provision, or something else.¹²

What I’ve tried to do here is clarify how and why housing supply does matter. “Supply and demand” is technically correct — but incomplete. Hopefully, walking through these three mechanisms gives a more grounded understanding of what that slogan really means, and offers a foundation we can carry into all the housing conversations yet to come.

1. There’s caveats even there, but that’s a whole other post.

2. Not quite, but it’s close.

3. To be fair, that excess capacity might nearing exhaustion according to folks tracking the Houston market.

4. The metaphorical seams here being self-imposed building restrictions, not any real issue with the city’s physical capacity to build more space and add more people.

5. This is beside the point, but there’s a reason apartment buildings will comp tenants a couple free months instead of just lowering the actual rent. Apartments are largely financed by debt. The value of the property, and therefore the value of the loans, is largely dependent on the rent the building can charge. Lowering the rent means admitting that the value of the building is less than the number in the prospectus, and, if the building owner does that, they risk having investors call back their capital.

Rent concessions, though, can be booked as a marketing expense which kicks the can down the road (affording the landlord some time for economic conditions to pick back up).

6. Wasn’t sure to put this so it’s going here — I was first exposed to the idea that developers will “build themselves off a cliff” a long time ago by

Not a box of crap tower

(Sonja Trauss), Executive Director at Yimby Law, Suer of Cities, and all around mote-in-the-eye of housing obstructionists everywhere.

7. For my level-62 Georgists and transit aficionados, we could haggle over whether this is better understood as access value instead of location value…but let’s do that in the comments if anyone’s so inclined.

8. And if you ask for provolone instead of the standard mozzarella, everyone loses their minds and forces you to do 30 community meetings wherein they get to debate the relative merits of different dairy products.

9. Sounds pretty un-American, doesn’t it? I mean, we’re the country that invented stuffed crust pizza, after all.

10. As Nolan Gray has pointed out re: minimum lot sizes “In urban areas, tiny or highly irregular lots can make property rights fuzzy. In rural areas, you need a large lot to safely accommodate things like septic tanks and wells for drinking water.”

11. For any Quakers in the audience, this is how I imagine y’all approach the game.

12. There’s even a fun conversation about using public housing development as countercyclical macro policy…but I digress.