One measure of dysfunction in a housing market is the spread between the cash value of a home and the construction cost of a replacement home on the same site — in other words, the cost of the dirt the home is sitting on.
By this measure, the most expensive coastal cities — as well as sought-after neighborhoods in cities with lots of new housing like Houston and and Atlanta — are in deep trouble, with San Francisco at an eye-watering ratio of 2.98 and LA at 2.53.
High costs for dirt are tied to zoning restrictions on high density building: when there is little (or no) high-density zoning, it’s not profitable for developers to build new housing stock (though public housing might fill in, it would be very expensive to build as well, thanks to the costs of acquiring the dirt). Tentative high-density experiments just raise the price on a piece of dirt commensurate with the number of units that a builder could site there — but flooding an area with high-density zoning increases the supply to the point where it is profitable to build lots of stock, which restores a sane ratio of construction costs to supply.
A common objection to increasing a lot’s permitted housing density or – loosely speaking – upzoning it, is that it simply raises the value of the land in reaction to the increase in density rather than resulting in cheaper homes. Although there is truth to the observation, it is a poor argument against raising density. When upzoning raises land values it indicates that the scarce factor drawing a premium is not land per se, but the units zoned upon it. It is mistaken to think that upzoning will reduce the land value component of homes simply by dividing a fixed land value over a greater number of units. The value of land depends on its characteristics, one of which is the number of units it is zoned for – i.e. the number of households allowed to call it home – and changing that number affects the land’s value. But upzoning also increases the number of zoned units in the housing market as a whole, and in so doing will contribute to easing their scarcity.
For upzoning to meaningfully suppress housing prices, it must be applied en masse. Upzoning a limited number of lots – where “limited” means small compared to the relevant housing market – will raise the value of the upzoned land without measurably influencing home values. To suppress housing prices, upzoning must substantially ease the scarcity of zoned units and, for this to happen, upzoning must be applied at sufficient scale vis-a-vis the relevant housing market.
The expensive coastal cities have no shortage of land per se, but of zoned units. Such units can be thought of as slots for households to stake a claim in a location, or call it home, allowing them to live in the area and access its job market. It is these slots whose scarcity is drawing a premium in the expensive coastal metros, reflected by inflated land values, whereas land per se is not in short supply. The San Francisco Bay Area, for example, whose shortage of zoned units is most acute, spanned 1,386 square miles as of 2010 and housed about 8 million people. That is enough land to house 75 or 100 million people at the average densities of Paris or Manhattan, respectively, leaving plenty of space for more moderate scenarios (see here for Paris and here for Manhattan).
Paying For Dirt: Where Have Home Values Detached From Construction Costs?
[Issi Romem/Buildzoom]