Robert J. Shiller, co-creator of the Standard & Poor’s / Case-Shiller home price index, theorizes that land and real estate are surprisingly poor long-term investments (and he means really long-term). From 1915 to 2015, farmland values have appreciated an average of 1.1% a year. Home values are even less impressive, appreciating over this period an average of 0.6% a year.
Using supply and demand logic, Shiller points to the correlation between investments in new residential construction and home prices. High levels of construction tend to occur during times of rising housing prices (which indicates high demand) and fall when home prices drop (indicating low demand). Further, when sufficient housing is built, prices level off and decline, causing investors to stop putting money into new construction.
This supply and demand argument, while simplified, is bolstered by the fact that farmland was much less effected during the 2008 Great Recession compared to home values. During the recession, farmland prices dipped 3% on average nationwide, much more manageable than the 35% drop experienced in home values. The demand for farmland remained mostly the same during the recession since people continued to rely on the stuff farms produce, like food, whereas demand for homes dropped as former homeowners moved into rentals or in with family members. Hence the price shock in homes compared to farmland.
But what happens when investors want to respond to rising demand by building more new construction — but are unable to due to local government restrictions?
A case study for California
Houston, Texas, is the only major U.S. city without zoning laws, according to the Urban Land Institute. Here, the permitting process is fast and new residential and commercial construction is booming. Further, despite the lack of government oversight, the city is still organized into appropriate living, shopping, working and cultural districts.
How has Houston managed to develop an attractive, successful city without zoning?
First, zoning is extremely difficult to enact in Houston, since city laws require any zoning ordinance to be approved by popular vote. But it’s no free-for-all, as city officials are forced to think outside the box to ensure the city has proper setbacks and safety standards (e.g. factories aren’t located next to schools or homes). So, instead of boxing off the city into different use districts, they enacted broad regulations that essentially did the same job as zoning, but without the map. For example, cell phone towers need to be a certain distance from residential neighborhoods. This makes it simpler for developers to build, encouraging construction and investment.
Contrast Houston’s laissez-faire attitude with California’s quintessential zoning nightmare, San Francisco.
Zoning map of Downtown San Francisco, image courtesy San Francisco Planning Department
Building in San Francisco is notoriously difficult. Permits were taken out on less than 3,200 multi-family units in 2015 (and this was a high year for construction). Yet the adult population in San Francisco increased by approximately 9,000 individuals in the same year, according to the U.S. Census.
As a result of construction falling far behind population growth, home prices and the price of rents have increased much faster than incomes, leaving residents in a precarious position in 2016 as the city teeters on the verge of a housing bubble. Forbes has labeled the city “dangerous to the investor.”
San Francisco is an extreme example of what happens when zoning gets out of control. But similar cases of over-regulated zoning are popping up across California, particularly along its exclusive coastal cities, causing prices to rise too fast for residents to keep up. The consequences are a low and declining homeownership rate in California — 53.4% in mid-2016, compared to 62.9% nationwide — disappointing for real estate professionals.
The fix? Loosen zoning restrictions across the state, particularly in high-cost areas where jobs are concentrated, and watch the builders pour in.