Monday, June 23, 2014

How density limits bring about gentrification

It had to happen, I had to talk about gentrification sometime. For those not in the know, gentrification is a process in which a community, either a poor one or a middle-class one, sees an influx of new residents of a significantly higher income level than current residents. This often comes with new housing, services and stores made to cater to these new residents. Anti-gentrification activists warn of possible displacement as housing for the poor and middle class is destroyed to make way for more luxurious housing, and the loss of local stores and community.

Now, to be quite frank, I find anti-gentrification activists to be merely another form of NIMBY. It's funny how the rich don't want the poor in their backyard while the poor... don't want the rich in their backyard either. Anti-gentrification activists blame the rich for fleeing urban neighborhoods in the 50s and 60s (white flight), and now blame them for coming back.

Anyway, anti-gentrification activists tend to be on the front line of NIMBY movements to block density and any kind of construction in established communities. Height limits, regulations making it hard to renovate, downzoning (making zoning even stricter and allowing even less density), all are tools they tend to use. In a way, it's understandable, they see all the new buildings and renovations all meant to appeal to a richer, higher class type of people than current residents and they simply think that the way to avoid gentrification is to simply avoid construction and renovations. It can somewhat work, as the rich won't tolerate living in rundown tenement housing amongst the rats and bed bugs... but it's absurd because you also condemn current residents to living in rundown tenement housing amongst rats and bed bugs. Talk about the cure being worse than the disease.

I think clear thinking is needed on the issue of gentrification, and that these construction and density restrictions in fact make gentrification worse, not better.

Dynamic of the housing market

One of the basic facts of the market is that luxury products tend to have higher profit margins than mainstream products. So the first market segment that will be addressed is usually the richest people, who are the "low hanging fruits". As the upper end of the market get saturated (which doesn't take long as there aren't that many rich folk around), producers will start to make products for lower sections of the market, until they reach the bottom and the entire market is saturated, or at least until it's as low as they can do without becoming unprofitable. So the market satisfies the rich's needs first and goes down to the list after.

So what happens if there are restrictions on how much of anything can be built? Well, then the upper end of the market will not be saturated, so only the richest will have their needs served.

I don't know who said it, it is not me and I would like to attribute it correctly, but anyway, there is this great quote I've read: 

"If carmakers were allowed to build only 10 000 cars per year, they would only be making luxury cars".

We even have a confirmation of this principle in real life. In the 1980s, Japanese companies were compelled to accept "voluntary" quotas on the number of cars they would export to North America, under threat of facing extremely high tariffs. Since the number of cars they could make for the North American market was limited, they responded by creating Lexus, Accura and Infiniti, luxury brands of their otherwise mainstream, middle-class cars. The Japanese automakers responded to quotas by going after the luxury market to get as much profit from this fixed amount of cars as possible. It's not just because profit margins are higher for luxury cars, but also that the profit per vehicle is larger even if the profit margin is the same. 10% profit on a 20 000$ car yields 2 000$ profit, 10% profit on a 60 000$ car yields 6 000$ profit.

The fact is, the housing market is exactly the same.

If you limit the number of housing units people can build in a desirable spot, then promoters will automatically build housing for the highest possible end of the market that would be interested in living in that spot. So when an area becomes newly desirable or a building restriction (due to zoning or parking minimums) is lifted, naturally the first buildings that will be built will be for the richest people who want to move there.

This is normal, and it should be temporary, because there just aren't that many rich people around. If you continue accepting new constructions, at one point the luxury housing market will be saturated and the new constructions will be more affordable as the promoters have to target poorer demographics.

Unfortunately, when the first constructions occur, there is often panic about "gentrification", many seem to believe that any new constructions will inevitably be for the richest, and so try to block any construction, or at least limit them. But in fact, this is a self-fulfilling prophecy, because by restraining supply increases, they keep housing in severe shortage and make sure that supply isn't able to increase enough to ever saturate the upper end of the market. So the reason new constructions aren't targeted to the middle class and below is because we don't allow enough of it.

Still, there is a way for the poor and the middle class to outbid the rich for the available land in a neighborhood...

Higher density: the mass' ace in the hole

I've said it often and I'll repeat it: multi-family uses tend to generate more profit per square foot of land than single-family use. Even if the profit margin is lower, the profit associated with one condo building tends to be higher than that of houses built on the same terrain, by sheer numbers alone. So that's how people can outbid the rich, by tolerating higher densities and smaller units than the rich will.

One of the tactics used by the anti-gentrification crowd is to limit density to what exists currently. The reasoning is that blocking the construction of anything is quite hard, but if you limit density, you make it much harder to build anything because any replacement of a building with a new one will not be able to dilute the value of the older building amongst more units. So the new units will have to incorporate the old units' value, a cost that is a severe drag on profits and so may make new projects harder to justify financially.

The law of unintended consequence is in full force here. These limits also impact current residents by making housing more expensive. As I said in an earlier article, what limits the price of housing is the ability to add new housing, the cost of building new units is a ceiling to how high the price of current units can be. If you restrict additional supply, you are in a shortage situation where prices are likely to explode. It also results in keeping housing around well after its "best before" date. Furthermore, it makes sure that the ONLY new units that can be built will only be for the richest people who want to move there, because these density limits deprive the middle class and the poor of their one ace in the hole that allows them to outbid the rich: higher density and smaller units.

So though density limits may reduce the pace of construction, it will also make sure that all new constructions will be the type the anti-gentrification activists hate, for people at an income level far above the current residents'. They have just made it impossible to build new housing for people similar to current residents.

An example of what density limits to prevent gentrification brings about: the "monster home"

There is no greater demonstration that density limits are useless to prevent gentrification than the phenomenon of so-called "monster homes" or "monster houses" that are quite common in Vancouver and Toronto. In both of these cities, there are exclusive single-family detached zones quite near to the center of the metropolitan area, zones in highly desirable locations that would normally attract low-rise, if not mid-rise, multifamily developments. However, these developments are banned and density is severely limited as lot sizes are imposed by zoning and only single-family developments can occur. In terms of density limits, you can't do much better.

So what happens? Essentially, either rich people themselves or developers buy older houses, that are already expensive but that are not suitable for the rich (too small, not enough amenities, etc...), they tear them down and build modern houses in their place, houses that are as large as allowed in zoning. These houses are tremendously expensive, not only because they are luxury housing, but because they must include in their price the cost of the earlier house that got torn down.

In Vancouver, older houses to the right, monster house to the left
Surrey, a Vancouver suburb, an older bungalow in the foreground with a recent monster house in the background
Monster houses tend to be less talked about because communities in these areas are much weaker than in developed urban neighborhoods, as these are car-dependent areas, the direct environment where people live matters less as few people walk and bike. Still, it is gentrification at its worse, because since these are low-density middle-class developments being replaced by luxurious low-density developments, the displacement is really one for one, if not two for one if lots are merged. And the new houses are so expensive they are unaffordable for all but the richest.

When a neighborhood becomes highly desirable, there really is no real way to keep it from gentrifying, the rich will outbid everyone on a level playing field. The only solution is to allow higher densities, which can allow current residents to keep residing there by accepting higher density housing.

But what happens if the rich also tolerate higher density housing? Many rich people go for condos in mid-rise or high-rise towers, does that mean that they are utterly unbeatable when they accept high-density housing?

Yes, it does. But it's not a problem, because the great thing about density is that it doesn't take a lot of place. And there aren't that many rich people to go around, so if they accept to live in high-rise condos, they will inevitably take very little space and the danger of displacement will be negated.

In conclusion

It is normal for some place that is reviving after years of neglect to have an influx of people who are richer than current residents as promoters will first satisfy the desires of the richest people, since there is more profit to be made with them than with other people. However, that is temporary as the upper end of the market gets saturated very quickly, if people don't try to maintain an housing shortage by limiting construction in a misguided attempt to prevent displacement. It's like tearing off a bandage, the slower you go, the more it will hurt.

So the solution to gentrification is to allow even more construction to allow the upper end of the market to get saturated quickly, to relieve pressure on house prices and to allow current residents to outbid the rich by accepting higher density housing.

At least, that's the solution is the problem anti-gentrification activists fight against is effectively the displacement of current residents... if the real unspoken problem they seek to prevent is the presence of richer people, that they seek to maintain homogeneity in a neighborhood, then that is no "solution", but neither is social mixity a problem in my view.

4 comments:

  1. Your point about monster houses (I've usually heard them referred to as tear-downs) can also be instructive at the opposite end of the spectrum, namely depressed run-down neighborhoods. Because of restrictive zoning laws, you can't put back anything much more dense than what already exists. Therefore, unless the neighborhood becomes suddenly super-desirable, leading to tear-downs and new luxury houses, the only other alternative is stagnation at best, and blight and eventual abandonment at worst. It just seems that no matter what, it's simply not economically viable to redevelop a property to the same density it had before, let alone a lower density. This seems to be true even where the building has been neglected to the point of dilapidation or even falling down on its own. There's just too many sunk costs, even if the land has gone vacant. Without the opportunity for densification, while throwing big subsidies at a property for redevelopment, the best we seem to get is the crappiest cheap vinyl-clad construction you can imagine.

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    1. It is possible to re-develop with the same density without becoming unaffordable, But in order to do that, you need to have a cultural mentality of letting houses depreciate so that after 30 or 40 years, the house is basically scrap and worth only the value of the land. But in North America (like in Europe), houses are generally seen as investments, it's not that they don't depreciate over time, they do, but people spend a lot of money on maintenance and renovations to maintain their value. Often, the only thing about the house that really appreciates is the land on which it is built. Still, that doesn't mean that there aren't a few "fixer uppers" around with value down on the floor (especially in Detroit). Just randomly, I checked on zillow.com for Kansas City, MO, and some old houses are being sold for 10 000$. That's not much more expensive than the price of the lot. Of course, these houses are really crap now.

      Note also that some Vancouver houses are listed as "lot value only"... it's just that the lot is worth 700 000$ by itself!

      Still, in general, with density limits, renovations are more likely as redevelopment than tearing down and rebuilding, people buy rundown housing for cheap, use the old house as a shell for a major renovation, then flip it on the market. If we allowed it, there's no reason why old houses couldn't be renovated into duplexes or other multi-family housing.

      But still, you're correct that redeveloping well-maintained, still valuable housing into same-density housing by tearing down and rebuilding will inevitably make it unaffordable for the type of people who used to live there.

      PS: there is also a phenomenon called "filtering" where middle-class housing degrades a bit over time and become poor housing, a bit like middle-class cars become poor people's cars after 10 or 15 years, once they're on used car lots. It's just not that common nowadays in urban areas, with rich people coming back to cities.

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  2. Not sure who started the luxury car analogy, but I first heard it from Let's Go LA: http://letsgola.wordpress.com/2014/06/14/the-lamborghini-and-the-dingbat/

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