Sunday, November 5, 2017

Housing: Part 267 - Lot Size and Housing Demand

I haven't written much about this, because I'm not sure that the aggregate data bears this out.  But, the trend is so universal and extreme in the Phoenix area, there has to be something going on.

Since the financial crisis, new homes in Phoenix have been squeezed into very small lots.  There are many in-fill residential developments going up with two story homes that have barely more than a back patio.  This is especially surprising because the growth of Phoenix has largely been based on affordable middle class homeownership, and part of that ideal has always been the backyard swimming pool.  Most of the new homes since 2007 don't seem to have room for a pool.  This is a fundamental change.

The reason I think this is the case is because land prices are high because of low interest rates.  We can see this in the price of farm acreage, which has remained high.  But, home prices have been pushed to a level below their previous norms because of repression in mortgage credit markets.  This means that demand for housing in Phoenix is held down, putting downward pressure on the quantity of housing purchased.  And that demand is constrained by limited credit access, not by spending preferences.

The price of the home itself, in places like Phoenix, will be regulated largely by the cost of building.  So, the cost of lots is high and the cost of the homes themselves is relatively level.  If we didn't have repressed mortgage credit, this wouldn't matter much.  Low real long term interest rates would lower the cost of the mortgage at the same time they would raise the cost of the lot.  Home sizes might rise, but not so much at the expense of the lot.  Today, I think there is tremendous downward pressure on lot size - enough to lead to these fundamental shifts in home design.

Since financial repression is the binding constraint in housing markets, this upends many intuitions we might have about the market.  Yields on housing investment are very high while long term real interest rates on treasuries are very low.  This is odd.  Future market shifts will not be a result of these yields moving in parallel, which is what they might have done in the past.  Future market shifts will more likely result from these yields re-converging, in one way or another.

With continued financial repression, that might mean that housing starts remain low, rent inflation high, and generally real housing consumption will continue to decline until a new equilibrium is reached.  I'm not exactly sure what the endgame looks like there.  I suspect there would be a two-tiered market where upper middle class families would tend to live in larger homes while other families would rent smaller units.  Maybe in that case, these large patio homes would remain the norm in entry level markets, especially if low real long term interest rates remain low as a result of the various ways that capital repression maintains the limited populations and high costs of the Closed Access cities.

But, if financial repression is eased so that marginally qualified borrowers can buy homes again, then home prices should rise and long term real interest rates will also rise.  In that case, lot sizes will also increase in some cities.  Our intuitions will tell us that rising interest rates and rising home prices will cramp housing demand and favor entry level homebuilders of the kind that are building these crowded new neighborhoods.  But, in that scenario, it might be the case that neighborhoods which have been planned and permitted for very small lots would be out of favor, and builders with larger lots would gain market share.

This is all academic.  The sorts of shifts in mortgage market regulation I am describing here aren't even on the political radar right now.  So, it's probably not particularly useful to you as a reader.  But, I am reminded of this issue every time I drive around suburban Phoenix and notice those incredibly small lots.


  1. KE--

    A some point in the distant past (20-35 years ago), the same thing happened in L.A. area. Even places where there was cheap land, such as the Inland Empire, they were squished-together housing tracts that struck my eye as awful, as I was used to the backyard pool, front yard with a tree set-up you mention.

    Changing Consumer tastes? Yards, pools take maintenance. Two-income families don't have time for house-yard work.

    Larger economies of scale than we realize? That is, cramming together houses results in much higher productivity--the builder-developer makes more money. 100 houses in a development, rather than 50.

    City zoning? Old minimum-lot-size rules die under developer pressure (or campaign dollars)?

    I wish Phoenix-L.A. builders would simply go to the old row-houses you see in some Eastern cities. The single-family detached houses with five feet of separation? They just don't look right.

    1. I suspect that when that happened, it was when residential credit was tight after the 1990 recession.

  2. I am confused, even more than usual. Tougher underwriting standards means only the better-off can become homebuyers. That would mean upscale development for the upper middle class. Per square foot sizes on new housing held up. So why baseball-card lot sizes?

    Maybe people want dinky yards in the heat. Retirees and singles.

  3. Over the last 42 years, the average new US house has increased in size by more than 1,000 square feet, from an average size of 1,660 square feet in 1973 (earliest year available from the Census Bureau) to 2,687 square feet last year.Jun 5, 2016

    1. Think of it this way. Based on even a moderate sensitivity to real long term interest rates, prices in the US are probably something like 20% too low. Ballpark, that's a combination of a lot that is very expensive and a house selling for 40% less than replacement value. That's why sales are really low even though prices are high. Builders don't have much of an incentive to build when they can't sell the total product at a price that covers the cost of the structures plus the market value of the land. What ratio would you choose if there were complementary products and one was selling at a 40% discount? There are millions of existing homes for sale with lot sizes larger than the size that current conditions warrant. So new homes meet the needs of the current context, which is a lot of the underpriced component and a minimum amount of the component that is priced without a discount.

  4. Not sure...but in some regards consumer preferences must be important...if Phoenix zoning allowed it would you see row housing?