Thursday, December 19, 2019

Housing supply isn't constrained in Phoenix

Scott Sumner has a post over at econlog today about the mystery of low housing starts.
But what if supply is also constrained in Phoenix and Las Vegas?  I don’t have any good explanation for what that might be so, but the data strongly suggests that there is some sort of supply problem.  The high prices are back, but construction remains severely depressed......I have no idea why supply in these markets is so constrained.  I’ve read articles that make vague references to the cost of land and labor, but no real explanation of why things are so different from 2003.
As Scott frequently points out, bubbles are not nearly as numerous as they are made out to be.  It is important to remember that what happened in cities like Phoenix in 2005 was an extreme anomaly.  A combination of population flows and capital flows that briefly pushed both the demand for real shelter and the funding available for it high enough that the local short run supply curve became disruptively inelastic.

In most cities at most times, where demand hasn't pressed quantity demanded so far up the supply curve that it becomes inelastic, changing demand only has minor effects on price.  When markets are relatively normal and supply isn't extremely inelastic, changing demand mostly affects quantity.  Even in 2006 and 2007, housing starts underwent extreme fluctuations before prices followed them down.  So, the signal in Phoenix is a reasonable reflection of changing demand.  (There was another anomaly in housing, after the crisis, where severe limits to lending pushed prices down in many cities.  That, again, though, was an extreme anomaly.  As Scott shows in his post, slowly this anomaly has reversed, also.  So, Phoenix was subjected to two anomalous housing events.  An extreme upswing in prices - what you might call a bubble - followed by an extreme downswing in prices that was also far from a level that long term fundamentals would justify.)

Source
You can see this in population and migration data.  One effect of extremely tight lending that has prevented aspirational middle class homeownership since the crisis is that population and migration trends that had been steady since WW II into places like Phoenix have been sharply curtailed.  Migration briefly declined to nothing in Phoenix for a few years after the crisis, and has since recovered to a level where the difference between Phoenix population growth and US population growth is only about half what it was pre-crisis.

Phoenix builders could build thousands more homes each year without much rise in cost.  Actually, prices in the low tier existing housing stock in Phoenix probably need to rise a little bit more to make building profitable.  This is a sign that lending regulations are the key variable moderating demand.  Building rates are highly correlated with income and with home prices, both within and between metro areas.  Low tier demand is in retreat because it has been pressed into a landlord's market.  This shows up both as a decline in inter-metro migration and in a retreat of real housing consumption combined with high rent inflation in low tier and rental markets.  The FHFA and CFPB's have-nots are either stuck in place or in retreat.  This also shows up in American Housing Survey data that suggest household size has continued to slowly decline among homeowners but has reversed and started to climb for renters, since the crisis.

What about the issue of costs?  I suspect there is something to that.  Low interest rates do make land more expensive. (Back yards are much more rare in the new neighborhoods in Phoenix than they used to be.)  Regulations, etc. have all probably risen somewhat since the crisis.  So, low tier prices might need to rise even more than they would have needed to without those issues.  But these are marginal changes that can't be responsible for such universal and extreme shifts in building rates around the country.

Source
On the topic of labor costs, however, I think there is something interesting here.  Here is a graph of construction employment in Phoenix as a percentage of total employment.  This did briefly rise during the boom, and then collapsed to very low levels after the crisis.  This is especially striking if you believe, as I do, that Phoenix never had an oversupply of homes, only a sharp negative demand shock, which is clear in the population chart above.  (I think the 2010 dip is probably due to a data revision, which is likely due to population growth that was lower in 2008 and 2009 than shown.)

Economists such as Peter Boettke and Arnold Kling talk about the economy as a coordination problem.  I think this is a valuable and useful way to think about the economy.  The problem here is that this extreme disemployment in construction has been universally accepted as something that was necessary.  Economists have treated the collapse in construction employment as the necessary correction that had to take place, and blamed the slow recovery on the scale of that correction.  But, what if that wasn't a correction at all?  What if that was the disequilibrium.  Consider the scale of the damage we have imposed on our own economy through monetary and credit strangulation that we were able to permanently disassociate 3-4% of the Phoenix labor force from a reasonable and useful local industry.  This damage has been so diligently imposed that the dislocation remains in place a decade later and these workers have disappeared.  Builders complain of a labor shortage.  What happened to them?  Did they give up? Did they move away?  Did they have to go through a difficult (and unnecessary) transition to other work?

Hysteresis has been an idea sometimes used to explain the slow recovery.  Here's your hysteresis.  Even today, I commonly see people react to slow housing starts by asking, "Aren't we still working off the oversupply of the bubble?"  That is absurd.  It was absurd when Bernanke asserted it in 2011.  It was absurd in 2005, frankly, though one can certainly understand how conventional wisdom got it wrong at the time.  The fact that this idea is still floating around the zeitgeist in 2019 is a signal of how misguided conventional wisdom has been about housing.  The persistent unemployment of those workers was a policy goal shared by both populists and technocrats.

26 comments:

  1. Great post.

    Amother factor, which is amorphous and perhaps not measurable, is probably every large city becomes more expensive to build in as time goes by.

    More regulations, and the land is easiest to build on gets used. Land that needs remediation is brought into use where gullies must be filled for hillsides levelled. If the city requires that infrastructure be inserted at builder cost, then as new developments get further from water lines and electrical lines, costs are raised.

    As cities grow and traffic gets worse, then those properties with locational advantages appreciate, raising the average price but not lowering the cost of new production.

    I don't know how much of this applies to Phoenix, which I last visited 10 to 15 years ago and there seemed to be land everywhere.

    ReplyDelete
    Replies
    1. That's true. Even in Phoenix, as the city grows, good locations increase in value. But that's a long term, slow process. Maybe half a percent a year on a good unit of amenity or location related real rent increases. Or, simply higher costs of dense building that ends up happening in high value areas. But, again, that's just all part of the rent/amenities/size trade-off. It shouldn't lead to extreme shifts in supply like we have seen recently.

      Delete
    2. One point I am trying to make, and perhaps I should write an article for someone somewhere, is that as nations urbanize, aggressive steps must be taken to ensure housing does no become too expensive.

      Of course the big simple solution is no property zoning. That will help a lot. If you have zoning, you will almost inevitably have property owners and financiers deciding on supply. See Hong Kong, or Los Angeles.

      But other factors (mentioned above) do get in the way, restraining new supply. I think cities and nations need to aggressively act to boost supply, always leaning towards making it easier to build housing.

      Texas used to tax property to highest and best use, thus effectively evicting property owners who did not upgrade their land.

      Communist China tackles the problem though huge multi-million unit housing projects, such as the one underway in Shenzhen. That's millions of units, vs. thousands in Los Angeles.

      interesting topic.

      Delete
  2. Don't place any weight on the calculated population change in the decennial census year. The intercensal estimates are calculated by estimating components of change relative to a base census year; -births, -deaths, and net migration.

    Everyone is counted in the census instead of estimating components of change so when fewer people were in Phoenix than expected, too much of the decline is showing up in one year in the ACS data in your chart. More likely, the net migration component of change estimate was significantly off in the surrounding years.

    ReplyDelete
  3. California Companies Are Rushing to Find Female Board Members--NYT

    So, a one-bedroom apartment in LA costs $2,500 a month.

    The solution is to force public companies in CA to have one female board member.

    ReplyDelete
  4. Any analysis of the Phoenix housing market that ignores water is incomplete. Even if it turns out that water is irrelevant to housing construction costs, it still needs to be addressed for the analysis to be complete.

    ReplyDelete
    Replies
    1. I don't think water is a particular constraint in Phoenix. Also, building was robust in Phoenix before 2007 and the pattern of building rates over time in Phoenix is similar to many other cities. Both of these observations suggest Phoenix's water access is not important on this issue.

      Delete
  5. https://www.nber.org/papers/w26573

    KE-- you probably saw this, worth looking at.

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