It is no secret that the country’s housing market is suffering from an acute supply and demand imbalance. Supply has lagged with decades of under-building adding up to a severe shortage. Years of latent, suppressed demand have been released by healthier consumer financials and remote work flexibility. While the Federal Reserve has temporarily poured cold water on some demand segments by increasing mortgage rates at record pace, our long-term issues won’t be solved without generating more units to meet growing housing needs.
Others have made convincing arguments pleading for more building, so we won’t focus on repeating these sentiments. Suffice it to say we see vacancy at near record low levels, and we know housing prices and rents have behaved more manageably at times of higher supply. Rather, we want to focus on the investment market these conditions have brought on, and what forward-thinking localities can do to leverage housing as an economic development tool.
These conditions have resulted in perverse incentives for the capital markets and an increased focus on housing, from investors that one of us has called “parasitic” and the other would simply characterize as “rational”.
Investors think in terms of “risk-adjusted” returns. The spectrum of the housing market consists of for-sale and rental housing in single-family or multifamily structures. Investors have built and sold for-sale housing, and built, sold, acquired, and held rental housing. Investors’ required returns are highest when they take the most risk, such as building a brand-new neighborhood of for-sale housing in a far-flung suburb or redeveloping a blighted urban industrial property for rental. Their required returns are lowest when they take the least risk, such as buying a fully occupied, brand-new rental property in Manhattan.
It generally follows, then, that developing new housing should be the most challenging and therefore most lucrative activity in the housing sector. We should hope that the capital markets push investors towards fulfilling this essential, value-creating function. Instead, the litany of constraints on new construction across the country have made it “too hard” to build new housing and “too easy” to generate returns through lower-touch investments in housing.
The genesis of the single-family rental sector was the Global Financial Crisis, but the subsector has persisted and grown due to the ongoing lack of affordability. Coming out of the recession, housing prices were so depressed as to compensate landlords (and then some) for the fragmented and operationally involved nature of managing a portfolio of scattered homes. Over the course of the most recent cycle, investors have continued to take advantage of individuals’ inability to afford ownership even as their lifestyles command more space. Technology and data science have aided in the acquisition and management of these properties. And the pandemic years of historically high rent growth have created persistent returns.
These are reasonable examples of the market stepping in to try to meet a need. But in a society in which so much of our wealth-building is anchored to homeownership (we can debate whether homeownership as a North Star is best for society), a higher share of single-family rentals means less opportunities for young or lower-income people to enter into that wealth-building ecosystem. The concept of a starter home is disappearing. Our inability to build sufficient housing has made investors the most competitive buyers for much of the nation’s most affordable housing. We see yet another example of capital begetting capital in our system, with a lack of entry points for those who aspire to grow wealth from a lower baseline.
Likewise, in the multifamily space, the “value-add” subsector has grown. Many investors assess the most attractive risk-adjusted returns to come from renovating existing multifamily buildings – updating kitchens, going from carpet to faux-hardwood flooring, adding amenities – and increasing rents. Existing housing stock might in turn move from low-moderate income rents to middle-upper income rents. This has been a lucrative and active part of the housing market.
The national housing market has evolved into the type of big hairy problem whose solution seems so simple and yet so daunting and near-impossible. We would love to wave a magic wand and up-zone the country, bring building costs down, and more efficiently match new supply to rapidly-evolving demand. Short of that, we have to focus on what more housing can do for localities and how forward-thinking municipalities can lead on the issue.
Research shows that much of the country’s recent migration patterns can be explained as pursuit of affordable housing. In the cycle following the Great Recession, certain markets across the South and West saw the highest population growth in the country. Darling metros like Austin, Nashville, and Denver recorded outsized growth while some of the country’s biggest coastal cities actually saw population decline.
Prior to the COVID-19 pandemic, when remote work was less common, much of this migration was driven by employers. Employers saw Sun Belt metros as attractive for many reasons including business-friendly tax environments, accommodating state and local governments, lower costs, and attractive lifestyles. Housing for their employees was no doubt a significant factor in some of these corporate relocations or expansions. New York and San Francisco rents proved so burdensome as to affect employers’ ability to attract talent, even as tech job growth seemed inclined to favor these geographies when possible.
The Sun Belt markets by and large may not have strategically focused on housing as a tool for attracting employers, but they found their natural housing affordability to be an asset. Many of these markets still had decent housing supply after the housing crisis, or still had “room” to sprawl outwards while also experiencing re-urbanization. While the average Sun Belt metro was not breaking ground on up-zoning and density, it likely had more space and was more accommodating to housing developers.
These markets saw continued in-migration during the COVID pandemic and remain hotbeds of general economic and population growth. However, even they have begun to experience the challenges of limited housing supply. A preponderance of their housing supply has been absorbed and they have seen untenable housing price and rent growth. Some Sun Belt metros are now on the precipice of the same housing supply problems that helped fuel migration from the Coasts to them in the first place.
In the meantime, the rise of remote work has expanded the map for newly formed and moving households. Metros can win migration through means other than jobs. The hottest markets of the 2010s – places like Austin, Denver, and Nashville – have seen their housing prices rise to unmanageable levels for many households, joining the housing-constrained coastal markets. Interest rate increases have made housing costs even more burdensome.
This leaves opportunity for markets that can offer affordable housing. Tulsa, Oklahoma has a median home price that is 40% below that of the country overall. Though no one could have predicted the remote work wave brought on by COVID, Tulsa was forward-thinking on remote work at a time when most of us could not have imagined downtowns shuttered due to a pandemic. Tulsa Remote was launched in 2018 and has brought in more than 1,200 remote workers through grants and additional support services. The program appears to be a resounding success, adding significant new local earnings to the economy and creating additional jobs above the remote ones attracted. While the program was not centered around housing, it paired an affordable market with an additional nudge to get ahead of what could be a massive economic wave for cities that were previously left behind.
Remote work has done more than just allow some higher-income employees to station themselves in attractive vacation towns. While it has not been a salve for everyone, unfortunately excluding some of those in the most need, it has allowed workers across the economic spectrum to rethink their lifestyle and living quarters. It has allowed millennials to move into more space and worry less about their commute. Hybrid work models may result in someone living in rural or suburban Pennsylvania and commuting to Manhattan once a week.
This opens up the possibility of an economy in which geographic migration is driven as much by housing affordability and lifestyle preferences as it is by job location. Across the country, many metros that previously dedicated economic development resources to trying to lure employers with tax incentives would do well to think about their end consumer – residents – and how to create or maintain a housing market with enough supply to be affordable. Those whose housing is already affordable may just need a small nudge, like Tulsa Remote’s $10K grant, to put themselves on the map for remote workers.
Through the Aspen Institute’s Latinos and Society Program, we have recently been working with the City of San Bernardino, California on an Investment Playbook to help catalyze the revitalization of its struggling downtown.
Interestingly, among all the hype about migration to the Sun Belt, the Riverside-San Bernardino-Ontario metro area, colloquially known as the Inland Empire, has been the largest beneficiary of net migration during the COVID period. The reasons for this are simpler and more obvious than many narratives we craft around migration. While we perceive people to be moving at high rates, ditching Silicon Valley for Austin and New York for Nashville, in 2021 the number of people changing residences was actually the lowest it has been since 1948. But migration within the same metro or same region was a large share of what did occur. The Inland Empire can simply be understood as a cheaper alternative to Los Angeles and San Diego while remaining in the same region.
During this metro level growth, San Bernardino’s downtown core has not been a beneficiary, despite having one of the best multi-modal offerings in the country. The Inland Empire’s housing grows more and more expensive itself, and its growth risks tapering off far below the potential its transit and natural attributes could accommodate. We, and many others we spoke to, bemoaned the fact that Texas could eat into California-resident migration that could more logically go to San Bernardino. But the numbers remain simple enough to tell the story: the Inland Empire median home prices may be 37% below Los Angeles’, but Houston’s are 47% below the Inland Empire’s.
Now with a forward-looking municipality and other public and private sector actors coalescing to push change in San Bernardino’s fortune, housing has the potential to become a centerpiece of an economic development plan. The city government has targeted sites in its downtown core that are ripe for redevelopment into dense, mixed-use, mixed-income housing. Pair these (relatively) affordable units with retail and innovation amenities in near proximity, and San Bernardino could suddenly become the perfect place for a San Diego resident to stay in Southern California close enough to their once-a-week in-office workdays, while getting more spacious, high-quality housing at affordable rates, and bringing economic dynamism to a community in need of it.
Economic development policy has long centered around jobs, believing residents would follow. In 2018, cities across the country threw the kitchen sink at Amazon to try to attract the jobs, residents, and economic activity of HQ2. Existing superstar cities won that battle. But the game may be changing: even before COVID sparked a remote work revolution, the world has been evolving into one in which jobs follow residents.
Decades of under-building housing have created a vicious cycle – homeowners don’t want to see new development, investors benefit more from hoarding limited supply than creating new supply, and cities see housing costs increase until it’s too late and their economies start bleeding residents. The new normal, a world in which affordable housing is scarce and remote work opens up the map, is one in which forward-thinking municipalities can use affordable housing as their primary economic development tool. This period of unprecedented federal funds flowing into cities presents an opportunity to invest in housing as a matter of the greatest importance.
For all the mindshare that has been spent trying to attract the biggest and best corporations, cities and regions can leverage a much more straightforward economic development unlock: providing workers across the economic spectrum with places they can afford to live.
Bruce Katz is the Founding Director of the Nowak Metro Finance Lab at Drexel University. Michael Saadine is Managing Partner at Invisible Group, a new interdisciplinary real estate investment platform.
 Freddie Mac