The (New) Urban Crisis

Here is something I didn’t expect to read in a business publication.

Readers of this space know we like free markets” the editorialists at the Boston Business Journal wrote. “But it is also the conventional free market, with arbitrary constraints on supply (much of it brought by regulation), that has turned Boston into one of the most expensive housing markets in the country. So it is the local real estate market that turns us into quasi-socialists, for it is Boston and environs’ incapacity to build housing for average people that is the biggest threat to the future of the local economy. When it comes to housing in Boston, government cannot stand by and simply watch the marketplace do its thing. The result will be to price out the middle class, and to turn the city into a boutique, a place only for the wealthy and a financial non-starter for innovators with a lot of ideas but little money and those who want to raise a family here.”

The Business Journal is reacting to the new urban crisis. That term was coined in the 1970s to describe the economic, social and fiscal decline of older central cities as the middle class, the affluent, and businesses followed the flow of public money to the suburbs, leaving the collapsing cities with the old, the sick, the poor, the troubled, and little if any tax base to support them. Most localities built before 1950, without enough parking and road space for the auto, but with places people could walk to, mass transit, and relatively high-density housing, never recovered. The new urban crisis is that a much larger share of those in younger generations, and people all over the world, wish to live in the few surviving socially, economically and fiscally viable U.S. central cities. And as a result the cost of housing in those central cities has gone through the roof.

The political response to the new urban crisis has been, as usual, misleading solutions that happen to accord with the self-interest of the interests that propose them. For one thing, while calling for public intervention in the housing marketplace, it isn’t as if the Business Journal is willing to see taxes collected to pay for it. A combination of low taxes (no gas tax increase for 22 years), low fees (much lower transit fares than NYC), extensive public services and plenty of waste and pension fraud have left Massachusetts in general, and its transportation system in particular, broke. How broke? When I calculated a “sold out future” ranking based on 2007 Census of Governments data on infrastructure spending, state and local government debt, pension underfunding, and taxpayer pension contributions, only Rhode Island was worse off than the Bay State. It was even (barely) worse off than NYC.

So with the roads crumbing and the Massachusetts Bay Transportation Authority (MBTA) broke, is the Business Journal willing to see higher taxes to allow the transportation system to survive? No.

Massachusetts finally increased its gas tax, and added a provision to have it keep up with inflation in the future. The response was a referendum to eliminate the inflation adjustment. Most of the Massachusetts business community was against the referendum, and for gas taxes that kept up with inflation. “The Greater Boston Chamber of Commerce, the Massachusetts Taxpayers Foundation and Associated Industries of Massachusetts, among others, have donated heavily to defeat the question. They want the gas-tax indexing because they see the desperate state of our transportation infrastructure.” But the Business Journal was in favor, and it passed.

The special interests buzzing around the new urban crisis fall into two camps. There are those organizations and people who earn their living in government and government-sponsored housing programs, who not surprisingly think the solution is more government and government-sponsored housing programs. And there are those who want developers to be allowed to build whatever they want, regardless of the area’s ability to provide the necessary expanded infrastructure (one of the usual solutions is to have new development not pay taxes) or the negative effect on the quality of life.

The Business Journal, not surprisingly, has been in favor of the deregulation agenda. What it fails to acknowledge is that in Massachusetts a deregulation agenda has been implemented, and succeeded, and it hasn’t made a dent in the problem. Government barriers to housing development fall into two categories. In the cities, the retroactive enactment of rent regulations (as in NYC in the 1970s) means developers and lenders would be foolish to invest in new housing, or the rehabilitation of existing housing. And in the suburbs, NIMBY homeowners seek to zone out multifamily housing or modest single family housing to keep the less well off, and their burdens, out of their towns. In response Massachusetts has done things that New York would never even contemplate.

Voters eliminated rent control by referendum in November 1994, and lingering protections for disabled, elderly and low-income tenants finally expired last yearThe Economist noted in 1998. While there was some displacement at first, the percent non-white in the formally regulated units went up, and so did investment in apartments in Boston and Cambridge, which have had renovation and new supply booms. In fact there is a massive apartment development boom in Boston right now, but it hasn’t made a dent rising rents. Among the worst off are the tens of thousands of students in the Boston area housing market. The city was shocked recently by the deaths of young people in fires in overcrowded, substandard housing units.

A collision of greed, neglect, and mismanagement is endangering young people in America’s college capital while enriching some absentee investors — landlords who maximize profits by packing students into properties — and universities that admit many more students than they can house” according to the Boston Globe. “It is a heedless calculus that begins with the flood of student renters and the landlords who freely defy housing codes, and is enabled by city inspectors who simply are no match for the health and safety challenges that result.”

Illegal, overcrowded apartments riddle the city’s college neighborhoods, including a significant number in violation of a city zoning rule barring more than four full-time undergraduates from sharing a house or apartment” this source reported. “Globe reporters and correspondents visited block after block of rental properties in student-rich enclaves — near BU, Boston College, and Northeastern University — and found overcrowding a fact of life.” They also found rodent infestation, overloaded and substandard electrical circuits, etc. With speculators buying up houses at prices families cannot afford, and chopping them up on the cheap into de-facto dorms. Clearly no excess of regulation here.

And for the suburbs, Massachusetts passed Chapter 40B, a state law that the New York State legislature would never contemplate. “Chapter 40B was signed by former Gov. Francis Sargent in 1969 as a way to encourage construction of affordable housing by reducing so-called snob zoning, such as one- or two-acre lots” according to the Business Journal. “In communities that fail to meet the 10 percent (affordable housing) goal, developers can bypass local zoning rules, such as limits on density, if 25 percent of the units they propose to build will be affordable.” The suburbs hate it. “Most of the communities that have met the requirement are large cities, such as Boston, Brockton, Cambridge, Holyoke, Lowell, Lawrence, New Bedford, and Worcester. Some suburban communities have also met the goal, including Concord, Lincoln and Northborough.”

But while the Business Journal (if not its subscribers who reside in the snob suburbs) would like to see more, the reality is suburban Boston, like the city itself, HAS had extensive multifamily development in the past 15 years, as opposition to it has decreased. And rents increases are moderate in the suburbs, where in fact many Chapter 40B developments were built in the 2000s. It is in the center, in the cities, that rents are through the roof.

There has been deregulation, and it has worked. But it hasn’t stopped the new urban crisis from getting worse. Thus the Business Journal’s odd response.

Mayor Marty Walsh gets it, for he sees working-class families getting priced out of his Dorchester neighborhood. The mayor’s plan goal to build 53,000 units in the next 15 years is ambitious and well thought out, especially for an administration with only nine months or so under its belt” according to this source. The Mayor proposes tax breaks and zoning changes, perhaps getting rid of the city’s remaining industrial areas. “But we believe the mayor still is relying too much on market forces to create something that has thin margins and a high NIMBY hassle factor. If middle-class housing is the priority that it should be, the mayor should be thinking on a bigger scale. He should propose that the city put some money down (let’s say $50 million) and have the universities and the private sector match it to buy land and create a comprehensive building program.”

With what money? There, as here, older generations have already spent tomorrow’s revenues on themselves yesterday.

And in any event, if the Business Journal believes government intervention in the market would solve the new urban crisis by making housing affordable, it need only look down I-95 to New York City, the place with the most intervention in the housing market, to see that isn’t so.

Here we still have rent regulation, for nearly half the rental housing stock, along with public housing and Mitchell Lama housing. And lots of rental units in small homes, which have had their property taxes held down relative to other types of property (though without an obligation to keep rents down as well). The firm I work for tracks market rate, investment grade apartment properties – those with 20 or more units that might attract investment from larger real estate companies with large bank or insurance lenders. Such apartments count for less than 10 percent of the NYC rental inventory (the comparable figures are 30 percent in Chicago and 45 percent in Los Angeles). In 2011, according to the Census Bureau’s governments division, New York City accounted for just under 10 percent of total local government spending in the Housing and Community Development category. NYC accounted for just 2.7% of the U.S. population that year.

So has all this intervention in the housing market made NYC housing affordable? Far from it. All NYC’s rent regulation and affordable housing programs have done, all they seemingly can do, is to provide special deals for selected households so that for them housing is cheap despite the fact that it is expensive overall. A few lifeboats in the storm. Generally limited to those who have been here for a while. Not immigrants, college-educated in-migrants, children who grew up here and want to move out on their own or, in the words of the Business Journal, “innovators with a lot of ideas but little money and those who want to raise a family here.” They are paying more for less and less space as the cost of that space gets higher and higher. Meanwhile, some of the lucky beneficiaries even get to cash out the public benefit of “affordable housing” and take the money with them out of town, leaving unaffordable housing for those coming after. This includes not only those formerly in the Mitchell Lama program

but also small homeowners such as myself (and Mayor DeBlasio). One reason we could sell our houses for such ridiculous amounts of money is that our property taxes have been kept low by an early 1980s law that shifted the tax burden to multifamily housing and commercial property. This allows bidders to put more of what they have into a higher mortgage payment rather than property taxes — and forces them to if they are to be the winning bidder for a NYC home. Those buying houses now, therefore, get no financial benefit from the limits on property tax increases. The sellers get all that benefit, and can take that windfall and head for Florida. Rent regulation isn’t means tested either, aside from luxury decontrol. Thus NYC’s housing programs have benefitted some, but made things worse for others, those not in on the deals.

If NYC is not unaffordable due to a shortage of government housing programs, is it unaffordable because of excessive regulation and taxation of new development, as the Real Estate Board of New York would surely claim? Hardly. NYC has the least restrictive zoning in the U.S., with narrow blocks, high permitted density and bulk, and limited yard regulations. NYC parking requirements are not nearly as onerous as elsewhere, and could (and perhaps should) be reduced further. (In any event developers can game the rules to get around them by subdividing lots). One family houses are allowed to be converted to two family houses in much of the city, and frequently are — even in the few places where this is not permitted.  Minimum units sizes are low, and proposed to go lower.

In much of the city, NYC has allowed those living in new housing units be exempted from paying a dime in property taxes for years and years and years. While other jurisdictions, even in the Sunbelt, require developers to contribute to schools and infrastructure as part of subdivision plat approval. NYC’s population has soared with virtually no addition to its infrastructure, which has become more and more crowded. All these factors have led to a massive development boom, one stunning for an older city that is already fully built within fixed boundaries at a high density. But it hasn’t been enough.

Meanwhile, according to Joel Kotkin, a man who made a career advancing the idea that no one wanted to live in walkable, transit-oriented cities anymore and they should be left to die in favor of auto-oriented suburbs, “as the cost of living has skyrocketed while pay has stagnated except for those at the very top, New York has shifted from a place people go to make it to a place for those who already have it made, or whose families have. And once here, the rich are indeed getting richer even as the rest of the city is barely holding on.” Nobody goes there anymore, it’s too expensive.

And in a poke in the eye at his rival Richard Florida, who correctly predicted that many cities would turn around and prosper because the “creative class” wanted to live in them, Kotkin noted “as the middle class has waned, even exemplars of the celebrated creative class — musicians, artists, writers — find the going increasingly rough, and unrewarding. Laments rock icon Patti Smith: ‘New York has closed itself off to the young and the struggling. New York City has been taken away from you.’”

So if neither excess regulation or lack of government intervention are causing the new urban crisis in New York, Boston, Washington, Los Angeles, San Francisco, and Seattle, among other places, what is? One has to go back to the suburbanization era, and the original urban crisis, to find out. What those like Kotkin believed to be a permanent shift in consumer preferences in favor of suburban areas and the suburban lifestyle, in fact turned out to be historically temporary period when the suburbs were new and the cities had grown old. I recently read a brilliant analysis of what that meant, which I’ll quote from extensively.

As new places, during the 1940 to 2000 period the new suburbs benefitted from:

Everything new and state of the art. A brand new home in the suburbs is new, comes with a warranty, and probably needs limited maintenance for the first few years. Also, it is built to the current fashion, with the layout, square footage, and room sizes people prefer today. The kitchen has stainless steel, not harvest gold. Everything about it is what the market is demanding today. As fashions and tastes constantly change and evolve, it seems unlikely older homes are hitting the market sweet spot, often requiring renovations, plus they require significant maintenance just to keep them up.”

No legacy costs. More broadly, the area has no legacy costs. There are no brownfields to clean up, no dead malls, etc. There are no unfunded pensions because nobody has accrued a pension yet. There are no bond repayments from yesterday’s boondoggles. And so on.”

I’ve seen this in the public finance data. Pensions may be underfunded, but retiree health insurance has been unfunded, a great deal for taxpayers when there are no retirees, particularly compared with the city with their many seniors getting the benefits they promised themselves and shrinking tax bases to pay for them.

No legacy institutions and culture. A greenfield isn’t saddled with bunch of deals, and accommodations made years ago. It isn’t saddled with a mayor who is the grandson of the city council president from 40 years ago. There are a limited number of powerful special interest groups. As anyone who has tried to change an organizational culture that no longer meets institutional needs can tell you, this is a daunting task.”

Which is why the suburbs were, at one time, considered the epitome of “progressive.” The places where ordinary people (so long as they were white) could have their own little house and their own little car and their own little school and be free of the landlords, the urban transit companies (they were private then), the incompetent school bureaucracy and its unions. And why the Democrats and Republicans alike used the government to create them, and the mass middle class that went along with them. One-family housing and one car per family came right away. “Snob zoning” for large houses on large lots and nothing in walking distance came later, in the 1970s and 1980s, along with white flight and (ironically) the environmental movement.

Ability to defer infrastructure costs. In particular, arterial street capacity and freeway capacity are built with a lag. This lets new towns avoid costs in the short term.”

Moreover, the federal government taxed cities to subsidize owner-occupied one-family housing, new highways and water and sewer systems, with the latter ending with Reagan Administration in 1980. It was decades into the suburbanization era that the federal government started supporting mass transit as well. Moreover, suburban infrastructure is inherently overbuilt, because there just isn’t much traffic along that two-lane country road. So when the subdivisions are built along it, at first the traffic is just using up excess space. Until it reaches a tipping point, and suburban traffic hell begins. The result is added desirability for the exurban areas further out, with their still empty roads.

Scale economics are in your favor. Costs consist of fixed components and variable components. In a growth scenario, the fixed portion gets amortized across more units, meaning your cost per unit drops. Also, this allows substitution of additional fixed costs for variable costs to gain further unit cost efficiency. As long as growth holds, that alone can drive down cost per resident and business. This helps keep taxes low.”

Efficiency of large lot development. New suburbs are usually developing relatively large parcels, which is efficient in that environment. For example, the land was probably acquired from a small number of original owners. The planning and zoning process is pretty much the same whether you are building five houses or five hundred. Again, there are unit costs efficiencies from building many units, etc.”

No matter what developers are allowed to get away with in the cities, urban redevelopment requires buying a building that is already there, paying its full value as an occupied and used property, and replacing it with something somewhat bigger. One building on one lot at a time, not a whole neighborhood like the one Congressman Calder put up in Windsor Terrace, Brooklyn 100 years ago.

Few low income residents. Because new towns tends to feature owner-occupied housing and new apartments, a job and credit history is generally needed to get in. Thus the nature of new places is avoid low-income people, and the associated social service costs. Part of the reason that the outer suburbs experienced particular stress in the housing collapse was because the weakened lending standards allowed people with marginal finances to buy in. A return to the status quo ante means those types of buyers will likely be excluded in the future. That doesn’t do anything to help lower income and working class people – they still have to live somewhere – but it will keep them from newer suburbs, as will restrictions like large lot size zoning and building codes that mandate upscale materials.”

Meanwhile the federal government invested in public housing projects in the cities, and later (in the 1980s) mandated that these be made available preferentially to the homeless, the mentally ill, the addicted, ex-offenders, and others the suburbs wanted to keep out.

The combination of urban special interests and legacy costs driving up taxes and cutting the quality of public services, the shift of public investment to the suburbs, and sheer age and obsolescence turned most cities into the holding places of the poor by 1980. Only a few survive – and even they have higher taxes and worse schools even today. In 1950 walkable urban neighborhoods with access to lots of jobs via mass transit were a dime a dozen. But cities started going down hill when their housing stock, mostly built from 1880 to 1940, started to reach 50 years old.

Now an ever-growing share of suburbs and Sunbelt cities are in the same situation.

You might say that this is a transitory state and the problems of the city will eventually hit the suburbs as well. Very true. And indeed, that’s what we see. Inner ring suburbs across America are struggling. Some of them are failed towns worse than any inner city. Many of today’s boomburgs will no doubt share the same fate 30 years from now. As a general rule, it seems that only the most affluent suburbs have staying power. But that doesn’t help you if you are a central city or inner ring suburb today.”

“Eventually all of the items above go into reverse. The town becomes ‘full,’ it gets old, and its own deferred costs catch up with it. Then all of the logic that made the greenfield so powerful works to equally devastating effect in reverse. As the population and tax base shrinks, fixed costs loom large, for example.”

“The kicker in all this is that the liabilities and costs almost all attach to the territory, not the people. Thus they can be escaped simply by moving to a new greenfield.”

“It’s like prospectors skipping from one clapped out mining town to the next. Or being able to run up a huge credit card in someone else’s name and skip town.”

The entire state of New Jersey is in that situation right now. So is the State of Illinois, excluding the city of Chicago (which still has its own problems). The suburban office parks and malls are emptying just like the multistory urban factories and tenements once did. The poverty rate is soaring in many suburbs, even suburbs of the limited number of older cities that are gentrifying. Moreover, younger generations have been left poorer than those who went before, on average and en masse, in other ways as well. And the most able and motivated of those disadvantaged generations are arriving, en masse, as refugees in the few remaining cities that survived the original urban crisis.

I can’t blame them for wanting to be here. They merely want the same things I wanted 30 years ago, having moved to the suburbs at age 10 and concluded that I didn’t want to live there or have my children grow up there.

Except that for my generation that was the preference of a small minority. Now a much larger share of the next generation wants to live in the smaller number of economically, socially and (more or less) fiscally viable cities, and a much larger middle class and urban population in the developing world wants to invest there. And there isn’t enough room. It doesn’t matter how much you subsidize, or fail to regulate, development if development sites cost $450 per buildable square-foot.

That means the developer would have to charge $450,000 for a tight (for a family) 1,000-square-foot apartment — just for the air the apartment would occupy. The cost of the actual building, and the developer’s profit, would be on top of that – and the developer probably expects to make a killing given the risk it – and its lenders — are taking. Would you like to put up some of your savings to invest in this deal, with the site alone costing that much? I wouldn’t. And upzonings and tax breaks and subsidies wouldn’t help the developer, or future home buyer or tenant at all. They would just jack up the cost of the development site until everyone was back at the point the market will bear, with more profits for the site owner who didn’t do a thing to add housing.

Back in Boston, according to the Boston Globe,

Boston needs to build 53,000 housing units by 2030 to keep pace with rapid population growth that is already increasing prices and squeezing out low- and middle-income residents, according to a city report. The report by Mayor Martin J. Walsh’s administration, previewed by city officials on Wednesday, calls for $21 billion in private and public construction that would increase Boston’s overall housing stock by 20 percent over the next two decades. During that period, the city’s population is expected to jump by 15 percent, to 709,000 people, according to the report. That would be Boston’s highest level since the 1950s, when large numbers of people began to leave the city for surrounding suburbs.”

The equivalent housing production for a city the size of New York? A total of 600,000 housing units in 15 years, or 40,000 per year. My response? It isn’t possible. And if it were possible, it wouldn’t be enough. Housing is in fact over-abundant in the United States, with most people having far more of it then they need or can afford to maintain. There is no affordable housing crisis nationally. What we have is a large share of the marginal national housing demand for housing, and the global demand for housing investment, concentrated on a few relatively small patches of land. For urban areas to become truly affordable, we need to built two more Boston’s somewhere, and two more New Yorks, or 10 San Franciscos. (Or perhaps ruin the originals so no one wants them anymore).

City building on that scale is taking place in China, and once took place in the United States. And those U.S. cities were built by the market economy, not by the government (as were the suburbs). Can the U.S. come up with more places that more people will see as legitimate substitutes for Brooklyn, now trendy to a ridiculous extent, the dreamworld that is the only chance for young people to get a life and entrepreneurs in certain fields to start a business? I’ll discuss that in my next post.