Thinking about the growing housing affordability problem

Introduction

This report focuses on an important component of the affordability issue associated with the ease (or lack thereof) with which a typical middle class household can buy a home.^1,2 The next section briefly documents that house prices have reached historically high levels in many markets and that price growth has outpaced income growth almost everywhere over time.  If the pattern continues, we will come to the first time in U.S. history when ownership was generally unaffordable to the middle class in the majority of metropolitan areas in which there were large numbers of good jobs. Essentially, homeownership is joining health care and higher education as important sectors in our society in which the middle class can no longer take affordable access for granted. Section II also shows that deficient supply of new housing—not some problem on the demand side of the market—is the driving force behind the country’s deteriorating affordability conditions. 

Two key principles are identified that should guide any policy intervention. The first is that policy should help increase the number of new housing units delivered to the market. If that does not happen, the policy is likely to be irrelevant and possibly counterproductive. A second key characteristic of good policy design is what might be thought of as the transparent costs principle. This means that good policy requires its costs, not just its benefits, be visible and priced. Without the ability to know what is being gained and at what cost, the policy almost certainly will not be implemented efficiently and could be counterproductive. 

Section III uses these criteria to evaluate a host of actual and potential policy proposals using these criteria. We first take a deep dive into two of the most prominent recent proposals—for rent control in New York City and for development of a 50-year mortgage market nationally.  Neither of these policies increase supply and their costs are not well recognized or acknowledged by their proponents. Demand-side policies alone, which include interest rate buydowns and other strategies to lower mortgage rates, as well as allowing the use of 401(k) funds for a downpayment, not just the 50-year mortgage proposal, generally are unhelpful and can be counterproductive by worsening affordability problems. The reason is that housing supply has become much more inelastic over time. Stated differently, in today’s housing markets, new supply does not increase much in general, including when home prices increase a lot. Hence, trying to make housing more affordable by subsidizing demand in one way or another simply shifts out that demand along an almost fixed supply. That results in higher prices, which exacerbates the affordability problem.

That leaves supply-side policies. Four types are examined in Section III.  The first are direct interventions intended to generate more new housing units. These policies include selling federal land with a stipulation that housing be built on it, upzoning that allows densification of an area, and expanding the types of housing units that are allowed (e.g., accessory dwelling units (ADUs) and modular housing (or manufactured homes)). Each of these will or could increase the amount of new housing units supplied, which means they possess at least one of the two core traits that distinguish a good policy. However, recent research suggests that we should not expect a large or immediate increase in housing supply from upzoning. This is an important implication of this part of the analysis—namely, there does not appear to be a supply-side intervention that will quickly lead to a large enough surge in supply to materially alleviate affordability concerns. 

This suggests we also need to look elsewhere on the policy front if we are to make more progress. One set of alternatives involves using the fiscal resources of the federal and state governments to encourage localities to allow more building. One example is a recently passed bill by the Senate Banking Committee (called the Road to Housing Act of 2025) that rewards communities which allow more housing development by allocating them a bigger amount of grant funds. Another way to use the powers of higher levels of government would be to set national or state standards regarding the use of certain types of structures such as modular housing. This could have a high longer-term payoff because under our current system of dispersed local control of building permitting, different types of modular housing often are mandated (or, more likely, banned) in different jurisdictions. Having a standard rule that allows for a given quality product across the country could lead firms to invest much more in product development because those costs could be defrayed over a much larger scale of business for a bigger set of markets.

A second set of alternative supply-side policies involves changes to the nature of the local regulatory structure currently in place. As discussed below, our system of strong local control of the permitting process is the genesis of the growing undersupply of new housing units. Hence, changes to this system are going to be extremely important if we are to meaningfully improve housing affordability conditions over time. One such change would be to increase the role of state government in the permit review and approval process. In the United States, the permitting process is a state function, with most states delegating that responsibility to local entities. The rationale is that nearby neighbors know most about conditions in the area and, thus, are best suited to evaluate development proposals. There is truth to that, but our form of local control also violates the transparent costs principle of good policy design. The local regulator typically makes decisions based on a building permit’s costs and benefits to current residents. It is not required to care about the costs to outsiders who might have gained much from accessing new housing in a community had the proposal been approved. Thus, this system is biased towards rejecting building permit requests, which suggests we need to broaden or supplement regulatory control beyond local groups or jurisdictions if approvals are to be increased. 

Another substantive potential change to the nature of the extant local regulatory regime would allow for more types of housing to be built by right. Currently, zoning rules are so restrictive in many jurisdictions that much new development needs some type of variance or rezoning. The uncertainty and high cost of that review process complicates—and undoubtedly kills—many prospective housing developments. One way around this would be to move towards something like the Japanese model, which has 12 different zoning categories.³ Use is restricted in each of these zones, but common practice is to allow a maximum use of different zones in a given geographic area. Thus, different types of residential products (e.g., single family detached units, townhomes, apartments, ADUs) would be allowed by right within a jurisdiction, but there could be restrictions on how much of any type would be permitted. Regulatory reform in this direction would obviate the need for what often are lengthy and expensive quasi-judicial review processes to obtain permits.   

A final fundamental policy change discussed at the end of Section III involves restructuring of the property tax system. That analysis indicates that we should tax land much more than structure. Doing so would tax large lots, not large housing units, more, thereby putting a visible and higher price on low density, especially in the areas with the highest land values.⁴  That said, changes to the tax system are highly consequential, so they should not be done without careful consideration and a lengthy phase-in period.

In sum, there are a number of important lessons and guidelines we should heed and follow if we are to alleviate growing affordability problems across the country. First, focus on policies that do or will increase the supply of new housing. Avoid demand-side subsidies that do not. Second, recognize that, while direct interventions to increase housing supply are useful, they are unlikely to be able to rapidly improve poor affordability conditions. Third, encourage federal and state governments to use their resources to encourage useful experimentation with good supply-side policies. Fourth, work towards implementing changes to the structure of our permitting regulation and taxation of housing. Our regulatory system is biased towards turning down requests to build, and local property taxation typically is not structured to encourage structures relative to land. Reform in both areas is critical to improving affordability conditions over the longer run.  Both are political issues that will take time to solve, so the time to start the reform process is now.

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