Apartment rents have declined over the past year, according to data collected by ApartmentList.com. I attribute the decline to high new construction levels in 2022 and 2023, which forced landlords to cut their asking rents as the new units came to market. But people worried about affordable housing have noted that much of the new construction was fairly expensive. They wonder if building new, expensive apartments lowers the rent on entry-level apartments.
The same question arises in single family housing. Home prices have been soft so far in 2024 after fairly high construction last year. Concerns about affordable first homes are not assuaged by construction of “McMansions” with high asking prices.
Economics, however, clearly points to good news: more high-end construction does lead to lower prices at the low end of the market, though not to the extent that new construction of low-priced housing would.
Imagine a metropolitan area with a good balance of apartment supply and demand at the upper end and the middle, but strong demand for low-end apartments. Further, imagine that developers have misjudged the market and built only high-end units. What happens?
Those new luxury apartments will not stay empty for long. Landlords would rather accept a lower rent than no rent at all. The upper-end rents drop.
But who moves into the new luxury apartments? People who had been in middle-market units. They saw bargains available and moved up. That leaves an oversupply in the middle of the market. So rents fall there, until people move up from lower-end properties. And when those folks move up, then low-end apartments become more available and their rents drop.
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This simple description assumes just three types of housing, although the market is really a continuum from high-end to low-end. The analysis is the same.
This logical analysis has been backed up by serious academic research, summarized in 2021 by UCLA researchers and in 2024 by the Bartlett Center.
Note that if developers had correctly judged that the greatest need was for low-end housing, , they would have built low-end units in the first place. The drop in low-end rents would have been more pronounced and happened faster. So when a market needs low-end apartments, building high-end units is better than nothing, but not as good as building low-end apartments.
The same analysis holds in the single family market. A batch of new large, luxurious houses tends to depress the prices of other houses. People in middle quality housing put their homes on the market so they can move up into the new houses.
Affordable housing has often been older housing. Brand new homes, even those aimed at the first-time homebuyers, tend to have modern electrical systems, plumbing, windows, and so forth. People of limited means have historically settled for what they could afford. Similarly, low-income families tend to buy used cars rather than new cars.
What would it take to get more used houses on the market? The current owners need to sell their houses. What inducement would they have to sell? Better housing available.
The same process would lower prices of luxury homes if more inexpensive housing units were built, in a somewhat more complicated way. Instead of imagining people moving down toward the over-supplied low end, we consider that any housing market is in continual churn. Young people are looking for their first apartments, then they look for better apartments or first houses. Older people die, move into retirement homes or downsize into small homes. When more low-end homes are built, prices at that end of the market drop. In order to fill the middle-quality homes, those prices have to fall. And with lower prices in the middle, upper end housing prices drop.
Housing prices seldom drop. We have to think of price increases or decrease relative to overall price changes. So when the analysis leads to home prices falling, substitute the clumsier phrase, “home prices rising by less than inflation.”
The more markets are segmented, the less fluid the process is. Racial segregation would mean that price changes in one neighborhood have less impact on other neighborhoods. Age restrictions on housing, such as senior living communities, also limit competition among different neighborhoods. But most real estate markets have a wide continuum of properties. People can move in small increments. Combine that with the normal churn and there is plenty of competition. So McMansions compete with middle-class houses, which compete with townhouses, duplexes and apartments. Increase construction of any type of housing tends to pull down prices (at least relative to inflation) of all housing.
