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More Apartment Regulations Equal Higher Rent Growth

More apartment regulations can result in higher rent growth, Axiometrics apartment data shows.

By Louis Rosenthal | Friday, November 4, 2016

With the 2016 presidential election fast approaching, and with the fate of all three federal branches up for grabs, let us not forget the old adage that "all politics is local."  This is particularly true for the rough-and-tumble world of local land-use policy disputes, including apartment regulations.

Sometimes referred to as NIMBY (not in my backyard), LULU (locally unwanted land uses), or BANANA (build absolutely nothing anywhere near anything), these disputes typically pit the interests of residential developers against existing homeowners, both of whom have very different visions of what a neighborhood and city should be and whom it should serve.

When we talk about land-use regulations we are referring specifically to zoning ordinances that prohibit certain types of development. These ordinances might, for example, limit the area measurements, density and height of new developments. Of course, those most interested in building tall, large and dense developments are invariably apartment developers hoping to capitalize on job-growth trends and unaffordable single-family housing in certain metros.

For a case study in how these disputes play out, look no further than the San Francisco Bay Area. In the face of increasing housing prices and excellent job growth, the demand for new housing has skyrocketed as more and more Americans hope to take part in, and contribute to, the unprecedented wealth creation occurring in and around San Francisco.

Yet, a curious drama is playing out in Palo Alto, CA, as the issue of housing affordability appears to have come to a head. Whereas most cities in the United States would celebrate strong job growth, Palo Alto residents and political leaders are actually hoping to limit job growth.

As Palo Alto Mayor Patrick Burt recently said in an interview with Curbed, “Palo Alto’s greatest problem right now is the Bay Area’s massive job growth.”

While this might seem peculiar coming from a mayor of a city, it makes sense when we consider that his overriding goal is not to grow the Palo Alto economy, but to “keep [Palo Alto] similar to what it’s been historically.”

One way to ensure that Palo Alto retains its historic charm is to limit the rate of housing growth. The goal is that no matter how many jobs are added in the Silicon Valley, people will have to look elsewhere for affordable housing — even if that means tolerating long commutes. In short, the regulatory power of the city is able to institutionalize development restrictions (i.e., land-use regulations) to ensure that housing growth remains low even as demand is high.

As a result of these burdensome apartment regulations, we would expect to see an impact on local real estate and rental housing markets. Specifically, if homeowners work with the city council to increase the regulatory burden on developers, this in turn should reduce the rate of housing growth. If housing growth declines in the face of unchanged (or even growing) demand for rental housing, then rents should rise as existing housing units are effectively rationed according to ability to pay. In sum, in the more intensely regulated housing markets in the U.S., we should see larger apartment rent growth, net other factors.

To investigate this relationship, we use an interesting measure of the local land-use regulatory burden, called the Wharton Residential Land-Use Regulatory Index (WRLURI). Introduced by Joseph Gyourko, a professor at the University of Pennsylvania, the index assigns scores to different towns, cities, and metropolitan areas according to how difficult it is to build in these areas. Higher values on the scale indicate metro areas with more regulations, where developers will find it more difficult to build and face more opposition.

In the chart above we’ve plotted the Wharton index values for the top metropolitan areas in the country along the x-axis. The higher the index value (i.e., the farther to the right on the X-axis), the stricter the developmental environment. Lower values on the scale indicate more developer-friendly markets, where procuring permits is easier and subject to fewer constraints.

Along the Y-axis, we used Axiometrics apartment data to calculate the long-term rent growth of each market. We use long-term rent growth in order to account for some of the other factors that might complicate the relationship between the two variables.

The story in the chart confirms our theory: rent growth increases as markets become stricter in terms of the residential regulatory environment. This suggests that metro areas that are more restrictive benefit existing owners of rental housing who are subject to less competition than they would be in other, less strict, metro areas.

Also note the regional dimension to the chart. The most heavily regulated markets are in the Northeast and West regions of the country, whereas the least regulated markets are in the Midwest and South. This suggests that the residents of charming, old New England towns and temperate West Coast locales are more interested in protecting the “quality of life” at the expense of new development and lower rents for newcomers.

When we think about the San Francisco Bay Area, and the Silicon Valley in particular, we tend to think of a thriving megalopolis creating all sorts of new technologies that promise to change our lives for the better. Critical to this vision, however, is the idea of inclusiveness: that the wealthiest and most productive areas of our country represent a beacon for those struggling in declining markets with few jobs and opportunities.

However, when residential construction is constrained in the service of retaining what a city once was, housing prices go up, and newcomers find it difficult — if not impossible — to chase new opportunities.

Americans were once known as a highly mobile people, willing to pick up everything and move to thriving areas of the country. In the mid-19th century, Horace Greeley famously said, “Go West, young man.” Today, he might have to add, “…if you can afford it.”

Louis Rosenthal

Louis Rosenthal

Real Estate Analyst

Louis Rosenthal researches and analyzes current apartment trends in the United States and correlates them with economic indicators. He also studies the urban landscape and other metrics to develop in-depth reports and presentations for clients. Louis recently earned his Master of Science in Public Policy, focusing on housing, landuse patterns, real-estate dynamics and economic development. He combines that knowledge with his four years of practical experience in tax analysis, regression analysis and presentations to develop insightful analysis. An accomplished writer, Louis’ work has appeared on Forbes.com and Axiometrics’ blogs, among others.

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