Politicians are increasingly discussing broad upzoning as a housing affordability solution. Instead of one home on a property, you can now build two homes on the same amount of land. All across the city, in some cases. The assumption is if there’s two homes on a property, it’ll be half the price. Makes sense, right? There’s a reason politicians let people come to their own conclusions, without explaining the impact. It’s because that’s not at all how it works, and the industry has long known this.
Real Estate Is Priced By Highest And Best Use
Real estate values are determined by the “highest and best use” the property has. The catchy phrase means the optimum use determines value. It doesn’t really matter what the current use is, if there’s a cost effective and better use. This isn’t a secret real estate investor tactic you learn at airport Marriott conventions either. It’s a basic rule for everyone in the real estate industry – from agents to appraisers.
Still not clear? Let’s do an example of two similar lots, in a fictitious world without zoning. The first lot has a house on it, and the second a commercial building. Similar houses in the neighborhood go for about $1,000,000, and similar commercial buildings for $2,000,000. In this neighborhood, say it costs $50,000 to demolish a house, and about $300,000 all in to build a commercial building.
Knowing this, instantly changes the value of the property with the house. The property with the house on it is now worth $1,650,000. That’s the value of the commercial property, minus tearing down the house, and building a commercial building. Even if you plan on buying it to use as a house, you need to pay the value for it’s best use, not current use. In this case, it’s conversion to a commercial building. Now, how does anyone ever get a house? That’s why zoning exists.
Limited Zoning Can Actually Preserve Affordability
To prevent over use of developing for booms and busts, regions use zoning. Zoning is when governments define the type of use a property can have. This prevents the “highest and best use” rule from dominating short-term trends. Instead of the highest and best use for all types of properties, it’s just the best use for the specific zoning type. For example, residential zoning would require a change in zoning to build anything other than housing.
In the above example, let’s say the house is restricted by zoning to its current use. If the house is unable to be converted to a commercial property, it can only be traded as a house. Not optimal for the person selling the house, who wants a maximum theoretical profit. However, it’s great for a homebuyer looking to buy a house and not knock it down. As you might have guessed, zoning can have a massive impact on the value of property.
Broad Upzoning Makes Existing Housing More Expensive
You might already be able to spot the issue with broad upzoning now, but let’s spell it out. Politicians lead people to believe buying half a property will be more affordable. Unfortunately, broad upzoning doesn’t actually build homes. It only increases the value of every lot’s potential to build homes. Where there was one house, you can now build two.
Existing homes are immediately worth the value of the maximum zoning, less the cost of knocking it down and building two. Every property now requires a real estate developer to get the full value of use. Since real estate developers don’t do it for free, you also need to inject profit into the cost as well. In short, politicians increased the cost of housing, without actually building more housing, all in the name of affordability.
Broad Upzoning Also Fails To Create New Housing
Well, that sucks – but at least housing is built, right? Two unaffordable houses are better than one? Not exactly. An MIT study that hoped to prove upzoning led to more supply and falling rents, accidentally proved the opposite. Instead, the researcher found rents and prices both increased. Further, it didn’t actually create any additional housing. The author concluded, “short-term, local-level impacts of upzoning are higher property prices but no additional new housing construction.”
Sure, more housing needs to be created – that’s a given. However, broad upzoning of whole areas, possibly cities, doesn’t make sense if the goal is improved affordability. In this regard, planned and controlled upzoning makes a lot more sense. It’s also worth noting when these discussions appear – right after strong price growth, as prices pull back. It’s almost never at the bottom of the market, when price growth would be minimally impacted.
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