Canada

Broad Upzoning Makes Housing Less Affordable, And Doesn’t Add Supply

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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15 Comments

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  • Mortgage Guy 9 months ago

    Can confirm. Basic appraisal principle. The only real way to make housing more affordable is to increase the value of dollars, and stop giving people more and more to borrow to buy something.

    That’s not a popular take though, because it generates smaller loans, and commissions are paid on upfront costs, not long term. It also makes it harder to get persistent inflation.

  • SH 9 months ago

    The issue is not, and never was, about supply, but rather demand. Zoning changes can do nothing on that score.

    With the Liberals wanting to bring in more than 1.2 million foreign nationals over the next 3 years (announced today), no amount of supply will be able to house this tsunami at reasonable prices.

    Speculators win big as long as the Trudeau Liberals are in power.

  • Rick Hyne 9 months ago

    If politicians want to make housing more affordable then they have to create less demand and limit foreign investment ownership.

    To create less demand, the feds, provinces and municipalities need to generate high density market housing through apartments. Not everyone needs to own their own house, but a having a home to raise a family with all the amenities can be made possible through proper public development.

    Removing the demand will lower prices and availability.

    Splitting properties and adding housing may not be suited in some neighborhoods as more public services will be needed to serve the increase.

    • SH 9 months ago

      With the Liberals announcing today that over 1.2 million immigrants will be accepted over the next 3 years, there will no decline in demand.

  • Eric Swanson 9 months ago

    Good cautionary article.

    Though here’s an article where the author of the cited “MIT study” reciprocally cautions against misinterpretations/over-generalizations: https://thefrisc.com/housing-arguments-over-sb-50-distort-my-upzoning-study-heres-how-to-get-zoning-changes-right-40daf85b74dc

    For example, it appears the Chicago upzoning provisions only applied to ~6% of the city, and only to existing mixed-use business, commercial and downtown areas (i.e. this was not broad citywide upzoning).

    It’s also interesting to note that planned upzoning in smaller areas (vs. broad upzonings) may risk greater speculative land value increases and greater windfalls for certain landowners than broad upzoning because you then get to speculate on the location and details of those planned and custom upzonings; a phenomenon familiar to Vancouver around major corridors and planned Skytrain stations. This leads some to argue that the higher the percentage of land covered by the upzoning (and the associated uplift), the lower the additional speculative pressure on land values.

    In any case, this all makes me think that a good combo might be pairing broad upzoning (to the extent you want to go that route) with some of the renter and displacement protections utilized elsewhere and also figure out how to better capture/tax the uplift created (putting downward pressure on it at the same time).

    And ditto the comment by Mortgage Guy (echoing other BD articles) re: the driving influence of access to fire-hoses of cheap credit. Yep.

    • Jason Chau 9 months ago

      You’re looking at the single paragraph, without actually taking into context the next one – which implies the timing is key.

      Zoning is a key element of appraisal, yes – increasing it will 100% always increase the value of homes without a change to the house. This isn’t up for dispute, it’s a principle of appraisal.

      It doesn’t create housing either, only the potential to create housing. If you look at Vancouver, the upzoning mandate shot detached prices up while multi-family units were falling. Even the new developments built through duplex zoning are more expensive than a detached home, divided into two.

  • Lj 9 months ago

    Government Municipalities Feds need to penalize builders who sit in land For years allotted to makes houses. They land bank amd release controlled supply Of houses/lots creating artificial demand and FOMO. E.g City should give them 2 yrs to makes homes in a subdivision else use it or loose it rule should apply. builders Release 20/40 lots at a time while there are 1000 lots available for sale and there are 100/200 people inquiring and ready to buy. If they release only 40 lots at a release what will 200 people do? FOMO in. Then builders says sold out PH1 in 2 days. Few weeks or months later Ph2 with another 30-40 lots is announced with 20-40k more per house. This scam by builders should be punishable.

  • Sam Wong 9 months ago

    The quoted study’s author clarifies, “The study absolutely does not find that increasing an area’s housing-unit count reduces affordability . . . Upzoning, from that perspective, is undoubtedly a key tool in the arsenal of planners.” See: https://urbanaffairsreview.com/2019/03/29/upzoning-chicago-impacts-of-a-zoning-reform-on-property-values-and-housing-construction/

    • Jason Chau 9 months ago

      Increasing an area’s housing unit count isn’t what’s being discussed. The article discusses broad upzoning increases existing housing’s cost, without creating new housing.

      That doesn’t clarify the issue. It addresses a totally different point.

      • LS 9 months ago

        It is what is being discussed. Chicago is a low growth area so not much housing is being created. Function of the market, not a failure of upzoning.

        What the author is clarifying is that upzoning needs to be combined with protections for renters and some targetted affordable construction to preserve affordability. The point is upzoning should still be done, it just can’t be the only thing that’s done. Very different from the BD conclusion that upzoning is harmful to affordability.

  • Jason Azevedo 9 months ago

    The government and banks are doing everything they can to create Death pledge’s and slavery. Where are the days when you could work at a grocery store and buy a house? The way of life in Canada is being destroyed by the new generation that controls things that are more greedy and out of touch and are also more spiritually poor partly from society as a whole and partly from being spoiled. Humans are insatiable and when we are spiritually poor their insatiable nature becomes irrational as a human being.

  • VG 9 months ago

    Rick – It’s not as if foreign investors are living in these condos. They rent them out. There are some cases where units stay empty, but that’s a small number. Most of these investors couldn’t give a hoot if they rent out a 1 bedroom say for $2000, $2500 or $1750. They take what the market gives them as long as someone’s in the unit. These investors help with the supply side of the equation. A rented out unit still accounts for living quarters for one household regardless of whether it is owned by investors or not. An investors aren’t stupid, eventually they will adjust how much they are willing to pay for units based on lower rents and higher TMI. Eventually lower rents will feed into lower valuations of condos.

    Now when it comes to detached housing, it’s a slightly different story, but even in the absence of foreign investors, there would be enough well-heeled Canadians to keep the prices of detached homes elevated.

    • Rick Hyne 9 months ago

      Foreign investors are contributing to the demand side by having the ability to purchase properties at inflated market rates. If there were no foreign investors, the ability for many to purchase homes would drop causing the demand side to drop until it meets with ability.

  • LS 9 months ago

    This is nonsense for so many reasons:

    1. Single family detached dwellings are unaffordable to anyone except the top 10-30% of families in most cities. Preserving most of the land for them is incredibly unequitable and will ensure that the vast majority of residents are priced out of most of the land forever.
    2. Mass rezoning doesn’t automatically increase the market value of every property to the highest use, because actual developers are still a minority of the market. Yes developers will pay a higher price because it is more valuable to them, but that happens gradually, not all at once.
    3. Developers buying up properties and building new supply is what we WANT. More supply means more people can live there, and helps prices. And no, the new duplex/triplex will not be cheap, but it provides supply for people to live, and reduces pressure on more affordable supply by reducing competition for it.
    4. You are trying to generalize one study from Chicago (with limited upzoning, not broad) to the general case. That cannot be done. In fact here is what the author says:
    “The study absolutely does not find that increasing an area’s housing-unit count reduces affordability. The logics of supply and demand are still at play in American cities, and increasing the number of housing units is key to meeting demand. Policies that exclude certain types of people from certain neighborhoods, like zoning codes that prevent apartments from being built in communities filled with single-family homes, simply reinforce segregation and inequality. Upzoning, from that perspective, is undoubtedly a key tool in the arsenal of planners.”

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