Are luxury condos downtown good for Austin's housing market?

Hundreds of fancy, high-priced condominiums and apartments are being built downtown.  Will these hurt or help home affordability in Austin?  Many in Austin believe they will hurt.  At least one Austinite, anyway, believes that, if I've read Scott's posts at Political Suicide right.  (See his posts 1, 2 and 3.)

There are two issues to keep straight here.

1. Will these condominiums cause home prices elsewhere in Austin to decline below today's prices?
2. Will prices in the rest of Austin be lower with these new condominiums than without them?

Scott says the answer to #1 is "No."  I think he's almost certainly right about that.  Austin's population is burgeoning and its economy hopping; demand for housing will likely continue to increase briskly.  Supply is badly lagging demand, as demonstrated by skyrocketing prices.  IMHO, a couple thousand new units downtown are not enough to cause prices elsewhere to decline.

But Scott appears to think the answer to #2 is also "No," or at least that the new units won't make any difference.  There he's wrong.  Building expensive condos and lofts downtown will help hold down price increases elsewhere.

If we let the affluent buy the luxury housing they want, they will not bid up the price of modest housing.  That's what we're seeing throughout central Austin now.  The wealthy are displacing the merely well off, who are displacing the middle income, who in turn are bidding up the price of properties (in East Austin, for example) that ought to be cheap.

Unless you assume that every downtown unit will be used as a second home or will be bought by someone drawn to Austin solely by the new lofts, adding lofts downtown will free up housing elsewhere in the city.  That is, if 1,000 Austin households move downtown, they will free up 1,000 homes elsewhere in the city.  Maybe some of these homes will be more expensive than the new downtown digs; some will be cheaper.  All of them will be available for others to buy or rent.  These buyers, in turn, will free up other housing, and so on in a chain reaction that will filter through the market.

Filtering

Scott mocks this as "trickle down" economics.[2]  Economists call it "filtering" and it is a proven phenomenon.  There are still many debates about it, such as how it affects specific neighborhoods.  But many, if not most, economists agree that filtering accounts for most of our low-cost housing.

One economist (at p. 9) describes the process this way:

When households with relatively higher incomes demand better units, they often acquire a new unit with its enhanced features at a lower cost rather than trying to retrofit their smaller, older unit.  The construction of new units increases supply and leaves the older, less-desirable housing to those with less income.  Prices on older units face downward pressure.  The same process take place for the houses vacated by the middle-income households.  Economists call the process by which existing units drop in value "filtering."

Other economists (at p. 15) have noted that filtering actually requires a supply of new high-quality housing:

The process of filtering is especially important for low-income rental housing, because new construction at higher quality levels tends to be more profitable than new construction of low-quality housing, for reasons linked to depreciation and durability.  Through the process of filtering, the supply of bottom-quality housing is dependent on new housing construction at all levels, not just newly built "affordable housing."  Malpezzi and Green demonstrate that metropolitan area growth in the quantity of low-quality housing units is quite sensitive to the quantity of new, higher-quality housing supplied.  In their words, this pattern indicates that "to the extent that a city makes it easy [emphasis added] for any type of housing to be built, it will also enhance the available stock of low-cost housing."

Economists Somerville and Myers (at p. 53) have done a study in which they concluded that regulatory barriers to new construction discourage the filtering down of housing stock.  Such barriers instead encourage housing to "filter up" -- i.e., to gentrify.

I'm not cherry-picking here; there are oodles of studies like these.

Now I don't have a study relating to Austin specifically.  Nor do I have a study predicting the impact of the expensive high rises being built downtown.  But there's no reason to believe that the principles of economics cease to apply when you cross Austin's city limits.  Building more homes -- even super-expensive ones downtown -- will mitigate price increases throughout the city.  Housing will be cheaper elsewhere in Austin if these condos are built than it would be if they weren't.  The chain reaction of vacancies spurred by this new construction will, perhaps, result in fewer properties in East Austin being gentrified or "filtered up."  Or perhaps the price increases south of Ben White will slow.  The precise effects are impossible to predict.  But it is possible to predict that there will be some effect, and a good one (at least for homebuyers), for Austin's home prices.

Let me emphasize again, though, that I don't believe that these condominiums will cause a decline in home prices from today's levels, or that the number of affordable homes will increase from today's level.  Demand for housing in Austin will continue to increase at a brisk pace.  This increased demand will almost certainly outpace the additional supply coming downtown (and elsewhere).  Prices are going to continue to go up.  But with new housing downtown, they won't go up as much.

The garage

Scott draws an analogy that I think illustrates my point.  Assume that an employer has 300 employees -- 50 managers and 250 regular employees -- and a garage with 200 spaces.  Each of the 50 managers has a free reserved spot (i.e., luxury housing).  The 250 regulars have to compete for 150 free spots (the affordable units).[3]  Further assume that each quarter, the work force increases by 4 regulars and 1 manager.  Each new manager automatically receives a reserved space.

As a new manager is added each quarter, there will be one less spot for the regular employees.  With a decreasing supply of unreserved lots, an increasing number of regular employees will be crowded out and forced to use a less desirable alternative.

This is a pretty good analogy for a housing market with stagnant supply and increasing demand:  cheaper units will be converted to more expensive units -- they will "filter up" -- as the affluent outbid the less affluent.

Now suppose that the employer adds three new spots next to the garage for executive officers.  (Super-luxury condos.)  This frees up three new spots in the garage but, as Scott observes, after three quarters of growth, these three new spots will be taken by new managers.  The regulars won't be any better off.

This is where he's wrong.  The regulars are better off: they have three more spaces than they otherwise would have.  Without the three new spots, they'd be competing for 147 spots; now they're competing for 150.  Put differently, three more regular employees get to park in the garage than otherwise would be the case.  That they're not better off than before the executive parking was built is a consequence of increasing demand, not the employer's failure to build more "regular spots."

Similarly, increasing the supply in the luxury segment of the market will eventually benefit the other segments.  Unless we want the wealthy to continue bidding up the price of modest homes in Austin, we'll let them get the housing they want.

[1] See 1 (asserting that the planned residential development and "super-condos" being built downtown "will only further inflate [Austin's] cost of living indices," and accusing the City Council of "raising the cost of living" by seeking "to transform the prime green spaces and park lands of Austin into multi-story, multi-million dollars condominiums[.]"  I say "appears" because in his posts he conflates #1 and #2: sometimes he argues that the new units won't lower prices from today's levels, and sometimes he argues that the new units will make things worse.

[2] See 2 and 3.  It is a "trickle down" theory, I suppose, but it has nothing to do with Reagonomics.  That term usually refers to the theory that large tax cuts for the rich enable them to invest more capital in the markets, thereby spurring increased production and wealth that trickle down to the lower income.  It is a macroeconomic theory about tax policy.  Our issue is whether increasing supply in a single market in a single city will affect prices.  It's microeconomics, and pretty straightforward microeconomics.  (For this reason, it makes even less sense for him to deride this as "supply side" economics.  He implies that the study of market prices should be limited to the demand side, which is nonsense.)

[3] To be complete, we should describe the regular employees' alternative to the employer's garage.  It might be another garage farther from the office and therefore less convenient.  Because there are more employees than spots, the first 150 get to park in the employer's garage, and the rest have to make do with the less convenient parking.  Employees will have to get to work earlier than necessary to get the good parking; that is the "price" they pay for the unreserved spots.

Comments

[M1EK]

Well put; I obviously agree; but I doubt this will make much of a difference to the folks who can maintain the type of cognitive dissonance about economics exhibited by old-school liberals.

[Matt]

Austin Bloggers censors their content, please be wary of their practices. They censored my post on September 11th for political motivations.

[Bruce]

I think you've done an excellent job explaining this. Sadly, I also think it will make little difference. You are presenting a very reasoned argument, but the people you are trying to convince aren't truly disputing the laws of economics. They are really just against the idea of luxury condos and "those rich people" who are coming to turn our city into Dallas.

[Scott]

I posted a reply on my blog as it was too long to include in a comment. And I just *love* how people already know what's going to happen before a response has been made. That along with a few keywords tells me a lot about ya'll...

[M1EK]

Scott,

I, for one, could have predicted exactly what you would write. Somehow blaming greed for gentrification's ills while simultaneously ignoring the fact that landlord greed means they're not going to let high-end properties sit vacant if there are tenants to be had, even at a lower rent (changing segments).

This is how the housing market works. Properties do, indeed, shift from segment to segment. Supply and demand does, indeed, work. Yesterday's luxury properties are today's mid-range properties and so on.

[AC]

Scott, I don't have much to add, except to dispute your statement that the luxury condos downtown are displacing poor people. They're being built on abandoned warehouse sites, or are replacing commercial uses.

Rainey Street is the only place downtown I'm aware of that condos are replacing other housing. But the majority of the residents there wanted to sell for the highest price; they pushed to permit redevelopment. They would have been quite bitter if the City had stymied redevelopment there for their sake.

[M1EK]

AC,

I think his argument was more along the lines of gentrification (forcing out via higher property values), which is an argument that is so obtuse it makes my teeth hurt. The choice isn't gentrification or "as-is"; it's almost always between gentrification or blight, since those property values are going up due to proximity whether or not the new development happens.

[Scott]

I was warned! Warned, I tell you! They told me it was futile and like a dumb schmuck, I just didn't listen. Guess I learned my lesson, huh?.

Make you a deal; you see things your way and I'll see them mine. It doesn't surprise me that we see gentrification differently. You can see it through your development lawyer friend's eyes and I'll see it through the eyes of those people sitting in the Rosewood/Zaragosa free clinic or the thousands of people from New Orleans that lost everything in Katrina last year that had to stay at the Convention Center and Red Cross (btw, interesting that you changed your disclaimer on your about page. From a lawyer's perspective, how big of a difference is there between the words "many" and "some?" I mean were there "many" injuries from defective tires or just "some?")

So, I guess on this issue, we are each screaming at a brick wall because our perspectives are polar opposites. I suppose there's some consolation that we do have some common ground which bodes well for any future topics.

Also, I'd like to let you know that I'm formalizing a comment and posting policy on the site in direct response to your concerns. I may not agree with some of your views but my site is not about censorship or even the perception of it (I closed down the user registration until I can get the policy posted). Thanks for your input on that.

[Scott]

AC,

I want to apologize for that last remark. It was cold and uncalled for and I don't mean to turn this thing personal. It's just very frustrating on this side as it seems that nothing I can write seems to suffice.

If you look at my writing, I try not to make it personal and even though I feel that at times, some things have been said that I have taken personally (I mean, I think just about anyone would take offense to comments like "an argument that is so obtuse it makes my teeth hurt.") The numerous comments like that over the course of these posts got to me and it resulted in my little dig above. I'm not comfortable letting it sit out there and I apologize to you and will do my best to not let that happen again.

Thanks.

[jake]

I don't agree that folks in the downtown area are being hurt by the development. First, the owners will have the choice to sell at greatly increased prices increasing their wealth. The ones that stick around will have better neighborhoods, schools, and infrastructures to enjoy. And, most of the downtown development is new housing. For example, I just bought a condo on East 6th street that replaces an empty lot. My commute will be much shorter and I will have the ability to take public transit to work.