I'm not making this filtering stuff up.

Here's how two economists describe the filtering process:    

The filtering model describes the housing market as a series of submarkets differentiated by unit quality. Rents fall as quality declines, so units that are lower on the quality ladder have lower rents than units of the same size in the same location at the top. Without expenditures on maintenance, renovation, and repairs, units decline in quality as they depreciate physically and technologically. As this occurs, the units move down the quality ladder. The cost to maintain a given level of quality is assumed to increase with unit age. Extra expenditures on maintenance and renovation can move units back up the ladder. Relative rents in the different submarkets vary with the distribution of income across households (demand) and the supply of units in that submarket. When quality is least expensive to provide at the time units are built, new units will be of high quality. The supply of the most affordable, lowest quality units will be those units built in earlier periods that have been allowed to depreciate and move down-to filter down-the quality ladder. Landlords will choose a level of maintenance to maximize profits, and that choice determines into which housing submarket their unit will fall. When incomes, population, and the housing stock raise rents in the submarket for higher quality units relative to those in the submarket for lower quality units, landlords in the latter submarket have a greater incentive to increase maintenance, renovation, and repair expenditures to cause units to filter up, that is, to move to the higher quality submarket. Reducing the supply of low-end affordable units can potentially exacerbate affordability problems for the least well-off.

That's from Somerville and Mayer, Government Regulation and Changes in the Affordable Housing Stock (pdf).  Filtering is a tested, empirically-validated model.  It is how housing markets work.

Comments

[M1EK]

I like how you went with an "I'm not making this up" before the inevitable paleoliberal cries that you were making it up - kind of like that weird Scott guy who made such a fit when I said the housing market trickled down.

I will say that the originally intended price point does make a difference - you can build new construction at several different slots; and you can build units that will drop down quicker than others. The nice old stuff at deSaligny (I think Barnstone built it in the 1980s) held up better than the stuff from the next segment down in the 1990s, for instance. The units can depreciate, but they do have fundamental characteristics which are immune to depreciation like size of rooms, complex amenities, etc.

[AC]

I'm not sure my citing economists will help much with that crowd -- they think economists are just making it up too.

As always, I think the analysis applies to the units at the margin. The lowest-quality, highest-maintenance units in the expensive sub-market will tend to filter down first, while the relatively high-quality units in the affordable sub-market will be the first to filter up. That's a nuance that will be lost on most of my target audience, I'm sure. But that's why the cries that "Hey, the Austonian units will never filter down" are irrelevant. Of course not. You have to look at the units on the cusp.

[bittergradstudent]

One question: if a housing price shock is severe enough, might it just create enough of an economic incentive that all of the housing of a certain class gets upgraded in a certian amount of time--i.e., while the price of low-value housing might be deflated via filtering, it is no longer reasonable for there to be low-value housing in that neighborhood anymore, and the people wanting to rent a moderately maintained 600 sq ft 1 BR are just going to have to look elsewhere?

Isn't the above effect the engine behind gentrification? And I should add that I think this is largely what's happening in austin, exacerbated by Austin's zoning laws. Developer X wants to rent a semi-upscale complex. It is impossible to get zoning rights for a new complex in a desirable non-downtown neighborhood. So, rather than building a new development, the developer buys a cheap, somewhat run-down complex (which already has the correct zoning), and then either tears it down or renovates it. The people previously living there are priced out, and move farther from the city center.

[bittergradstudent]

As in, isn't it possible that the pricing environment experiences a shock that the price/demand structure within a certain submarket becomes completely prohibiitive, espescially in a market like Austin's where the laws make supply pretty inflexible, and the rate at which people are moving in is creating a massive demand shock?

It seems, at least from my half-assed thought experiment level analysis, like the above process is best at describing slow disturbances to a housing market, rather than rapid shocks

[AC]

All good points.

My thoughts:

Yes, I think a sudden increase in demand could inflate prices across the board without owners having to upgrade their properties. The apt analogy here might be the hotel market in a city hosting a giant event like the Superbowl. Every piece of crap will rent with a big mark-up.

When you say filtering describes "slow disturbences" to a housing market, I think that's right, except I would put it this way: The filtering model assumes that the supply of housing quality is somewhat elastic, which means the landlords have time to respond to rising or falling rents. Landlords can respond to rising prices pretty quickly, so "slow" here would just mean a few weeks or months. Increases in demand usually don't happen suddenly. I think filtering explains even tight markets.

When rents are rising rapidly, I would expect very few properties to "filter down." Fewer might filter up, though.

I absolutely agree that the best way to speed up the destruction of affordable apartments is to make it hard to develop anywhere else.

[Apartment complex]

Among adjustments for other characteristics which affect market prices, it is necessary to pay particular attention to those which are not automatically compensated for by the method used. These are location, time, remaining economic life, and utilities and services included in the rent.

http://www.apartmentcomplexesforsalesold.com