Community Dividend

Explaining the shortage of affordable housing

Community Dividend explores why affordable housing shortages persist in so many communities.

Stephanie Omersa | Community Affairs Analyst

Published October 1, 1998  | October 1998 issue

"Our community cannot grow without more affordable housing, but inexpensive housing is almost impossible to build."

"Why do builders continue to construct expensive houses and ignore the needs of so many working families?"

"Some people commute 80 miles round trip to their jobs because they cannot find housing in our community."

"What strategies can our community use to get more people into affordable and decent housing?"

Sound familiar? Chances are, if you are a community development practitioner in the Ninth Federal Reserve District, you have heard or uttered comments and questions just like these about your community.

According to community leaders from across the district, the affordable housing crunch is particularly severe in communities that are experiencing job growth without a comparable increase in the supply of housing. We wanted to know why affordable housing shortages persist in many communities.

The purpose of this article is to explore the difference between "market demand for housing" and "housing need" and to try to explain why housing needs are not being met. The article offers an explanation of the effects of increased purchasing power and decreased input costs on the price and quantity of housing units.

While we cannot tell you specifically how to address the affordable housing shortage in your community, we hope to provide you with a better understanding of your local housing market.

Large House

While there appears to be a significant need for more affordable housing in many communities in the Ninth District, builders continue to prefer larger, more expensive homes. We wanted to know why.

Market demand versus housing need

The first step in understanding affordable housing issues in your community is to understand the difference between market demand for housing and housing need.

Each individual or household in a community selects housing based on a variety of factors, such as style, size, lifestyle choices and location. Price also plays a critical role in housing selection. Each household has budget constraints, which determine how much the household can afford to pay. Based on both individual preferences and budget constraints, each household has a demand for housing.

In a given community, the market demand for housing is the sum of each individual household's demand for housing.

The concept of housing need is different.

It is based on community or societal standards rather than on the level of demand in a competitive market. Standards used to measure housing need may vary slightly, but they generally include minimum guidelines for physical adequacy and affordability.

For example, a household with housing need may be defined as one spending more than 30 percent of its income on housing or living in an overcrowded or physically substandard unit. Comparing the number of households that do not meet these standards to the number of affordable and physically adequate units available provides a measure of a community's housing need.

A simple example should help to clarify the difference between these two concepts.

A family in Billings wants to purchase a three-bedroom house on the outskirts of town for no more than $100,000. The family finds a house that has the amenities they want for $90,000. In this case, the family's demand for housing is met and they have no housing need.

A couple in Sioux Falls wants a two-bedroom apartment close to downtown for $500 per month. Unable to find anything less expensive, the couple settles on a unit with the amenities they want for $600 per month. In this case, the couple demands an apartment with certain amenities at a price that is not available in the market. By paying more for housing than they can afford, they are classified as having housing need.

What does it mean when you hear your community needs 50 more units of affordable housing? Chances are, it means you have 50 households like the Sioux Falls couple that demand housing at a price not available in the market. These households generally choose one of three options:

  • Share housing with other households (frequently resulting in overcrowding);
  • Find low-amenity (often physically substandard) housing to fit their budget constraints; or
  • Pay more for housing than they can afford. In each case, they are classified as having housing need.

Increasing purchasing power

It appears that an increasing number of households are demanding units at prices that are not available in the market. Why?

In many cases the answer is simple: budget constraints. While many potential buyers want to purchase new homes, their wages are often too low to afford even the lowest-cost housing. In other words, these households demand housing at a price that is not profitable for builders. Community development practitioners often refer to this as the "wage gap."

The wage gap can be addressed by increasing the purchasing power of individual households. Raising wages, providing monthly payment subsidies or implementing other strategies to increase the amount of individual household income available to pay housing costs will increase purchasing power.

Let's look at how to reduce the wage gap for the Sioux Falls couple. One spouse works full-time for $10 per hour while the other attends college full-time. If the working spouse found a better job paying $13 per hour, the couple could afford at least $600 in rent. The change in the couple's budget constraint increases their demand for housing to a level that is supplied in the market. In this case, the couple's demand for housing is met and they no longer have housing need.

To raise the level of purchasing power in a community, localities can create higher-wage jobs through business expansion or attraction. Assuming that consumers' preferences are to increase spending on housing, increasing purchasing power raises the market demand for housing.

Market supply of housing

The next piece in the affordable housing puzzle is to understand what determines the market supply of housing units.

Developers and builders construct housing that allows them to maximize profits, given the costs associated with building, such as zoning regulations, labor, materials, and so on. Based on the price of land and other inputs, builders have a minimum cost for which a new house (or apartment) can be constructed.

While many builders will construct homes in a range of prices, most have a base price for their lowest-cost starter homes. Builders don't offer homes below this price because it isn't profitable. If builders in your community construct expensive houses, it is either because they do not understand the market (and will soon be out of business) or there is market demand in the community for high-cost, high-amenity housing.

Builders will construct lower-cost housing with fewer amenities if there is market demand and the projects are profitable. Consequently, blaming builders for constructing "high-end" housing is not a useful way to approach an affordable housing shortage. Instead, a better idea is to find ways to reduce the cost of housing and make this market attractive for builders.

Increasing the lower-cost housing supply

One way to increase the quantity of lower-cost housing is to decrease the cost of inputs for home construction.

A variety of factors, including zoning regulations and costs of land and materials, affect the final cost of a new home. Like any other product, changing the costs of the inputs affects the price of the final product.

Strategies to reduce the cost of new home construction include:

  • Decreasing land, infrastructure costs;
  • Building smaller homes;
  • Reducing regulatory costs; and
  • Using alternative construction methods and materials.

In a competitive market, reducing the costs associated with new-home construction, while maintaining profitability for the builder, results in an increased quantity of less-expensive homes.

As an example, let's assume that the Billings family would be happy with a smaller lot than is required by zoning regulations.

The developer can decrease the cost per house by $10,000 by reducing lot sizes in the subdivision and building more houses. The family decides to invest the lot savings into a family room and still pays $90,000 for the home. A family friend, who could only afford to pay $80,000, can now afford a house in the subdivision, too.

The builder still makes a profit, but additional households can now enter the market.

Why do such shortages persist?

If increasing purchasing power and reducing construction costs will get more people into housing they can afford, why can't communities address their affordable housing shortages?

On the demand side, many strategies to increase purchasing power are unworkable or too expensive. Firms are unable to raise wages in a competitive market, and subsidies to homeowners require substantial, long-term resource commitments. On the supply side, communities may resist adopting regulatory changes that allow for alternative construction techniques and smaller lot sizes.

It's important to acknowledge that creating higher-wage jobs or reducing construction costs will still not allow all households to purchase housing that is both affordable and physically adequate.

Many workers cannot obtain higher-wage jobs, and strategies like reducing lot sizes can only result in a certain amount of cost savings. In some cases, public and private subsidies are needed to construct homes for households that demand housing at prices that are simply too low to be provided in a competitive market. While existing housing is sometimes more affordable, well-maintained and inexpensive houses are in short supply in many places.

If these towns continue to attract lower-wage jobs and workers, the supply of these houses will quickly be exhausted and housing need will continue to grow.