New Studies Explain Why Housing Is So Expensive And Why It Is So Hard To Make It Cheaper

Most Americans—more than 80% in a recent National Association of Home Builders poll—think housing affordability is a problem in their community. Yet despite the widespread agreement that housing is too expensive, it remains difficult for developers to build the housing needed to increase affordability. A few studies in the recent issue of the Journal of Economic Perspectives shed some light on what communities must do to reduce the price of housing and why doing what needs to be done is so hard.

The first study examines perhaps the most logical cause of high housing costs—high building costs. The authors, Brian Potter of the Institute for Progress and Chad Syverson of the Booth School of Business, note that building costs account for 60% to 70% of the full cost of bringing a new house to market. If building costs have increased over time, then it would not be surprising to see housing costs go up, too.

To track costs, they use housing cost data from RSMeans, a company that has been tracking cost data for the construction industry since the mid-20th century. They find that while building costs have exceeded overall inflation since the mid-1970s, these costs generally do a poor job of explaining housing prices. In a variety of cities over different time periods, growth in housing prices is substantially larger, and sometimes smaller, than growth in building costs. The table below shows the ten cities with the largest deviations in price from building costs over five-year intervals from 2010 to 2024. For example, over the 2020 to 2024 period, housing prices in Miami, FL grew 8.6% faster than building costs, while in Lake Charles, LA prices grew 2.8% slower than building costs.

The authors also find that the cost-price relationship has weakened over time. This suggests that something besides building costs is having a growing impact on housing prices. They note that one such factor could be regulations that prevent additional supply in high-demand areas.

Building on this first study, the next study by Boaz Abramson of Columbia Business School and Tim Landvoigt of the Wharton School estimates what happens when cities add more supply. They develop a model to evaluate the impacts of different housing policies on housing price-to-income and rent-to-income ratios. They examine a demand-side policy—direct housing subsidy—and two supply-side scenarios: One that increases supply at the top of the market and one that increases supply at the bottom of the market.

The results for the subsidy are not what most people would expect. Their model estimates that giving people $100,000 towards the purchase of a house raises prices and worsens affordability when supply is unable to respond to the additional demand the subsidy creates. They also find that the subsidy increases rents, too, since some wealthier people who are indifferent between renting and buying at the higher price enter the rental market and bid up rents. The result is that most people end up worse off. As they say, “The lesson is that only policies that raise supply (or decrease demand) will make housing more affordable.”

Adding supply to the bottom of the market generates better results than the $100,000 subsidy and makes lower-quality housing more affordable, but the best policy according to the model is adding supply to the top. Adding supply to the more expensive end of the market reduces rents and prices across the entire housing-quality distribution. This may seem counterintuitive, but it makes sense. When more expensive housing is added to the market, wealthier people no longer compete with middle- and lower-income people for lower-quality housing. This decrease in demand for housing in the middle and lower end of the market leads to lower prices. As the authors say, “In short, increasing the supply of housing in the top segment is more effective at reducing house-price-to-income ratios than adding supply in the bottom rental segment.”

These modeling results are consistent with other research that shows adding more market rate housing, even expensive housing, improves affordability by allowing the filtering process to work: When wealthier people move into a new house, it frees up their old house for someone with slightly less income, which in turn frees up that persons house, and so on. This process makes it easier for everyone to afford a home.

So, if building more housing makes housing more affordable, and there is plenty of evidence that it does, we should be building a lot more housing. But we are not. The third paper by law professor Chris Elmendorf and political science professors Clayton Nall and Stan Oklobdzija helps explain why.

This study examines survey data to better understand how people think about the housing market in their communities. One common explanation for why people tend to dislike new development, including new housing, is the homevoter hypothesis. The idea is that homeowners who are also voters tend to have a lot of their wealth tied up in their house, which makes them leery of any nearby development and its associated ills—noise, traffic, loss of views—that may erode the value of their homes. As a result, they stymie new development to protect their largest asset.

While this story makes some sense, the authors find little evidence for it in the survey data. For example, the homevoter hypothesis predicts that homeowners prefer higher housing prices since that increases the value of their asset while renters prefer lower prices since they do not get the benefit of asset appreciation. But in their survey, they find that 57% of homeowners would prefer prices to fall in the future, not increase. Unsurprisingly, 85% of renters would prefer prices to fall.

Instead of the homevoter hypothesis, the authors suggest that the real reason people oppose new development is they do not understand housing markets. Only 35% of respondents correctly predicted that a significant increase in the supply of housing would reduce housing prices, all else equal. Only 31% correctly predicted that an increase in supply would reduce rents. Even more interesting is that this misunderstanding of supply and demand dynamics was unique to housing. As shown in the figure below from the paper, 86% of respondents correctly predicted how supply chain problems in the auto industry would impact used-car prices, while 59% correctly reasoned that better fertilizer would increase crop yields and reduce grain prices. As the authors put it, “Supply skepticism…is distinctive to housing.”

This lack of understanding has a few implications. First, voters who want lower prices will be less willing to support policies that increase housing supply since it is not clear to them that more supply helps. Second, since they do not really understand the forces at work, they will be more likely to support non-supply ideas to lower housing prices, such as rent control or direct subsidies. Sure enough, the authors find that more than 80% of respondents support rent control and down-payment subsidies while less than 55% support supply-side policies like reducing parking minimums or allowing more infill development, despite evidence showing these latter policies help reduce housing prices.

A final implication from not understanding how housing markets work is placing blame on the wrong things. In the paper, the authors show that survey respondents were more likely to blame developers and landlords for high housing prices than state or local governments that restrict supply through regulations. This is wrong, but it helps explain why policies like rent control are popular: If voters believe developers and landlords, not supply and demand, control prices, it is not surprising they want government to take that power away through policies like rent control.

The big takeaway from these three studies is clear. Building costs are not the main cause of high housing prices in most places. Instead, rules and regulations that restrict the supply of housing, such as minimum lot sizes, parking requirements, and height limits, are what make housing so expensive. Unfortunately, many people who say they want cheaper housing do not really understand how supply and demand work in the housing market. Advocates for more housing must continue to teach policymakers and voters how housing markets work to overcome this barrier. Since most people understand how supply and demand operate in other markets, this may not be as hard as it seems. Either way, there is still a lot of work to do.