October 20, 2017

Is Geography Destiny?

Zoning and other local land use regulations have increased over the last three decades, particularly in high–growth cities and metropolitan areas. In our most recent Insight, we examine the relationship between government regulations, geography, housing supply, house prices and rents.

A 2016 study by Paul Emrath of the National Association of Home Builders found that government regulations account for 24.3% of the final price of a new single-family home built for sale. These regulations limit increases in the supply of housing and thus boost house prices and rents. Economists use the concept of supply elasticity to characterize these situations.

When builders can easily add housing units in response to growth in demand, housing supply is elastic–it can stretch like an elastic band to meet the demand. When builders can't provide many new units despite the lure of higher prices, housing supply is inelastic.

What difference does supply elasticity make?

  • House prices are almost twice as volatile in inelastic cities as in the elastic group.  Increases in demand cannot produce much more housing, thus prices must adjust by a larger amount. 
  • House prices in the inelastic group are 2.4 times higher than in the elastic group, and the house price to income ratio is twice as high.  Additionally, the homeownership rate in the inelastic group, which includes cities like San Francisco, New York, and Chicago, is only 56 percent compared to 64 percent in both moderately elastic and elastic areas.

Which matters more, regulation or geography?

  • While both regulatory and geographic constraints combine to determine elasticity, inelastic cities can be identified solely by the level of geographic constraints. 
  • Geographic constraints encourage cities to implement stricter land use regulations.

The bottom line:  Both the impact and the likelihood of lasting regulatory reform appear to be limited by geographic constraints in cities with inelastic housing supply. Simply put, where you live makes a difference. For San Francisco, New York and similar cities, geography may be destiny. However, even with some of the challenges homebuyers face in today's housing market, current low mortgage rates offer monthly mortgage payments that are more affordable than at almost any time in history.

If you think you might be ready to buy a home, learn the steps for getting ready at My Home by Freddie Mac®. It offers information and resources to get you on the right path to homeownership.