When Increasing Housing Supply Won't Lower Rent

Housing will be built where it is most profitable to do so, not where "demand" (in terms of number of households) is strongest.
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Housing will be built where it is most profitable to do so, not where "demand" (in terms of number of households) is strongest.
Downtown St. Paul, Minnesota. (Photo: photo.ua/Shutterstock)

Downtown St. Paul, Minnesota. (Photo: photo.ua/Shutterstock)

In the debate about solving the housing affordability problem, the usual supply-demand model is too simple. Simple sells. If demand goes up, so must supply. Otherwise, housing becomes more expensive. Thus, the tail wags the dog. Of course we should ease restrictions on building more housing. Economics 101. What about Geography 101? Rural vs. urban:

Median pay in northwest Minnesota, at $15.73 per hour, 26 percent less than the $19.92 median in the Twin Cities. But the city-rural gap in rents people pay is far larger. Average rent in the Twin Cities is $1,090 for a 2-bedroom unit, compared to roughly $600 per month in Roseau or Thief River Falls, an 81 percent gap.

For some reason, Roseau renters historically pay a lower percentage of their income toward housing than renters in the Twin Cities, and low rents have been stubborn.

Owners are reluctant to raise rents, so the value of new construction is driven downward, said Paul Vitrano, vice president of global government relations for Polaris Industries.

“Ultimately, rents will need to increase or new construction will continue to be constrained,” Vitrano said.

Paul Vitrano represents one opinion about the new housing conundrum in rural areas. What the market will bear doesn't come close to covering the cost of construction. Which explains the strange comment, "rents will need to increase or new construction will continue to be constrained." The rent is too damn low to alleviate the housing crunch.

On the other hand, in the same article, some people do blame wages. Unlike the city, there isn't enough "demand" to justify the investment in real estate development. In this case, demand is defined as the number of people at a certain income level. The wages are too damn low to alleviate the housing crunch.

Whatever the reason, real estate markets don't play out the same way in rural areas as they do in urban areas. Perhaps we need a better model of the market. I'm not convinced that the above is just a rural phenomenon, particularly when no one can agree upon why small towns can't support new housing. Color Kevin Edberg (Cooperative Development Services in St. Paul, Minnesota) similarly skeptical:

“(I noticed) the juxtaposition of the Roseau housing story ("local firms can't grow because the region doesn't have housing") and other recent stories about "local/regional businesses can't find skilled workers". The storyline in both cases is that demand (for labor or for housing) is going unmet; an implication in both is that the public should pay more to subsidize skills development or housing stock. What's not being discussed with clarity is "at what cost?". Demand being a whole series of relationships between price paid and volume supplied, it would seem reasonable to ask if businesses are willing to pay high enough wages to entice people to work for them. There are a number of economists that suggest that the skills gap goes away if wages increase, and that the whole business argument about the skills gap is a rent-seeking attempt by business to move the cost of worker training from a traditionally private expense to a public expense. Is the same true of housing? Do the jobs (that are going unfilled in NW MN) pay enough to allow a prudent worker to rent/buy a home in the region?

I don't have a particular ax to grind, and I am not particularly prone to conspiracy theories. The fact that wages have been so sticky for so long causes me to wonder about why we are not seeing wage increases in the face of unmet demand.

In Economics 101 parlance, I expect a labor market to function like a real estate market. With labor supply constrained, wages rise. Higher wages attract more labor and bring the market into equilibrium. In Geography 101 parlance, where is the market? I expect labor supply to be constrained by distance and borders. Lower labor costs elsewhere may entice employers to move instead of raising wages to attract new hires. For many tradable jobs (e.g. manufacturing), the geography of the labor demand is global (or national). Whereas the geography for labor supply is local (or regional). There's the "skills gap" (in geographic terms). Also, there's the conundrum explained.

Housing will be built where it is most profitable to do so, not where "demand" (in terms of number of households) is strongest. Real estate is most profitable in places where demand (in terms of wages) has the least geographic constraints. Manufacturing and other such tradable jobs usually found in rural areas are tied to the global demand for labor. That puts a cap on the cost of housing locals can afford. That's true in the city, too. But unlike small towns, cities also sport significant populations of tradable jobs that are not tied to the local supply of labor (e.g. nuclear engineer). There's the "rent gap." Why sell square footage to a waitress when you could sell the unit to a software developer?

The small town housing crunch is really a jobs problem. The big city housing crunch is really a jobs problem. If global labor were bidding on real estate, then rent could go high enough to encourage new construction. For local labor, market forces are no help whatsoever.