Red-Hot Housing Market Shouldn't Change Planning Principles

William Fulton on
May 1, 2004

Many years ago, overwhelmed by the sheer size of the numbers involved in modern society, humor columnist Russell Baker suggested that we should replace all numbers greater than 10,000 with the word "lotsa." As in, McDonald’s has sold lotsa hamburgers. Social Security entitlements involve lotsa money. A war requires lotsa missiles.

We are approaching this point with California home prices. Every month – every week – brings another round of home-price headlines so ridiculous that they seem like something out of The Onion, the satirical newspaper. These days, a house in California costs lotsa money. Inevitably, the planning system gets blamed for the mess, and if the economy goes south, you can bet that the building industry will lobby for land-use reform in Sacramento based on the argument that planners have left us with unaffordable houses.

But are high home prices really due to planners and their crazy processes? The answer is yes and no – or, perhaps more accurately, no and yes. The recent run-up in prices has occurred not only in the context of California’s typically kooky and complicated planning system, but also in the context of a very peculiar housing market. Let’s take a look.

We’ll start with supply and demand. Conventional wisdom suggests that prices are going up because demand is outstripping supply. There is clearly some truth to that argument. But if you look at the supply and demand patterns of the last 15 years – since the last big price run-up – it is clear that more is going on. All through the 1990s, housing experts told us that we were under-producing – building only about half as many houses as the market needed. At the same time, home prices in most of the state were flat all through the ’90s.

Now we’re in the opposite situation. Housing production is higher than it has been at any time since the late ’80s. Production is approaching 200,000 units a year, the level housing experts say is needed to meet demand. And there is more variety in new housing, including attached and multi-family units. Yet home prices in California have doubled during the last four years – from a median of around $200,000 to a median of around $400,000 – and show no sign of slowing down.

So, what gives on supply and demand?

Several things. First, we fell so far behind during the ’90s that supply is still scarce even though production has increased. Second, the current market escalation comes after a decade of flat prices. Sure, prices are double the $200,000 median of four years ago. But median was also $200,000 in 1990, before the recession and real estate bust. If you average the doubling of prices over 14 years instead of 4, that is a 5% annual increase – high but not exorbitant. Finally, the current run-up is due in part to boom time desperation. We must buy now at any price so that we don’t have to pay more later!

Then there is home mortgage financing. The way our home finance system is set up, the actual selling price is only one factor. What matters most is the down payment and the monthly payment, the PITI (principle, interest, taxes, and insurance). The days of a 20% down payment are practically over, thanks to mortgage insurance, government programs and various financing strategies that allow people to buy with as little as 3% to 5% down. A small down payment boosts the monthly payment, but the combination of low interest rates, thanks to the Fed, and low property taxes, thanks to Proposition 13, means that the IT portions of the monthly PITI are constrained.

Because most buyers qualify for a mortgage based on their ability to cover the whole PITI, it stands to reason that the lower the interest and tax payments are, the higher the principle payment can be. Taking out a 5% loan as opposed to an 8% loan saves several hundred dollars a month. Paying 1% of sale price for property taxes rather than 2% or 3% saves another several hundred. Put the two together and you might have $600 to $800 a month more to throw at the actual purchase price – which, at these interest rates, is enough to leverage another $120,000 to $150,000. If interest rates were higher and Proposition 13 did not exist, California’s $400,000 house would cost $275,000. It would have to because the combined monthly payment would be the same.

On top of everything else, steel prices have been going through the roof – not a problem on single-family houses, but increasingly a problem for the multi-story, multi-family projects being constructed under the "smart growth" rubric in urban areas. Steel prices have increased 30% since December and doubled on the spot market.

The psychology of demand, the cost of financing and taxes, and the cost of materials are all factors in the quick run-up in home prices. So what about those pesky planning processes that builders always blame?

There is no question that planning policies play a role in framing the underlying price structure for California houses. Some communities restrict the number of houses that can be built; planning processes can be long and unpredictable, especially when the California Environmental Quality Act comes into play; and communities have increasingly sought to place the cost of infrastructure on developers through the use of impact and development fees. But have the costs associated with "the system" increased by 100% over the last four years? Of course not. The planning system is not that volatile. It’s more like a constant underlying the housing market. With this in mind, there are a couple of points worth making about the role planning plays – and the role it could play – in housing markets.

The first point is that planning policies probably shave some production off the top in a hot market. In the absence of planning and permitting processes, developers would simply let ’er rip in a market like this one, building housing units as fast as possible. Planning processes inevitably slow the pace – which is part of the point of planning, designed to ensure that growth does not overwhelm communities and their infrastructure.

The second point is equally important: Planning and permit processes cannot easily stimulate construction in a down market such as we had for most of the 1990s. Builders often argue that if planners would "get out of the way" in a recession, production would go up. But the truth of the matter is that construction in a down market is dampened not by planning, but by financiers unwilling to loan money and builders unwilling to take a risk on reluctant buyers. Sometimes even huge public subsidies cannot force the market to build something the market does not want to build.

So, planning processes tend to shave production a little in boom markets and cannot stimulate construction in bust markets. Over time, this probably means slightly reduced housing production. If that’s true, then how can planning and planners better deal with the imbalances and price run-ups that we see today? The answer is simple: Plan well to begin with, and then stick to the plans you make.

Planning well usually means resisting short-term economic forces in the service of long-term benefit to the community – focusing on workforce and low-income housing, for example, instead of permitting developers to build only high-end houses. Equally important to planning well is keeping the plans you make. That means allowing developers to build the housing you want when – as now – the market motivates them to do so. One clear cost that planning imposes on developers is the cost of processing time, a cost that can be fatal if it means that developers miss the hot real estate market and must wait years until the opportunity to build arises again. One thing planners can do to help is expedite processing of good projects.

Put another way, the best thing local governments and their planners can do to help the housing crisis is not to "get out of the way." The best thing they can do is send clear signals about what they want, and then let developers do the job of implementing the plan when the opportunity arises.