Concentrating on Housing

Housing has become more expensive. Below is a figure that illustrates the change in housing prices since 1975 by state. By far the leaders in housing price appreciation are the District of Columbia, California, and Washington. The price of housing in those states has increased about 2,000% – about double the national average. That’s an annualized rate of about 6.7% per year. That’s pretty rapid seeing as the PCE rate of inflation was 3.3% over the same period. It’s more like an investment grade return considering that the S&P has yielded about 10% over the same time period.

Of course, there are plenty of high-paying employers in those states. Strict zoning laws are a big issue that helps to prevent the quantity of housing supplied from expanding. For example, DC has famously strict height restrictions. Strict zoning can have obvious negative effects on density. These include setbacks, parking requirements, height requirements, window requirements, anti-brothel blue laws, etc. More recently, I’ve heard that construction firms are holding back on construction due to volatile home prices and the greater possibility of a loss. While this might be true in the short run, it can’t be true in the long run when competition would exploit profit opportunities.

All the myriad of building approvals and specifications can also increase the administrative cost to construction firms. Often increasing production costs simply reduces the supply of construction output. However, to the extent that these costs are fixed, the regulations also increase firm concentration by increasing the economies of scale. Concentration might cause firms to act in ways that are less like those in a perfectly competitive market and more like monopolistic competitors. This hypothesis is more than just hot air. The total number of firms in the US increased by more than 10% between 1997 and 2019. In the same time period, the number of residential construction firms shrank by 55%.*

That’s not a slam dunk, but it should give us pause. Market concentration can happen for a variety of reasons, such as due to good ol’ fashioned price competition. But, rather than competing on the margins of material housing costs, firms are likely competing on the margins of administrative compliance.

*The US switched between SIC and NAICS. I lined up the industries as well as I could to include single family unit builders, multi-family unit builders, and developers who sell directly to buyers.

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