A New Wrinkle in the Housing Market

Experiments with working remotely and fears about the pandemic may lead some people to move away from urban centers. There is some debate about the extent to which that may happen, and only time will tell. But will the pandemic lead to urban depopulation?

The answer to this question is not as simple as it might seem at first glance. Before thinking about the effects of the pandemic, let’s think about the differences between a city like Houston or Atlanta and a city like New York or San Francisco. These two types of cities have vastly different regulations on construction of new housing.

In cities like Atlanta and Houston, rising demand for housing mostly leads to more homes being built, and the prices of homes essentially reflect the cost to build them. In cities like New York and San Francisco, there are many limits to building. Homes can’t be built for all the people who want to move there, and prices are higher than the basic cost of construction. In New York, Boston, Los Angeles, and the San Francisco area in particular, home prices have risen far above the cost of construction.

In a city like Atlanta, if demand for housing declines slightly, it will generally result in fewer new homes being built. Rents and home prices are unlikely to be significantly affected, unless there is such a rush out of the city that there is a glut of housing. Typically, it is cities with building restrictions, such as New York City, where home prices and rents are more likely to be affected.

However, the severe shortage of housing in New York City complicates this basic supply and demand picture. In the pre-pandemic market, rents kept rising, prompting thousands of people to move out of the city each year. In the post-pandemic market, thousands of people are still likely to move away, but this is expected to cause rents to decline. What explains the difference between those two dynamics?

One way to think about it is to consider that money is just one of the variables in the cost of a house. Money is easily measured and is fungible, so it is what we focus on. Of course, with any transaction, there are externalities, opportunity costs, and innumerable complications that sit in the background and factor into the total cost.

This is perhaps most clear with queuing. If the monetary price of a good is set too low, people will choose to wait in line to buy it, paying with a combination of time and money. We can think of that wasted time as part of the price. Or consider parents spending $400 for a drum set for their child. We can think of the price of that drum set as $400 plus the loss of peace and quiet. Maybe there is an equivalent electric drum set that the child can play with headphones on that sells for $600. If the parents buy that drum set instead, that gives us a sense of how much they value quiet.

The pandemic highlights some nonmonetary costs associated with urban housing. How does this affect the cost of homes where the cost is not tethered to the cost of construction? When new families move to cities where housing costs are not tethered to the cost of construction, local home prices increase, but the higher price doesn’t fund floors, walls, and roofs. Instead, the money is simply claimed by different interests, from the government to unions to various favored businesses. It is really a transfer. Landowners and existing homeowners claim windfall gains on their overpriced homes. Frequently in cities like New York, local governments create lengthy and expensive approval processes, which claim some of the transfer. Cities can also impose development taxes to claim some of this money.

If a family moves to New York City, for example, they have to outbid existing families for a home, increasing transfer payments to those interests. Families with less access to funds lose that bidding war, and they must move even if they prefer to live in New York.

We could think of the pandemic as a nonmonetary payment—an externality from living in a city. However, it’s hardly the only externality. For example, cities are noisy, crowded, and tend to have higher crime rates than suburban and rural areas. This means the price of housing in New York was already the result of a set of values and compromises. Since the pandemic adds to those nonmonetary costs, it lowers the monetary price.

It still may be worth living near Wall Street, so the hypothetical total price may not have changed at all, but the monetary transfer that the marginal family is willing to pay may be lower. The risks people assume by moving to Manhattan in a pandemic may limit the amount of money they are willing to pay. Manhattan before the pandemic was an electric drum set. Manhattan after the pandemic may be a standard set of skins.

Since the supply of homes in New York isn’t very sensitive to the price of homes, people moving because of the pandemic will likely have little effect on New York’s population. It mostly changes the terms of the bidding war for homes. Previously, people moving away have generally done so because they lacked funding.

In the post-pandemic market, nonmonetary payments replace some of the monetary payments. People who were moving away before the pandemic lost the monetary bidding war, but they might be willing to take on the higher risks that are now a part of a house’s cost.

Over the past couple of decades, hundreds of thousands, if not millions, of people have either moved out of New York or have been prevented from moving in because of the high cost of housing. Those people have new negotiating power. Rents may decline, but the effects of the pandemic will have to become extreme before it has much effect on net population growth or the continued demand for new units.

One way to think about the effects of the pandemic is that rents in cities like New York will still be elevated. However, more of the costs will be paid in the form of nonmonetary externalities, such as the risk of getting sick. It could be that thousands of people will move out of New York because of the pandemic, but thousands have been moving away for years. Now, it will just be different people. The pandemic may have changed the reasons for these moves, but it isn’t changing the scale of the loss people have had to accept when they have had to move.

A cure for COVID would be a blessing to humankind. But, until cities like New York fix their NIMBY policies that artificially limit housing, benefits such as a cure can’t really be shared in these places; they can only be traded. If the pandemic goes away, the people who feel newly freed to enjoy the joys and benefits of living there will only be able to do so by taking those joys and benefits from someone else. Cities like New York need a cure for both COVID-19 and NIMBYism.

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