Residential Real Estate: Feedback Loops and Inertia
Capital Thinking • Issue #757 • View online
You may have contemplated, or been asked at some point: “How will homeownership and residential real estate change after Covid?”
In my experience, most of these discussions become far-fetched hypotheticals about remote work, the role of cities, and other fairly myopic perspectives from the Zoom-Bourgeoisie.
But there is one specific way where I could see Covid having a pretty significant impact on the way that housing works in specific cities, and on how homeownership works there for regular people.
Covid Kills Inertia: Homeownership Edition
Homeownership is a peculiar asset class. Most of the time, when we think about assets and why they’re valuable, we think of them in terms of what they enable.
When you buy equity shares in a business, commercial real estate, treasury bonds, or other assets, the asset typically derives its value from what it makes possible.
More can happen in a world where the asset exists than in a world where it doesn’t. Value is created, the asset captures some of it, and that’s what you’re buying.
But residential real estate is different.
When you buy a house on a residential plot, a large part of the value of that house is in what’s not possible, and in what it excludes.
Part of the value of your home lies in the zoning laws and building codes that prevent your neighbour from tearing down their house and putting up a bar, or a retail store, or a condo.
The value of a good school district isn’t just that your kids get to go to that school; it’s also that other kids don’t. (That’s uncomfortable to say out loud!)
The price of residential real estate reflects everything it’s not; and can’t easily become.
This is why there truly is not a “free market” for housing in the same way there can be for goods and services.
The asset you’re buying and selling is entirely a product of the law and regulatory environment that dictates how the asset can be used, how it can’t be used, and how it can be bought and sold.
As a homeowner, you’ve bought a bundle. You get a home, leverage, tax breaks, and most importantly to this discussion, you get friction.
You can frame that friction in a positive or a negative light: proponents will argue that you need these rules in place to protect residents from displacement, preserve local social capital, and protect the intangible but undeniable value of neighbourhoods that have accumulated character over time.
Opponents see this behaviour as “pulling up the ladder behind you”: once you get into a neighbourhood, residents typically act and vote in ways that support their neighbourhood staying exactly the way it is: opposing more density, multifamily buildings, and especially subsidized housing.
Not all housing works like this, mind you.
When you buy a downtown condo, you do not have a whole lot of influence over what happens around you. If you own a rural plot of land, there may not be many rules over what your neighbours can do with theirs.
The exclusionary value of residential real estate is most concentrated in where that exclusion is most consequential:
1) single-family zoned neighbourhoods;
2) in fast-growing or highly unequal cities, where
3) development laws and zoning codes in place are expected to persist. That last part is important: it’s not enough for that exclusion to exist; people need reason to believe that it will continue to exist in the future.
In most cities, it’s a pretty safe bet to count on that kind of persistence, because it’s the emergent product of a system of local influence that has evolved over time and accumulated a lot of inertia.
The simple way to think about that system is as a three-way power relationship between developers, politicians and homeowners: the developers want to do stuff, and homeowners want them to not do that stuff.
Politicians influence the compromise through immediate decisions and long-term policies: they want economic growth from development, but they also want votes from the homeowners.
Every municipality is a little different in how this triangle relationship has evolved; but once it’s in place, it’s pretty hard to change.
In a world with few building restrictions, you’d expect to see positive feedback relationships around growth: investment spurs more investment.
However, in a world where local residents have influential power, you reliably see an offsetting negative feedback force from local opposition: more development (developers trying to change what’s there) creates more resistance from residents as they organize and focus on blocking that change.
In most North American cities, those feedback loops are a reliable form of inertia. But not everywhere.
Photo credit: Etienne Girardet on Unsplash