In a recent post, I argued that housing affordability is not as bad as it would be if housing prices were adjusted for all relevant factors, such as size, quality, and household income growth. Although homes are more expensive in dollar terms, they are significantly larger and better, and the average household income has increased significantly.
However, we know that there are housing affordability issues, especially for working and middle-class people in certain metropolitan areas. The household income required to buy a median-priced U.S. home has increased 50% since 2020 to $117,000, according to Bankrate research.
The economics of home prices are very simple. If prices rise, either demand has shifted to the right, supply has shifted to the left, or a combination of the two. While supply constraints are the biggest cause of affordability issues, we want to acknowledge that buyers are also partly to blame for the market shifts we’ve seen. It takes two people to tango. Housing is a normal good with a long-term income elasticity of demand close to 1, which means that the demand for housing increases as household income increases.
To lower prices, builders would have to shift the housing supply curve “to the right” by a larger factor than buyers would shift the demand curve. Your builder will know exactly what this will require. Less restrictive zoning (especially for multifamily housing), easier permitting and permitting processes, less stringent building and energy standards, freer labor and materials markets, and perhaps consumer acceptance of smaller, simpler homes.
Collectively, our experience in home construction and economic analysis reveals three key factors that contribute to housing affordability. These include zoning, building codes, and home size.
Nearly every jurisdiction in the United States imposes zoning regulations that, in some cases, severely limit the number of homes that can be built. Increasingly stringent building codes for safety and energy efficiency require more expensive construction methods and materials. American builders are moving from small, modest starter homes to large, flashy “McMansions.”
Affordable housing is unavailable due to zoning.
Economists have long recognized that zoning regulations are one of the biggest obstacles to growth in housing supply. Nolan Gray, an urban planner turned anti-zoning campaigner, wrote an authoritative critique of zoning, Arbitrary Lines (an excellent review by David Henderson). Gray explains exactly how zoning increases housing costs.
The most obvious way is to prevent new housing altogether, either by banning affordable housing or through clear rules to curb density. As a result, less housing is being built, resulting in the supply-demand mismatch seen in most U.S. cities today. A subtle way that zoning increases housing costs is by forcing the housing built to be of a higher quality than residents demand, through policies such as minimum lot sizes and minimum parking requirements. Beyond these written prohibitions and mandates, zoning often increases housing costs by simply adding cumbersome and unpredictable reviews to the permitting process. (p.52-53)
There is plenty of evidence to support the theory that zoning plays a major role in limiting housing supply and increasing home prices. Exhibit A is Houston, the most famous example of an unzoned metropolis, and therefore one of the most affordable metropolises in the United States. The lack of zoning means it’s easy to add more housing in Houston, especially in response to small price increases. Gray said, “Houston is building housing at nearly three times the per capita rate of cities like New York City and San Jose… In 2019, Houston built almost as many apartments as Los Angeles, even though it’s almost twice the size of Los Angeles.” (p. 144) This large supply elasticity in Houston allows the housing stock to grow in parallel with demand, thereby limiting price increases. Houston is the most affordable city among large cities, as measured by the ratio of median home price to median household income.
Building standards laws increase costs
Continuing the family tradition started by Grandpa Watts in 1948, we built several spec homes in 2005 and 2006, scraping together the cash until we faltered with the advent of the subprime mortgage crisis.
Joel took up architecture again after a hiatus of almost 10 years, and Tyler went into academic economics. After touring one of Joel’s constructions after the restart, Tyler noticed that all the exterior walls were constructed with 2×6 lumber, rather than the 2×4 lumber that has been standard since the advent of stick frames. Joel said this was mainly due to changes in building codes aimed at increasing external insulation and making homes more energy efficient. This code upgrade is just one of the most notable examples of a steady trend of increasingly stringent requirements, usually aimed at small improvements in safety and energy efficiency.
A series of studies commissioned by the National Association of Home Builders (NAHB) tracked the total cost impact of specific changes to the International Housing Code (IRC) on a home-by-home basis. These studies found that over the 2009 to 2018 IRC update cycles, code changes increased construction costs for a typical home in Joel’s area by an estimated $13,225 to $26,210. With continued updates, IRC may continue to increase costs indefinitely.
Another study by NAHB found that overall government regulations (zoning, building codes, design, safety, etc.) account for nearly 24% of the sales price of a single-family home ($93,870 when applied to the median new home price in 2021).
Small + Simple = Affordable
Homes in the United States have gotten much larger since the 1950s and 1960s, considered the golden age of affordable housing. The average home size has increased from 1,500 square feet in 1960 to a peak of 2,700 square feet in the mid-2010s. The average new home in the U.S. is now about 2,400 square feet, and builders have largely given up on building smaller starter homes.
Since 1960, housing less than 1,400 square feet, which once made up the majority, has collapsed to far less than 10% of new housing starts, even as the number of people per household has declined significantly.
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If you’re looking for more affordability, you should emphasize smaller, simpler homes – true starter homes. With the national average construction cost in 2024 being $195 per square foot (including everything except the land), a 2,400 square foot home costs more than $200,000 more to build today than a 1,200 square foot starter home. Strip out expensive features like granite countertops, high-end appliances, and high-end decorative items, and even the most expensive meter-sized, site-built homes in the 1,200-square-foot range could be built and sold at a profit for $100,000 less than today’s national median price of about $410,000.
So why aren’t more builders producing smaller, simpler homes to meet the dire need for affordable housing? Simply put, starter homes are relatively unattractive to both buyers and builders, especially because of the high cost burden of regulations such as zoning and building codes.
Let’s compare the costs of a sample 1,200 square foot starter home and a high-end 2,400 square foot McMansion. Assume that the total cost of regulation adds $100,000 per single-family home. Basic construction costs are, roughly speaking, directly proportional to the size and quality of the house. Therefore, absent extraneous regulatory cost burdens, a 2,400-square-foot home should cost approximately twice as much to build as a 1,200-square-foot home (not counting land costs). However, the cost of a strict regulatory system is not proportional to the size or amenities of the home, but is approximately the same amount for any size home. In other words, regulatory compliance adds about the same amount of spending to a starter home as a McMansion. The overall effect is to narrow the price gap between starter homes and McMansions, making the latter relatively cheaper than the former. Economists know this as the Archia-Allen effect.
In a less regulated world, a starter home might cost 1/2 as much as a McMansion, but once the regulatory burden is taken into account, a starter home is actually 2/3 as expensive, and the greater the fixed costs of regulation, the smaller this relative price difference becomes. As regulatory costs increase, the relative price of large, well-equipped homes falls. Not surprisingly, builders and buyers are increasingly seeking relatively expensive starter homes.
Ensuring that “low quality” products exist
Our favorite economics teacher, the incomparable Walter Williams, used to say, “Low quality goods are part of an optimal goods inventory.” Of course, how else can the material needs of the poor be met? This does not mean that Williams is unsafe or unworkable, but rather that it was created with cost in mind. For houses, that means smaller and simpler.
To ensure an abundance of low-quality goods, governments must avoid burdensome taxes and regulations that make it unprofitable and impractical for entrepreneurs to operate in low-price markets. Sadly, for many low-income people looking for shelter, regulations have forced shelter out of the market.
To ensure that the flow of affordable housing increases, governments need to largely eliminate the prohibitive cost rules and restrictions imposed by zoning and building codes. The words “If you build it, they will come” ring true to us, but take our word for it. Affordable housing will not be built unless governments reduce the burden of these excessive regulatory costs.
Tyler Watts is a professor of economics at Ferris State University. His younger brother, Joel Watts, is a home builder.
