Cavan Wilk wrote an article this week that I think needs explanation – as it reflects common misunderstandings of how the real estate market works – ones that are largely based on anecdotes. Cavan’s main thrust is this:
The only way to stabilize affordable residential rents in the long-term is to increase the supply of old buildings.
Moneybox deconstructs this argument as having two flaws. The first is a misunderstanding of the causation; Cavan argues that the age of the building is what causes the rents to decline. The second misunderstanding is the belief that age and quality run together. And I would add a third; the misunderstanding of new developments’ relationship to rents.
Moneybox illustrates the issues with the first issue:
If you take an area where there was a lot of demand for structures once upon a time, but currently demand is low, then you’re going to find cheap rents and old buildings. Conversely, if you take an area where demand for structures has historically been low and currently demand is high, then you’re going to find high rents and new buildings. But in these cases it’s not the age of the structures that’s driving the rents, it’s the rent that’s driving the age of the structures.
And also the second issue:
If you have expensive land, one way to make dwelling on the land cheap is to ensure that some of the structures built on the land are low quality. A low quality structure may be an old structure since old structures may, in Wilk’s words, lack “the latest amenities.” But for policy purposes it’s important to be clear that it’s the low quality rather than any of the more meritorious aesthetic features of old buildings that’s driving the affordability here.
In major cities like NYC, Chicago, or even DC the number of properties that illustrate quality with age is numerous: Willis tower, Empire State, Waldorf, Georgetown, etc.
The third issue is one that is often illustrated in urban markets like NYC. Rents are most often tied to two major factors, the prevailing market and the debt encumbering the property. An owner has a rent floor that is set by the debt service and operating costs of the property, and a rent ceiling that is set by the market. Factors such as the above mentioned location demand and quality clearly come into play on the market side, and also influenced the debt side (clearly at the time of financing). What drives the stock of old buildings growing or shrinking (through redevelopment, condemnation, etc.) is the replacement cost level of rent. If the cost of developing a new building (including the site, deconstruction of existing building, construction costs, and acquiring funds) is more than the replacement cost, then development of new stock cannot be profitable and won’t occur. Land is a scarcity, especially in urban locations like NYC, so often the cost of development far exceeds the replacement cost of existing improvements. In effect, this creates zones or areas where the stock of buildings will all be aging.
Here in Houston, that is fairly well illustrated both in the Galleria and downtown – new skyscraper construction has not occurred (with few very recent exceptions) in decades. However the older buildings are still in demand due to their location, and their quality has not suffer as owners and managers brought in internet cabling, touch screen marquees, etc as business practices changed.
Specifically to this point Wilk says:
New buildings, it turns out, are expensive even if there are lots of them. Of course, Silver Spring’s desirability in general has also greatly increased recent years, which is why there are so many new buildings there in the first place.
But, this is really a result of rents outpacing replacement costs, making new development profitable. Silver Spring is a suburb, so land costs and development costs have not risen to the heights of the urban core of DC. However, with more development and increasing scarcity of land, Silver Spring will reach a point in which development will no longer be cost feasible, but location demand will remain high because of proximity and accessibility to the city. The result; a Silver Spring of older, expensive rent buildings.