Market-Rate Construction Frees Up More Affordable Homes, Study Finds

Construction of market-rate housing creates a chain reaction that ultimately opens up affordable housing options for low-income renters, a study from the Federal Bank Reserve of Minneapolis has found.

Every 100 new market-rate apartments built can lead to 70 openings in lower-income housing within five years, economist Evan Mast estimated in the study, which tracked individual renter moves across 12 U.S. metros. 

When high-income residents move into new market-rate housing, their previous homes are freed up for other renters or homebuyers. When those residents move, their old place is then available for others and the price on it may lower because of a shift in demand. This process is known as filtering. 

New single-family and multifamily construction is on the decline and at this pace is unlikely to close the gap in housing affordability. Seventy major metros in the U.S. experienced a drop-off in new home permits last year, and construction of single-family and multifamily units fell 9% year-over-year nationwide.

The Biden administration is launching initiatives, like Low-Income Housing Tax Credit reform, on the national front to assist those struggling to afford housing. But those in the real estate industry have said reducing barriers to construction to increase the supply of housing would be more impactful, and this study provides support for that claim.

While filtering can lead to an increase in affordability, it isn’t always cut and dry. 

Filtering largely depends on local variation. Areas where rents are low and vacancy rates are high are unlikely to see new builds. A city with slower housing growth impacts the chain on every level.

If there are fewer new units created while demand is still high, a coinciding uptick in competition, and thus rent, occurs. Mast found that the Minneapolis-St. Paul metro has a high rate of filtering, with nearly 0.6 affordable units opening up for every new market-rate unit, while New York City has a below-average rate of less than 0.2 units freed per new build.

In a city with various construction challenges, high costs, extra fees and a housing shortage, like San Francisco, filtering can happen the opposite way. When there are fewer homes available but high demand, older homes that used to be accessible to first-time home buyers are more likely to be snagged by higher-income residents over time. 

San Francisco must permit 82,000 new housing units by 2031 to meet its state-mandated housing goals. Residents there just voted to approve $300M in housing bonds that will help build and renovate 1,400 affordable homes. 

Those with higher incomes may choose to live in lower-income neighborhoods instead. This, en masse, is known as gentrification, which can lead to displacement. Displacement occurs when those in lower-income neighborhoods have to move because of an increase in price and competition, even if they don't want to leave. 

"The overall body of evidence on filtering, gentrification, and displacement adds to the strong theoretical case that increasing the housing supply benefits households across the income spectrum," Mast's research states.