I was speaking recently with a City of Oakland policy director about the negative press the city was getting due to all the luxury housing units being built there. One news article even claimed these new units were increasing the area’s cost of housing, because they were more expensive than the existing luxury housing stock. The policy director explained that the point of all that luxury development was not to lower the cost of luxury housing (although in time it would) but to increase the supply of affordable housing. Say what?!

And his explanation made perfect sense. To understand why, imagine the following scenario:

  1. Oakland has a housing shortage, in which housing demand exceeds supply by 10,000 units.

  2. Based on an analysis of local housing demand, the City of Oakland seeks developer bids for 2,000 luxury units; 4,000 middle-income units; 2,000 low-income units; and 2,000 very low-income units.

  3. Developers prefer to build luxury units, which offer a better return on investment.

  4. Without developers, housing will not be built.

  5. As a compromise with the City, developers build 5,000 luxury units, 3,000 middle-income units, 1,500 low-income units, and 500 very low-income units.

  6. Within two years of development, all 10,000 new housing units are occupied and there is no longer a housing shortage.

  7. Even though the new housing addressed just half the demand for low-income and very low-income units (2,000 new units versus 4,000 units originally requested), within two years of completed development, the demand for low-income/very-low income housing no longer exceeds supply.

The above outcome only makes sense if we also consider the preferences and behavior of property owners and residents who were already housed prior to development of the new units:

  1. Property owners prefer to sell or rent to individuals on the high end of their market.

  2. Prospective buyers or renters will settle for less desirable housing when their preferred housing is unavailable.

  3. As a result of these preferences and behaviors, a portion of the existing housing stock will be occupied by households who prefer (and can afford) something higher in the housing market than where they are currently residing.

  4. For example, some households prefer luxury housing but settle for middle-income housing when they can’t find the housing they want most - likewise, households that prefer (and, of course, can afford) middle-income housing but settle for low-income housing because that’s what available.

  5. The original analysis of housing demand was faulty because it did not anticipate that the development of new luxury housing in itself would create additional demand for luxury housing. In other words, opportunity to move up quickens desire to move up. Or: build and they will come.

  6. New housing developments will cause ripple effects throughout the entire housing market, as some households move to new units that are better aligned with their preferences and budget.

  7. Households moving into the new housing developments leave behind vacant units.

  8. Households that prefer luxury units but had settled for middle-income units will move to the newly available luxury units.

  9. As a result, middle-income units will attract fewer affluent prospective occupants, who now have the option to move to luxury units in the new developments.

  10. As a result, the middle-income housing market opens up, attracting prospective occupants from lower-income units who had preferred middle-class units but had settled for less due to the previous shortage of such units.

  11. As a result of households moving up to middle-class units, the lower-income housing market opens up, attracting prospective occupants who had preferred lower-income units but had settled for very-low-income units due to the previous shortage.

  12. As a result, the very low-income housing market opens up.

  13. As a result, more homeless people move off the streets.

Here’s a simplified visualization of the process:

__2020 Housing-Luxury to  Affordable.png

This is a classic win-win situation, benefiting households, developers, city coffers, and the homeless. As an added bonus, the increased availability of luxury apartments and condos will attract affluent but aging homeowners whose houses have become a burden. As they sell their homes, the market for single-family homes will open up for younger families. As I said, makes sense to me.