I really enjoyed reading, "Long Run Housing Supply: Role, Determinants, and Measurement," by Albert Saiz from MIT's Center for Real Estate Research. The paper digs deep into the mechanics of housing supply and seeks to answer what fuels the rise (and occasional fall) of the world’s most vibrant cities. I highlighted a few of my favorite concepts below.
At the heart of his exploration is a simple but powerful idea: cities are not just shaped by demand but by how effectively they can meet that demand with new homes. When people flock to a city, lured by opportunity and amenities, housing prices climb unless the supply keeps pace. In cities where construction is flexible and land is plentiful, growth is accommodated much easier. But in places where geography or regulation squeeze the market, the result is a sharp escalation in prices, making the city’s charm inaccessible to many.
Long-Run Housing Supply Economics
The above chart represents a basic supply/demand representation of the long run-price and stock of housing in a metropolitan area. As demand increases from D0 to D1, prices must increase from P0 to P1. In the long run, new construction occurs from Q0 to Q1, due to the additional incentive to developers. As reference, housing supply represents the availability of homes that can be built or brought to market, while housing stock refers to the total number of existing homes.
At the new price P1, the market is in equilibrium and no further increase to the housing stock is needed. Note that construction costs (CC) indicates the intercept of the supply line (minimum construction cost) given no developer will build if they obtain a price below the total physical construction cost.
In a market with sharply higher construction costs, such as during the COVID crisis and global disruption of supply chains, housing prices may continue to rise while new construction declines. Placing construction costs at the supply intercept is critical given a housing unit, without subsidies, cannot be more affordable per square foot than the cost of construction in most places.
Land Values Relationship to Supply
While construction costs may adjust in the short term, the real bottleneck to increasing housing supply is the availability and price of land. Land values rise as more homes are built because as a city expands, finding desirable land to build on becomes increasingly more difficult. People generally prefer to live in central locations, where they have better walkability, access to jobs, schools, shops, cafes, scenic architecture, and vibrant urban life, as well as proximity to family and friends. As a result, in competitive markets, housing prices in central areas are higher because demand exceeds supply, and individuals must pay a premium to secure these prime locations.
Building, Busts, and the Long Wait for Balance
One of the most fascinating points in Saiz's work is how cities deal with downturns. In regions facing declining demand, such as post-industrial towns where jobs vanish, housing supply becomes stubbornly unresponsive. Even as demand drops, the existing homes don't disappear. They linger, often dragging prices below the cost of new construction. This mismatch leads to a long, slow decay, with neighborhoods falling into disrepair as prices plummet and new development grinds to a halt.
The below chart highlights a city where prices have fallen below replacement cost at P0. In other words, there will be no new construction and reinvestment into the stock until demand is high enough to bring prices back above construction costs (D1 to D2). A supply-side policy solution such as tax exemptions, coordination with local unions, or targeted subsidies, would help to lower construction costs and revitalize building.
In cities on the rise, construction costs anchor the market. Developers won’t build unless the prices cover construction expenses, meaning that, over time, construction costs form the floor for housing prices. And as cities grow, land becomes increasingly valuable, pushing prices higher and making affordability a distant dream for many.
Shaping the Future: The Role of Policy and Planning
Saiz’s research underscores a key challenge: cities that fail to build enough housing when demand is high will face the painful consequences of inelastic supply—soaring prices, housing shortages, and an eventual urban squeeze. In cities where land is available and regulations allow for growth, housing can keep pace with demand, stabilizing prices and fostering healthy urban development.
In a world where more and more people are moving to urban areas, the future of cities will largely depend on how well they manage their housing supply. Cities that can overcome their geographic and regulatory constraints will thrive, while those that don’t may find themselves caught in a cycle of affordability crises and stagnation.
Comments