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Why new construction isn’t easing Chicagoland’s inventory problem

by Meg White

New construction is often pointed to as one possible solution to the lack of affordable housing in this country. Indeed, it’s rare these days to read a National Association of Realtors release of market data that’s unaccompanied by a remark from the organization’s chief economist about the need for more building activity in the entry-level sector. 

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The numbers back up the rhetoric. The National Association of Home Builder announced last week that over the first six months of 2019, the issuance of single-family permits was down 6.1 percent over this time last year. A whopping 42 states registered a decline in single-family permits issued over this time period, with Illinois clocking in at a -10.2 percent growth rate year-over-year. 

Now that the Great Recession can no longer be blamed for a depressed new-home market, the homebuilder community has offered a succinct answer to the reason for its industry’s sluggishness. But some researchers are poking holes in their assertions of late. 

“We’ve been studying these markets for a long time and the mantra is ‘labor, lumber, laws and land,’” said Edward Pinto, codirector of the American Enterprise Institute’s Housing Center, noting that prices for building materials and skilled workers don’t typically vary much across the country. “How do you explain these tremendous variations that are happening across the country?”

To try answering that question, Pinto and his colleagues organized American cities into groups in terms of their movement in three areas: home price appreciation, wage and job growth, and new construction activity. Chicago scored relatively high on price growth, lower-than-average employment improvements and sluggishly in terms of new construction, a combination that worries Pinto. “That’s hanging on the Chicago market,” he said. As interest rates continue their downward slide and as rents increase, more Chicagoans are going to look to buy their own homes, only exacerbating the affordability problems here. “New construction isn’t there as a release valve.”

At least from an interest rate perspective, however, this is still a relatively new story. This time last year, few were predicting such low interest rates would be the norm in 2019. And new residential construction is a product that requires a lot of lead time. “It hasn’t been a year yet since rates really plummeted,” Pinto said, and for builders, “a year is really rapid.” But low rates and relatively easy lending conditions have flooded the market with more buyers just as inventory was starting to become more plentiful. 

“Demand is going to be very high,” Pinto said. “This is potentially going to bode poorly for Chicago.”

There’s also a stark difference in the type of housing that’s lacking. To get at this factor, the AEI Housing Center broke their data into two economic sectors: entry-level and move-up. In terms of how home prices have increased from a year ago, move-up buyers in Chicagoland have only seen about 1 percent appreciation. Entry-level buyers, on the other hand, have seen prices go up by three times that amount. Inventory is also a tale of two markets: Months’ supply is just 2.6 for lower-priced properties while it’s 6.5 months for the more expensive units. 

In terms of what builders are contributing to Chicago’s housing stock, the region falls well behind national levels. New construction makes up less than one percent of the homes coming on the market in Chicago, while that number is 2.1 percent nationwide. The overall share of new construction in terms of entry-level sales in Chicago is just 1.9 percent, while the move-up sector gets 7.9 percent of its sales from new construction. On a national level, those numbers are 5.4 percent and 18.6 percent, respectively. 

So if the national line about material prices and lack of skilled labor isn’t what’s holding back new construction in cities like Chicago, what is? First of all, labor costs are a simplistic way of looking at shortages. Rather than blaming high wages for the cost of construction in Los Angeles for example, Pinto suggested that really it’s the fact that tradesmen are more plentiful in lower-cost markets because their wages stretch further there. Also, while the actual cost of land is relatively stable, a more reliable and geographically linked problem for local builders is local permitting and regulatory delays, as well as impact fees.   

And assuming Pinto and his colleagues are right about the fact that lower lumber prices and an even labor market won’t bring new construction roaring back to Chicago, what will? One solution that’s piqued interest at the AEI Housing Center is enabling more accessory dwelling units and two- to four-flat buildings. Pinto said recent changes to single-family zoning laws in Oregon and Minneapolis are gaining traction because they don’t generate a lot of new rules for developers, and they work off of theories that have demonstrated successes over the long run. Incremental increases in density (say, a handful of two-flats where there was once single-family housing, as opposed to a big new high-rise) means cities don’t need to invest in a lot of new infrastructure. In fact, such density levels are closer to what many cities saw with the Baby Boom in the 1950s.  “A very small change in land use laws can have a huge impact,” Pinto said. “It brings middle level housing to the fore.”

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