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The Affordable Housing Shortage: Considering the Problem, Causes and Solutions

The author's data analysis concludes that a shortage of income is largely behind the housing affordability problem.

September 1, 2002


Ron J. Feldman Assistant Vice President

Article Highlights

  • Income shortage causing unaffordable housing crisis

  • Owner-occupied market remains affordable

  • EITC, housing vouchers best cost-effective response

The Affordable Housing Shortage: Considering the Problem, Causes and Solutions

Editor's note: When the writer Barbara Ehrenreich spent some time in the Twin Cities of Minneapolis-St. Paul to research her book Nickel and Dimed: On (Not) Getting By in America, she had trouble finding an inexpensive place to live. "There is one possibility—one place in the entire Twin Cities that rents 'affordable' furnished apartments on a weekly or monthly basis," she wrote, and had the presence of mind to place quotation marks around the word affordable. She ended up living somewhere else, and her quest for affordable housing became a signature theme of her Twin Cities visit.

Ehrenreich certainly tapped the local zeitgeist on that one. The Twin Cities media frequently report on affordable housing issues, and policy forums on the topic are commonly held. The mayor of Minneapolis made affordable housing a top priority of his campaign and first term last year, promising to build a thermometer outside City Hall to measure progress on the issue. Several months after election the thermometer had yet to materialize, according to local press reports, because the mayor's aides were unsure what the thermometer should actually measure.

That unbuilt thermometer is an apt metaphor for an issue that has galvanized so many and yet is so hard to define. This is not only true of the Twin Cities, but of cities and regions throughout the country—even many rural areas—where housing affordability has become a top public policy issue. The following article is an excerpt from a working paper produced by the Minneapolis Fed that not only helps frame the debate, but also offers a policy prescription. See the whole paper, including appendices, notes, tables and additional graphs.

Many observers claim that we are in the midst of an "affordable housing shortage" or, even worse, an "affordable housing crisis." The primary concern is that too many households live in "unaffordable" rental units. We hope to clarify the current debate by first measuring the size of the problem, then diagnosing its underlying causes and, finally, discussing treatments that policymakers should consider. While our review is hardly exhaustive, we conclude that a shortage of income is largely behind the housing affordability problem despite the current focus on housing. Policymakers should recognize that government financing of new housing units is unlikely to be a cost-effective response to low household income.

Measuring the number of unaffordable housing units first requires a definition of affordability. In this debate, a unit is considered unaffordable if a household has to spend more than 30 percent of its income on it. We use this standard to measure the size of the "shortage" because of its public prominence, even though we recognize that such a standard must be subjective. We also restrict our analysis to the rental-housing market; the owner-occupied market remains affordable by the commonly used standards. We find that the housing "crisis" is heavily concentrated among one subset of the population—poor renters.

We then examine two of the most likely potential causes. First, low incomes lead households to spend most of their income on necessities, like housing. Second, government regulation, in part designed to improve quality, can increase the cost of housing so that it is unaffordable. The costs imposed by land-use regulation can be particularly pronounced for the lowest-cost units.

After examining the data for the United States and for the Twin Cities, a metropolitan area reputed to have a severe affordable housing shortage, we find that low incomes are the primary reason why the poor live in unaffordable rental units. Even if costs fell significantly—by an amount roughly equal to estimates of the increase in cost due to regulation—the vast majority of the poor living in the United States and the Twin Cities would still live in rental units considered unaffordable. Again, we note our review is limited in its scope and sophistication. In some areas of the country, such as California and greater New York City, regulation may play a large role in explaining high housing cost-to-income ratios. However, others have come to similar conclusions that these select areas are the exception rather than the rule (see Glaeser and Gyourko 2002, for example).

Because of our diagnosis, we focus our discussion of policy responses on the link between low incomes and high housing expenditures. If policymakers believe that housing cost-to-income ratios are too high for low-income households, they should provide low-income households with additional cash or federal support, such as food stamps, for accessing other basic necessities such as food and medicine. After all, concern about a high housing cost-to-income ratio for low-income households only makes sense if housing costs prevent those households from buying other basic necessities. Concerns about affordability would assumedly disappear if households could spend over 30 percent of their income on housing and still acquire all the food, clothing and other necessities they need. Cash or federal subsidies for nonhousing necessities offer a more cost-effective way of increasing access to nonhousing necessities than subsidies that must be used for housing. There are surely some households or individuals for whom it makes sense to allocate public subsidies for housing (for example, the homeless), but they constitute a small part of the population.

Despite the reasoning showing that limited income is the primary problem and that public subsidies that can be used outside the housing market are generally the reasonable response, some policymakers will only support government subsidies for housing. These policymakers will have to choose between programs that build new units and those that provide households with the equivalent of cash for housing (that is, vouchers). During that decision process, policymakers must address the evidence that housing vouchers appear able to put households into affordable housing units at a significantly lower cost than production programs. Housing vouchers might prove less effective than production programs where government restrictions significantly impede the market supply of housing. In these cases, policymakers should consider the removal of regulations, a challenging task that will require balancing competing interests, including the desire to increase housing quality.

We make no claim of addressing all concerns raised about housing affordability in the United States in coming to these conclusions. We do not address data on rural housing markets, for example. Nor do we claim to highlight novel solutions. Instead, we hope this essay contributes to the more modest goal of framing the issues and encouraging the use of economic and policy analysis in future discussions. In that vein, we hope that the continued debate on housing affordability stays focused on specific failures in housing markets, the effects of existing government intervention—particularly land-use regulation—in housing market outcomes and the central role that income appears to play in generating concerns about housing affordability.

The data on housing expenditures

Those calling current conditions an affordable housing crisis rely on community or social standards to determine that a unit is "unaffordable" even when a household has the resources to live in it. This approach has been rightly criticized for several reasons, including its obvious subjective nature (see Appendix 1 of the working paper). Despite these reservations, we use the "30 percent of income" definition because it is the most frequently cited standard and one used by the U.S. Department of Housing and Urban Development (HUD). Specifically, this standard focuses on rental units and defines a unit as unaffordable if a household would have to spend more than 30 percent of its gross income on rent and utilities. Analysts have used the fixed-standard method in many ways, all of which suggest that the affordability problem is confined to households with very limited financial resources. (We focus on the rental market because the owner-occupied market, discussed in working paper Appendix 2, seems affordable based on frequently used social standards.)

Before we review these data in detail, we have to define the geographic boundaries for the housing market under examination. Much analysis and data describe national trends in housing supply, demand and prices. But, consumers and producers make decisions based on conditions in much smaller local housing markets. To address both perspectives while keeping our discussion focused, we review data for the United States and for a metropolitan area reportedly suffering from one of the worst affordable housing shortages in the country, the Minneapolis-St. Paul metropolitan statistical area.

According to recent congressional testimony from a HUD economist, the traditional approach to identifying a housing shortage compares the number of units affordable to households whose income falls between predefined amounts to the number of households that fall into that income group (see Nelson 2001). Incomes are generally expressed as a percentage of the median income for an area. So, for example, such analysis might compare the number of units affordable to those households with incomes at or below 80 percent of area median income to the number of households that have that income. On the national level in 1999, the only group of renters for whom a shortage existed were those considered by HUD to have "extremely low incomes" (defined as at or below 30 percent of area median income). Households with extremely low incomes typically fall below the official poverty line (see Nelson 2001). In the Twin Cities, a shortage of rental units is also limited to those households with extremely low incomes as of 1998. (Note that these 1999 and 1998 data from the American Housing Survey are the most current. The detailed 2000 decennial census data have not been released.)

Some object to this approach because it does not differentiate between existing affordable units and those affordable units actually available. A household with an income at the median for an area could decide to occupy a unit that is affordable to a household with an extremely low income. While the low-cost unit is affordable to the lower-income household, it is not actually available. To provide a more comprehensive view of affordability, we also examine the total number of rental households that spend more than 30 percent of their income on housing.

This second approach yields the same answer as the first: Virtually all those living in unaffordable units have very low incomes. In the Twin Cities, the most recent data show that 69 percent of all renting households in unaffordable units had extremely low incomes (another 25 percent had incomes between 30 percent and 50 percent of the area median). The national figures were generally comparable, although a smaller percentage of renters living in unaffordable housing had extremely low incomes.

Income as a potential underlying cause of the housing crisis

The fact that households in unaffordable units have very low incomes should naturally lead policymakers to consider low income as one of the potential causes of the "shortage." Very low-income households might have only enough money to pay for the basics. The most expensive basics will consume a greater share of their income. Housing is typically the largest expenditure for most households. Higher-income households spend less of their income on housing, on average, than lower-income households. As a result, housing ends up consuming a very large share of expenditures for low-income households, especially relative to higher-income households. (See graph for data on household expenditures and income for 2000.)

Looking to income as a source of a social concern is not a novel proposition for policymakers. The current measure of poverty has its roots in the amount of income a household needs to buy an adequate amount of food. But when the number of households in poverty rises, policymakers and the public do not typically consider it evidence of an "affordable food crisis" that requires the planting of additional crops. There is no formal connection between the amount of subsidies that farmers receive and the number of households below the poverty level, nor do policymakers typically scrutinize agricultural processors and grocery stores to find a cause of high poverty rates.

Chart: Expenditures on Basics By Household Income Quintile
Source: Bureau of Labor Statistics Consumer Expenditure Survey (data as of 2000)

Likewise, widely available data indicate that those with low incomes allocate 8 percent of their expenditures to utilities, twice the percentage of those with the highest incomes. Yet few have called on the government to build new generators to address excessive utility expenditures by the poor. Instead, policymakers typically view such data as evidence that some households have too little income and respond by, for example, providing more income to spend on energy
(for example, the Low-Income Home Energy Assistance Program and "lifeline" programs). But, before we can surmise that the housing crisis has its roots in income, we must examine an alternative explanation for the affordability crisis.

Another potential underlying cause: government regulation

The private market can and does produce low-cost housing, usually through a process called filtering, where existing housing units drop in cost as their relative quality falls, rather than through construction of new, lower-cost units. The most direct test of filtering suggests that this process captures the workings of the real world. Malpezzi and Green (1996, p. 1811) found that "high quality new construction is associated with a growth in the low quality stock. ... In 1995 ... new units led to an increase of nearly 2.5 percent in sub-standard rental units."

Although the private market appears capable of providing units that would meet affordability standards for the very poor, this solution has an important drawback. In housing markets, the actions of one household or firm can strongly influence the quality of life of neighboring households. For example, the owner of an apartment complex that lets the building fall in quality also has a negative effect on the value of the units nearby (a new building of very low quality could have the same effect). The owner of the building whose value is depressed might have less incentive to maintain its units, which, in turn, reduces the value of other units in the vicinity. Owners do not bear all the costs imposed by their actions and do not fully incorporate these costs into their actions. The result is that a private market might produce housing units that are cheap but which have too low a quality level.

Local government regulation, in theory, could address this failure. Local governments regulate land use in many ways, including restricting the types of housing built (e.g., apartments vs. single-family homes) as well as dictating the attributes of that housing (e.g., number of garages). While these rules could increase the quality of housing, they can reduce the availability of low-cost housing by, for example, limiting the total number of housing units produced in a community. The result is less housing and higher prices. As McFate (1999, p. 172) summarized, "We have regulated substandard housing out of existence—the result is that the poor have safer but more expensive housing, and less money available for other goods." (See working paper Appendix 3 for a discussion of quality trends in rental markets.)

Coming up with empirically sound estimates of the cost of local land-use regulation is quite difficult. One estimate using a reasonable approach found that a significant increase in regulation—more specifically, raising regulatory intensity from relatively low to relatively high levels—would increase rents by 17 percent. These results are generally consistent with other research findings, such as those reviewed by Fischel (1990). Moreover, the small number of detailed cost/benefit analyses find that regulatory costs exceed the benefits they produce. (Working paper Appendix 4 discusses another slightly more complicated justification for regulation, namely, to ensure the efficient provision of government service.)

Income is the cause

We have described two possible causes for the fact that most very poor renters live in unaffordable units: too little income or too much regulation. Because unaffordable units are almost all occupied by the poor, our expectation is that income plays a larger role than regulation. This conclusion is consistent with anecdotal information. As Anthony Downs (1991, p. 1105), one of the most prominent critics of local regulation, noted, "It is certainly true that eliminating all regulatory barriers to housing affordability would not come close to ending the existing housing affordability problems of America's low income households. Those problems are caused more by poverty and low income than by high housing costs. ... " Similar sentiments have been expressed in the Twin Cities by a mayoral committee investigating the affordable housing crisis: "It is important to stress that these cost reductions [from reduced local government regulation] ... will never be sizeable enough to fully eliminate the need for subsidies to produce affordable housing for all income levels" (Mayor's Regional Housing Task Force 2000, p. 8).

To test this theory, we use the most detailed recent data on housing costs in the Twin Cities to simulate a reduction in rents. We choose a 15 percent reduction in rents because it approximates the amount by which rents are estimated to increase by shifting from a lightly regulated to a heavily regulated environment (as noted earlier, this estimate was 17 percent). This reduction in rent drops the number of all renters living in unaffordable housing from 44 percent of all renters to 34 percent of all renters. This reduction in rent drops the number of renters with extremely low incomes living in unaffordable units from 80 percent of all such renting households to 70 percent. National data show similar results. The percentage of renters living in unaffordable units falls from 44 percent to 35 percent, while the percentage of extremely low-income households living in unaffordable units falls from 85 percent to 78 percent.

Certainly, this analytical exercise is more illustrative than definitive. Using another methodology, analysts have identified regulation as having particularly deleterious effects on housing prices in certain parts of the country, especially California and New York City. Moreover, the declines in the number of renters in unaffordable units produced by the decrease in rents was not trivial. Nonetheless, this exercise suggests that even a significant reduction in cost would not shift the vast majority of renting households currently in unaffordable units to affordable units. As a result, the simulation suggests that low incomes play the dominant role in explaining current affordability concerns in the country as a whole and in an area reputed to suffer from a severe affordability problem.

Policy responses

Since we view low income as the primary cause of our concerns about affordability, we focus our discussion on policies that address it. Issues policymakers face in reforming regulation in housing markets are discussed in Appendix 4 of the working paper. As a general rule, we believe that policymakers should respond to the high housing cost-to-income ratios by facilitating the ability of low-income households to acquire nonhousing necessities like food and medicine. Assumedly, we only care about high housing costs because they prevent households from acquiring these other goods and services. The provision of cash or cashlike subsidies is the most cost-effective way of assisting low-income households in acquiring the necessities that high housing costs crowd out. If policymakers provide subsidies that can only be used in the housing market, then they must address the fact that building new housing units appears to be a relatively expensive method of providing low-cost housing compared to the alternatives.

Nonhousing-related responses
Taken literally, a high housing cost-to-income ratio justifies increased nonhousing expenditures by the government. Observers care about high spending on housing by lower-income households because it leads to less spending on other items that observers consider necessary to thrive. The Minneapolis Affordable Housing Task Force (1999, p. 3) starts its report arguing that "children are going without enough food because their families cannot afford both food and rent." The notion that a high housing cost-to-income ratio justifies increased government support for nonhousing items may still seem counterintuitive and abstract. But simply consider the case of very high-income households paying more than 30 percent of their income on housing that can still afford large amounts of food, clothing, transportation and so on. We cannot believe that policymakers would support legislation to fix this "affordability" problem. This suggests that a high housing cost-to-income ratio in the absence of other nonhousing deprivations cannot be the source of policy concern.

If the problem is too little consumption of nonhousing goods, the government should increase its support for low-income households' acquisition of food, utilities, health care and the other items that high housing costs may limit (see Olsen 2001 for a discussion of this point). Subsidizing housing does not seem to be a cost-effective method for increasing a household's access to nonhousing goods and services. Programs that subsidize housing naturally seek to increase consumption of housing and thus drain away resources from the ultimate goal of increasing the delivery of nonhousing items. To increase a household's consumption of nonhousing goods by a dollar would require the government to spend more than a dollar, maybe much more, if the subsidy is restricted in its use to housing.

So a logical response to a high housing cost-to-income ratio is to directly increase the income of low-income households. The Earned Income Tax Credit is an example of a program that provides a cash transfer. Cash has the attractive feature of allowing the recipient to determine the highest-value use of the money. Alternatively, the government could provide these low-income households with additional food stamps, health insurance and similar benefits that make nonhousing items more attainable.

We emphasize that our argument for a nonhousing response to a supposed housing problem would not apply to households whose resources are so limited that they have no shelter. Food could not replace housing for these households. However, the number of households that would fall into these categories is a very small part of the population.

Some might object to policies that address the income aspect of the housing crisis through cash or other nonhousing transfers. We now turn to policy responses that would seek to subsidize the consumption of housing.

Housing-related responses: vouchers vs. production programs
Some policymakers would only support policies that direct government funds to expenditures on housing. A particularly important question for policymakers is if they want to subsidize specific new units or tenants through a housing voucher.

A summary of available research on housing assistance aimed at low-income households, albeit often limited and dated, offers several reasons to support vouchers. The most important in our view is that vouchers provide affordable units at a much lower cost than new production programs by relying on older, already existing housing units (the kind of housing that nearly all households live in). The General Accounting Office (2001, p. 2) recently found that after controlling for unit size and general location, "total per-unit costs for housing production programs are from 32 to 59 percent greater than for housing vouchers in the first year and from 12 to 27 percent greater over 30 years." Because they are more cost-effective, vouchers could serve more households than production programs.

More generally, a shift to vouchers is also consistent with the view that the "housing" problems for low-income households represent "income" problems. The voucher system relies on private markets to provide low-cost housing. Vouchers increase housing consumption by increasing the income of households. Private markets can provide lower-cost housing more cost effectively by relying on existing units than can new production programs. As the case of filtering revealed and Quigley (1999, p. 48) highlights, "It is far more expensive to create low-income housing through new construction than through depreciation." A wide range of economists argue that increased income for poor households represents the most effective policy solution for an affordability problem.

As long as private markets are not overly constrained by regulation, the increase in consumption catalyzed by the voucher program should signal private markets to increase supply. Thus, vouchers should be effective even in areas with low vacancy rates over the long run. However, in cases where regulation binds the market's supply response, the increase in consumption induced by vouchers may only end up raising prices. In these cases, policymakers should consider attempts to reduce regulation, although, as discussed in working paper Appendix 4, making such changes will be a challenge.

Suggested Readings

Advisory Commission on Regulatory Barriers to Affordable Housing. 1991. Not in my back yard. Washington, D.C.

Downs, Anthony. 1991. The Advisory Commission on Regulatory Barriers to Affordable Housing: Its behavior and accomplishments. Housing Policy Debate 2 (4): 1095-1137.

Fischel, William. 1990. Do growth controls matter? A review of empirical evidence on the effectiveness and efficiency of local government land use regulation. Cambridge, Mass.: Lincoln Institute of Land Policy.

General Accounting Office. 2001. Federal housing programs: What they cost and what they provide. July 18.

Glaeser, Edward and Gyourko, Joseph. 2002. The impact of zoning on housing affordability. Working Paper 8835. National Bureau of Economic Research.

Linneman, Peter and Megbolugbe, Isaac. F. 1992. Housing affordability: Myth or reality? Urban Studies 29 (3/4): 369-392.

Malpezzi, Stephen and Green, Richard. K. 1996. What has happened to the bottom of the U.S. housing market? Urban Studies 33 (10): 1807-1820.

Mayors' Regional Housing Task Force. 2000. Affordable housing for the region: Strategies for building stronger communities.

McFate, Katherine. 1999. General commentary. Federal Reserve Bank of New York Economic Policy Review 5 (3): 171-177.

Minneapolis Affordable Housing Task Force Report, July 15, 1999.

Nelson, Kathryn P. U.S. Department of Housing and Urban Development. Testimony before the House Committee on Financial Services, Subcommittee of Housing and Community Opportunity, May 3, 2001.

Olsen, Edgar. O. 2001. Housing programs for low-income households. Working Paper 8208. National Bureau of Economic Research.

Orr, James A. and Peach, Richard W. 1999. Housing outcomes: An assessment of long-term trends. Federal Reserve Bank of New York Economic Policy Review 5 (3): 1-11.

Pozdena, Randall. J. 1988. The modern economics of housing. New York: Quorum.

Quigley, John. M. 1999. A decent home: Housing policy in perspective. Working Paper W99-007. Institute of Business and Economic Research, University of California-Berkeley.

State of Minnesota, Office of the Legislative Auditor. 2001. Affordable housing.

Susin, Scott. 2002. Rent vouchers and the price of low-income housing. Journal of Public Economics 83 (1): 109-152.

Turner, Margery Austin. 1998. Moving out of poverty: Expanding mobility and choice through tenant-based housing assistance. Housing Policy Debate 9 (2): 373-394.