A working paper from scholars at the University of Minnesota’s Center for Urban and Regional Affairs, “Build Baby Build?: Housing Submarkets and the Effects of New Construction on Existing Rents” finds that new market-rate construction has varying impacts on the rents of nearby homes. Within the first two years after construction, proximity to new construction raises the rent of lower-priced rental housing, but either depresses or has no impact on the rents of higher-priced rental homes.
The authors created a novel panel of rental prices for one- and two-bedroom market-rate apartments in Minneapolis, MN, from 2000 to 2018, using survey data collected by the commercial real estate analytics firm CoStar. To test the impact of new rental construction on nearby rents, they identified older buildings (built before the year 2000) located within 300 meters of at least one new building (built in 2000 or later) as a treatment group. They also identified older buildings between 300 and 800 meters of new construction, to serve as a comparison group. The study identifies 55 new-construction buildings, 136 “treatment” buildings, and 265 comparison buildings.
They assigned each older building to one of three market tiers or submarkets based on average rent in the building: low, middle, and upper. Researchers hypothesize that changes in housing supply will not have a uniform effect on the entire housing market—that the effect can vary by market tier. For example, luxury apartments are generally not substitutions for homes at the bottom of the price spectrum, so they can be characterized as in different market tiers.
Rents rose through the Minneapolis rental market during the study period. The average rent in existing low-tier units, including treatment and control group units, was $553 in 2000 and grew 43% to $787 in 2018. Rent in existing middle-tier units grew 40%, from $662 to $924. Rents in existing upper-tier units grew 33%, from $903 to $1,193. New construction occurred almost exclusively in the upper market tier, with an average effective rent in the first year of $1,727.
The majority of neighborhoods receiving new construction were in core urban areas adjacent to downtown Minneapolis. These neighborhoods had higher median values, higher percentages of residents with college degrees, and more white residents than neighborhoods that did not receive new construction. From 2000 to 2018, rent rose twice as fast in these areas, and median household income grew 84% faster.
The authors first look simply at the effect of proximity to new construction on rents across quality market tiers. On average, older buildings within 300 meters of new construction experienced no change in rent relative to buildings 300 to 800 meters away. They then distinguish the effects of proximity to new construction on rents in low, middle, and upper market tiers. Rents in low-tier units close to new development were 6.7% higher than units in the further-away comparison buildings, following the completion of new buildings. The authors observe a sharp increase in rent in these units in the year preceding the completion of new buildings, which they attribute to an anticipatory effect. There was no significant effect on middle-tier units. Rents in high-tier units were 1.7% lower than comparison buildings, though this difference was not statistically significant. The effect of new construction was strongest at very close distances (within 200 meters) and decayed as distance increased. These effects weaken but are still observable for at least two years post-completion. After one year, rents in high-tier units within 300 meters were 1% lower than further-away comparison units, and rents in low-tier units within 300 meters were 3.4% higher than comparison units.
The authors interpret these findings as evidence for a supply effect: new construction serves as a plausible substitute for existing upper-tier units and therefore creates price competition in the upper market tier and slows rent growth. They interpret higher rent growth in the low-tier units as evidence of an amenity effect: new construction can increase demand to live in the surrounding neighborhood, attracting new restaurants, entertainment, and other amenities. Landlords may increase rents more rapidly when they expect increased demand.
These findings underscore the need for policies that protect existing low-income communities from higher housing costs and gentrification-related displacement. The study did not look at long-term effects of new construction on rents, so the findings do not necessarily contradict research that shows increased housing supply at all levels can improve affordability in the long term.
The paper can be found at: https://bit.ly/2JW78uV