Understanding How Supply & Demand Impact Housing Affordability

In discussions surrounding housing affordability, the concept of supply and demand is often mentioned. You may have heard that zoning laws restrict the supply of housing, that state zoning bills will increase the supply, and that this new supply will lower prices. 

Basically, the more housing supply there is, the lower housing prices will be. This is supported by evidence too, with plenty of economic studies confirming it both in theory and practice. But how does it work in practice?

Let’s work backwards, first on prices, and then how supply and demand affects them. 

A Thought Experiment

Imagine you want to buy a new home, and imagine the housing market consists of one home, made by a developer. Why do you want that home? Because you want a place to live. Why does that developer want to sell you that home? Because they want to make money. So, what do they set the price at? Whatever makes them the most money: as high as they can go.

Still, there’s a limit to how high they can go, because they have to find someone who’s willing to pay that price. Good luck trying to sell a house for a billion dollars. Fortunately for them, and unfortunately for you, people really want to live in the neighborhood the house is in. Since they only want to sell one house, they only need one buyer, so all they have to do is find whoever is willing to pay the most. 

Think of it like an auction: everyone bids a higher price until one buyer, who is willing to pay more than the others, remains. If you can afford to pay more than everyone else, great, you have a home. If you can’t, you don’t.  

Where does supply come in? Imagine there is more than one house the developer wants to sell, instead they have a hundred homes. Now they don’t need just one buyer—they need a hundred buyers. 

Think back to the auction metaphor. The highest bidder is willing to pay a million dollars for a house, but the second highest is only willing to pay $950,000, and the third highest is only willing to pay $925,000, and so on, and so forth. So they can sell that first house for a million, but that second house goes for a little less, and the third house lower, and same with every house then on. The more houses there are, the more units that developers and landlords have to sell or rent, meaning they’re forced to lower prices in order to find buyers.

In Demand

Now you have a general understanding of how supply lowers prices. So does demand fit in? Demand determines how much buyers are willing to pay. If you try to sell a bottle of water in the middle of a grocery store, you won’t get very much for it. Not just because you’ll probably get kicked out, but because people can just buy a bottle for a couple bucks. 

Now imagine you’re selling a bottle of water to a couple of thirsty travelers in the middle of the desert. You’re going to get a lot more, because that bottle of water is a lot more valuable. Not only is there a limited supply of water, but the demand is very high. The same applies for housing. People are simply willing to pay more to live in San Francisco or New York City than they are in, say, West Virginia. Even if both places had the same exact housing supply, prices would still be lower in West Virginia, just because of the difference in demand. 

The Great Arizona Housing Drought

How does this fit into Arizona? For one, we know housing prices are high, with housing prices having almost doubled at $500,000 in the Phoenix metro since their previous peak in 2006. These price raises can clearly be connected to shortening supply. Simply, Arizona is rapidly growing, and housing construction has just not kept up to pace, with some calculations saying we are undersupplied by up to 133,000 units! People are moving here from places like California precisely because they are fleeing high housing costs. If we don’t do anything to act now, we’ll end up just like California—just without any beaches. 

We now know why more supply decreases prices, and more demand raises them. We also know supply is low, especially in Arizona, leading to higher prices. But why is supply low? Because cities’ zoning laws artificially restrict the supply. They do this in primarily two ways. 

The first is by limiting the amount of total housing that can be built. Since most residential zoned land is single-family, there are only so many units that can be built on a set amount of land. The second is that restrictive zoning laws increase construction costs. Many projects have long approval processes, with different levels of approval needed by the city council, each with a set of requirements. There are also often other boards that have to approve projects, such as design review. All of these requirements add up, both in time and money, which increase the cost of construction. 

These are important for price, not just because a lower supply leads to a higher price, but because a developer isn’t going to build homes they’ll lose money on, so they’ll never charge prices lower than construction costs. So the higher construction costs are, the higher prices will be. 

A Fixable Problem

Thankfully, zoning reform can fix this. By allowing missing middle housing like duplexes and triplexes to be built on single family zoned land, we can fit more housing in the same amount of space. We can also make the approval process more predictable and simplified, ensuring more housing is built for less money. With more units being able to be built, and with each unit being cheaper to build, we’d end up with many more homes at lower prices. 

Hopefully this intro on how supply impacts housing prices aids you in understanding why zoning bills like SB 1117 can help lower the price of housing in Arizona. Of course, the examples here aren’t 1:1 comparisons. If a developer built 1,000 homes they would probably sell them for very similar prices. Still, the principles discussed here do apply to the housing market on a larger scale. Building 100,000 new homes would make an impact on prices, and those numbers can be made even higher. 

More supply is key to lowering housing costs, so let’s work to increase supply. 

Want to write for us? We are always looking for writing about urbanism, housing policy, and related issues impacting Tempe and our state. Email us at TempeYIMBY(at)gmail.com

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