I grew up in Houston, and I’ve seen the benefits and the pitfalls of real estate development in perhaps the most lightly regulated city in the United States — a place where developers don’t fret about complex building regulations, because such regulations simply don’t exist.
The results are uneven, but can be inspiring. In the 1970s, for instance, Gerald Hines famously built the Transco Tower amidst wide-open farmland. The free market liked what it saw, and subsequent waves of development shifted the city’s economic and demographic epicenter.
Two thousand miles west, things look very different. California’s zoning regulations are so cumbersome that they’ve spawned an entire industry of “pre-developers” who have grown fabulously wealthy by obtaining entitlements granting other developers permission to build. This bottleneck has led to significant housing shortages, and left tenants and renters facing ludicrously high housing costs. Unsurprisingly, many low-income residents are now relocating to more affordable, lower-regulation states such as Texas, Arizona, and Nevada.
Of course, regulations perform an essential civic function. Without effective and properly enforced regulations — including peer-reviewed engineering and licensed inspections — we risk catastrophes like the Champlain Towers collapse. But such regulations always represent a trade-off. Too little, and you face a Wild West scenario, with the fate of urban communities entirely in the hands of developers — some of whom, regrettably, might cut corners. Too much regulation, though, and you choke the housing supply, and chase away residents who can no longer afford their city’s high cost of living.
The cost of regulation
Striking a proper balance starts with recognizing that even the best regulations carry a price tag — and that the bill ultimately gets paid not by developers, but by local residents. When planning a project, developers figure out the income it will generate, divide that by the cost to build, and use that yield to recruit investors. Each new regulation raises the cost to build, reducing yield and deterring investment — and as developers build fewer homes, the cost of housing increases.
Consider, for instance, the following types of regulation, all of which increase the cost to build:
- Building height restrictions, designed by local property owners to lock in the status quo.
- Zoning rules, which limit the kinds of properties that can be built in certain areas.
- Parking rules, which force developers to spend money building parking spaces, even as urban planners anticipate a future in which people won’t own cars.
- Design standards, which impose costly building requirements and can be incredibly strict in places where beauty is part of the local brand.
- Energy-efficiency rules, which place the burden of protecting the planet squarely on the shoulders of residents in new developments.
Making sense of all these rules imposes costs of its own. The California Code of Regulations contains more than 21 million words, versus 137,000 words for the average U.S. state, forcing developers to hire a small army of consultants and experts. Because of that, California’s affordable housing now costs an average of $400,000 per unit — three times as much as in Texas — and the state is seeing a serious shortage of blue-collar workers who have been priced out of their over-regulated communities.
A question of survival
That doesn’t mean we should toss out the rulebook. Our cities face enormous challenges, and governmental leadership will be vitally important in coming years. Houston and New Orleans suffer from flooding; Miami is grappling with rising sea levels; Los Angeles and San Francisco are dealing with homelessness. Such problems are real, and demand real solutions. But we can’t solve these problems simply by enacting regulations that shunt the cost of action across to developers.
In Houston, despite its hands-off reputation, developers of apartment buildings are now required to set aside up to 20% of their land for storm water retention — something that delivers no immediate benefit to the developer. Necessarily, that drives up the cost of development, and also the cost of renting an apartment. Effectively, the cost of flood prevention, which benefits the whole community, is disproportionately being borne by low-income renters — hardly an equitable way to solve the problem.
More direct action by policymakers also carries a cost, of course. In Miami, the U.S. Army Corps of Engineers has proposed spending $6 billion to build a six-mile long, 20-foot-high sea wall along the city’s waterfront, potentially lowering property values and driving up local taxes. Such measures are controversial — personally, I believe the Miami sea wall would be a mistake — but they foreground the true cost of action, enabling a meaningful debate about how much should be spent and who should foot the bill.
A better way
What’s the solution? It’s important to recognize that in the long run, this is a self-correcting problem. People will vote with their wallets. ff regulations choke the housing supply, they’ll move elsewhere. Similarly, if areas are overtaxed, or so under-regulated that they become unsafe or unlivable, people will relocate. One way or another, the law of supply and demand will shape the cities of tomorrow.
Once we accept that, it becomes easier to envision a more balanced approach. One useful step is to use incentives instead of regulatory mandates. Philadelphia recently offered developers a 10-year tax abatement for new construction. The following year, development increased by 39%. In coming years, increased supply will lead to lower rents, attracting more people to the city. That, in turn, will increase the tax base and enable better public services, ensuring both affordable housing and a better quality of life for residents.
Such solutions can be replicated in cities like Miami, Houston and San Francisco, but only if cities bring all stakeholders — including residents, businesses, and developers — to the table when considering new regulations.
Communities that get this right will deal proactively and transparently with future challenges, while avoiding economic contraction and population loss. By working together, and being upfront about the cost of proposed solutions, we’ll ultimately be able to solve the problems we face — while eliminating the red tape that threatens to hold back urban growth.
Daniel Ron is the managing partner at Scarlet Capital, a Houston-based real estate development firm.
This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners.
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