Why Foreign Money is Irrelevant to Increasing Density

On Monday, geographer Jim Russell published a post at Pacific Standard arguing why zoning for more density would do little to affect the cost of housing in cities such as San Francisco and Vancouver. Foreign demand for housing, he argues, undermines the efficacy of the density argument because so much of the housing stock they purchase remains vacant.

“I don’t see how greater density will help actual residents when a fuller picture of demand is painted that includes foreign direct investment in apartments that remain vacant.”

The concern over foreign money entering our local real estate market is not new, nor has it never been attached to housing price as an argument against density. I call this argument the “Foreign Money Argument.” But while Russell tries explain his concern regarding foreign investment in local real estate, his concern is irrelevant because if you're not building housing to meet demand, foreign or domestic, housing prices will go up.

Origin of Demand is Irrelevant

Whether or not demand for local housing is generated domestically or internationally is irrelevant to the need for increased density. Russell’s argument presupposes that foreign investors are interested in only new and/or high-rise luxury developments. For example, one of the common narratives against new development is that it’s only tailored for "luxury" residents.

“Most distressing is the real estate development aimed at investors looking not for shelter, but a place to park cash. Greater density for whom, Russian oligarchs?”

But this narrative assumes that not increasing density will exert downward pressure on the market—that those pesky Russian oligarchs will simply give up their plans to buy because the development project was denied. That is a ridiculous assumption.

With no new units to purchase, wealthy buyers simply out-bid competitors for existing units—units that would otherwise be made available to middle- and low-income individuals or families. By constraining the supply of in-demand units, overall housing costs increase.

On the other hand, even if we were to accept Russell's assumption that higher density development is what’s driving foreign demand in the local housing market, then increasing density should exert, at the very least, no upward pressure on other types of housing, while still relieving that pressure to whatever extent local buyers also buy the new high-density units.

Unit Occupancy is Irrelevant

In Russell’s post, the vacant units he refers to are largely luxury units in luxury buildings. While conceptually, the idea of a wealthy condo owner leaving his recently purchased luxury unit vacant can be infuriating in an expensive housing market, in all frankness, who cares? Middle- and low-income individuals and families are not in the market for luxury units. But, more importantly, even if you did care that it sat vacant; the state of the unit’s occupancy is irrelevant to its sale price.

Think of single-family home prices. If you want to sell a home, you hire a realtor and ask them what your realistic sale price is. For the realtor to give an informed number, he or she will first look around the market to see what other similar homes have sold for—comparables or "comps." When aggregated, those comps essentially create the overall cost of housing in your area. In no way does the occupancy of those homes or units affect the sale price. You could have a neighborhood completely devoid of residents, but as long as those units are actively sold and purchased, the cost of housing in the neighborhood will remain steady because the purchase price of your unit is only affected by the sale price of a comparable unit. Even if the neighborhood is lonely.

Foreign Money Primarily Affects For-Sale Units

Russell’s argument primarily applies to for-sale units, rather than rental units. As pointed out in Russell’s and similar posts, wealthy buyers are looking for investment property—something that will make them more money in the long run.  The purpose of buying an investment property is that you can sell it later at a profit, and you can only sell property you own, not rent. Not too many wealthy foreign investors rent apartments and then never live in them because rental units don’t appreciate in value that they can later collect. I’ve lived in my current apartment building for five years. If I move out tomorrow, does that mean I receive a check for a portion of the buildings value appreciation over those five years? Of course not.

The irony here is that failing to build more housing only makes foreign investment look more appealing because you are actually guaranteeing future scarcity—basically a guaranteed return on investment. Further, the fact that foreign money is primarily going to for-sale units over rental is actually very relevant to the density argument because it hurts renters.

Not Increasing Density of For-Sale Units Still Hurts Renters

When you don’t increase the available housing stock (i.e., density) to meet demand, you simply exert upward pressure on other housing prices. Because of the high demand, the market begins to find other ways to increase the supply of for-sale units, such as converting for-rent apartments into for-sale condos. For renters in places like California, this can lead to what are known as "Ellis Act Evictions."

For those outside of California, there is a law in this state called The Ellis Act (1985). In brief, the Ellis Act allows property owners to get out of the apartment rental business. Property owners are allowed to evict tenants (they are also required to pay them) so they may sell the property. When property owners utilize the Ellis Act, it’s usually for the purposes of converting low-rate rental units into higher-valued and in-demand for-sale condominiums.

When these conversions happen, you begin to see a decrease in the for-rent housing stock because they are being converted to for-sale units to meet that demand. As the supply of for-rent stock decreases it exerts upward pressure on rents not only because there are fewer remaining rental units, but because the refusal to increase density also results in fewer rental development projects which could adequately replace those lost in conversion. And as supply is constrained, the demand for rental units increase as the market now includes both pre-conversion demand and new demand.

We also need to acknowledge the fact that there are wealthy renters as well—those who are looking for luxury rental units to live in, not invest in. And just like in the for-sale market, as the supply of for-rent units decrease, the competition (demand) for the available rental units increases. Now wealthy renters are competing with, and out-bidding, the likes of you and me for otherwise reasonably priced rental apartments.

By not increasing density, the end result is higher for-sale and for-rent housing costs across the local market.

Missing the Forrest Because of the Trees

It is true that a lot of foreign money is buying local property. But this concern and argument is irrelevant to the need for increased density because it ignores the simple fact that demand is not limited to a specific type of housing, nor does the market care where demand originates. In the absence of policy mechanisms specifically targeting foreign investment, building more high density housing that appeals to foreign investment has at worst a neutral impact on the price of other housing, but is more likely at least marginally positive in terms of relieving market pressure and, if nothing else, helps the likes of you and me avoid being out-bid in our own backyard.