In New York City, spillover effects from localized new housing construction driven by tax breaks for developers include higher rents for nearby tenants. Is there a better solution than tax exemptions? Read on…
Property Tax Incentives for New Housing Spurred Gentrification in New York City
by Divya Singh
January 10, 2020
Excerpts:
In recent decades, significant increases in the rent-to-income ratios have worsened the affordability of living in cities across the world. A widely promulgated solution is to build more housing in cities. But if there is an excessive demand for housing in cities, why don’t developers build more units themselves? Experts have identified strict land-use regulations as one plausible reason for why they do not. Another reason is the property tax, which, by taxing any improvements on the land, reduces the return on new investment, which in turn restricts housing supply. A plausible policy solution would be to provide a tax break on new residential investment. But this raises the question: who benefits from such a tax break?
In my job market paper, I estimate who benefits locally from the property tax exemption for new housing in New York City. I find that the property tax exemption increased the number of rental housing available. However, at the local level, a larger number of tax-exempt housing within a block distance from existing buildings increased their rents by 2%. At first, this is a surprising result because it suggests that this increase in local housing increased rents locally. However, I show in my paper that this is not surprising when we consider the additional effect of the new investment, or the amenity effect. In particular, new available housing attracted high-income tenants whose residence in the area increased attractive business amenities such as sidewalk cafes and restaurants. The increased number of businesses had a positive spillover effect on rents in nearby buildings. In other words, the arrival of new residential building spurred gentrification.
To provide empirical evidence in support of my conclusions, I leveraged a fascinating policy experiment in New York City, which increased the rental housing supply by more than 1 percent within a year.
To calculate the rent effects in the neighborhoods which received new residential investment, I collected and harmonized several datasets from city government agencies. I compared the rent growth in the existing buildings located near vacant parcels (and which are more likely to receive new investment nearby) to the rent increases in existing buildings located in the same census tract but not near a vacant parcel at the time of the policy reform (and hence less likely to receive new investment nearby). I found that a 1% increase in the local rental housing stock increased rents in nearby existing buildings by 1.8%.
To make these mechanisms clearer, I then investigated the changes in the demographics and businesses in the affected regions. I found that the number of high-income, college-educated, and white tenants increased in the tracts that received at least one project, compared with those census-tracts which received none. Additionally, there was an increase in the number of businesses (such as restaurants) catering to high-income residents.
The investment onslaught permanently altered some neighborhoods in the city. Neighborhoods in Brooklyn selected for treatment, compared with neighborhoods not selected for treatment, saw an increase in sidewalk cafes (which, we have seen, are associated with high-income customers) and a decrease in the laundromats (which associated with low-income tenants) following an increase in the new housing units. Existing building-owners invested more in their buildings and were more likely to apply for permits for renovation in regions which received more investment.
The gentrification effects could partially explain why there is often local opposition to new housing. Existing low-income residents who do not value amenities brought-in by high-income residents are financially worse-off, which I calculate to be about $500 per unit per year.
Overall, the results highlight that it is crucial to incorporate such spillover effects when designing tax policies that encourage new residential investment.
Comments:
The first question raised is why don’t developers build more units themselves, without financial incentives? Singh gives us the answer many economists are increasingly stating: the property tax, which, by taxing any improvements on the land, reduces the return on new investment, which in turn restricts housing supply. But, does this fact give credence to the idea that the most plausible policy solution is providing a tax breaks on new residential investment? We believe this is not a good solution, but rather a costly give-away. A better solution is to change the property tax so that, without losing revenue, it eliminates the negative incentives (higher taxes on improvements) and replaces them with lower taxes on new residential investment. The incentive effect is further enhanced by raising the tax rate on land, thus discouraging speculative land holding. This is a land value tax.
Now the question becomes: does land value taxation (LVT) spur gentrification by raising rents on nearby properties? First, the practice of giving tax exemptions for newly constructed multifamily buildings tends to be localized, kick starting rapid construction activity, as owners of vacant land in urban cores usually have ready access to property investment capital. Furthermore, the zoning code limits what densities are allowed in a particular local area, therefore exerts a more immediate influence on building construction. A single zoning change can multiply the number market-rate housing units in a small area. In both cases nearby rents are likely to increase as those owners bring contract rent levels in line with full market rents. This is what Singh’s study observes.
On the other hand, LVT is also more of a background policy, with long-term effects. It also has a more widespread effect, covering an entire jurisdiction. Thus, all owners of land benefit by increasing their building values, no matter what zoning or targeted incentive programs come into effect. Nevertheless, because low-income residents tend to be renters, they would still be in a more disadvantaged position as the surrounding area gradually becomes gentrified through market rate construction and any concurrent amenity upgrades. Recognizing this reality however does not rationally submit to the opposition to new housing. Rent levels are governed by supply and demand; high demand with short supply attracts top-feeder investors who prefer the luxury market.
A recent ECONorthwest study for Portland Business Alliance found that despite the production of new housing units in recent years, the Portland region fell behind as newcomers outpace new supply. To keep pace with population demand, developers need to build 103,000 new units this decade; but only 79,500 were built so far. The ratio of new housing units built between 2010 and 2018 for every ten new households is 8.5. Portland needs a boost to housing supply.
Yes, low-income renters and owners will require financial assistance to keep from being rent-burdened or cost-burdened. One of the mitigation measures accompanying the implementation of LVT is a property tax deferral. This recognizes that a homeowner’s equity build-up constitutes future wealth but not a liquid asset accessible for payment of taxes. The issue that currently demands our urgent attention is displacement.
The solution to rising rents is not to curtail tax policies that encourage new residential investment. To the contrary, we need tax policy such as LVT to incentivize new development – to substantially increase the housing supply, especially multi-family housing. Multi-family units are less costly to build than single-family homes and are in fact favored by LVT because the sites are more building intensive. What we don’t need is tax policies in the form of property tax exemptions which entail revenue loss.
Finally, contrary to popular perceptions, there is compelling new evidence based on enormous data sets, that building many more homes in neighborhoods has almost no net effect on displacement in those neighborhoods but does lower rents, even in buildings very close to the new ones being built.
[from Alan Durning’s blog: KNOW THINE NIMBY (Feb 14, 2020). Alan is executive director of the Seattle-based Sightline Institute.]
So here we have it, a solution to rising rents and displacement: Usher in a progressive form of incentive property taxation (LVT) instead of giving out tax breaks; incentivize the development of many more multi-family dwelling units on vacant and underutilized land by shifting the tax rates off buildings onto land; and minimize owner cost burden with a tax deferral strategy and renter cost burdens with rent supplements.
