How growing income inequality affects places, part 2: The favored quarter gets richer, the wrong side of the tracks still suffers

The same divergence in fortunes appears to be accentuating price differentials between metropolitan sectors (essentially, “sides of town”). In an economy where the rich are getting richer than everyone else, the rich side of town is also increasing its comparative advantage over everywhere else.

LA office rents

This split was apparent during a recent trip to Southern California. The region might still be “polycentric,” but where one side of town — the Westside favored quarter — now completely dominates local wealth creation. What were merely lopsided prices before have now become absurdly imbalanced, with mediocre buildings on the Westside commanding top rents while perfectly nice areas, like Long Beach and Pasadena, are lagging badly.

In cities where houses or offices on the “right” side of town are scarce, such real estate becomes a privilege only available to the wealthiest people — who, as we’ve noted, are getting wealthier. Even though real estate prices generally track local incomes, the favored quarter of Los Angeles now has prices that track only the exploding incomes of the ultra-rich.

This Redlands ISEA animation of LA-area housing prices from 1988 to 2011, over the course of several cycles, illustrates the “flight to quality” that has occurred during the three busts (mid-90s, early-00s, 2010). At the start, high-value areas are relatively well dispersed across the basin, with only the inner city (particularly the near south and east) suffering from low prices. But, over time, the cumulative advantage of being near the beach increases over time — especially because prices don’t fall as much during the busts, but grow by just as much during the booms.

The trend is perhaps in sharpest relief in high-Gini areas like LA, but is broadly occurring across the country. Joe Light reports in the Wall Street Journal that lower-priced houses are lagging even as prices nationally rebound:

Between January 2006 and May of 2015, the median value of homes in the bottom third of the market has dropped 13% to $101,900, according to Zillow. The median in the middle third is down 6% to $172,600, while in the top third it is off 4.5% to $325,800… The [disinvestment] cycle has been hard to break in large part because low-wage workers have seen little, if any, income growth during the recovery—putting them in weak position to qualify for mortgages.

Recently, Rolf Pendall at the Urban Institute identified the most and least privileged neighborhoods in metro areas nationwide in the 1990, 2000, and 2010 censuses. Over those two decades, the most privileged neighborhoods saw home values rise by an extra $80,000, and their residents actually benefitted from that gain — their homeownership rate is twice as high as in the least privileged neighborhoods. (Since fewer than half of households in the least privileged areas are homeowners, their property value gains accrued to someone else.) Privileged neighborhoods also stockpiled human capital: the growth in their college attainment rate was four times higher than in the least-privileged areas.

This has tremendous implications for intergenerational social mobility, which is closely tied to income, human capital, and wealth. Not only do wealthier families have more private resources for their children, but in a country where schools are largely funded with local property taxes, wealthy communities have more public resources for their children. Thus, the “segregation tax” that penalizes property values in majority-minority communities creates a vicious cycle, and one that is only getting more pernicious — sadly illustrated recently by the events in Ferguson, Missouri.

Locally, stagnant housing prices in Prince George’s County have contributed to an ongoing foreclosure crisis. Stagnant housing demand from the “underwater limbo” is compounded by its relative isolation from the favored quarter’s jobs engine, and the area’s ongoing “segregation tax” discount. For example, in 1965-1975, the Levitt firm built two large “Levittowns” in suburban DC — Belair in north Prince George’s and Greenbriar in south Fairfax. Even though these are the favored and less-favored sides of their particular counties, near-identical ranches recently sold for an average of $300K in Bowie and $440K in Fairfax.

Meanwhile, formerly moribund downtowns adjacent to job-creating Favored Quarters are finding some success reinventing themselves as the easiest place to add new residential, away from the fierce FQ NIMBYs. The boom in downtown LA’s residential and retail market diverges sharply from its flatlining office market — which still suffers from 20%+ vacancy even though dozens of office towers have been converted to other uses. Downtown Atlanta and Dallas are similarly benefitting from escalating prices to their north.

Friday photo: Greedy developers built your city

Two rental houses on Capitol Hill

I recently came across these plans by a fantastically wealthy land speculator, seeking to profit by ruining DC’s pristine Capitol Hill neighborhood with a towering building crammed full of tiny rental “microunit” apartments for immoral singles — rather than wholesome nuclear families! This kingpin practices his avarice from posh Fairfax County, within a “resplendent” mansion overlooking the Potomac.

This paragon of greedy, out-of-town developers is, of course, George Washington, the very namesake of Washington city. Cities don’t arise via immaculate conception; they’re built by developers.

[The plans in the photo above are from GW’s Albert Small Collection. John DeFerrari’s book Lost Washington has a much more detailed account of the houses. Washington wrote to his architect, “Although my house, or houses… are I believe, upon a larger scale than any in the vicinity… capable of accommodating between twenty and thirty boarders.” A later, even greedier, developer popped up (and popped-under) the ruined buildings in the aftermath of 1814’s fire, and the buildings grew to six stories tall. Anti-pop-up NIMBYs take heart: it then descended into criminal infamy and was bulldozed for a park.]

How growing income inequality affects places, part 1: Rich metros are getting richer

graphs from Emerging Trends 2015

No, it’s not just you: prices are increasing faster in gateway cities than in “nonmajor markets.” Graph from ULI/PWC’s 2015 “Emerging Trends.”

One of the over-arching trends in the post-industrial economy is that the rich are getting richer, to a great extent because technology makes it easier to increase returns towards a few, at the expense of the many. Researchers have recently found that a substantial proportion of wealth inequality is due to higher housing prices — so, it stands to follow that the places which house rich people would also get richer.

Earlier, I wrote that previously accumulated human capital advantages means that “The most valuable places are becoming even more so: they account for not only an outsized share of wealth but also the gains of recent years.” This appears to be taking place both between metro areas and within them.

The combination of recession and recovery have had very differential impacts on metro areas, according to the Brookings MetroMonitor. Metro economies whose wealth was tied to housing or manufacturing have lagged, while those tied to technology and energy have grown substantially. (Necessary caveats: This map shows change in gross output, which is heavily influenced by population — both baseline and growth. Thus, it may overstate growth in smaller, faster-growing metros and understate growth in larger, slower-growing metros. Also, the fossil-fuel extraction industry has done very well recently, explaining one-third of Texas’ relative gains, but past performance does not necessarily predict future results.)

GMP change in recent years

So, to some extent, differential price gains are related to income gains — after all, property prices generally track local incomes. Yet prices in first-tier cities, as shown in the graph above, are increasing even faster than incomes, and some form of the hated “speculation” may be at fault. Property in these so-called “gateway cities” is an increasingly popular investment for institutional capital — the money managers who store wealth for the rich. Institutional investors have raised their allocation to real estate by over 50% since 2010; super-low interest rates on cash seem to be behind a surging interest in “alternative asset classes.”

Gateway cities’ large markets and great name recognition means that their real estate values are more stable, transparent, and liquid than smaller cities’ markets. Investors are willing to buy property in gateway cities at lower yields, and thus higher prices (from CBRE’s 2nd half 2014 capitalization rate report):

CBRE 2H2014 cap rates east

Buyers in Baltimore expect 7% yields on their investments, while buyers in DC expect 4.75%. That doesn’t sound like a huge spread, but it’s a 47% difference — a building earning $1M a year in income would command a price of $14,285,714 in Baltimore, but $21,052,631 in DC.

Note that the list is bifurcated: Boston, DC, and NYC, the gateway cities, are all 5% or under, and everywhere else is 6% or up. Investors are willing to pay a lot more money to get the same income in larger (and more reliable) markets, and so prices get bid up.

The same factors that draw equity (ownership) investment to gateway cities also draw commensurate amounts of debt investment — amplifying equity’s effects two to four-fold. Leverage creates a vicious cycle, as we saw during the housing boom: Banks lend based on comparable sales; higher comps mean higher prices are justified, which results in more debt, which raises comps even higher for the next guy.

Friday photo: The first sprouts in a freshly plowed field will be weeds

Country road again

An ecological analogy for retail:

Many of the plants we call weeds originally evolved in tough conditions, where there is annual glaciation, periodic flooding, or severe fires – extreme events that leave exposed, bare earth. It’s in these devastated conditions that our weeds are at home. They germinate first and grow the fastest. And through these characteristics they have found important roles in re-establishing healthy ecosystems… Once the weeds are established, longer-lived plants, less adapted to disturbance, germinate and the process of succession begins. The process may end in a grasslands, woodlands or forest, depending on the soil and climate. Indeed, the weeds create the conditions of their own inevitable demise – inevitable unless of course the disturbance recurs.

The “weedy species” that so many bemoan, the token dry-cleaners and fast-food joints that sprout in brand-new buildings, are one key to building a retail market. Over time, better adapted shops will take root — and given enough stability, species will evolve into very specific ecological niches. These new species will both adapt to their environment, and also change the environment around them. The key is to give the habitat time to evolve by avoiding excessive disturbance — a condition ecologists call “disclimax.”

Cultivating biodiversity requires striking the right balance between stability and renewal. The goal should be less to conserve individuals than to maintain the health of overall communities, to not seek out stasis forever but to manage change for the long term.

Gradual change within human communities also helps to sustain and build linkages, according to a paper by sociologist Katherine King: “A gradual pace of redevelopment resulting in historical diversity of housing significantly predicts social relations.”

CNU conversations: Striking before the neighborhood’s hot

DeKalb Market, Long Island University

Yet more thoughts from our (apparently quite long) lunchtime conversation about community-building.

We talked extensively about how, but where would these strategies have the greatest impact? It’s important to jump off the price escalator — to opt out of the gentrification process — early on, before outside capital floods into the neighborhood.

The “tipping point” in neighborhoods is always tied to outside money. First, an urban neighborhood is “discovered” by suburbanites looking to spend their extra $20s in cute restaurants, then by institutional investors looking for $2 million investments, and pretty soon the whole place jumps the shark. But if the small dollars are ever going to have a chance to win the game, they’re going to have to start early on — or else console themselves to small, subsidized slices of the neighborhood, post shark-jump.

“Favored quarter” locations in gateway cities are probably too far gone (more on this in a future post). Even the immediately adjacent areas have probably been bid up too far to be affordable without turning to outside capital. A Place Corp takes a substantial investment of time, rather than money, so the key is not to overpay.

One approach that can work where explosive change appears inevitable is what I’d call a “waterfall TIF.” This uses redevelopment revenue from a “sacrificial” area — for instance, an underutilized industrial corridor separating a gentrifying area from a stable area — to shore up the affordable housing stock in adjacent areas. Two examples:

  • The Hill District in Pittsburgh is a historically poor, African-American neighborhood overlooking downtown. The Lower Hill was demolished for urban renewal, displacing 8,000, but it was never fully developed, except for one arena. A recently adopted TIF to develop the site will direct property tax revenue “into two separate accounts: one for infrastructure needs in the Lower Hill and one for reinvestment in the Middle and Upper hill.”
  • In Houston, the Midtown TIRZ spent $15 million to purchase 34 acres of the adjacent Third Ward, including hundreds of vacant lots, which was then handed to nonprofits and thus taken off the market.

By the time the usual affordable-housing resources, like TIF funds and inclusionary units start to flow, it’s already too late — prices will already be on an upswing. For maximum effect, resources need to start flowing before new construction and new investment create new amenities, which raise property values. Of course, this requires neighborhood organization (and probably capacity-building) beforehand, to identify areas about to undergo change, and to plan for the process.

Think of it as an approach comparable to Transferable Development Rights, which have preserved many rural communities, just applied to urban communities instead. To use the photo as an example, imagine if some of the value created by the Downtown Brooklyn rezoning (affecting the sites in front of Flatbush) could also have steered capital funds towards rehabilitating and expanding NYCHA’s Ingersoll Houses (at back right).

Friday photo: Vanquished twin cities

Pittsburgh various

Vanishing twin syndrome” is an eerie phenomenon wherein one fetal twin seems to absorb another. Its counterpart, in the annals of American cities, might be called “vanquished twin syndrome”: where one city annexes another, then proceeds to obliterate any trace of its core through concerted redevelopment.

Three of the more notable examples are cities settled at confluences, which naturally offer a choice of multiple townsites on various riverbanks.

Denver faced Auraria across Cherry Creek, the Allegheny River separated its eponymous town (pictured above) from Pittsburgh, and the fork of the Milwaukee and Menomonee rivers fostered three towns — Juneau (east), Kilbourn (west), and Walker’s Point (south).

Yet as these towns were absorbed into larger cities across the way, the old downtowns of Auraria, Allegheny, and Kilbourn all declined into Skid Rows, offering a uniquely cheap combination of deteriorated, frontier-era buildings within a short walk of the principal downtown. Shunned and looked down upon by the ascendant city’s downtown elite and starved for resources (namely the intra-city transportation links that funneled commuters to the principal downtown), they became prime targets for urban renewal.

Kilbourn was wiped out early on, by a City Beautiful government complex. Allegheny’s center was leveled by Alcoa in the 1960s. Auraria was demolished for a university campus in the 1970s.

In a weird twist on the theme, Minneapolis absorbed its rival St. Anthony — but proceeded to tear down its own birthplace, while neglecting its rival for so long that it remained standing until the adaptive-reuse age could rescue it.

Friday photo: Bonsai, artificial limits to growth, and humility

Phipps: bonsai since 1960

Cities are living things that require supporting infrastructure: physical infrastructure, social infrastructure, green infrastructure. They also need room to grow and change.

The exception that proves the rule are bonsai, “the most unnatural nature that exists.” Trees can survive when confined to tiny boxes that constrain their growth. This 55-year-old Scotch Pine at the Phipps Conservatory would, on a managed plantation, have a trunk one foot wide — wider than the magazine at right, about half the diameter of the planter this tree lives in — and be 60-80′ tall.

However, bonsai require a lot of care and feeding just to survive, including extensive pruning to thwart natural growth instincts. Without that pruning, the tree gradually consumes all of the soil’s nutrients and starves. All this intervention turns what should be a robust, independent tree into a fragile hothouse flower, subsisting on life support. At this juncture, even if it was freed from its constraints, this tree could never match the size of its wild counterpart. It’s a neat inversion of the usual relationship between man and nature, but like seeing a bored tiger at a zoo, it’s also a bit sad to see.

Natural systems also impose limits on their own sustainable growth, of course. Cycles see growth culminating in decline and death, then renewal and evolution. But nothing that’s alive stands perfectly still.

Those who propose to stop growth should have the humility to acknowledge that doing so will change the very nature of growing things. By giving themselves free rein to change the city, they are placing a tremendous burden on the resources of future generations.