If you don't understand filtering, you don't understand housing markets. Because lots of people plainly do not understand filtering, here's my attempt at an explanation:
When property values rise, low-quality housing "filters up" to the high-quality housing sub-market. The reason is that rising rents encourage landlords to invest more in the property. When property values fall, high-quality housing "filters down" to the low-quality housing sub-market. The reason is that falling rents encourage landlords to invest less in property. The key in either case is that old housing costs more to maintain than new housing.
Here's the longer version:
Housing naturally deteriorates as it ages. Stuff breaks. Stuff -- expensive stuff like the roof -- has to be replaced. Minor wear and tear accumulates over the years until the place is downright seedy.
Seedy, that is, unless the owner regularly invests in maintenance. Every homeowner knows that. It would be nice if the mortgage payment and property tax covered the cost, but they don't. Those occasional, "extraordinary" expenses turn out not to be extraordinary at all. And they are far more frequent for older home. Thus, as a house or apartment ages, it takes ever more money to keep it in good shape.
Every landlord with an old property confronts the same decision: Should I spend the money to keep the property in top shape, or should I let it go?
Keeping the property in top shape allows the landlord to charge more rent. But it also costs the landlord more in maintenance and periodic renovation, especially for old apartments. What the landlord decides to do depends on the current market, his estimate of future demand, and about a million other things. But we know one thing for sure: A landlord is less likely to maintain an apartment in tip-top shape when the rent for tip-top apartments is falling. Declining rents mean a declining return on the maintenance investment. That spells less investment .
Without constant maintenance, apartments deteriorate from "tip top" to "slightly dilapidated." Renters, sensible people that they are, are not willing to pay as much for bad quality. Rents fall, and the apartments "filter down" into the pool of affordable housing.
If you want more affordable apartments, build more tip-top apartments. Increasing the supply of high-quality apartments lowers the rent for high-quality apartments, all else being equal. Falling rents for the good units encourage landlords to let the older ones slide into the affordable sub-market.
On the other hand, if you want to raise the rents for older properties, then discourage the construction of new apartments. Restricting supply will raise the rents for high-quality housing, including older, well-maintained properties. Higher rents will encourage landlords to spend more on maintenance and renovation to move their properties from the low-quality sub-market pool to the higher-quality sub-market.
This is pretty basic supply and demand. But some people just don't believe it. I think there are three reasons.
First, apartment renovation usually coincides with new housing construction, and people mistake this association for cause and effect. Condos and apartments get built during periods of rising rents. Everyone understands that. But the same rising rents give landlords an incentive to invest in renovations and upgrades. We thus should expect new construction and apartment renovations to go hand in hand. These are symptoms of the same market forces, not cause and effect.
Second, people mistakenly use what is happening to their apartment to extrapolate to the entire market. The filtering process does not guarantee that every older property will become more affordable. On the contrary, as rents rise, some old properties will be torn down and replaced with new, more expensive units. The old units never get a chance to filter down. But this is simply an example of the "filtering up" that occurs when rents rise.
The remedy for "filtering up" is more housing, not less. If we halt new construction in order to preserve the existing stock of low-quality units, we guarantee that more of the low-quality units will eventually filter up. We cannot predict exactly which units will filter up and which will remain affordable. We just know that there will be more of the former and fewer of the latter.
Finally, neighborhood gentrification can blur things. Gentrification is a complex process. It typically occurs because other neighborhoods have become more expensive, pushing buyers and renters to what otherwise would be a less desirable neighborhood. The increased demand raises rents, which spurs more renovation. In other words, rising rents in one neighborhood can cause units in another to filter up.
Gentrification can also be spurred by falling crime rates, improved amenities (such as new parks or a decommissioned power plant), and by new investment in the area. Sometimes it's just chance. It is rare, though, that adding new housing causes a rise in rents. In fact, new housing would not be built unless rents were already rising. New housing is thus generally a symptom of gentrification rather than the cause.
- Are luxury condos downtown good for Austin's housing market? (Sept. 11, 2006)
- Those high-priced condos will be great for families with children. (May 28, 2007)
- Freeing up space for others. (June 7, 2008).