Build, Baby, Build: The Effects of New Construction on Existing Rents

The US is in the midst of an ongoing affordable housing crisis, and there is intense debate among scholars and activists about the role that high-end luxury apartments may play in lowering rents for everyone, especially for those living nearby. A new peer-reviewed study co-authored by CURA senior research associate Tony Damiano explores how the construction of new, high-end apartment buildings affects rents in nearby existing apartment buildings in Minneapolis.

Some scholars hypothesize that the housing crisis is mostly an issue of supply and demand, and that the new high-end housing will absorb demand from higher-income residents in growing neighborhoods, thereby slowing rent increases for everyone living nearby. Others contend new luxury apartment buildings bring in new amenities and high-income residents, which could result in more demand and higher rents for nearby renters through gentrification.

In their new study, Build Baby Build?: The Housing Submarkets and the Effects of New Construction on Existing Rents published in the Journal of Urban Affairs, Damiano and his co-author, Chris Frenier tackle this question by studying how the construction of large luxury apartment buildings impacted rents in existing buildings in Minneapolis between 2000 and 2018, a period of rapid expansion and growth in the city.

In the rental housing market as a whole, the researchers found no statistically significant effect of new luxury apartment construction on rents in nearby buildings. However, when they broke out the rental market into segments, they found different results for high-end buildings and lower-end buildings.

Their results suggest that, rather than being an either/or effect, new luxury buildings have varying effects depending on the quality of the existing building. The figure below shows starkly different trends in rent depending on 1) whether or not the building was considered high or low quality at the beginning of the study period and 2) whether or not the existing building was close (within 250m) of a newly constructed high-end apartment building.

As the figure shows, rents in lower-tier buildings close to new construction rose about 15%, after adjusting for inflation, between 2010 and 2018 which was about 9  percentage points more than similar lower-quality buildings farther away from new construction. While, in contrast, at the top end of the market, they observed the opposite trend. Rent in existing buildings that were close to new construction were about 2.5% lower after adjusting for inflation compared, while high-end buildings farther away from new construction did not see their rents decline on average.

Change in Rent by Distance to New Market Rate Building by Market-Tier in Minneapolis 2010-2018

Source: author calculations, CoStar

While this chart is suggestive of different effects between market-tiers, there are a lot of confounding factors that influence the timing and location of new development and patterns in changing rent. Therefore Damiano and Frenier employ statistical modeling to better capture what, if any, of these differences in rent trends can be attributed to being close to new construction rather than some other reason. They used what is called Difference-in-Differences analysis to compare how rents changed for those existing buildings close to a newly constructed luxury building and similar buildings that were farther away from any new construction.

Estimated Effect of New Construction on Rents by Market-Tier with 5 Years of New Construction

Source: Author calculations, Costar

Even after using causal statistical modeling they found that in the first five years after new construction, rents in nearby pre-existing high-end buildings were slightly lower, by about 2%, than those in similar luxury buildings not close to new construction. The researchers posit that new luxury apartments directly compete with existing luxury buildings for high-income tenants, which results in slightly lower rents in that part of the market due to the supply effect.

In contrast, older, lower-quality buildings near new luxury construction had higher average rents (about 4.5%) in the first five years after new construction than existing lower-quality buildings located farther away from new construction. This suggests that for lower-quality buildings (more likely to be occupied by lower-income residents), the new high-end construction signals to existing landlords that there is demand to live in the neighborhood and that they can raise rents more than they would otherwise, which is evidence of the amenity effect.

The study points to two key implications. First, it validates the concerns among existing lower-income communities about possible gentrification due to new high-end development. New development can and does bring in higher-income residents and businesses that cater to them, and the findings suggest this can increase rents, at least in the short term. Second, while pro-growth policies like zoning reform are necessary,  they  are not sufficient on their own to ensure that new development benefits all residents, not just higher-income households.

From a research perspective, the authors emphasize that this study demonstrates the importance of understanding how policy changes and market interventions affect different populations and market segments in different ways. This is especially important in our current moment, which is marked by record-high income and wealth inequality.

From a policy perspective, the authors recommend a holistic approach to tackling the housing crisis. That means supporting the aforementioned zoning and permitting reforms, such as those in the Minneapolis 2040 plan, as well as policies that directly support affordable housing for lower-income residents, like vouchers, preserving and producing more permanently affordable housing, and tenant protections like just-cause eviction and rent stabilization.