Why the new starter home is a rental for many low and middle-income households

We are in the midst of a major housing crisis. Rising rents and home costs are placing a diminishing supply of housing options out of reach for many low- and middle-income households. In the United States, rents in multi-family housing units peaked in quarter two of 2023, after increasing 19.2% since 2019. In November, 2023, Canadian rents were up 9.9% year-on-year. Often assumed to be an issue with social, subsidized or government-funded housing, our latest data reveals concerning challenges across a much wider spectrum of income levels.

Severe challenges persist in addressing social housing needs (England has 1.2 million households on a waiting list). It is a parallel deficit in attainable housing for middle-income households, however, that escalates new challenges for cities and broadens the impact of affordability-related issues.

Take London, UK, the London Plan has a 10-year target for the creation of 522,000 units, equating to 52,200 units per year. However, based on the Greater London Authority’s annual reporting, the city has yet to hit this annual target. If you consider that this is already a conservative target (in 2020, the standard method for housing needs estimated that 93,000 units need to be provided each year to meet London’s demand), it's easy to see how the housing deficit will continue.

There are insufficient subsidized or social homes or 'attainable' housing options for low- and middle-income households. The U.S. Department of Housing and Urban Development and the Canada Mortgage and Housing Corporation both consider a unit affordable when households are paying no more than 30% of their pre-tax income on housing costs. Attainable housing is often used to refer to housing that meets the needs of those households making between 80 and 120% of Area Median Income. Looking at the heatmap of nationwide rent burden in the U.S. below, a stunning proportion of the country sees at least 30% of households rent burdened. This indicates a critical lack of supply for a range of income levels.

Why is this crisis more relevant today? Looking at the 10-year house price-to-income ratio, we can see that house prices far outpace salaries. In Canada and the U.S., the 10-year ratio sits around 50% – housing prices have grown 1.5 times income. Potential homeowners must use an unsustainably high proportion of their annual income to buy a home. In England, data from the Office of National Statistics reveals that only the cheapest 10% of houses are now considered affordable for the middle-income bracket.

For many hopeful first-time homeowners, buying a home feels beyond reach. The global housing market is contending with the impact of high-interest rates and inflated construction costs. The average, annual percentage rate on a 30-year fixed mortgage is now nearly 8% in the U.S., up from 2.65% offered in January 2021. With interest rates expected to stay significantly higher than the norm for the last decade, many households will find it more challenging to access homeownership. And, households that have to re-mortgage to a much higher rate will see a substantial increase in their monthly mortgage payments.

This leaves house seekers asking: should I continue to rent? Many factors make renting more attractive – and feasible – than homeownership. In addition to mortgage payments, homeownership requires additional capital costs, such as a down payment, broker fees, interest payments and maintenance. These costs compound to produce a higher monthly cost for households. In the U.S., the cost of an average monthly home payment is now $3,322 – the average monthly new lease payment is almost $1,000 cheaper.

Renting also provides homeowners with more flexibility than homeownership. Tenants can relocate to a new home with greater ease than homeowners, a massive benefit if your housing needs change. Plus, rentals often come with better amenities and services, such as fitness centres.

Even if households are determined to buy, many will be unable to find a home they can afford. While increasing interest rates should put downward pressure on house prices, so far housing markets have been surprisingly resilient. There is a combination of factors behind this, but essentially supply has remained tight as forced sales and repossessions have been limited during the current correction, in sharp contrast to previous cycles.

Fundamentally, homeowners are often unwilling to sell their house for less than its perceived value unless they have to, limiting the supply. Additionally, the cost of a new mortgage is also a deterrent for homeowners who might look to sell. This 'lock-in effect' incentivizes homeowners to stay in their current home. With homeowners choosing not to sell and housing creation not up to pace, the number of affordable homes for sale continues to dwindle.

How can major cities work with the private sector to improve the delivery of attainable housing? Tax credits have traditionally formed the backbone of incentives that the public sector provides to further attainable housing development, but these are not the only tool in the public sector’s proverbial toolbox. Solving the housing crisis requires support from the public sector and this needs four key ingredients:

One of the largest challenges is the lack of available land for development. In European cities, there is little land left to be developed. Furthermore, zoning restrictions impede the delivery of multi-family housing units. The theme here is policies that promote density. Developers must be able to build more units on smaller lots for economic feasibility. However, the nature of density must suit the fabric of the community. Many communities with primarily single-family detached homes are not equipped to support mid- or high-rise multi-family housing developments. Instead, a sensible density change could alter zoning to allow for multiple housing units on a single plot or the introduction of Accessory Dwelling Units (ADUs), such as a garage apartment.

ADUs – and zoning reforms to permit ADUs – are emerging across the U.S. in answer to the housing crisis. As one of the hottest ADU markets in the country, Southern California has seen strong demand despite economic headwinds. Permit applications of ADUs across the state have increased steadily since 2017 with three times as many permit applications in 2022 at 30,000 applications. While there is some lag between the number of ADU permit applications and completed ADUs, the appetite for additional housing solutions suggests that permit applications will continue to rise.

Even as cities alter zoning codes and decrease the restrictions on multi-family creation, there is a larger, and potentially more formidable, obstacle for developers: the community members who say, “not in my backyard.” This is a notorious obstacle to large-scale urban development, but there is an important takeaway from the movement: it is critical to have community support. When proposals to increase density and deliver additional housing face opposition, how can we find a solution?

Early community engagement and urban mediation can facilitate productive conversations with community stakeholders and produce creative solutions. As my colleague, Eime Tobari, discussed, it is critical to figure out what 'good' looks like for each community. Residential developer, Groupe Prével, initially faced community backlash regarding its proposed Village Lacey Green development in Greater Montreal, Canada, as the project was going to require a change in zoning. Working with the community to find a solution, a task force was formed including representatives from Prével, the city and the community. Aided by an urban mediator, the task force found a design solution that worked for all.

The public sector has tools to leverage beyond tax incentives that help to address the barriers to affordable housing creation. In the U.S., planning requirements, such as parking minimums, limit the size of multi-family developments. Decreasing or eliminating mandatory parking minimums opens up a larger portion of a plot for development. The Lucy Gonzalez Parsons Apartments in Chicago, Illinois, replaced a city-owned surface parking lot with 100 new housing units, 50 of which are affordable, making 60% of the Chicagoland area median income. Chicago’s introduction of the 2022 Connected Communities Ordinance made the delivery of this 126,000 sq ft development possible through reduced parking requirements, expanded TOD boundaries and new guidance for density bonuses.

Besides loosening parking requirements, cities can also 'fast track' planning applications for certain affordable housing solutions. The London Plan introduced a fast-track route for development proposals that provide 35% affordable housing and meet other relevant planning requirements. Cities can use mechanisms, such as a fast track, that simplify the planning process to incentivize affordable housing creation.

Finally, density bonuses can be granted by cities for developments that deliver additional affordable housing. These bonuses come in multiple forms and can be used to increase the number of dwelling units per acre, increase building height and change the floor area ratio – or the proportion of a lot that is open for development. A density bonus introduced in San Diego, California in 2016 helped create 463 affordable housing units.

Beyond ensuring that neighbourhood infrastructure can support development, there is the challenge of delivering sustainable development. The public sector must consider the future of the built environment and the potential impacts and risks of our evolving global climate. The next wave of green infrastructure development — and how public transportation, energy, water and resource demands are accounted for — will heavily impact the capacity of cities to address housing.

Realizing a thriving housing sector across our cities is one of the greatest challenges ahead and one that requires strong leadership and creative solutions appropriate to unique regions and markets. I am confident that the real estate community can meet the challenge and prove to be transformative partners in the critical work of creating prosperous places that benefit all.