There’s an apparent contradiction in urban America’s real estate market. On one hand there’s a general housing shortage, namely of affordable workforce housing. But there are lots of luxury condos that get built and stay empty, unable to sell at their exorbitant prices. The New York Times recently cited a report stating that a quarter of condo units built in New York City since 2013 haven’t sold. Similar tales can be found in fellow superstar cities like Seattle and San Francisco.
These vacancies provide ammo for those pushing a Nimby agenda. They will use it as proof that there isn’t really a home shortage, or that no amount of new construction will cool prices. Others, noting that empty units outnumber the homeless population in some cities, call for vacancy taxes, or expensive programs to repurpose these units for low-income housing.
But these arguments misunderstand real estate economics. Just because new luxury condos sit empty doesn’t mean there’s a housing glut, nor does it mean that the condos themselves are in low demand. Let me explain.
I’ll start with the mistaken idea that unsold new units signal a glut. If someone wants a better sense of whether or not their city has enough housing, they should look up vacancy rates. The rental vacancy rate in healthy markets is between 7-8 percent, and is now 6.8 percent in the U.S. But in America’s most expensive metros, it’s far lower. According to Realtor Magazine, the 10 metros with the lowest vacancy rates read like a who’s who of the ones with affordable housing problems. They include Boston (6.5 percent), Washington, DC (6.3 percent), San Francisco (5.6 percent), Denver (5.3 percent), and San Jose (4.3 percent). Metro New York City has a higher rate because of some distressed suburban markets, but in the city proper it’s 3.6 percent.
In contrast, just looking at the vacancy rate of new condos is misleading, since it’s a smaller sample size. The Times headline may have blared out that one in four new condos were unsold—but that’s still only 4,100 units, a tiny number in a city with 3.4 million total units and 8.5 million people. Their vacancy, moreover, doesn’t mean there’s no demand for them. Rather, they’re part of a unique sales cycle, which leads me to my second point.
All products have sales cycles that involve spending some time as unsold inventory. For example, grocery stores are full of food that sits “unsold” on shelves. But that food is part of a standard inventory turnover process—it is put to market for a short period, usually sells well before it perishes, and is replaced by new food. The same thing happens for clothing, cars, furniture, and everything else, although the length of the sales cycle varies by product.
The average time that homes sit on the market is 2-3 months. A standard absorption rate—or the percentage of available units in a market that sell in a given month—is 15 percent. That means a major metro with, say, 30,000 units on the market will generally sell about 5,000 per month, leaving 25,000 units still available. And another 5,000 new units will likely be completed during that period, replacing what was sold. So if a metro routinely has 30,000 unsold units, some of which sit around for months or even years, that’s not a sign that its market has crashed. Those units are just the housing version of unsold food sitting on a grocery shelf. They are “on display”, so to speak, and most will be purchased in reasonable time.
For luxury units, the sales cycle goes even longer. The Times noted that some of the empty ones in New York had been sitting around since 2013. But many of them are vast Manhattan penthouses being listed at 7- and 8-figure sales prices. That kind of housing doesn’t play by the same rules as normal housing. Developers know there’s a strong but fluctuating market of foreign buyers who have vast resources, and can bite at any time. So developers purposefully bid up units, and keep them on the market for prolonged periods, in what is effectively an act of speculation. The carrying costs they’ll foot over these multiple years are minor compared to the windfall they’ll get if their unit sells at the marked-up price.
This is why new luxury condos stay empty, and why, despite the bad optics, that fact doesn’t matter. These vacancies don’t say anything about the larger housing picture, nor are they bad unto themselves. Calls to tax them are just a distraction.
Rather, the key to making housing affordable is broad land-use liberalization that will allow construction of units for multiple income levels. That way “luxury housing”, which is geared towards well-heeled buyers and thrives on speculation, isn’t the only type built.