Talk Your Book: Why We Don't Build Enough Houses

0:04Welcome to Animal Spirits, a show about markets, life and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:34We're joined today by Kobe Lefkowitz. Kobe is a partner at Backyard, a real estate development firm based in California. Kobe, welcome to the show. Thanks so much for having me, Michael and Ben. Great to see you as well. So housing affordability, major, major issue. And every time we hear the same answer, they're not building enough houses. I don't know what that means, but I know that you do. So for our audience, we're going to talk all about the housing shortage today and why you can't just build more houses, which seems to be the sensible solution here. Before we get to that, give us a bit of your background.

1:11How did you get into the real estate industry? What do you know? Just give us your credibility before we start asking all these sort of questions. Sure. Yeah. So my background is an urban planner. I went to architecture school, wanted to draw a little bit, wasn't technically gifted enough, shifted into planning, but always knew I wanted to get back into real estate development. And so urban planning is really the meat of what's behind our housing shortage. We're trying to understand that because without planning departments, there's no zoning codes or building codes. And so that really is the operating entity that drives through a lot of these questions that we're going to answer today.

1:48After school, I went and worked for an institutional REIT based in Washington, D.C., doing some asset management and portfolio management, a little bit of acquisitions work before moving up to New York to do development, a little bit more asset management for a smaller boutique firm doing multifamily, a little bit of hospitality before striking out on my own with a couple of partners where we build infill apartment buildings in Southern California and now trying to bring some work back in New York. So what is your general feeling of the housing market? It's kind of a squishy question, but how does your experience with the housing market shape of what you're trying to do now?

2:27Yeah. So there's a couple of different ways that someone in real estate investments can interact with the housing market. There are real estate investors who just buy homes, buy small duplexes, quadplex, and maybe they do some value add investment. And that's predominantly what most people who say they're in real estate or real estate investment do. I'm in development specifically. So we'll go look for land in most cases. Sometimes there might be a house or duplex or something on a large lot. And we'll look to build, in some cases, 10 units, 20, 40, 50. We try to stay under 50 units to be more in a neighborhood scale.

3:07But because we're looking to build things, we need to forge relationships with the cities that we work in. It's a little bit different than if we were just buying a duplex. We don't need to talk to anybody in the city if that's the case. And so as a developer, it's really important that you work in a market that allows us to allows you to build. It sounds simple, but you're facing so much friction in this process. Entitlements, the process of getting permits to build any new housing could be as little as a couple of weeks in a smaller Texan city, and it could stretch on to four or five, even 10 years in a place like San Francisco, which is crazy.

3:45We'll talk all about the frictions. That's where we're going to spend most of this episode. Why? Who is causing the frictions and why can't we just eliminate them. Before we get there, one of the things that you hear most frequently cited on the internet is, well, there's no houses because Blackstone is buying all of them. Can you talk about the institutionalization of single family homes and just some of the nonsense that we see repeated over and over? Yeah, I'll start by saying that's not true. We don't have a housing crisis because of Blackstone or BlackRock or any other color and natural mineral that someone wants pair together.

4:21Start of institutionalization in housing goes back to the late 80s, early 90s. There were some tax reform changes and changes in how REITs were structured. Long story short, it opened up the doors for more institutional investors to get comfortable in the asset class. There was increased transparency requirements, disclosure requirements, and liquidity parameters that allowed pensions and high net worths to feel more comfortable. But before the 80s and 90s, you really didn't see large investors in this space. They tended to stick to commercial assets, but the allocations weren't that high. Over the next couple of decades, as this appetite grew, it obviously culminated at Local Peak in 2007.

5:08There became this comfort where firms who who thought it was a little messy previously to own somebody's home, developed a process and a system that made sense. There's a lot of third-party managers. They don't have to be interacting directly with tenants. And they were able to see that cash flows in some markets could lead to 7%, 8%, 9%, 10 % annual yield, which is really strong for some of these firms to say nothing of appreciation upside. So all of that is the backdrop before 2010 and 2011 in the recovery from the Great Recession, where these firms started a foray into the acquisition of single-family homes.

5:51They didn't really touch the asset class before then. So this phenomena is really in the 2010s. And now we're seeing it obviously continue into the 2020s. But it is relatively new. And there's a large flood of capital entering the space based off of 20 or 30 years of comfort. So we're going to drill down to some local municipalities and how they differ by cities and areas. But I want to talk about the national housing market, because it fascinates me to know how it's evolved. So you had the 50s after everyone came back from the war, and there was a GI bill. And I love those stories about Levittown and stuff, where the government literally backed these loans and said, get out there and build a bunch of houses.

6:32And they went from building like 100 ,000 houses in the Great Depression to like a million houses in the 1950s. And it still kind of boggles my mind they were able to do that. They basically built the suburbs, right? And that seems like that building kind of kept going through the 60s, 70s, 80s. And even in the early part of this century, I guess part of it was the loans they were going to people, but they built enough houses in the early 2000s, right? During that bubble. And then when the bubble burst, it seems like all the home builders said, never again, we're not going to get caught in this situation.

7:03And it's almost like the last housing boom and bust has screwed us over now. Like how much is just that sense of the home builders saying we got taken to the woodshed last time and we're not going to let that happen again? How much does that have to do with the fact that we're not building enough houses this time around where they've seen this before and they said it's not going to happen to us again? Yeah. Builder sentiment is a really key indicator here. And There was a lot of reticence post-2008 and into the early 2010s. We've seen that recover somewhat. This ties back into planning and zoning, where a lot of places that saw homes in the 50s, 60s, and 70s, and then in the 80s, 90s, and early 2000s, these ex-urban communities just don't have any more land.

7:50How far can you drive before you qualify? In the 60s and 70s, you could build outside of New York with pretty great ease. In the 90s and early 2000s, you could build an hour outside of Orlando or Tampa or Miami. And now you're pushing up against those barriers where people feel comfortable going. So it's partially a land story. It's partially a sentiment story. There's obviously a rate story to be told in there as well. But the genesis for this modern version of the crisis is 30 and 40 years in the making. And now as we're trying to, or by necessity, we're going to have to infill cities because there's not much land to go build on.

8:36We're facing these frictions. So talk more about the frictions. Who's creating them? And all right, if you wanted to, or if a developer wanted to build land or build a project outside the city or in the city, who says no? And why does it take five to 10 years? Yeah. So we can click in on, I work in California. I can talk specifically to San Diego or Los Angeles, but five or 10 years is more of a San Francisco story. So at very high level, The way building any apartment building works for a single asset is you acquire land and it has an underlying zone. So it might be an RS1, an RS2, an RM1, 3, 4, super complicated.

9:25If you look in the zoning code in any city, there could be dozens and dozens of classifications and then hundreds of subclassifications. So from the outset, there's not always an ease in knowing what you can build. It's not as simple as saying you have a 5 ,000 square foot lot, you can build whatever you want. It's very prescriptive. Where do these classifications come from? They come from planning departments. And so in the - Sorry to keep interrupting, but is that a city by city, state by state, federal thing? Like where do those classifications get handed down from? So it's city by city, town by town.

10:04In the 1920s, there were national planning acts that allowed municipalities to adopt zoning. We can talk about this maybe later, why everywhere sort of looks the same. A lot of planning departments in small towns, if there is a planning department, it's one person who's doing everything and they can't write the code. These things are thousands of pages long. So they just copy and paste what the town or city next door did. And so when you drive through the Sunbelt and you see every community looks exactly the same, even though they're different cities, it's oftentimes because the underlying DNA is the same.

10:38It was just copy and pasted. So those codes are then administered by a local planning department that they're hired, they're not elected. And to go back to this example of this 5 ,000 square foot lot, you have to figure out what you can do on it. And these codes lay out things from the height, the bulk, the mass, how many units, can it have a coffee shop on the ground floor? How far does it have to be set back from the street? And where the rubber meets the road with this friction is that even though these communities have laid out all these rules through thousands of pages, they still go through some level of discretionary review.

11:19So a city might have reviewers to say, OK, we think that this is an RM4 lot and you can build 10 homes here, but we're not sure. So we're going to go back and review this for a couple of weeks. And, you know, those weeks can mothball and take a little bit longer. Who are those people? Are they elected officials or are they, who are they? They're not elected officials. They're just called planners. In some places, they're reviewers as well, but they're hired from planning departments around the country and they administer any new permit, whether it's a single family home up to a 200 unit apartment building.

11:53And are they incentivized one way or the other to say yes or to say no? This is where it gets tricky. In some communities, they're incentivized to prolong the process. if they really like the character of their community, right? I moved into Middletown, Tennessee, or wherever it might be because I like the character. And now it's sort of changing. I don't like there's apartment buildings. And I don't like that the quaint bungalow neighborhood I was in is sort of shifting. So I can't legally deny these projects, but it's a long weekend coming up. And I've got other projects I can look at. I'll set this permit to the side.

12:33And when that happens across three, four, five different levels of review, you get to a point where now you're a year later from when a developer submitted their initial application to build what they reasonably thought they could. It's not like building a 25-story building in a single-family neighborhood. These are neighborhoods that the city has laid out that you should legally be able to build here. they have their hands in their pockets and they can't really do anything because it's it's purely at the discretion of planners within the city. I'm planning this with a broad brush here, but it doesn't seem like many politicians have taken this up as like their this is their thing.

13:09Like we need to build more housing. I want to make it easier. Where are the places where there actually is some good going? Because we can get into the bad stuff. That's probably more fun. But I've seen places like Minneapolis or Austin thrown out as good examples of listen, They're building more houses or apartment complexes in these places and rents are going down or housing prices are going down. This is a good thing. What did some of those places do right? They got into the nitty gritty that a lot of politicians, frankly, not because of any motivation one way or the other, but they're just not able to dive deep into the intricacies of a planning department.

13:48And so there can be grand proclamations made one way or the other. We want more housing. We don't want more housing. But that doesn't mean anything unless you go in and you change the codes that govern a city. And so what Austin and Minneapolis have done over the last couple of decades, they've sort of taken a fine-tooth comb through all of their existing laws. And they've said, all right, in 80 % of Austin, it was illegal to build anything other than a single family home. That doesn't really make sense. Maybe someone wants to have a cottage in their backyard for their mother-in-law to stay in or their kids, or they might want to build the triplex, live in one unit, rent out the other two.

14:26That doesn't really change the character of the neighborhood. they had to go through and revise their zoning codes and their land use regulations to say, in these areas of the city, we're going to allow these uses to be built. And Minneapolis famously became the first city nationwide to allow up to a quadplex built on any lot in the city, which was pretty, it's novel in the 21st century and the second half of the 20th century, but this is how cities used to be built. You didn't used to have to go get a permit that adhered to a certain zoning code. There's some upsides and downsides to that, but that's why a lot of times in some of our most favorite places, say in New York or Detroit, these neighborhoods built pre-war, a lot of them in the 19th century, people just built sort of whatever.

15:15And it led to some tough outcomes where some of them could have been fire traps and building codes were implemented to make sure that people were building safely. But then post-war, when we had that great boom after the GI Bill, it was predominantly laid out in single-family zones. And that sort of ossified for the last 70 years. What you're describing, does the same dynamic exist outside of cities and suburbs? Or are there different challenges and obstacles? Yeah. Yeah. The tricky thing with housing policy and Ben, to your point earlier, wanting to zoom out on a national level, is that it's different in every city and every city suburbs.

15:56And, you know, as we talk about solutions afterwards, we can get into to maybe how we would rectify this. But let's say you live outside of New York in Long Island and you're in Comac and the town council says we're going to allow for apartment buildings to be built on 50 % of the land here, right? Previously, you couldn't build on 10 % of the land. We're going to increase the amount where you can build. You might say, hey, I don't like that. I'm going to move to Glen Cove or to Cold Spring Harbor because I don't want to live near apartments. And communities can basically craft their laws to prohibit other forms of housing from being there.

16:42So it's sort of this ability to shirk one's responsibilities. And so it's very difficult because there's no regional cooperation amongst towns and cities and suburbs to have a broader response to the housing crisis because someone can always opt out. So even if someone, if a president came in and said, my only objective is to build more housing, I'm going to do like they did in the 50s and we're going to guarantee all these builder loans. It might not even help that much because some of these municipalities just wouldn't let enough people build. Is that correct? There's no magic wand, right? So there's something that urbanists say and people online that people poke fun at, which is fair enough.

17:21But they'll say like it's illegal to build this sort of thing in 80 % of America and 70 % of America. And so even if you had 0 % interest rate loans and you were offering 90%, 95 % LTC, which would be a huge boon to developers, be great. What's LTC? Loan to cost. So if a building costs a million dollars, we're going to allow banks to loan$950 ,000, 0 % interest rate, which would be amazing. You'd have developers lining out the door to do that. But in most of America, it wouldn't make a difference because it's illegal to build. Let's say you wanted to have more quadplexes. You couldn't build that.

18:02In places that have had broader affordability, like the Sunbelt, like Minneapolis, they've changed those laws so that you can build more densely throughout the city. What about a local politician? Could a local politician run on that? Or is it so not popular that nobody would even consider doing that? Yeah, it's not popular at all. You know, there's I think they'd fight. They find quite a bit of feedback. And this would be across political spectrum. What is what is the feedback in Minneapolis been? I have to be careful to say, like, oh, I'm viewing this through a charitable lens and that I see new housing permits going up.

18:37And I don't I have friends in Minneapolis, but I can't tell you the exact sentiment. There's a lot of Midwest nice there. I feel like Midwest people would seek quietly grumble about it. But, you know, they wouldn't complain that much. That's. Yeah, go to Grand Rapids. Ben is a total pushover. I never send a drink back like these guys in New York. Yeah, that's right. That's right. So there might be a passive acceptance or some mumbling under one's breath. That's sort of the argument that I've made that, look, people are going to, they might say before bills pass or before buildings are constructed, that this is going to change the fabric of the neighborhood.

19:17Everything's going to hell. And then after they're built, it's like, oh, OK, not a big deal. and oh, there's a new burrito place on the ground floor of this building that my kids love. Okay, that's great. I get all these benefits of new development, but it's very difficult to put oneself in the shoes of what a positive change could look like because we sort of live in a vitocracy where it's very easy to say no. And this goes back into, why can it take five, 10 years in San Francisco to get a building approved? There's a lot of what's called discretionary reviews where for a number of reasons, whether someone in the community, whether someone on the planning board can say, I don't know if this is the right building for this neighborhood.

20:05And it's totally fabricated their complaints, but they can file a motion for an environmental review to be conducted, which, you know, in the heart of San Francisco, there's really no there's no broad environmental impact that can be had by another new apartment building because it's all apartment buildings around you. Right. But these sorts of challenges can be filed by individuals where they're empowered to do so. So, Kobe, even if, not even if, who, a big, wow, that's a great question. A huge aspect of all of this is capital. And who in their right mind is going to fund a project that might get passed in five years?

20:51What sort of returns would you need to see for an investor to be like, sure, I'll give you my money. Who, it's not going to happen. Yeah. So, there's two answers there. But the first is that's why a lot of developers and home builders have moved to the Sunbelt. It's a lot easier to build in Texas and Tennessee and Arizona than California and New York. And so we've seen more affordability there because there's more housing and there's just less friction overall. A lot of my friends in the development world, that's what they do. It's just go build in Florida, less of a headache. You could probably build two or three projects in Florida by the time it took you to build one in New York.

21:29The argument for people to build in New York or Los Angeles or Boston or San Francisco is, look, these are very expensive and very desirable cities. There is a very, very narrow funnel of products that will get approved. So if we are one of the few products that gets approved, we can capture the market. And that's pre-COVID why you saw somewhere like San Francisco have one bedroom apartments deliver for an average of$4 ,000 a month because there was just no new supply. And so if you were one of the few buildings that could deliver that and grit your teeth, you would print money. So before we hopped on here and hit record, you were showing us some data from New York saying that, I don't know, it's like the 70th most building per capita, even though it's one of the biggest cities in the country.

22:14Are we ever going to be able to figure it out in big cities like this? Your point earlier about the land, I'm thinking of, remember the scene in Far and Away where Tom Cruise rides his horse and he just puts a stake in the land? And it's like, that's how he... Dude, Kobe wasn't even born when that movie came out. That's true. You're old. I'll go with it, though. I get the example. Put Farhan away on your list. I'm going to have to do a Tom Cruise quiz to all our guests. But to your point of there being no more land, where can people even build in San Francisco and New York anymore? Isn't it just that they're going to have to continue to go further out?

22:46So even if the regulations got better, isn't it just too much of a pain in the ass to find places to build in those kind of cities? So I think people would be surprised at how much land there actually is in cities and what level of density people in close proximity to each other is pleasurable. So if you go to Paris, one of the most beautiful cities in the world, the density there is about the same as New York City, as Manhattan, rather. So the densest parts of Manhattan, all these towers, is achieved in the heart of Paris with six-story buildings. The lot coverage is much higher there than is usually allowed in the US.

23:22So this is one of those other land use regulations beyond simply zoning. Not just how many units you can build, but how much of the lot can you build on, sort of stuff like that. I don't know if that's fully desirable because they're building out to 90 % of the lot in some cases. It means there's less light, there's less air. But in a lot of the US, there are minimum lot sizes. So you might be able to build 10 units on a lot, but that lot might have to be half an acre large, which pushes everybody out. And so you might only be building on 30 % of the land there. Without going to densities of a Parisian level or an East Asian city, you can get to 60%, 70 % and still feel super comfortable.

24:06And a lot of our quaintest beach towns that you see in New England or certainly up in Michigan, you get densities that rise to these levels and it's totally fine. This is sort of the thing that we've been advocating for in San Diego and in Los Angeles. Let's say you have a 5 ,000 square foot lot. You could very comfortably, and we've built this before, four or five homes on a plot of land that previously only had one. And in many respects, you improve the quality of life there because, you know, you're through landscaping and through planting trees and fencing. If you do these in a really thoughtful way, it doesn't feel like a barren open space where you just let your dog out, your kids to run the yard.

24:50It becomes more cultivated. So if you were to just say in select neighborhoods of expensive cities, we're going to allow you to build four units like Minneapolis did, that increases the amount of people who can live there by four times. and it doesn't result in towers. So it just requires a reframing of how people think through cities can be built. Because for the last 70 years, we've thought it's only single family homes. And in the downtown cores, we'll build 25-story apartment buildings. It leads to what's called in urban planning circles, the missing middle. So you have the one and two family units and you have the 100 family units, right?

25:30You don't have the 4, 10, 20 unit buildings that comprise a lot of our favorite neighborhoods because they've been rendered illegal, right? Through these zoning codes. And so Michael and I, whenever we talk about the housing supply issue, and we always say, we premise it with like, we feel for young people because it's just a no-win situation. I kind of always default to not saying it's never going to get fixed, but if it does, it's going to be a long, long time. Or do you feel that way as well? That like, this is just a problem that is kind of, you know, here to stay for a while. Yeah. Unfortunately, it's going to be later rather than sooner.

26:11And that's just the nature of the beast where we're in a supply crisis. It's not a demand crisis. You know, there are a lot of people out there who have enough money to buy homes if the homes were affordable enough, right? But they're renting because, or they're living with their parents because there's just nowhere for them to live. Even somewhere that had really quick approvals times, like you can get your permit in a month or two months, it's still going to take you a year to build and complete and move into those homes, right? Maybe there's some places where you can do it in six months. But in the most expensive cities, coastal cities on the Northeast and Southwest, it could take you four years quickly, you know, to build new units from approvals all the way to move-ins.