Unpacking the Housing Paradox: Building More, But What Kind?#

So, the simple answer to unaffordable housing seems obvious, right? Just build more houses! Well, we have been. New construction is actually getting close to the highest rate it’s been since the 2008 crash. And that’s happening despite incredibly high construction costs that popped up because of supply chain problems.

The real twist is whether we’ve been building the right kind of housing. As costs went up and profits got smaller, the only type of place that stayed profitable to build was luxury property. Now we’re in a really strange spot. We might actually have too many houses… or at least, too many of the expensive ones.

I know what you’re thinking – sounds great, right? Wrong. Even with all this new building, most estimates say we’re still short by about 4 million homes across the country. And if developers can’t sell the fancy luxury homes they’ve already put up, they’re way less likely to build the other types of homes people actually need. This could leave landlords in a tough spot, potentially facing bankruptcy for buildings like the ones you see around, and unless something big changes, it could even lead to renters ending up without a place to live.

Just to give you an idea, this is what $218 million bought in Palm Beach, Florida. The luxury rental market in many places is crashing. Meanwhile, half of all renters in the US are paying more for rent than they really should be. Some people have sold everything they possibly could just to try and get by.

A Closer Look at the Numbers and Types of Homes#

There’s a bit more complexity to the number of new homes being built, but one thing is crystal clear, especially in America: we’ve been building a lot more apartments. Just two years ago, we actually broke the all-time record for the total number of new apartments finished within a single year. This record had stood since the 1970s.

That last big jump in the 70s happened because Baby Boomers were starting to enter the housing market. They wanted cheaper places closer to cities, not the big, cookie-cutter Levittown style suburbs they grew up in. The apartments built back then were generally pretty good – mostly well-made with decent-sized layouts that could even fit larger families easily. Government programs that helped subsidize housing also played a role, meaning developers could pretty much always count on finding someone to sell or rent to. But mostly, it was just plain old supply increasing to meet demand.

That building boom eventually fizzled out because of tough times: the recession of 1973, the oil crisis, the end of the Bretton Woods system, and growing new international competition all took turns hitting the US economy hard. This made it more expensive to build, and people had less money to buy new apartments. By the time the market bounced back, the Baby Boomers had mostly lost interest in apartments anyway and were heading back to the suburbs, only this time looking for much bigger houses. (Quick side note: Back then, we didn’t even fully realize we were in a recession until the end of 1974. Fun fact: New property construction has usually been a better indicator of the economy than the economists themselves!)

What Fueled the Most Recent Building Boom?#

Anyway, this most recent construction boom was driven by several things:

• New building had recovered after the 2008 crash.
• People were interested in living in apartments again.
• According to a report by the Harris poll, dual-income no kids (DINK) households became the fastest-growing group of home buyers in America.
  • Having two people working makes low-maintenance apartments really appealing.
  • No kids means less need for the extra space you typically get with a single-family house.
  • DINK households also generally have more spending power. This made building new places for them very profitable.
• Younger renters or buyers with cash were often happy to pay extra for fancy-looking features like expensive looking fittings, fixtures, materials, designs and amenities. Things like a faux marble waterfall countertop or a couple of treadmills tucked into a corner room were actually pretty cheap for builders to add, but they let properties sell for a much higher price than standard budget-friendly homes, even if the apartments themselves were the exact same size.
• Interest rates were also very low. Builders usually use construction loans to pay for the land and the actual building. The interest rate on these loans while building is going on is super important. New apartment building slowed down a bit around 2016 when rates went up, but then everything went wild when COVID-19 showed up.
• Right after global lockdowns, stopping new construction was tough. But then a few extra things made apartments super popular:
  • People took remote work jobs and moved to different cities at record speed.
  • Add in stimulus money, low interest rates, booming asset markets, and young adults who didn’t want to be stuck inside with their parents all the time… and it was a perfect storm for developers to make money.
• New luxury apartment buildings popped up everywhere, often with flashy ads to get people interested.
• The biggest factor of all? Developers didn’t necessarily have to hold onto these buildings forever once they were built and rented out. The whole building could be bundled up and sold to a financial institution. They would then put these buildings into a residential real estate investment trust (REIT), which would then be sold to other investors who wanted to own a piece of a large group (a broad portfolio of real estate) without having to actually manage the properties themselves. These REITs aren’t new, but they got way more popular, especially for residential buildings. This system worked well to push more building, but you might already see how it sounds a bit familiar (think back to financial crises). For the builders and lenders, once the apartments were occupied (“heads were in beds”), they didn’t really care what happened to the building later because it wasn’t their asset anymore.

The Types of “Luxury” Being Built#

Not surprisingly, a lot of this new “luxury” housing turned out to be… well, not that luxurious. It was really just expensive housing with some marketing budget behind it. Those aren’t always the same thing.

Extremely large but poorly designed and cheaply built homes aren’t a new thing, especially in suburbs in America. “McMansions,” as they’re sometimes called, are designed for buyers who don’t have unlimited money but still want a house with a four-car garage, a billiard room, two guest bedrooms, and an extra formal living room nobody ever uses. The way to do this was to build houses with a lot of square footage but keep the cost per square foot very low. This usually means cutting corners on materials, insulation, and how well it’s built. Down the road, these homes become very expensive to keep up, but the price you pay upfront for the sheer space is hard to beat. Or at least, it was hard to beat until supply chain issues made building materials super expensive. No matter how many corners you cut, bigger homes just need more stuff.

According to the National Association of Homebuilders, the average price of a new home in 2024 was $428,000. This means in most places, it just doesn’t make financial sense to build a brand new single-family house, because you could buy an older house plus the land it sits on for about the same price.

So, the new wave of luxury housing has mostly been in the form of apartment buildings. They’ve effectively become the “McMansions in the sky.”

Let’s break down the different levels:

• Extreme High End: Developments like 432 Park Avenue, 157 The Shore Club, and Central Park Tower. These super tall buildings, mainly along Billionaires Row in Manhattan, have sold single apartments for hundreds of millions of dollars to people like Michael Dell, Ken Griffin, and everyone’s second favorite Twitter personality, Bill Ackman.
• Premium Developments: Below that, there’s a wave of newer buildings with apartments ranging from $1.5 to$10 million in most big cities. Households in the top 10% of incomes already spend about half of all money in America, and they’re willing to pay a lot extra for new, fancy housing.
• Largest Group: Investor Stock Apartments: These are the most common new developments. They have nice-sounding names like The Concord or The Bay View. These are mainly mid-rise or 5 over 1 style buildings built to a specific budget, specifically meant to be a financial asset. Giving people a place to live is kind of a side effect. A change in building rules about fireproof construction after the 2008 crash made 50 over 1 buildings much easier to build.
  • The bottom floor is usually set up for retail stores.
  • Above that are four or five stories of wood-frame construction for the apartments.
  • These buildings are some of the cheapest structures to build per square meter.
  • They became the most profitable because they could be sold or rented at a high price compared to how much they cost to build.
  • This made them perfect, low-risk/high-reward assets to put into the portfolios of big companies that have bought thousands of these multifamily dwellings.
  • Plus, the retail space below gives another way to make money through rent that isn’t directly tied to the apartment market.

The Serious Problems with These New Buildings#

Okay, hot take alert: Yes, these buildings often look pretty ugly. But at a time when we really need more places to live, maybe we shouldn’t be too picky about how they look. However, there are two other problems that are much, much more serious than just some flashy, ugly fronts.

The Biggest Problem: Nobody Wants to Live There (at the Asking Price)#

But then there’s the biggest problem of all with this new “luxury” living space: A lot of people who need housing don’t want to live in these specific places at the price being asked.

Because of the luxury branding, many of these new apartments are more expensive than homes that are much larger. This is particularly true for bigger apartments that might have enough bedrooms for families with children. A four-bedroom home is pretty common in most American suburbs. A four-bedroom apartment, though? That’s usually a penthouse that comes with an ultra-luxury price tag. If you like scrolling through Zillow, try finding a four-bedroom apartment in your city or town that actually costs less than the average four-bedroom home. It’s tough.

As more new buildings are finished, they’re making the market even more crowded in certain cities – a market that got way too much built way too fast. Now, in some places, developers are offering months of free rent or even fancy concessions like holidays or jewelry just to get people to sign a year-long lease.

Now, you’ve probably already asked the logical question: If nobody wants to rent these places unless they get freebies, why don’t they just make the rent cheaper?

Well, here’s the kicker: They can’t (or think they can’t).

Yes, according to basic math, paying $2,000 a month** in rent for a year with **3 months free** works out to the same as just charging **$1,500 a month straight up. But the finance folks, the “number crunchers,” don’t look at it that way.

Most of these buildings will be sold based on a multiple of how much income they are making. This is known as the capitalization rate or cap rate. In plain English, it’s what percentage of the building’s purchase price it returns in income every year.

So, a $10 million building** bringing in **$500,000 a year in income would have a cap rate of 5%. Or, another way to see it is, if investors are okay with a 5% cap rate (which is roughly where the market has been), then a building making $500,000 a year** is considered worth **$10 million.

BUT, if those apartments are listed at a higher base rent and are bringing in $600,000 a year** (even if it's boosted by temporary deals), then the building is suddenly valued at **$2 million more on paper! It looks way better to have an apartment listed for $2,000 (even with freebies) because that number can be multiplied by 15 or 25 times (depending on the cap rate) to get an impressive sales price. The people valuing the building don’t necessarily need to dig into the special deals made earlier in the lease.

Now, the big companies buying these multi-million dollar properties aren’t completely dumb. They know this is happening. But they often don’t care that much because they figure once people move into a place, they usually don’t want to leave if they can help it. According to Nerd Wallet, the average cost to move houses is more than $1,700, and let’s be honest, it’s a major pain in the ass besides the money. Even if people do move out because the rent gets too high later, it doesn’t really matter to the original developer because by that time, the building has probably already been securitized and sold off to some big, faceless REIT investor.

The Refinancing Risk#

There’s one more reason why the whole industry is desperate to make these income numbers look as good as possible, as quickly as possible. A lot of these new buildings were financed back when interest rates were very low. Most construction loans only last between 3 and 5 years before the developer needs to get a new loan (refinance). If these buildings aren’t making good income fast enough, they will be very hard to refinance. This means a lot of developers who borrowed heavily (highly leveraged) could find themselves in a really dangerous financial spot.

The Disappointment and the Future#

The most frustrating thing about this whole situation is that medium-density housing is actually desperately needed in America. It’s probably the best way to tackle problems like endless urban sprawl, needing cars for everything, and housing being too expensive. Unfortunately, we took a good idea and seem to have built it in the dumbest way possible.

Now, if you’re thinking all of this sounds like a perfect chance to finally buy some affordable real estate, you might want to watch the next video in this series. It digs into why a real estate crash probably won’t help you afford a home.

And hey, make sure to like and subscribe to keep learning how money works!