Decay, Abandonment, and . . . Profits? An Unlikely Combination in Real Estate Markets

Could property insurance policies, which were originally conceived as protection for property owners during times of hardship and loss, play a role in neighborhood decline? In the latter half of the 20th century, conditions in U.S. real estate markets — especially in the residential market — provided a good environment in which to consider that question.

Using data from the period, economists Ingrid Gould Ellen, Daniel A. Hartley, Jeffrey Lin, and Wei You study what happened to neighborhoods when insurance policies were rendered overly generous because of regulatory requirements.¹ They begin their story in the 1960s, when the U.S. government implemented a program intended to provide low-income families with better access to affordable housing. Their paper, "The Bronx Is Burning: Urban Disinvestment Effects of the Fair Access to Insurance Requirements," shows how one particular component of the program, which sought to increase the supply of reasonably priced property insurance (and thereby help landlords provide affordable housing for their tenants), created distortions in residential real estate markets — with negative consequences for the affected neighborhoods.

During the 1960s, as the lure of suburban life drew people away from central city neighborhoods, the stage was set for a profound shift in population patterns. This shift left significant portions of urban communities suffering from neglect and decay. A pernicious, detrimental chain of events played out in which populations dwindled, rents decreased, and neighborhood vitality diminished. The authors describe how these despairing circumstances led landlords to lose confidence in the economic value of their properties, making abandonment — and the insurance payouts that followed — very attractive.

Early in their paper, the economists recount how, in the late 1960s, Congress took bold steps to help central city neighborhoods regain their economic footing. Lawmakers aimed to facilitate better access to housing in urban areas, particularly for families living in low-income neighborhoods. As part of this initiative, new legislation sought to make homeowner's insurance more accessible. The resulting regulatory package, known as Fair Access to Insurance Requirements (FAIR), was hefty, consequential, and popular.² Take-up was swift, with 18 states offering FAIR plans in 1968, increasing to 26 states by 1970. The volume of insurance policies issued under the plans likewise grew substantially, from 300,000 in 1969 to 5.7 million by 1977.

From the perspective of insurance providers, the program came with formidable conditions. All insurers were required to share losses in what was essentially a mandatory form of "loss pooling." The program also forbade insurers from considering so-called environmental hazards (such as fire risks) when evaluating applications for coverage. What's more, insurers were required to offer unusually generous payout benefits: When policyholders filed claims, they could feasibly receive more money than their properties were actually worth.

As the authors explain, the repercussions of the regulatory constraints were dramatic, with many insurance policies being granted that otherwise wouldn't have been. State-level data show just how loose underwriting standards became. In Illinois, for example, only 1 percent of insurance applicants were denied coverage under FAIR plans.

Against this backdrop, risks borne by insurers intensified as central urban neighborhoods slid into decline. In state after state, as risk levels became ominous, a unique set of circumstances emerged: For certain property owners, it became financially attractive to neglect or even abandon properties and seek insurance payouts instead.

Media reports soon depicted an insurance landscape marred by fraudulent insurance claims. (Given their susceptibility to foul play, most FAIR plans were unprofitable; between 1970 and 1998, they posted collective losses of $1.5 billion.)

How did conditions deteriorate so decidedly? To find out, the authors compared neighborhood-level vitality before the implementation of FAIR plans (1960 and earlier) to outcomes thereafter (1970 and later). Their analysis covers 6,000 census tracts, with each tract being examined once each decade between 1950 and 1990, yielding 30,000 tract-year observations in all.

Their results show that after 1960, most central cities (whether they enacted FAIR plans or not) experienced population loss and declining property values. In cities where FAIR plans were most likely to be in force, however, instability was even worse, with more homes falling into dereliction. By 1980, the average census tract in these cities had lost hundreds of homes. Population and incomes had fallen as well, highlighting "the complex interplay between insurance policy, housing markets, and neighborhood dynamics" while effectively "revealing unintended consequences of FAIR plans." As is the case throughout much of the study's findings, timing was important: Neighborhoods in which FAIR plans arrived early (by 1970) were prone to decline the most.

After explaining the association between FAIR plans and neighborhood-level economic deterioration, the authors investigate what happened to the properties themselves. Exactly what did the physical decay look like? They identify fire as a prominent source of damage, whether due to negligence, accident, or even arson.³

Drawing on data for fire incidents nationwide, the authors estimate that after 1968, cities in early-FAIR states suffered 32 percent more building fires than non-FAIR cities. The role played by fire becomes even more compelling in light of other developments revealed in the data, such as the vast reduction in fires after 1980, when policy reforms scaled back the generosity of FAIR plans and "reduced the problem of over-insurance."

The frequency of fires, the authors write, was likely facilitated by landlords' increasing propensity to abandon buildings. When neighborhoods were in decline, they attracted a type of real estate entrepreneur predisposed to abandonment. To these property owners, neglect was part of the investment process: This type of property owner would willfully decline to maintain their building, setting their sights on a premeditated period of deterioration that would conclude with an insurance payout bigger than the value of the building itself. This overcompensation, the authors write, was recognized by government officials at the time as particularly troublesome because "a landlord would immediately choose to abandon their property" when offered this type of reward.⁴

The authors note that their findings, as concerning as they are, do not have negative implications for all regulatory interventions in insurance markets. Nonetheless, their study suggests that FAIR plans could have been designed to provoke less abandonment, and their research illustrates how policy programs, despite their best intentions, can have unintended consequences. For policymakers, property owners, and everyday citizens alike, the results reported in "The Bronx Is Burning: Urban Disinvestment Effects of the Fair Access to Insurance Requirements" offer a new way to understand the myriad interactions that shape real estate markets.