Chart of the Day: Rent Gap Theory

There’s a wonderful article at Strong Towns by Daniel Herriges that folks interested in Twin Cities housing will likely enjoy. The piece contains this chart, which attempts to explain some of the real estate forces behind gentrification and disinvestment. Folks who spent much time learning about old-school urban geography eventually come across this concept — the “rent gap” — as a way to analyze urban development patterns over time.

Here it is:

There’s even a Wikipedia page (and German translation: Mietlückentheorie) which explains what’s going on here:

Rent-gap theory … developed in 1979 by the geographer Neil Smith as an economic explanation for the process of gentrification. It describes the disparity between the current rental income of a property and the potentially achievable rental income. Only from this difference arises the interest of investors, a particular object (to entire neighborhoods) to renovate, resulting in an increase in rents and also the value of the property.

Investment in the property market will therefore only be made if a rent gap exists. Thus, it is contrary to other explanations for gentrification related to cultural and consumption preferences and housing preferences. The rent-gap theory is a purely economic approach.

Herriges uses the graph to explain why cycles of investment and disinvestment can be so disruptive to urban neighborhoods. Best of all, the article includes some wonderful maps of Twin Cities multi-family housing construction over the last few years. They show our development and construction pattern pretty clearly.

Here they are:

All Twin Cities residential building permits, 2009-16 (mostly single-family homes):

 All permits for 2 or more units:

All permits for 3 to 19 units (what’s often called “Missing Middle” housing):

All permits for 20 to 99 units. You can see these clustered along rail corridors and near downtown Minneapolis:


Herriges is arguing that small-scale investments are less disruptive, and less of a force for change and classic gentrification, than large-scale big projects.

The punchline about the Twin Cities metro:

In the Twin Cities, as in most metro areas, Missing Middle development is comparatively scarce in favor of single-family homes and very large projects. And those large projects concentrate in only a few neighborhoods. Big developers pick winners, swarming to the neighborhoods where the profit is. And nobody else can afford to be in the game. The cost and complexity of permitting and regulatory compliance favor the big guys.

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One Response to Chart of the Day: Rent Gap Theory

  1. kingledion February 22, 2018 at 9:05 am #

    This is what the housing problem is, in full. The two cities need to make it easy and legal to upgrade a single family home. Homes in may parts of both cities are cheap, certainly by comparison to the suburbs. The cost to purchase and upgrade a house to a duplex would be competitive with rent in many parts of the city.

    In Windom Park, there are several houses available on Zillow for under $250k, in the 1500-2000 sqft range. You could buy the property, spend another $150k to modernize and expand the house to maybe 2500 sqft, then $100k more to build an accessory dwelling (lets say a 1000 sqft granny flat). That granny flat would rent at maybe $1200 (again going by Zillow, and more if its designed for roommates).

    Compare that with a regular old 2500 sqft house in Minnetonka, which will cost you about $500k on the low end. Same price, but with one option you get rental income and you are 2.5 miles from both downtown and the University.

    The problem is, of course, the overhead to get construction approved would be up to hundreds of thousands of dollars, plus the frustration of dealing with whatever setbacks the process comes up with. The R1 or R2 zoning doesn’t allow that floor area ratio, doesn’t allow the accessory building so close to the property line, etc. So local government action, instead of making it economically feasible for middle class homeowners to upgrade their own homes, basically forces properties to descend down value curve until the rent gap opens up wide enough that a big developer can take action.

    Local governments need to encourage homeowners to invest in their own properties by liberalizing the ways in which they can do so. Let people add accessory dwellings, upgrade to duplexes or triplexes, run businesses out of their homes, etc. That is the way to prevent gentrification.

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