How will Colorado River cuts affect housing prices? A Loyola expert explains

What’s the best way to curb water use in households and businesses served by the Colorado River? Benjamin Edelstein, an assistant professor of economics in the Quinlan School of Business, suggests it’s by letting the market do what the market does best.

“As an economist, I believe, deep down, you can put a value on water. It’s at least as valuable as what you’re paying for it,” Edelstein said. “Otherwise, you wouldn’t use it.”

That market-based view, and the research Edelstein has undertaken to support it, is likely to draw increasing attention among utility managers and policymakers in seven western U.S. states that rely on the Colorado River for large shares of a shrinking water supply that will soon be more stringently rationed.

In the past two decades, drought, climate change, and rising demand for water in rapidly developing cities have diminished the river’s flow by 20 percent and left Lake Powell and Lake Mead, the nation’s two largest reservoirs, at historically low levels. The federal government has stepped in with a plan, released in late July, that will require Arizona, California, and Nevada to draw roughly 20 percent less water.

The 10-year framework has reignited debate surrounding a century-old agreement among seven U.S. states and two Mexican states that caps the signatories’ Colorado River water allotments. For many years, Edelstein said, states in the upper basin—Utah, Colorado, New Mexico, and Wyoming—did not take their full allotments, but with reservoirs drying up and snowpack in the Front Range mountains feeding less water to rivers and tributaries they are, and there isn’t enough water to go around.

“We kind of ended up in this mess because we overtaxed the river,” Edelstein said. “We’re asking more of the river than it could possibly ever give.”

Hard choices

For years, cities like Phoenix, which relies on the Colorado River for 40 percent of its water supply, have seen cuts on the horizon and made efforts to prepare. But with cuts scheduled to begin January 1, water procured from massive infrastructure systems, like the Central Arizona Project—a 336-mile canal that pumps water from the Colorado River across the desert to Tucson and Phoenix—will need to be supplemented.  According to area water managers, that could mean drawing water from alternative rivers and aquifers, upgrading piping systems and treatment plants, and entering lease deals to purchase water rights held by other entities.

Even with these actions, policymakers and utility companies likely will need to implement regulatory and price-based incentive structures to curb household, business, and agricultural water use and bring demand in line with supply.

“A primary instrument we might think that utilities are going to use to reduce water consumption is going to be price-based,” Edelstein said. “So you raise the cost of water, people are going to consume less of it.”

That is certainly true in the southwestern U.S., where steep utility rates have nudged homeowners to replace their turf lawns with native plantings, rock gardens, or other less water-intensive alternatives.

In fact, Alex Hager, writing for NPR, reported that Phoenix lowered peak summertime water use since the 1980s by about 40 percent, largely due to rate hikes. Last year, residents saw a 13 percent increase in their water bills. More generally, Edelstein estimates that a 10 percent increase in a customer’s utility bill will yield a 6 percent decrease in their outdoor water use, an encouraging signal of the power of price-based incentives.

“I’m not anti-grass,” Edelstein said. “If your kids are outside playing in the backyard every single day, then quite possibly your evaluation of the grass there is high enough that policies should support it. But we can’t kid ourselves. This is socially expensive in the sense that there is only so much water to go around.”

The effect of rate hikes varies by water use. In economic terms, Edelstein said, indoor water demand is almost purely inelastic—people will pay just about any price for drinking water, clean dishes, and a hot shower. Demand for outdoor water, on the other hand, is highly responsive to price shifts.

Utility rates aren’t the only lever city officials and utility companies can pull to encourage homeowners to use less water. Mandatory watering requirements, landscaping restrictions, and public messaging tools are common alternatives. None of these, however, are as effective, empirically speaking, as consumer rate increases, “the optimal instrument for us to use,” Edelstein said.

That doesn’t necessarily mean, however, that rate increases are politically palatable. As policymakers and utility managers in the Colorado River basin wrestle with hard choices about how to keep water flowing and budgets in check, Edelstein’s research could be particularly instructive as an assessment of alternative pricing instruments. While much of the media attention surrounding the new federal plan has focused on the near-term future, Edelstein’s work is more far-sighted.

Water impact fees and the housing market

In a recent working paper, Edelstein examined the effect of the water impact fees (WIFs) on single-family housing costs and water use in metropolitan areas of Colorado near the Front Range mountains. Builders pay WIFs to connect new units to an area’s water system, but how these costs are baked into home costs and their efficacy in encouraging water-efficient housing are an understudied piece of the economic puzzle.

According to Edelstein’s analysis, utility providers in at least 10 states have switched from charging flat WIFs to variable WIFs that assign fees proportional to a development’s expected future water use, often a function of the lot size. In the Colorado Front Range, these fees have doubled from 2000 to 2019, with the average water impact fee for a new single-family house estimated at $20,000 in 2019, nearly 10 times higher than the national average.

Interpreting a dataset integrating WIF policies, aerial imagery of irrigated and non-irrigated land parcels from the U.S Department of Agriculture, and newly built single-family home prices, Edelstein found that variable WIFs reduced “new single-family lot size by 15 percent and irrigated areas by 30 percent, decreasing household water use by 15 percent.”

Is this good news? Yes and no, Edelstein said.

While evidence of declining home water use is promising, the fees triggered a spike in housing prices—a $1 increase in WIFs resulted in a $1.06 increase in home costs, or roughly $20,000 per home on average. In addition, they led to a rebound effect, in which greater housing density contributed to a 3 percent increase in total water use among providers.

“We’ve figured out this really circuitous way to pay for the fact that water is becoming more expensive in the western U.S.,” Edelstein said. “We’re charging the developers to cover these capital costs, which changes the types of houses that they build, which changes house prices, and then home buyers eventually pay for the water that they use in the housing costs.”

The takeaway? “If we switched to [consumer rate increases] instead, we’d be far better off.”

All these considerations might seem remote to Chicago residents who live beside Lake Michigan, a 22,300-square-mile freshwater lake that reliably supplies drinking water to 6.6 million people in Illinois. But Edelstein said the legal and economic implications of water scarcity along the Colorado River basin are well worth paying attention to.

“Illinois currently uses 76 percent of its allowed water allocation from Lake Michigan, according to a Supreme Court decree,” he said. “So there’s certainly some space slack in the system. But in a world where there’s a 10- or 20-year drought in the Illinois area, which is not particularly far-fetched, we can imagine there being a lot of friction between Illinois and its neighboring states over how much water is being extracted from Lake Michigan.”

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