If apartment buildings are built in a neighbourhood of detached houses, then the house prices fall, especially next to the new apartment buildings. There is less privacy in the garden if many windows overlook it, and there is more congestion and crime if more people live nearby. The neighbourhood’s common interest may be to block the development of large buildings in it. However, an individual homeowner finds it profitable to sell to a property developer who will replace the detached house with a large apartment building, because the cost of reduced house prices is borne by the neighbours, not by the seller.
One way that neighbourhoods try to prevent this tragedy of the commons is to require all homeowners to join an association and agree to be bound by the rule that the association can prohibit new buildings or expansions. Such rule-based solutions are usually vulnerable to legal loopholes and changes in government policy that invalidate the restrictions. Game theory offers a solution without requiring any external enforcement: if one homeowner extends her house or replaces it with a bigger building, or sells to someone who will, then the neighbours respond by building apartment buildings around the property of the first breaker of the social norm of non-expansion. Then the view from the first expanded building is only the walls of the others, which makes the expansion unprofitable and deters enlargement in the first place.
The punishment for the first extension has to be certain enough to deter it. In particular, the homeowners next to the violator of the norm must be incentivised to build even at a loss. This incentive can be provided by requiring the neighbours of the homeowners next to the violator to punish those who do not punish the violator. This punishment can again be the development of large buildings next to their property. Those who refuse to punish the non-punishers can be punished the same way, etc, in concentric circles around the original violator.
The incentives provided by dynamic games such as this one may seem strange, but can be easily coordinated by a homeowners’ association without any legal power. The association simply publishes the rule that (a) enlargement of current buildings or the construction of new ones is forbidden and (b) if someone breaks the rule, then any new construction in a specified radius around the first rule-breaker is allowed. If one enlargement or new building is profitable, then typically a few extensions next to it are also profitable. The fewer neighbours of the first rule-breaker that build bigger houses as punishment, the more profitable an extension is for any neighbour. So some neighbours will punish the first violator. This will make the house prices of other neighbours fall, which reduces the cost to them of selling their houses to property developers for apartment building construction, i.e. reduces the cost of punishing the original rule-breaker.