Affordable Housing

A proposition will appear on the November ballot in California, which, if passed, will abolish restrictions on the scope of rent control local jurisdictions can impose. Polling data indicates that it will pass. A number of cities will undoubtedly take advantage of the opportunity provided to expand the scope of rent control. Apartment construction will slow down or come to a halt in the State. Strong action will have been taken to treat the symptom, not the problem.

In a number of major urban areas in the Northeast and west coast, we have a housing crisis. A significant percentage of the population is devoting a major portion of its income to housing, or living on the streets. What could we do if we actually wanted to cure this problem?

First, we need to acknowledge that this is a not structural problem. In many parts of the country shelter is quite affordable. In places like Phoenix, Houston and Denver, there is often an oversupply. During the ’80s, Houston apartment buildings were being bulldozed in an effort to cure a glut. The largest industry in Detroit is the demolition of abandoned houses. Scarcity of land is often cited as a cause of housing shortages in places like San Francisco. Even a cursory survey would reveal thousands of acres of unused and under utilized land in the densest of our cities. The problem is political. Political risk and entitlement costs are the barriers preventing production of a level of supply that would push prices down to levels most of the population of the impacted cities could comfortably afford.

Second, taxpayer money is going to be required to produce BMR (below market rate) housing in our major urban areas. There is no realistic chance that the voters in Boston or San Francisco will elect politicians who will permit enough construction for the market to take care of the problem. The current fad is percentage of BMR as a requirement to get a permit to build. That just passes the cost along to market rate buyers or renters — a different, unfair and inefficient form of taxation.

Let me outline a plan that gets to the heart of the problem without the layers of gorilla dust that are being thrown at the problem. The public is being taxed in the form of tax credits, BMR requirements, and non-profit developers who tap multiple subsidies. The results are inefficient and insufficient.

As a thought experiment, let us say that it costs $400,000 to build a two bedroom, one bath apartment. That number is too low for some cities, but it is convenient for purposes of an example. In order to attract private capital in today’s market, a return of 8% would be required. I won’t bore you with details, except to say that 8% covers the cost of debt, equity, and the 10% profit needed to induce a desire to participate in a program. The 8% number means that the rent would have to be $32,000 per year net to the owner of the building. Add $16,000 per year for operating expenses (taxes, insurance, maintenance, reserves, vacancy, etc.). That gets you to $48,000 per year or $4,000 per month. Let us say that you determine that a working family in your town could afford $2,000 per month in rent by devoting 33% of disposable income to shelter. How would you get there?

If the government put out a set of specifications for an acceptable apartment unit, which passed inspection upon completion, developers could be motivated to build the $400,000 unit and rent it for $2,000 per month (plus adjustments for inflation) in perpetuity in return for a payment of $200,000. No need for layers of subsidies and endless hearings. Enforcement would be very easy. If a developer failed to keep rents at the specified levels, or failed to maintain the building, the penalty would be foreclosure. The unit could then be auctioned off to any qualified operator willing to sign on to the rules.

Over time, numbers would have to be adjusted to take account of market realities. The cost of funds will increase as interest rates increase. Median income for lower wage workers will change. Construction costs will change. However, there is enough information readily available to make those changes in a realistic fashion. The acid test would be whether anybody signs up to participate in the program.

Given political will, and modular construction, we could solve out housing problem in a few short years.

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