Where Do We Start When Solving The Affordable Housing Crisis?
Note: a portion of this article was published by the Washington Business Journal on 1/31/2020.
Lots of discussions are happening nationally about the need to create more affordable housing. Local governments are brainstorming solutions on how to accomplish this. Often, these solutions put the burden on the private sector. The key to solving the affordable housing crisis is held by local governments and any solution must begin with them.
So what is affordable housing?
Affordable housing is considered affordable when a person or a family spends 30% or less of their income on housing needs.
The higher the income, the higher the monthly payment a family can allocate toward their housing costs.
In 2019, the Washington Metropolitan Area's Median Family Income (MFI) for a household of four was $120,000. This means a family of four, say the Smith family, that earns $120,000 annually (i.e., 100% of MFI) can afford to earmark $3,000/month toward their housing costs ($120,000 x 30% /12).
Let’s introduce the Johnson family, that makes $60,000/year (50% MFI). For a home to be considered affordable to them, their allotment cannot exceed $1,500 of their monthly income.
What if, however, there are no housing options available to the Johnson family at that price?
Free Market Economics
In free markets, developers build homes for families earning closer to 100% MFI, i.e., marketed at $3,000/month rent range. This is because there is a concentration of households around this MFI level (thus the 100% local MFI). Herein lies the supply shortage problem of affordable housing.
To solve the problem, we need to further diagnose it.
Generally, developers build housing in two types of neighborhoods: 1) where people earn greater than 80% MFI, and 2) where people earn less than 60% MFI.
Neighborhoods where housing is over 80% MFI
While there are many non-profit developers who contribute to the affordable housing stock nationally, most housing units are produced by for-profit entities that expect an economic return on their investments.
Affordable housing means that a landlord artificially depresses the rent below what the open market would otherwise charge for the same unit (e.g., up to 60% MFI.)
The lower the rent, the lower the income generated by this investment, and if too low (affordable) the project becomes economically infeasible. Developers build in communities wherein they can achieve required returns and bring supply where there is a market demand for it.
There are other factors that place upward pressure on rent, increasing housing costs and making it only affordable to those who earn higher than 100% of MFI. Such escalation impacts the overall expense of delivering housing, which again adds pressure on increasing rents to justify the returns, delivering housing to target higher-income earners (i.e., people making above 100% of MFI) that can afford to live in higher-income areas.
Bottom line: There are limited economic incentives for developers to restrict rents unless it is mandated by local jurisdictions, such as via inclusionary zoning.
Many local jurisdictions have used Inclusionary Zoning to require a percentage of housing units delivered in a project (typically ranging from 8% - 15% of total units) to be available to those who earn between 50% and 80% of MFI. Those ranges vary between jurisdictions. Such mandates have been helpful in adding to the affordable housing stock, particularly during positive economic times. There are instances, however, when such mandates are out of sync from market realities and cause development activities in that market to slow down, reducing housing supply, causing rent to escalate more and inadvertently contributing to the affordable housing crisis.
Neighborhoods where housing cost is under 50% MFI
Because there are no economic enticements for developers to restrict rents, the federal government created a program in 1986 to incentivize investments in affordable housing. The Low-Income Housing Tax Credit (LIHTC) was signed into law by President Reagan in the Tax Reform Act of 1986. In a nutshell, investors in low-income housing receive tax advantages on their investment in exchange for providing a source of funds to a project that makes it viable to develop affordable housing that otherwise would not be available because, as we have seen, restrictions on rent are not supported in free markets. Developers utilize this program to develop and fund affordable housing nationwide.
Without subsidies or government programs, due to suppressed returns, the development of housing in these areas of lower-income populations might not happen at all, which will further exacerbate the lack of housing affordability along with undermining the condition of the existing stock.
While the LIHTC program was pioneering and innovative, it alone is not enough to solve the affordable housing crisis. Below are some challenges that have limited the production of affordable housing.
Additional funding sources are required. As costs of construction continue to escalate, particularly in urban areas, LIHTC equity has not been enough to bridge the gap between what a project costs and what it can generate in income and debt. Most current LIHTC deals require additional subsidies from local governments to make the project economically feasible; however, most local governments have limited resources to address this and fund affordable housing.
LIHTC deals are complicated. Even with adequate funds, executing LIHTC deals is challenging given the many sources of monies involved, state and federal credit regulations, local requirements and restrictions, etc. Many market-rate developers prefer to avoid this overly complex landscape of financing and regulations.
Funding applications are only accepted once a year. In most jurisdictions, there is only one time per year when the window for accepting public financing applications opens for developers to submit projects. This reduces the number of projects that can begin construction each year.
Applications requirements are extensive and costly, usually mandating the project to be “shovel-ready.” To file a competitive application, applicants must invest hundreds of thousands (and, in some cases, millions) of dollars to advance the entitlement and design phase to prepare it as shovel-ready with the hope that the application gets funded, but success is not guaranteed. Not many developers are willing, or able, to take that risk.
In summary, it takes more time, requires more upfront at-risk investment, and is overly complex to build affordable housing. There is more predictability, less risk, and faster execution when developing market-rate housing. Hence the lack of affordable housing supply.
Big obstacles, small fix
In addition to the intricate financing structures required for building affordable housing, there are other obstacles that are controlled by local governments that limit or prolong the production of housing, including affordable housing in any given region. On average, it takes more time to complete the design of a project, get zoning, and obtain permits than the actual construction duration of that project.
Below is a sample of obstacles that can be fixed at almost no or limited cost:
Obstacle: Lengthy entitlement and permitting process; (1-3 years) as compared to matter-of-right zoning.
Solution: Allow for enhanced matter-of-right zoning envelopes and favorable zoning constraints for affordable housing projects and expedited permitting process.
Obstacle: High ratio of parking spaces required for a project (even in urban markets), which drives up the cost of the project.
Solution: Reduce parking minimums and/or grant parking relief for affordable housing projects.
Obstacle: Lack of prioritization of local funds (not necessarily lack of funds) for affordable housing.
Solution: Dedicate a percentage of a local jurisdiction's general obligation fund to finance affordable housing.
Obstacle: Limited rounds of financing application cycles that restricts the number of projects that can get started per year.
Solution: Accept applications at least twice a year.
Obstacle: Expensive public benefit package requirements including high permits, utilities, and regulatory fees even when building an affordable housing project.
Solution: Waive such fees for projects that are delivering 100% affordable housing.
Role of the Public Sector: REMOVE BARRIERS
The public sector can accelerate affordable housing production by removing barriers. At a minimum, local governments should make it easier for qualified groups to develop affordable housing by 1) expediting entitlement, particularly near mass transit, 2) expanding financing application cycle to at least twice annually, 3) expediting construction permits, and 4) waiving impact and other fees related to affordable housing projects. These are low-hanging fruits that can be implemented at no added financial burden.
Many local governments have started to remove such barriers, including the District of Columbia, which has facilitated a higher rate of production of affordable housing in our nation’s capital than many other states. Let's hope others will follow suit.
We need to create inclusive cities, neighborhoods, and communities where everyone, regardless of their background or economic status can call home and be able to live and thrive.
There is a lot the private sector can do to support more production of affordable housing, but we will leave that for another post.