Affordable housing is unaffordable
Specifically, I will be writing about the funding of affordable housing via the taxation of market rate housing and how that affects housing prices. It's true that in some instances, affordable housing funds come from the general fund which is funded via other taxes, but that kind of goes beyond the scope of this blog. For the purposes of this post, when I say "affordable housing", I specifically mean a price controlled unit sold lower than market value, and not innovative market rate housing like tiny homes or creative uses of space in a condo.
There are generally two ways developers may provide affordable housing:
So to make sure everyone's following this...the city put restrictions on how many houses he can build on his own property, limiting potential housing stock. Then the city says they can have the freedom to build more houses back as long as the developer gives something back in return. That's not quid pro quo. That's extortion*.
At any rate, the market rate of these houses were generally around one million dollars. The two below market rate houses were sold off in a lottery system to income restricted buyers at a bit over $200k a pop. The income restriction at the time of writing for this city is $103,350/yr for a family of 3 (typically around 100% of median household incomes). So what does this mean? The developer took a bath of $1.6 million on the two below market rate (BMR) houses. To make up for this loss, the profit on the rest of the 15 houses must balance out the two BMRs. That would be $106k per house for the other 15. So if the density cap, as well as the affordable requirement, wasn't in place, the market rate houses could have penciled at below $900k with a bit more savings in compliance costs.
In the big picture, what this means is that a lucky select few of the lower to middle class gets a boost (the applicant pools are extremely large), developers get pushed toward higher end houses because those are now the only ones that are financially viable. The vast majority of the middle class as well as the lower class, once again, gets screwed, as mid-range houses lag behind.
The in-lieu fees are a bit more transparent, but sometimes still wonky. San Francisco recently passed a new in-lieu fee structure. For projects containing fewer than 25, 20% of the gross square footage has a fee of about $200 per square foot. For projects 25 units or more, it's $200 per square foot on 33% of the gross square footage.
So let's say a project has 24 units at 1,000 square feet each (as of this writing, the prices are about $900k-$1.2mil per unit).
1,000 SF * 20% * $200/SF = $40,000 fees per unit
* 24 units = $960,000 of fees for the project for affordable housing portion alone
But what if we go to 25 units? From the link, as well as a glance at the San Francisco Planning Code section 415.5, it does not appear the fees operate on margin, where the first 24 is based on the lower fee but subsequent units are based on the higher fee (but I could be mistaken here), so the gross square footage for all units (not just those exceeding the unit threshold) would be at 33%.
1,000 SF * 33% * $200/SF = $66,000 fees per unit
* 25 units = $1,650,000 of fees for the project for affordable housing portion alone
So if you are able to build that 25th unit, would you? It would cost you $650k in fees alone for that one additional unit. With construction costs in San Francisco at around $300/SF, an additional 1,000 SF unit would be an extra $300,000 plus any other costs like utility runs, other city fees, and . This means your entire profit off the additional unit is pretty much wiped out and likely then some.
In all likelihood, you would need to build a number of units above 24 in order for it to be worth it, resulting in a black hole of unit numbers from 24 to whatever, where it doesn't make sense to build due to the fee structure. So even if your site can fit 24 units plus a few extra, why do it if those extra units will only break even in profit and create higher risk? You'd be better off building only 24 units, and making them larger, positioning yourself for a higher income customer, to try to recapture some lost revenue from inefficiency by fiat. Once again, a lucky select few of the lower income gets assistance, the high income people get more luxury housing, and the middle class get screwed.
Okay, okay, but what if the fee structure works on margin or are not based on the number of units? Many cities have a flat fee for affordable housing. Pleasanton, for example, has a flat fee of about $44,000 per house whether it's a 1,600 square foot house or a 14,000 square foot house. For San Francisco, according to the calculations above, each 1,000SF unit has fees attached of $40,000 (or $66,000). This may not seem like a whole lot for a unit that costs a cool million (4-6.6%), but this adds up. Who wouldn't take a $40k-$66k discount when people's checkbooks are being squeezed this hard from the cost of housing? What the fees mean is that for every 15 to 25 homes sold, there should be enough money left over to just give to someone to buy one additional unit.
Is this what happens?
No. Affordable housing in the political sense has become a misnomer (what else is new). I discovered that it is very difficult to find costs per square foot differences between market rate and affordable housing. There was a study done in 2011 that compared the two with market rate housing ($281/SF) coming in slightly cheaper per square foot than affordable ($288/SF), but the data set was limited.
One major issue with the expense of affordable housing is that any project with taxpayer funds or public subsidies must utilize prevailing wages for construction workers. My clients have observed between 30-50% increases, and higher in the lowest end of single family detached housing, in costs of construction between using normal labor and prevailing wages. Even if you completely negate the profit factor assuming the highest ends of around 25% margins, and completely ignore any inefficiencies caused by enacting and transferring money from the private sector to the public, you'd still be hard pressed to negate that one cost increase alone.
Finally, in a 2004 Reason Foundation study, they found that new housing stock drops drastically after such affordable housing requirements are added to the law books. It also found that these requirements and fees also yield few affordable housing units being built. This is in line with what's happening in San Francisco today, with permit applications declining after harsher affordable housing regulations were passed. Lower supply with increasing demand, higher prices. Want more "affordable" housing? Be careful what you wish for. You just may find that affordable housing is very much unaffordable.
*I'm using the dictionary definition of "extortion", not a legal accusation.
There are generally two ways developers may provide affordable housing:
- Provide below market rate units within the development. Occasionally, this will come with perks like density bonuses, but many times, it's just mandated by the city that the developer must provide a certain percentage.
- Pay an in-lieu fee to the city, which varies by city.
At any rate, the market rate of these houses were generally around one million dollars. The two below market rate houses were sold off in a lottery system to income restricted buyers at a bit over $200k a pop. The income restriction at the time of writing for this city is $103,350/yr for a family of 3 (typically around 100% of median household incomes). So what does this mean? The developer took a bath of $1.6 million on the two below market rate (BMR) houses. To make up for this loss, the profit on the rest of the 15 houses must balance out the two BMRs. That would be $106k per house for the other 15. So if the density cap, as well as the affordable requirement, wasn't in place, the market rate houses could have penciled at below $900k with a bit more savings in compliance costs.
In the big picture, what this means is that a lucky select few of the lower to middle class gets a boost (the applicant pools are extremely large), developers get pushed toward higher end houses because those are now the only ones that are financially viable. The vast majority of the middle class as well as the lower class, once again, gets screwed, as mid-range houses lag behind.
The in-lieu fees are a bit more transparent, but sometimes still wonky. San Francisco recently passed a new in-lieu fee structure. For projects containing fewer than 25, 20% of the gross square footage has a fee of about $200 per square foot. For projects 25 units or more, it's $200 per square foot on 33% of the gross square footage.
So let's say a project has 24 units at 1,000 square feet each (as of this writing, the prices are about $900k-$1.2mil per unit).
1,000 SF * 20% * $200/SF = $40,000 fees per unit
* 24 units = $960,000 of fees for the project for affordable housing portion alone
But what if we go to 25 units? From the link, as well as a glance at the San Francisco Planning Code section 415.5, it does not appear the fees operate on margin, where the first 24 is based on the lower fee but subsequent units are based on the higher fee (but I could be mistaken here), so the gross square footage for all units (not just those exceeding the unit threshold) would be at 33%.
1,000 SF * 33% * $200/SF = $66,000 fees per unit
* 25 units = $1,650,000 of fees for the project for affordable housing portion alone
So if you are able to build that 25th unit, would you? It would cost you $650k in fees alone for that one additional unit. With construction costs in San Francisco at around $300/SF, an additional 1,000 SF unit would be an extra $300,000 plus any other costs like utility runs, other city fees, and . This means your entire profit off the additional unit is pretty much wiped out and likely then some.
In all likelihood, you would need to build a number of units above 24 in order for it to be worth it, resulting in a black hole of unit numbers from 24 to whatever, where it doesn't make sense to build due to the fee structure. So even if your site can fit 24 units plus a few extra, why do it if those extra units will only break even in profit and create higher risk? You'd be better off building only 24 units, and making them larger, positioning yourself for a higher income customer, to try to recapture some lost revenue from inefficiency by fiat. Once again, a lucky select few of the lower income gets assistance, the high income people get more luxury housing, and the middle class get screwed.
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| What if other things we buy are similarly "affordable" like the government does with housing? |
Okay, okay, but what if the fee structure works on margin or are not based on the number of units? Many cities have a flat fee for affordable housing. Pleasanton, for example, has a flat fee of about $44,000 per house whether it's a 1,600 square foot house or a 14,000 square foot house. For San Francisco, according to the calculations above, each 1,000SF unit has fees attached of $40,000 (or $66,000). This may not seem like a whole lot for a unit that costs a cool million (4-6.6%), but this adds up. Who wouldn't take a $40k-$66k discount when people's checkbooks are being squeezed this hard from the cost of housing? What the fees mean is that for every 15 to 25 homes sold, there should be enough money left over to just give to someone to buy one additional unit.
Is this what happens?
No. Affordable housing in the political sense has become a misnomer (what else is new). I discovered that it is very difficult to find costs per square foot differences between market rate and affordable housing. There was a study done in 2011 that compared the two with market rate housing ($281/SF) coming in slightly cheaper per square foot than affordable ($288/SF), but the data set was limited.
One major issue with the expense of affordable housing is that any project with taxpayer funds or public subsidies must utilize prevailing wages for construction workers. My clients have observed between 30-50% increases, and higher in the lowest end of single family detached housing, in costs of construction between using normal labor and prevailing wages. Even if you completely negate the profit factor assuming the highest ends of around 25% margins, and completely ignore any inefficiencies caused by enacting and transferring money from the private sector to the public, you'd still be hard pressed to negate that one cost increase alone.
Finally, in a 2004 Reason Foundation study, they found that new housing stock drops drastically after such affordable housing requirements are added to the law books. It also found that these requirements and fees also yield few affordable housing units being built. This is in line with what's happening in San Francisco today, with permit applications declining after harsher affordable housing regulations were passed. Lower supply with increasing demand, higher prices. Want more "affordable" housing? Be careful what you wish for. You just may find that affordable housing is very much unaffordable.
*I'm using the dictionary definition of "extortion", not a legal accusation.
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