This article is the fourth in a five-part series I am writing on affordable housing. Each article includes a podcast where I explore some of the themes and get a little personal with the experts I interviewed. Check out this article about public housing’s role in the affordable housing landscape, this one about how public housing fits into the housing ecosystem, or this one about the 35-year-old tax credit that is shaping the affordable housing industry. I will be updating it with links to the other articles as they are published. This special series is made possible by the generous underwriting of MRI Software.
There is a common scenario that plays out when neighborhoods become “desirable.” As more people move in from other places, the demand for real estate goes up and prices adjust accordingly. This is a natural component of a free market. Prices go up to match supply and demand for properties just like they do for any product. The difference is that rising property prices and the elevated rents that go with them have a human cost. Long-time residents can get displaced, people can be forced into uncomfortable or unhealthy living situations, and the most vulnerable of us can lose their housing security.
Since 1981, the U.S. government has considered anyone spending over 30 percent on their after-tax income “cost-burdened.” The number of people that fall into that category has crept up since the 1960s. The Joint Center for Housing Studies just released their latest State of the Nation’s Housing Report and their findings are stark, particularly for renters. “Some 20.4 million renters (46 percent) paid more than 30 percent of their incomes for housing […] (24 percent) are severely burdened households that paid more than half of their incomes for rent.” The study also found that housing cost burdens “have moved up the income ladder,” adding, “remarkably, 70 percent of renter households earning between $25,000 and $34,999 and nearly 50 percent of renters earning between $35,000 and $49,999 were also at least moderately burdened.”
At first glance, this might seem like an unavoidable outcome of our capitalistic society. People invest in rental properties to make money and they want their properties to make as much money as the market will bear. But there is a growing number of people who don’t see prices escalating out of reach for lower-income residents as inevitable. These people are finding new ways to create what is known in the housing industry as N.O.A.H., naturally occurring affordable housing. Even though N.O.A.H. is not the same as “affordable housing,” which is defined by the use of programs such as the low-income housing tax credit to subsidize below market-rate rentals, it is a critical component to a city’s culture, economy, and equality.
Fairness follows finance
The money sloshing around our capitalistic economies has a growth imperative. Because of uncertainty and inflation, money is only invested in something if the people investing it think it is able to grow. This means that investors in rental buildings expect as high of a return as possible in order to compensate for their risk and their opportunity costs. For centuries this has pushed landlords and property managers to escalate rents when demand outstrips supply.
Maximizing return on investment is the most straightforward way to think about real estate investment, but it isn’t the only way. There are a growing number of organizations that would like to put their money to work, not just for themselves but for society. Non-profits, endowments, and trusts often donate to affordable housing projects as a way to advance their mission. They don’t intend to make any profit on these investments. The problem is that these organizations are a droplet of much-needed water in the giant empty bucket that is our housing affordability crisis. “Philanthropy has been around two percent of our GDP for as long as anyone can remember,” says Mark Ethridge, partner at Ascent Real Estate Capital. “If we want to grow mission-oriented dollars, we have to be more innovative about how we get people to put more money into that bucket.”
Earlier in his career, Ethridge, like other junior associates working in real estate capital markets, cut his teeth on the less desirable apartment complexes. He noticed the trend of investment shops buying older complexes, raising rents, and then selling them off and realized that trend didn’t bode well for many long-time residents of his hometown of Charlotte. “The [low-income housing] tax credit program is not equipped to buy older, unrestricted properties,” he said.
The Federal tax credit program was created to incentivize the development of more rental units, but the affordability problem we are in now is not something we can just build our way out of. Right now we have such a housing deficit that even if we build at the country’s full capacity, it would take four years just to get us to where we need to be right now in terms of housing stock. That doesn’t take into consideration the extra housing needed to keep up with the population growth or the other non-financial barriers to building new dwellings like unfavorable zoning and local opposition.
So in order to bring rents down, Ethridge knew he would have to find a way to keep prices on existing rentals modest. To do this he turned to his hometown of Charlotte’s affordable housing bond, which was amended to include provisions for the preservation of existing affordable properties as well as new developments. To be eligible to receive financing from the city’s bond, Ethridge and his team promised to create deed restrictions for their properties that would maintain the current levels of affordability for at least 80 percent of the units, as well as have provisions that protect existing occupants.
For the equity portion of the investment, Ethridge was able to structure deals that would be able to provide a steady six percent on investment capital through dividends, with a target of total return of as much as eight percent. “If you think about it, many REITs pay around a six percent dividend,” Ethridge told me. “By at least providing some payback to conscientious investors, you end up getting a much larger pool of potential funding sources.”
Many investors want to use their capital in ways that they agree with morally, but few of them are willing to forgo any profit for their morality. What might seem like a small ROI in today’s hyper-growth market should also be put into the context of risk to reward. Affordable housing is already seen as one of the least risky investments, people have shown that they will forgo other expenses in order to preserve their favorable housing arrangements. Pegging rents below market practically assures that properties will have almost no vacancy.
There are plenty of other organizations pursuing this same strategy. Many of them, though, are organized as non-profits so any loans for properties are tax exempt. This wasn’t the path that Ethridge and his team wanted to go, however. “If you talk to my partners, the fund managers, they are 100 percent committed to the for-profit way because they want to show that capitalism can work for the people and that there are market-based reasons to preserve affordable housing.”
Building the missing middle
I have heard many people shrug off the country’s affordability problems by saying something akin to, “there is plenty of vacant housing that low-income people could live in.” This might be true but it ignores the simple fact that low-income people are usually not at liberty to just move to wherever they can find the cheapest rent. The majority of Americans do not move from the place they were born; the number of people moving every year in the country has been declining since the early 1980s (with the exception of a slight uptick during the pandemic) and most homeless individuals live in the same town where they became homeless. Many lower wage earners are forced to commute from cheaper exurbs to their jobs in the city centers, causing an increase in consumption and traffic while further burdening those that can least afford it. Plus, this approach has been shown to concentrate poverty in a way that makes upward mobility much less likely.
To really help alleviate the housing affordability crisis, the supply of affordable housing needs to increase in places where people want and need it the most. Creating affordable housing in the middle of nowhere does little for those struggling to pay rent in Los Angeles or New York City. Local governments realize this. Many are upzoning areas to allow more development of what is called the “missing middle,” buildings like duplexes and fourplexes that can be built without requiring a major change to the character of a neighborhood. This style of development is less expensive on a per-unit basis than single family homes and provides the kind of density needed to help bring prices down. But changing the zoning to include larger buildings isn’t enough to spur the kind of development we need.
“There is not a lot of clarity in local governments as to where exactly they will find the housing that they need,” said Jason Doyle, CEO of Gridics, a zoning intelligence platform used by cities. “Most cities know directionally which way their housing is going but don’t know where they can best rezone to incentivize it.” Doyle is working to parse through zoning restrictions, housing data, and lot sizes to create technology that is able to generate interactive maps showing where housing can and should go.
“There is a growing trend of cities proposing legislation to eliminate exclusive single-family zoning in an attempt to create housing supply,” Doyle said. “That is akin to using a sledgehammer where it would be better to use a scalpel by taking a data-driven approach to identify the ideal areas to soften single-family zoning restrictions.”
Cities are trying to find the best way to allocate additional density allowances in places where it will do the most good, such as close to transit stations and work centers. City officials and property developers are trying to find the best way to build additional density that will not get bogged down by one opposition group or another. Finding that balance is hard, but not impossible. “A lot of large, unpleasant affordable housing structures have left a lot of locals with a bad taste in their mouth for affordable developments,” said Karin Brandt, founder of coUrbanize. She works with developers to help them interface with locals and convince planning boards to approve new developments.
The traditional way that cities conduct a public review of new projects is through council meetings. In-person meetings self-select for a certain type of person, a vocal minority that usually opposes change. Now, neighborhood councils are often conducted over Zoom and developers have gotten a lot savvier about the way they are able to understand the neighbors, both through in-person and online interaction. This approach, mixed with a newfound political contra-NIMBY activism, has worked. “By broadening the outreach, you can start to include the voices that often go unheard, many of which are benefiting from more affordable housing,” Brandt said.
There is also the inevitable pushback from homeowners about the possible negative impact on their home values to consider. More housing supply means lower prices, right? Well, it turns out that the reality is much more nuanced than micro-economic theory would lead us to believe. Building larger, more affordable apartment and condo buildings hasn’t proven to decrease the overall price of homes in an area. One of the most robust studies done on the topic happened in New York City in 2006 where researchers studied the impacts of about 43,000 units of city-supported housing completed during the 1980s and 1990s using data from nearly 300,000 individual property sales. They found that “both nonprofit and for-profit [affordable housing] projects generate significant, positive spillover effects. This finding in itself is significant, given the widespread skepticism about the impact of subsidized housing on neighborhoods.”
Spillover is an economist’s way of saying that we all depend on each other. Human suffering is not good for economies, just like it is not good for cities. Microeconomics theory only works when you zoom into the individual level but the forces that shape societies work in the most collective of ways. More density leads to more lively urban centers, more of the shops, cafes, and activities that spur our economy in the most beneficial of ways. “It is really bad for the local economy when people are paying more than 50 percent of their income on rent,” said Bob Simpson, founder of Simpson Impact Strategies, a multifamily social impact advisory firm. “When people have money left over after they pay rent, those dollars are going to have a stimulative effect on the local economy.”
Maybe an even bigger impact of affordable housing on the economy comes from what it can prevent. “People who don’t have access to affordable housing experience a lot of health effects from stress,” Simpson said. “Attention spans in children are lower and that negatively impacts education. We pay for this as a society ten years down the road.”
A place for people
There is a connection between morality and free-market economics that we inherently feel in our cities, although they often don’t play out for decades. Housing shortages can benefit those lucky enough to already own property but eventually weigh on neighborhoods in ways that lower the standard of living for everyone.
Building and preserving affordable housing might seem at odds with the zero-sum theory of property speculation but only if you ignore the impact of social stability on economic advancement. Many of our cities are struggling under the weight of their cost of living. This is proof that less supply doesn’t always correlate with more valuable assets. We need to reduce the human costs of the housing affordability crisis, but we can’t do it with charity alone. We need to find economically viable ways for affordable housing investment. We need to better understand the needs of everyone, even those who don’t have a voice. We need to grow our cities in a way that benefits all of us. We can only do these things if we embrace the fact that what is better for people is better for real estate.