Commentary: The Failure of the Market Underlies the Problem of Affordable Housing

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Photo by Brandon Griggs on Unsplash

By David M. Greenwald
Executive Editor

Most Californians agree on one key point—we do not have enough affordable housing.

In an op-ed in CalMatters, Cynthia Strathmann, the executive director of Strategic Actions for a Just Economy, acknowledged many different, at times overlapping, explanations for why this is the case—and while she acknowledges, “Each of these explanations is more or less true,” at the end of the day, she finds that “the private market has failed to provide us with the housing we need.”

While some of that might be structural, she points out, “The market’s failure to adequately supply a public good is neither surprising nor unprecedented. If the point of building homes is to generate profits, unmet demand will inevitably exist in places where money cannot be made.”

Moreover, the Urban Institute found “that building homes for low-income households is not sufficiently profitable for the majority of developers, who need to charge market-rate rents to cover construction and operating costs.”

As the Urban Institute notes, “For every 100 extremely low income households, there are only 29 adequate, affordable, and available rental units.”

And yet, with such high demand, developers are not exactly “racing to build affordable apartments.”

Why?

As they argue, “It turns out building affordable housing is not particularly affordable. In fact, there is a huge gap between what these buildings cost to construct and maintain and the rents most people can pay. Without the help of too-scarce government subsidies for creating, preserving, and operating affordable apartments, building these homes is often impossible.”

This seems to be one of the most important sticking points in local debate.  Most people, even those generally distrustful of developers and new developments, acknowledge that housing costs are unaffordable, and that we need more housing for low-income people.  (Of course, as you well know, building that low-income housing next door presents all sorts of problems).

The Urban Institute’s tool is helpful.

“Development costs a lot of money,” they write.  “Developers rely on loans and other sources to fund construction before people move in and start paying rent. But developers can only get those loans and equity sources if the development will produce enough revenue to pay back the loans and pay returns to investors.

“The gap between the amount a building is expected to produce from rents and the amount developers will need to pay lenders and investors can stop affordable housing development before it even begins, leaving few options for the millions of low-income families looking for safe, affordable homes.”

The basic problem, for low-income housing, is that in many locations “the rent the poorest families can pay is too little to cover the costs of operating an apartment building, even if developers could build that building for free.”

The Urban Institute has a nice tool here to that examines the problem looking at data from Denver.

They note, “To illustrate this problem, we examined data from the Denver metro area, which is experiencing a growth in rental housing demand but is not a traditionally high-cost city. The rental housing conditions in Denver are largely representative of other US cities.”

Take a look here.

The tool shows the impact of three major costs—first, land acquisition; second, construction; and third, the developer fee.

As they note, in some cases “developers are able to use public land to develop affordable housing. But when that option is not available, there is little a developer can do to lower the land cost.”

Developers then fund development through loans, tax credits and grants.

As noted, “federal, state, and local governments have limited amounts for tax credits and grants, so even if a development qualifies, funding is not guaranteed.”

They note, “if there aren’t enough grants or tax credits out there, why don’t developers just take out bigger loans to get the building off the ground?”

The answer: “The lenders won’t (and shouldn’t) let them.  In short, “The size of the loan a bank will make depends on the project’s net operating income (NOI), or the amount of money it expects to bring in from rent after accounting for operating expenses.”

Moreover, “if the rent is set at rates that a working family can afford, that NOI is going to be quite low. It might even be less than zero if operating costs exceed revenue. The lower the NOI, the lower the size of the loan.”

They might be able to fill the gaps through more apartments.

But the Urban Institute warns that “adding more apartments is only useful if developers can fill them, which might be possible in larger cities but harder as you move farther away from dense urban areas. Additionally, creating large communities of affordable housing has its social and economic downsides, particularly if it unintentionally segregates low-income families from the rest of a community. It all depends on the scale and shape of the particular place.”

There is also the possibility of higher rent, but, “when does affordable housing stop being affordable?”

For a building to qualify for tax credits, “the apartments must be affordable to families earning no more than 60 percent of the area median income (AMI). Additionally, many rent subsidies are targeted to extremely low-income families, or those earning less than 30 percent of AMI.”

In short, “The current standard is that a family should pay no more than 30 percent of its household income on rent. Anything more is no longer affordable.”

You can see the problem here fairly easily.  There is a reason why the state of California is looking at projects that have between 15 and 20 percent affordable housing.  You might be able to get to a higher level with more in the way of subsidies and by lowering other costs.

But, for the most part, affordable housing is going to be leveraged from market rate housing.

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About The Author

David Greenwald is the founder, editor, and executive director of the Davis Vanguard. He founded the Vanguard in 2006. David Greenwald moved to Davis in 1996 to attend Graduate School at UC Davis in Political Science. He lives in South Davis with his wife Cecilia Escamilla Greenwald and three children.

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27 thoughts on “Commentary: The Failure of the Market Underlies the Problem of Affordable Housing”

  1. Richard McCann

    This makes the point about my comment earlier this week on Davis’ RHNA target. We need a lot more new market rate housing to pay for the affordable units. However, the bottom line implication is deeper than that–we’re going to need a wealth transfer from existing homeowners to low income households to cover the cost of this housing.  Unfortunately Prop 13 created a high barrier to this necessary solution.

    1. Keith Olsen

      we’re going to need a wealth transfer from existing homeowners to low income households to cover the cost of this housing.

      Richard, who’s this “we”.  Speak for yourself, if you want to transfer your wealth go for it.  But don’t speak for the rest of the homeowners.

        1. Keith Olsen

          I already stated my response.  If you don’t like it that’s your problem.  You don’t always answer my questions either, but I can’t just shut down the discussion like you did the other day.

          1. David Greenwald Post author

            This is exactly the reason why we are in this mess. The answer is always no. There is never any proposal for making things better, it’s always just “don’t do that.” Or as Dunning used to call it – the CAVE syndrome – “Citizens Against Virtually Everything”

        2. Walter Shwe

          The fact of the matter is that Keith has no real answer for affordable housing. He would rather watch as the ranks of the unhoused grow by leaps and bounds.

          1. David Greenwald Post author

            Which wouldn’t be a big deal except that he is hardly the only one in that boat.

        3. Walter Shwe

          CAVE Syndrome = Single-Minded Anti-Development Obstructionists

          I appreciate someone bringing to my attention the self-polluting and traffic contributing NIMBY obstructionist group called Our Neighborhood Voices.

        4. Matt Williams

          I want to thank Walter for bringing the Sacramento organization  Our Neighborhood Voices to everyone’s attention.  I had not heard of them before Walter’s snarky comment above.  It was interesting to read their approach to Sacramento issues.
          The politicians are taking away our ability to speak out when developers damage and gentrify our neighborhoods.

          A series of recently passed laws allow developers to build multi-story, multi-unit buildings right next door to single-family homes and deny our ability to fight back. We are a coalition of thousands of California neighborhood leaders creating a ballot initiative that would bring back our ability to speak out about what happens in our own neighborhoods. 

          Stop the Blank
          Check to Developers!

          Instead of actually working to create new housing without traffic gridlock, sprawl and environmental damage — Sacramento politicians handed a blank check to developers to build what they want, where they want, without contributing to new transit, schools, or roads — and without our ability to speak out.

          After accepting tens of millions of dollars in contributions from for-profit developers, Sacramento politicians passed SB 9 and SB 10 — two damaging laws that essentially tell us to ‘sit down and shut up’ about what is happening right next door to our homes while developers demolish single-family homes and build multi-story, multi-unit projects.

          We will not sit down — and we are speaking out! We are standing up to overturn these damaging laws by passing a statewide initiative that restores our neighborhood voice and sanity to our planning process. We can’t turn our local planning over to developers — the result will be gentrification, displacement, traffic gridlock, environmental damage, higher taxes and sprawl.

          It Isn’t Affordable Housing! It’s Massive Profits for Developers.

          The politicians say they took away our neighborhood voice because we need to lower the cost of housing. But their two bills create NO new affordable housing.

          There are ZERO requirements to build new affordable housing. The developers will make billions and the facts show that these two state laws will create massive displacement — forcing working families out of their own communities.

          We Can Have New Housing Without Even More Traffic Gridlock.

          There are proven ways to create new housing without gridlock and sprawl. We can build new housing near rapid transit, we can create more housing in our downtown areas next to jobs, we can reduce the red tape that increases the cost of housing, we can create affordable backyard cottages that keep our parents and kids in our communities while preserving the scale and character of our neighborhoods.

          There are solutions — but the politicians gave their developer donors the ability to build market-rate, multi-story projects in every neighborhood and took away our ability to speak out about projects that are being built literally right next door to us.

          The Developers Make Billions—We Pay the Bill.

          What is so dangerous about the giveaway to developers is not just that it will take away our neighborhood voice—it will leave every California family with a significant new bill.

          The two laws passed by Sacramento do not require developers to contribute one new cent to roads, transit, schools, parks, police and fire protection, new water sources or any other service.

          They profit — we pay!

          That’s just one of the reasons neighbors from every corner of California are joining us and fighting back.

           

           

           

           

           

        5. Keith Olsen

          Builder’s Remedy only impacts infill, not peripheral.

          David, sprawl comes in many forms.

          Here’s a definition I’m using:

          ” to spread or develop irregularly or without restraint”

      1. Tim Keller

        The dirty secret is that the single family housing that is “needed” to finance the capital-A affordable is, in in turn, subsidized for the rest of it’s existence by the higher density neighborhoods.  Such is the evidence provided by Strong Towns and illustrated here:
        https://www.youtube.com/watch?v=7Nw6qyyrTeI

        While I dont mind subsidizing capital-A affordable, I think the housing that we create in order to provide that subsidy should NOT be money-losing single family housing… but instead a wealth of market-rate apartements, condos, co-ops and townhomes that themselves are net-positive for the city.

    1. Walter Shwe

      Davis NIMBYs and Our Neighborhood Voices are organizing on social media and other sites to stop Village Farms and projects that intend to use the Builder’s Remedy.

  2. Jim Frame

    We need a lot more new market rate housing to pay for the affordable units.

    It won’t work, and will only result in massive numbers of the kind of housing that’s bad for the climate and bad for communities.

    Since the state has — not unreasonably — tasked local communities with the responsibility for accommodating affordable housing quotas, it should also give those communities the tools they need to accommodate that housing without destroying themselves in the process.

      1. Matt Williams

        David, you didn’t understand Jim’s comment.  He is simply pointing out the unfunded mandate that the State has imposed on localities.  The State providing both the mandate and the funding addresses the lack of affordable housing.

        1. David Greenwald Post author

          I understood that point. But he made the argument that the states mandates will result in housing that’s bad for the climate and my response is that the current practices are bad for the climate. I have long argued that the state should implement a new increment tax to replace redevelopment.

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