Growing Attention to Crisis in Affordable Housing

I was interested to run across this Yahoo opinion piece about the coming crisis in working-class housing:

https://beta.finance.yahoo.com/news/rent-crisis-lot-worse-100006208.html#

The article says, that even if wages go up faster than rents (and I don't know anyone that does), this problem will not go away.

Since people are running for president, I urge all the candidates to take a moment from their favorite emotional hot-button messages (religious judgment, gay rights, and border walls) to propose a way to make people's lives better: more housing they can afford, in places they want to live.

California's Carbon Tax Will Hurt Real Estate Investors

Beginning in 2015, California is fighting climate change by increasing taxes. It saved money by cancelling redevelopment programs that provided affordable housing. That was dumb, by canceling a program that reduced driving for one that will raise gas prices.

Carbon "markets" aren't new, but there's no evidence that they're working to improve the environment. In Europe, the existing structure is failing due to plummeting prices and demand. The Economist Magazine calls the market "below junk" status in this article:

http://www.economist.com/blogs/schumpeter/2013/04/carbon-trading

And what the effect of California's creation of a new tax, and a market to trade the tax, in order to "fight" climate change?

Gas prices will go up.  This article from U.S. News points out that the tax isn't even calculated yet! What's the rush?

http://www.usnews.com/opinion/economic-intelligence/2014/09/10/california-carbon-gas-tax-could-cost-drivers-big

So, in the state that epitomizes urban sprawl, the state does something to make it more expensive to drive. Annoying for the well-off, critical for the working class. And in the name of being environmental. Nice irony.

Real estate investors have the right to form an opinion on this, and I suggest they communicate their displeasure.

• The same governor eliminated state support for affordable housing in 2012, which encouraged developers to build housing. A study found that affordable housing intensified use of public transportation. 
• California already has the second highest gas taxes in the U.S. This will make us Number One, and that's a bad thing, because it's a cost of living here and doing business here, as opposed to every other state.
• Business real estate needs business, and business needs people. Making getting around more expensive, and business more complex, is the opposite of encouraging people to do business. 
• What effect will the new tax have on reducing greenhouse gasses? Is there any evidence? Shouldn't we expect some concrete reasoning on the part of the people running the government?  (I'm just kidding.)

Real estate investors, big or small, want growth, stability, and confidence. Creating a new tax, and an exchange to shift the tax, is a dumb idea. Affordable housing support was an ongoing program without any obvious drawbacks, and some apparent benefits. 

Here's my suggestion: make cities work better, so people live closer to where they work and shop and go to school. Skip creating a new institution of a tax market.

An Open Letter to Donald Trump

Donald Trump

Chairman, President, and CEO

The Trump Organization

725 Fifth Avenue

New York, NY 10022 USA

September 16 2015

Dear Mr. Trump:

Please consider proposing, as a candidate for the office of President of the United States, a program to redevelop American city centers. The benefits to the country would be:

• Increasing the number of housing units available to the bottom eighty percent of the population, including workers, seniors, and new families.
• Reducing the number of miles driven using automobiles, by increasing the use of public transportation, bicycling, and walking. If the concerns about global warming have any validity, this may produce more improvement than other, theoretical approaches.
• Bringing consumers and business back to decaying city centers.
• Stimulating creativity to urban planning, reducing the size of housing units to fit the trends in household demographics, encouraging community and social involvement, and innovation in business formation.
• Creating jobs for construction workers and associated industries in modifying obsolescent structures into mixed use residential/retail/office environments.

Your background as a successful real estate developer would set you apart from all other political contenders as a proponent of urban revitalization. Using private and public money, and tax credits, some financial formula exists to attract smart developers to improve city centers and vacant big box properties. It would also be a positive program that will benefit most voters, who struggle with finding affordable living situations close to their jobs, offering safe neighborhoods and energy-efficient designs.

Best Wishes,

Bruce Haulley, CCIM

Apartment Rents Are Not High Enough to Justify Building New Construction in Coachella Valley

This title asserts two issues:

1. Rents are low, and not likely to increase significantly, and...
2. ...Construction is expensive.

1. Rents are low in this area, and not likely to go up considerably.

Rents in Coachella Valley range about 80¢ per square foot  (big units in Indio) to about $1.50 PSF (small units in Palm Springs). 

This compares to $2 PSF in up-scale areas of Los Angeles. New construction in LA is projecting $4 PSF for luxury apartments, with amenities and concierge service. 

As I posited in my last blog entry, rents are probably not going to shoot up in this area, because the average working household won't be able to afford it. Without wages going up, the cost of living is the barrier.

2. Construction is expensive, and shooting up. 

Construction companies contracted during the last Recession, and the survivors are now very busy. They're not likely to cut their prices. In addition, the cost of materials is very high, historically (supply and demand pushed up prices).  

Plus, cities have made it increasingly expensive, and risky, to propose development. Architectural design, consultant studies, attorneys, and insurance pre-load any development ideas with hundreds of thousands of dollars of costs -- before even being approved by the city. I know developers that are bitter after their experience with various Coachella Valley city planners. I see their point. 

So what are the economics?

Rewards have to attract the developer. By investing in T-bills, money can earn two percent. By making real estate loans, it can earn about seven percent. So developing, with its risks, must earn more. 

Most developers I know won't consider a project that will earn less than fifteen percent, considering the hours of effort, and riskiness of creating a project.  And that's a bare minimum. Let's use twenty percent "internal rate of return".

Every IRR calculation starts with the initial investment. Let's say that a twenty unit apartment building in a working class neighborhood will be our goal. Let's use Palm Desert, a nice upper middle class area in Coachella Valley.

Rents are about $1.20 PSF in Palm Desert, according to CoStar Data. 

Let's build our twenty units as two bedrooms, about 800 SF.

Vacancy in Palm Desert is about three percent (CoStar), but most underwriters use a minimum of five percent vacancy.

Expenses for an apartment building run between 35% and 40% of rent revenues.  I'll use an average of those numbers, or 37.5%.

So, it looks like we would have an asset worth about $2.5 million after building it and filling it with paying tenants. (And this is figuring we just had the money sitting around, and didn't need to borrow any. More on this later.)

What would it take to create this $2.5 million asset?

Forgive the generality, but this calculation is a personal decision for each developer. If their time is worth anything, and they see risk as a cost, there's just nothing left over for buying land in a desirable area and going through the process.

Okay, I'm not wringing my hands and complaining about life. Investors can use this information to make decisions. See next chapter...

It just doesn't pay to build apartment buildings in California -- Chapter One

There's construction going on in Coachella Valley, but it's not building apartments. Why? It's not worth it.

Real estate development requires a few solid investments way before any return: money, time, skill, and the ability to tolerate risk. Lots of risk: the economy can (and does) change during the long development process, interest rates go up and down, and city planners throw wrenches into the machinery whenever they can.

So the person who decides to build new real estate has to be smart and experienced, have a lot of money available, two years of time and attention, and mental toughness. Does he build apartments?

No, because the effort isn't worth it, at this time.

Rents are about as high as people can afford. I'm not very political, but the spread between income classes has left most people living on about the same as many years in the past. Rich people are getting richer, but not working people.  I found this illustration of information from the Congressional Budget Office:

You can find the image above at http://www.facethefactsusa.org/facts/income-gap-between-rich-middle-class-and-poor-widens.

In other words, over almost thirty years, in constant dollars, 80% of households in the U.S. increased their after-tax income by only 18% to 40%. Cost of living went up, gasoline went up, rents went up, but available income to most households didn't, very much.

Again, I'm not being political. However, I wouldn't tell investors that rents in average California apartments are poised to increase much, because people just can't afford it.

This also explains why, in Coachella Valley, the hot commercial real estate sectors are single family home building (over $600,000), and hospitality. The well-off are driving real estate development, because they have the discretionary spending available.

More on the financial analysis of apartment development in the next chapter.

Chapter 4, letter to Governor Brown: Combine the two issues to be really creative and forward-looking. And it makes financial sense.

Governor Brown, you are the perfect actor to articulate a vision of the future for California, in which carbon emissions are reduced through innovative urban design, bringing housing to its residents.

• It would reduce carbon emissions, by encouraging walking, bicycling, and public transportation. I’m a Californian, so I understand most people need a car for kids, groceries, and spontaneous trips. But let’s add other options, and reduce the use of automobiles. Existing mass transit will be used more intensively, improving its value to local governments.. 
• It would revitalize California's decaying downtown areas, bringing residents and businesses into city centers, with their need for services, groceries, and transportation.
• It would create safe, modern housing for teachers, seniors, landscapers, bookkeepers, restaurant workers, daycare workers... you get it. People who aren't upper-middle class. 
• Developers are smart in judging the market and returns. They'll be partners in revitalizing downtown areas and coming up with new ideas. I think they will suggest ideas that will improve in energy efficiency, safety and security, business interaction, and social involvement. I suggest looking at urban sites of obsolescent retail malls, vacant, and unlikely to be filled up with old-style retailers using hundreds of thousands of square feet.  
• It would create construction jobs. 
• It makes great financial sense. Future tax credits, and encouraging developers to borrow money to build affordable housing in city centers which are languishing, and getting paid back? Smart move. 

Thanks for your time reading this, or for the time it took to change the web page. To be fair to you and other state officials, nothing I'm saying is new or unique. However, no one has put it together into an effective program that creates results. This is an opportunity for you.

If you'd like, I'll make myself available to the State of California as a volunteer board member. However, I am planning on running for President in 2020, against Donald Trump and Kanye West, so I'll need to keep some flexibility in my schedule. 

Best Wishes,
Bruce Haulley, CCIM

Chapter 3: Being Creative in Planning the Future

Okay, here’s my challenge. Apply the big thinking that creates climate change concerns to affordable housing, in fact, all of urban real estate. Here’s my contribution, and I’d like to hear yours:

• Make housing units smaller. Smaller means cheaper and more people are living alone, particularly as they get older.
• Put housing in urban areas. Use in-fill locations to design and build dense units with community features.
• Align new small housing with mass-transit. Either build on busy streets, or change the routes of buses to fit population changes. I own a car and a motorcycle, and I’d still like to use public transportation often, especially commuting.
• Combine housing with other uses, like retail, self-storage, child care, and office.

I could spend time arguing that making cities denser, as opposed to encouraging urban sprawl, is more effective in combating greenhouse gasses, but it seems so obvious it doesn’t need to be argued. (Let me know if you disagree). 

Being a capitalist, I prefer to let the open market determine products. That works for phones, clothes, and restaurants, but it's not working for real estate. Through a complex chain of inter-related players, it's too expensive to build apartments. City fees, insurance, architects, construction, and attorneys all add up to, in my area, costs of about $135 per square foot to build apartments, plus the cost of the land. Rents are about as high as working people can afford ($.80 to $1.20 PSF), so it does not make financial sense to build apartments. Upper class single family homes, yes. Hospitality? Yes. Apartments? No.

Here’s my thesis: smart urban planning and development beats climate change initiatives in financial sense. And it needs smart government to make it happen.

Chapter 2: What’s the best investment for the State to make?

In commercial real estate, we use the concept of “internal rate of return” (IRR), to compare investments. Whether it’s a retail shopping center or baseball cards, every investment involves a cost  at the outset, and a return over time. 

Let’s consider investing in affordable housing compared to defending against the future hypothetical costs of climate change. 

 

For climate change, we've gotten nothing. (You can argue, but I’d like to see your facts.) The U.S. Government Accounting Office (GAO) can’t figure out what benefits taxpayers are getting from the many billions of dollars spent each year on policies that are purportedly aimed at addressing climate change. (http://www.forbes.com/sites/larrybell/2011/08/23/the-alarming-cost-of-climate-change-hysteria/).  We have a drought, but it’s a stretch to blame the drought on climate change.  Maybe the forest fires are worse, but the logic is self-referring: if we had spent more money in the past, things might be better today. I’d like more support. (Climate change threatens future problems, but I don’t know anyone that’s been killed or injured by climate change).

What benefit did the State receive for its investments in affordable housing prior to 2011? A recent study of California affordable housing developments (peer-reviewed by an economist at U.C. Berkeley) found:

• Access to affordable housing improves education outcomes by reducing the mobility of low-income families
• Affordable housing improves resident health by reducing exposure to environmental hazards and frees resources to pay for health expenses and food
• Citing NAHB’s economic impact of home building model, the report notes that construction of LIHTC units generates jobs, taxes and economic income
• NAHB estimates that in a typical year the affordable housing credit supports 96,000 jobs
• The report also noted affordable housing yields an increase in regional competitiveness by lowering local housing costs and increasing employee retention
•  Challenges the notion that affordable housing developments reduce neighboring property values, and notes that well-maintained properties may raise values in distressed neighborhood
• Affordable housing saves taxpayer money by reducing demand for other government services, including homeless, health and other social program
• Improves commuting behaviors when locating near transit options.

And the state gave out loans, not money. The money was paid back by developers with interest. Investment in affordable housing by state and local governments creates immediate, concrete benefits, while climate change investment is long-term and hypothetical.

 

Back to my IRR analysis....

 

·         No one can say with certainty how much financial return our present investment in climate change will produce. This, alone, makes the investment a poor choice.

·         In spite of my research, I could not find _­­an accounting of the money spent by the California Tax Credit Allocation Committee for affordable housing over the years. Still working on it. However, there are 49,000 housing units that are available to families and individuals at below-market rents. That's something concrete.

In the absence of facts, it’s hard to have a reasonable discussion. Stay tuned.

Chapter 1: Dealing with Real Problems in California

Dear Governor Brown:

I understand that you vetoed affordable housing funds in 2011, and that you are now making a proposal to implement climate change initiatives. I’ll make a simple argument: that where people live and how much it costs, is more important to Californians than the potential problems of climate change. I'll make a suggestion at the end.

 

Googling “California drought” and “climate change”, I find a number of stories that say that the drought is “worse” because of global warming. Okay, droughts occurred in the region before man invented the internal combustion engine.  How much worse is it?

NASA scientists issued a report stating that “One question that’s lingered as long as the drought itself is just how much, if any, of the drought is due to climate change. New research has an answer: up to 27 percent. It also has another important number: climate change has made the odds of severe droughts like this one twice as likely.”

Other scientists disagree.  “…Nate Mantua, a climate scientist at the Southwest Fisheries Science Center who has previously written about temperature variations in the region... was critical of the paper’s attribution aspect. He said that while it’s possible human-driven global warming could have played a role in the region, the study's modeling efforts didn't convincingly replicate certain patterns and that he felt more confident that natural circulation patterns played a more likely role in pushing temperatures up across the region since 1900.       ( http://www.climatecentral.org/)

Okay, here’s my point. There’s room for doubt about the effect of industrialized society on nature. Spending large sums of government money on a debatable issue is poor policy. (I understand that you, Governor Brown, called people "troglodytes" for being unconvinced about climate change. No offense taken, I've been called worse.)

However, there’s no doubt that working class people can’t afford reasonable living accommodations near where the jobs are.

The Los Angeles Times reports that “A minimum wage worker in California must toil about 130 hours a week in order to feasibly afford a two-bedroom rental, a new report found”.  (LAT March 11, 2013)

This map illustrates the hourly wage a person must earn to get an average apartment:

The map can be found at http://www.huffingtonpost.com/2015/06/01/minimum-wage-apartment-hourly-salary-housing-costs_n_7472472.html

In California, a person must earn an annual wage of $53,000 to afford an average two bedroom apartment. 

So, is this a problem? I think so. Don’t you? What do people do if they can’t find a place to live that they can afford? They go to a (distant) area where they can afford housing, and drive to the job they want.