In my recent testimony on affordable housing supply, I highlighted the superiority of markets over government solutions and pointed to the ineffectiveness of the Low-Income Housing Tax Credit (LIHTC), which offers generous tax credits for builders that rent units to tenants earning below 60% of area median income.
During the hearing’s Q&A, I did not have time to elaborate on my ideas or refute some of the misstatements about the LIHTC program. I will do so here.
Our best hope for more affordable housing is to build more housing at the middle of the price range, rather than expand the LIHTC program.
Assume a simplified model of the housing market with three groups of people: upper, middle, and lower income people. Building new houses at low price points is impossible without subsidies. Building new houses at moderate price points is difficult because regulations at all levels of government have made building expensive. That only leaves developers the option to build houses at high price points with few buyers that can afford these homes.
As a result, the market builds:
- A few very expensive houses for upper income people,
- Hardly any moderately priced houses for middle income people, and
- A few houses for lower income people. These houses are expensive to build but they are made affordable through LIHTC subsidies and the use of housing vouchers.
Overall, the market builds too few homes and over time, a housing shortage develops.
Before concluding, however, that we need to spend more money on “affordable” housing, let’s first consider another version of a simplified, yet functioning market: the car market. Just like new and existing homes, there are new and used cars. Some people own cars or homes, others lease or rent them.
In this market, the impact of regulations on car manufacturing is more limited (although with EV mandates that is certainly changing). Cars, unlike houses, are generally affordable to broad swaths of people.
In this functioning car market, we build:
- A few very expensive cars for upper income people,
- A lot of moderately priced cars for middle-income people, and No cars for lower income people.
In such a functioning market, no one would propose a tax credit for car manufacturers to build cars for lower income people. It is preposterous because of filtering—the concept where older used goods are passed down the income ladder as newer and more technologically advanced goods become available.
With cars, as middle-income people buy new cars, they sell their older, still serviceable cars to someone of lesser means, and so forth until everyone, including someone of low-income owns a serviceable, but not a new car.
The difference between the housing and car market is that car manufacturers are still able to build new cars at moderate price points allowing them to meet demand. Therefore, the root cause of housing unaffordability is government regulatory failure that has made land scarce and home building expensive.
Claims made during the hearing that I would have liked to refute:
Claim 1: LIHTC expansion could add up to 200,000 new “affordable” units per year, as a study by Novogradac claims. This is most definitely false.
- The study may not be objective as the methodology is short and the company conducting the research is one of the main beneficiaries of LIHTC. Its findings should therefore be taken with a grain of salt.
- The 200,000 new housing units are most certainly a significant overstatement. Credible peer-reviewed research has shown that LIHTC merely crowds out private developers. If the private sector would build the same number of units as LIHTC, then LIHTC does not add to supply, it merely wastes taxpayer money.
- To the extent that the private sector would build 200,000 market-rate units regardless, then LIHTC creates a select few winners that end up living in these units. Such an outcome is inherently unfair as everyone else, no less deserving of lower rents, has to pay higher ones.
- Furthermore, data from the Department of Housing and Urban Development (HUD) show that only about 50% of LIHTC developments are new constructions. The other 50% are rehabilitations, which don’t add to the housing supply since they merely repurpose an existing unit.
Claim 2: Preserving an older unit is a good way to maintain affordable housing. It may actually be the opposite.
In a functioning market like the car market, no one is proposing that car manufacturers rehab 20-year old cars. Why? Because they are building plenty of moderately priced new cars so that other serviceable cars filter down to those of lesser means.
In housing, preserving an older unit may actually worsen the supply shortage because it ignores the opportunity cost of the land: Older homes often sit on land that could be better utilized. For example, a single-family detached unit built in 1940, sitting on a 10,000 sq. ft. lot, could be torn down and replaced with four townhomes that sell for the same price as the original unit. Preserving that old home foregoes the opportunity of creating three additional housing units and thus impedes the filtering process. The same logic applies to older apartment units that could be replaced with more dense units
Similarly, with apartment buildings, efforts aimed at preserving “affordable” housing can sometimes be misleading. Consider this case in Florida where Freddie Mac touted its preservation of low-income rentals, while the property owner bragged about the ability to raise rents. The details are as follows: The buyer/investor found a property that already provided workforce/low-income housing at well below 80% of area median income (AMI). Fannie Mae and Freddie Mac in order to provide financing require that tenants earn below 80% of AMI. Due to liberal lending terms, the buyer/investor is able to load up the property with debt. The buyer/investor then makes renovations to take advantage of what they call an “extraordinary value-add opportunity” to “significantly enhance revenue.” This allows a repositioning to higher income tenants as the occupants of the building are still generally below 80% AMI. This way Freddie Mac gets to tout its “preservation success,” while the owner brags about its profit enhancement.[1]
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I maintain that the root cause of the housing supply shortage is a government regulatory failure that has made land scarce and building expensive. If more states and cities roll back burdensome zoning and land use regulations, such reforms could provide hundreds of thousands of new homes each year and thus allow more Americans to access their own American Dream.
To read my entire testimony, see here.
[1] For example, see a Wall Street Journal article on a 352-unit complex in the Tampa area that was purchased in the spring of 2018 by Bridge Investment Group. The development is named Plantation at Walden Lake, in Plant City, FL. The article states that “Freddie Mac, the country’s largest backer of apartment loans, will offer low-cost loans to real-estate owners willing to keep their buildings affordable to middle-class families for years to come.” Bridge Investment Group, the investor, said about its plans for this development that was 95% leased back in the spring of 2018: “Over the last three years, Mercury Investment implemented a multimillion dollar capital improvement program that included enhancements to the community’s pool and other shared amenities, as well interior upgrades. The remaining renovated units present a significant value-add opportunity for the buyer. ‘Plantation at Walden Lake’s strong occupancy and potential for further renovation make it an extraordinary value-add opportunity,’ said Elorza. ‘Renovating the remaining units will help the property compete with newer communities nearby, and will significantly enhance revenue.’” https://www.tampabaynewswire.com/2018/04/26/cushman-wakefield-negotiates-35-7m-sale-of-tampa-area-apartment-community-for-mercury-investment-67396