The Challenge of Housing Affordability


Every cloud has its silver lining -- and every silver lining has its cloud. The wisdom of the first statement is evident in the positive impact that the collapse of the securities markets in 2000 had on interest rates and residential real estate prices over the past few years as investors shifted out of stocks and into real property assets, like homes, which saw a tremendous increase in value. The cloud in the silver lining of higher real estate prices, however, is that affordable housing, both rental and single family, is fast becoming an oxymoron.

As home prices continue to rise, more and more Americans find themselves priced out of home-ownership and struggle to find affordable rental housing. In general, affordable housing is crucial in attracting and retaining business, sustaining employment growth and ensuring a healthy political and economic climate in our communities. Recognizing the impact that affordable housing has on our communities, Congress and local government have stepped in with initiatives that promote and facilitate the construction of affordable housing.

Seller's Market Strains Rental Housing

One place where a seller's market exists is in Southern California's residential real estate sector, where supply is dwarfed by demand. Since 1984, over 287,000 net jobs were created in Los Angeles and Orange Counties, yet only 78,000 single family residences were built. According to DataQuick, the median price of an existing home in California in November 2003 increased 17.8% year-over-year and sales increased 15.7% over the same period. The median home price in Los Angeles is now in excess of $365,000, which, at today's interest rates, requires a monthly debt service payment of around $1,750, assuming 20% down and a 6% interest rate. Meanwhile, median monthly income in Los Angeles County for a family of four is $3,640.

Since an affordable home is commonly thought of as one that requires the payment of no more than 30% of a family's annual income toward principal, interest, property taxes and insurance, a quick calculation between income and housing costs shows a dramatically widening gap between what we earn and what we can afford to pay for a home. Staggeringly, one in eight lower-income working families earning at least the full-time equivalent of the minimum wage reported spending more than half of their incomes on housing.

However, statistics alone do not adequately convey the impact of a lack of adequate affordable housing on a community. A decent, affordable place to live brings with it certain quality of life benefits fundamental to a strong and stable nation. Improvements in housing can be linked to improvements in schools, safety, job access and transportation.

Some incorrectly believe that higher housing costs singularly affect low-income families. But the reality is that moderate-income families - including teachers, safety personnel, hospital workers and senior citizens - must stretch to make ends meet, let alone afford to own a home. These homeowners often have limited savings and increasingly must rely on adjustable rate loans to afford their initial purchase. A job layoff, a salary freeze or a decrease in retirement benefits could easily result in a mortgage default. This economic pressure is hardly conducive to ensuring a quality of life for the average citizen and makes it increasingly difficult for communities to attract the best and the brightest.

As middle-income families are pushed out of homeownership by increasing costs, rental housing is similarly strained by the increased demand. This translates into higher rental rates, which has a domino effect on lower-income families.

The root causes for the lack of affordable rental housing include the rising housing production costs in relation to family incomes, inadequate public subsidies, restrictive zoning practices, adoption of local regulations that discourage housing development, implementation of prevailing wage legislation and loss of units from the supply of federally subsidized housing. Low interest rates and wealth earned in the stock market bubble also helped to drive up home prices. Further, as a reaction against long commutes and large subdivisions, homebuyers and renters rediscovered older, more traditional neighborhoods. This rediscovery caused prices in these previously affordable neighborhoods to increase. Irrespective of the cause, the demand for convenient, affordable housing is not being met.

Easing the Strain

Despite the bleak outlook, there are initiatives that can be utilized by the private sector to keep a project's bottom line in the black while also bolstering the supply of both affordable rental and single family housing. Congress, recognizing that the problem of affordability now affects one-quarter of the nation, has implemented incentives to produce new affordable rental housing. The Low Income Housing Tax Credit ("LIHTC") has provided investors with a ten-year stream of credits against income in exchange for producing affordable rental units. Each state is allocated a share of the LIHTC based on its population and is charged with allocating the LIHTC among qualified developers.

In California, for example, the demand for credits usually exceeds their availability by about four-to-one. The California State Treasurer's Office established the Tax Credit Allocation Committee ("TCAC") in order to mete out tax credits. By federal mandate, TCAC adopted the Qualified Allocation Plan, which further refines the selection process for tax credit allocation, giving preference to those developments that encourage smart growth, implement energy efficiency and serve the lowest-income tenants. Preference is also given to those developments where the affordability restrictions will remain in place for the longest period of time.

In New York, tax credits are awarded by the New York State Housing Finance Agency. This state agency has its own Qualified Allocation Plan to allocate tax credits among developers that similarly includes a scoring system that evaluates projects based on location, housing characteristics and the intent to serve a population of individuals with children.

Savvy developers will gear their projects and their LIHTC applications to ensure a tax credit allocation. As much as 100% of a development's construction costs can be financed through a combination of tax credits and conventional or bond financing.

To combat the strain of increasing home prices on homeownership, the newly proposed Homeownership Tax Credit program ("HTC") (which is modeled on the LIHTC program) would allow single family developers of affordable housing to sell tax credits against income for constructing or rehabilitating homes that meet affordable program requirements. If adopted, the HTC legislation is expected to provide $2 billion in new private investment in affordable housing per year. The program targets census tracts with median incomes of 80% or less of the greater of the area median income or state median income. Each state would receive an annual allocation of tax credits starting at $1.75 per capita, subject to a cost-of-living adjustment. For-profit and community-based developers would then receive an allocation of the credits under a competitive process, guided by each state's annual plans for affordable housing. Developers can then sell the tax credits to corporate investors and use the sale proceeds to fund the gap between the cost of development and the price at which the home can be sold to an eligible buyer.

On the local level, municipalities are passing inclusionary zoning ordinances that require developers to include a number of affordable units in new apartment complexes or new developments. In exchange for these set-asides, a developer is eligible to receive land use and planning concessions to offset the cost of the affordable units. These concessions are available to any developer building in the area restricted by the inclusionary zoning ordinance.

Tax-exempt bond financing can also help a multifamily developer tighten the gap between project costs and housing affordability for its tenants. The interest rates on the bonds offered by local government issuers is significantly below the rates offered through conventional institutional financing, even with today's low interest rates. By teaming up with an eligible issuer, a public-private partnership can be formed that will provide the developer with the extra funding needed for an affordable housing rental project.

Another option to developers interested in promoting affordable housing is not so much a financing mechanism, but a land use planning alternative called "smart growth." The smart growth concept centers on policies designed to counteract urban sprawl. These policies include limiting outward expansion, encouraging higher density developments, encouraging mixed-use zoning, reducing travel by private vehicles, revitalizing older areas and preserving open space. While affordable housing is not a direct goal of smart growth, it can be a direct result of the smart growth initiative. The first requirement to smart growth is the recognition of an urban boundary that limits suburbanization. With a firm urban boundary, developers are encouraged to build vertically and to build urban in-fill projects. While construction on greenfield sites away from the core of a city and centers of employment may appear less expensive, the increased densities found in smart growth developments can help spread the costs of land, environmental remediation and infrastructure over a larger number of housing units. Accordingly, these units can be sold at prices that are competitive with, if not lower than, those projects built on greenfields. Smart growth development of this type is additionally beneficial to local communities because the developments are located close to jobs, which in turn reduce housing and commuting expenses. The community is also a beneficiary of smart growth development as the reduction in brownfields, the remediation of pollution and the decrease in traffic improve the quality of life for the citizens of that community.

Lifting the Cloud

Population growth in the United States will create 13 million to 15 million new households over the coming decade, creating a need for homebuilders to construct about 1.6 million new homes each year during that same period. These numbers do not account for the millions of rental units and single family homes that this country needs to provide to catch up with the lack of affordable housing supply on the market. While the obstacles to the provision of affordable housing are formidable, through successful public-private partnership arrangements, land use and financial incentives, developers, cities and states can lift the cloud for the more than 28 million Americans who face limited access to decent, safe, affordable housing.

*article courtesy of Lewis G. Feldman and Douglas A. Praw of Pillsbury Winthrop LLP, lfeldman@pillsburywinthrop.com / dpraw@pillsburywinthrop.com.