True confession: I’m an unabashed free-market capitalist. I have a bachelor of science degree in economics. And most people who know me are well aware of my conservative tendencies. Yet I’m a huge supporter of affordable housing. I’ve heard the conventional wisdom that affordable housing tends to be advocated by those on the liberal side of the political spectrum. So what gives? How can such a conservative free-market guy have strong positive beliefs about affordable housing?
For purposes of this discussion, I want to focus on the Sec. 42 low-income housing tax credit (LIHTC) program. The Department of Housing and Urban Development is a different story and one to tackle in another article. For starters I’d like to offer some gentle criticism of Congress for its choice of nomenclature when establishing the program as a part of the Tax Reform Act of 1986. Why couldn’t it have been called the Sec. 42 affordable housing tax credit? Using the term “low-income” triggers negative connotations in many quarters. We’ve been stuck with this moniker from the beginning, and it can be a tough sell in smaller and rural communities. Still, the program has been able to garner bipartisan support.
The LIHTC program has been a smashing success. It truly exemplifies the way a public/private partnership should work. Rather than being administered by central planners in Washington via a massive inefficient bureaucracy, the LIHTC is handled by state housing finance agencies (HFAs). There’s no question that tighter guidelines for program design and administration would be a marked improvement. State HFAs have created a hodgepodge of rules, regulations, social engineering, and other detractions that serve to diminish the effectiveness of the program. However, from a free-market perspective this is about the best approach conceivable to delivering affordable housing on a national basis.
But the fundamental question of whether or not government should be in the rental housing business still hasn’t been answered. Some might say that the correct solution is to let the free market build the housing, if in fact the demand is sufficient. However, this is a simplistic view that fails in several respects. First, the cost to build an apartment community has skyrocketed over the past 30 years. Hard and soft costs have driven the overall cost to $125,000 to $150,000 per unit for basic construction. When taking into consideration current interest rates in the 4.5 percent range, a 95 percent occupancy factor, an equity dividend rate of 7 percent to 8 percent, and expenses per unit of $3,400, a new apartment unit must rent for close to $1,000 per unit per month.
Now consider this. Using a rule of thumb that a person’s rent shouldn’t be more than 30 percent of his or her monthly income, a renter would need to make approximately $40,000 per annum to support a rental rate of $1,000 per month. This equates to slightly less than $20 per hour for the normal 40-hour work week (excluding overtime). How many jobs can you think of that pay less than $20 per hour? I know a lot of school teachers who make less than this. I know that meatpackers in Dodge City, Kan., don’t make anywhere close to $20 per hour. According to the Bureau of Labor Statistics (BLS), the median wage for Production Occupations is $14.74 per hour (May 2011). This category encompasses a good portion of the manufacturing sector. Here’s more. Office and Administrative Support workers earn $15.02 per hour (median). The median wage for Sales and Related Occupations is $11.94 per hour; Building and Grounds Cleaning and Maintenance Occupations, $10.87 per hour; and Personal Care and Service Occupations, $9.96 per hour. In fact, according to the BLS, the median wage for all occupations is $16.57 per hour.
The LIHTC program provides a development subsidy (as opposed to a rent subsidy) so that a developer can in effect “buy down” the cost of development to the point that less rent can be charged. Absent this, how else will rental housing be constructed in cities and towns of all sizes throughout America? How will hardworking citizens who earn less than $20 per hour find decent housing? How will employers who want to open a plant in Frankfort, Ky., or a call center in Sioux Falls, S.D., be able to do so if the workforce cannot find an affordable place to live? Several of the resort communities in Colorado offer an excellent case in point. In the ski towns of Aspen, Vail, and Telluride, there is such a shortage of affordable housing that service workers commute as far as 50 miles each day, each way. The problems caused are immense when employees cannot make the trek during inclement weather. This whole issue boils down to one of economic development.
A free-market purist might argue that allowing the marketplace to resolve this situation is the prudent thing to do, where supply and demand would ultimately reach a point of equilibrium. And theoretically this may be true. However, for this to happen, wages would need to rise across the board by 25 percent. Conversely, building costs would need to decline at least 20 percent across the board. How many years would it take for this to happen? What would the impact be on our economy if wages increased this much or building costs declined this amount?
Our political climate has created very uncertain times, particularly where tax reform is concerned. As a conservative capitalist I support tax reform ... but my perspective may be a bit different than some of my free-market brethren. For decades the U.S. economy has been built on an increasingly complex income tax code. The hue and the cry for streamlining our tax code is growing. When (not if) it becomes a reality, there is a danger that some serious unintended consequences could occur. It’s kind of like the game of Jenga®–remember the game comprised of wooden blocks? Players build a tower out of the blocks and eventually build it higher by pulling pieces from lower on the tower. The game is over when the wrong block is pulled causing the tower to collapse. Our economy and our tax code are so complicated and inextricably linked that doing away with one or more components of the code could cause a Jenga-like economic collapse. There isn’t a computer program in existence that can model all the various elements of the economy as they relate to the tax code. Thus, major changes in the code should be made incrementally over the course of a number of years rather than all at once.
So here’s the bottom line.
- Without some sort of subsidy–either development or rental–it will be very difficult to deliver affordable rental housing in this country because the cost of production is too high.
- A development subsidy is probably a more cost-effective and efficient way of accomplishing this.
- Affordable rental housing is integral to the economic engine of our country. American enterprise cannot grow and expand without a workforce. And this workforce cannot exist if it doesn’t have an affordable place to live.
- The only way to dramatically change the economics of rental housing without wrecking the overall economy is to make incremental changes in the tax code over a long period of time.
Free-market solutions are generally desirable but must take into consideration the complex interrelationship of our tax code and the economy. Meanwhile our political leaders should take note of the LIHTC program as one of the most successful public/private partnerships we’ve ever seen in this country.
R. Lee Harris, CRE, CPM, is president and CEO of Cohen-Esrey Real Estate Services, LLC, a Kansas City-based commercial real estate organization that has managed more than 60,000 multifamily units since 1969. The firm is active in 170 markets spanning 20 states and is involved in the management, development and acquisition of conventional and affordable housing. Other business units are involved with construction and tax credit syndication. Visit the company’s website atwww.cohenesrey.com