Episode Summary
- Affordable housing is a supply and demand issue. Any opportunity to increase supply is a good thing and should be as deregulated as possible.
- Going too far below AMI can be a bad thing. Leading to longer development times, magnifying a community's supply problem.
- Understand how a building makes money. Rent is just one of 4 important pieces. Vacancy factor, Operating expenses, and paying the bank are all big bills for whoever chooses to make more housing.
Links To Sources
This week I spent more time thinking about this: Too much affordability is a bad thing? (4 min read)
I think what people miss in the conversation about affordability is the relationship between these 3 ideas:
Supply and Demand - two thoughts from an economist (1 min read)
AMI - (4 min read)
Proforma basics - (5 min read) This is the best one I stumbled across. If you know of a better one, please share!
Transcript
Hey everybody it's Kyle. Where, on this podcast, I share, discuss, ponder, and try to connect some dots through the best content I've discovered each week related to urban planning, architecture, and cities.
This week we're looking at a very specific case study, a specific pattern, Council Bill 120081, in Seattle.
Before we get to the bill I'm going to add a little bit of context. As a small...small small small...incremental developer in my community, I've been trying to figure out this affordable housing problem. In order to solve the problem...I wonder what do you need I need to understand? I don't want to be like every other developer. What do I need to understand to be part of the solution? And I think there's 3 things:
- Supply and demand
- Area median income
- "Proforma"
Then we'll get to a case study in Seattle. And how the lack of understanding between these 3 things is why Council Bill 120081, unfortunately, won't really help.
Supply and Demand
Microeconomics 101. Supply and demand is the relationship between sellers and buyers.
If we apply that to housing it's the people looking to own or rent -- they drive demand.
And it's the developers, flippers, current homeowners that control and create the supply.
Typically a marketplace goes through cycles -- I'm way out of my league here -- but hang with me.
If there's not a lot of houses in a particular location. Supply is low. If suddenly a lot of people want to live in that location. Demand goes up. This means that price goes up.
Eventually what should happen are two things:
- Either the supply catches up to lower price (build more housing)
- Or eventually demand decreases because the price point is too high and people look else where.
Think of any major urban area, specifically on the west coast and in the sun belt. These place are experience huge population growth. And there just isn't enough housing being built to catch up. Thus price increases. Price increases then create an affordability problem.
But how do we determine what "affordable" is and means? Obviously 2 bed room 2 bath in Manhattan is different than a 2 bed room 2 bath in Manitoba.
That leads to point number 2.
Area Median Income
The area median income is the midpoint of a region’s income distribution, meaning that half of households in a region earn more than the median and half earn less than the median.
Now we're in Statistics 101. Remember median is different than mean. Median is the number exactly in the middle of a data set. The mean (average) is when you take all the numbers add them and divide by your sample size. Median is used by regulators because it won't be skewed by a small proportion of small or large values.
SO. Area median income is the exact middle income for your physical area. If there's 10 households, order them by income, what's the number for house #5? That's your area median income.
Then to determine affordability, you say house #5 is our baseline, our starting point. Typically described as 100% AMI. If you look at house #5 and go lower than that cost you enter into affordability typically banded by increments of 20 points. 80% AMI, 60% AMI, 40% AMI. The lower you go from house #5, our median, the more affordable that particular dwelling becomes.
The trick the problem. Is how buildings make money. This leads to the pro forma.
The pro forma is real estate talk for projecting a properties income. In accounting you would call this your income statement, maybe your profit & loss statement.
And there's 4 big sections on every proforma.
- How much money do you think you'll make (rent or sale price)
- How much money will you lose between transactions...the vacancy factor.
- How much money do you think you'll spend (construction costs or costs to operation. "OpEx" for all the cool developers.
- How much money do you pay each month to the bank? This is "Debt Service". Most developers leverage their cash. So there's a check that goes to the bank each month. What's that number
After you look at your estimated rent, take out 5%-10% for vacancy, take out your expenses, then pay the bank what you're left with is your money before taxes.
Of course, if you're trying to solve for affordability taking 20%, 40%, 60% off your revenue means there probably isn't money left over. You probably don't have money to even pay the bank. Which means you don't have a project. Which means you don't build more housing. Which means demand continues to go up. Which means the price to buy a home, the price to rent continues to rise.
And that takes us to Seattle, Council Bill 120081.
I'm quoting now an article from Natalie Bicknell, at the urbanist.org,
"Seattle city council passed Council Bill 120081, which provides density bonuses (i.e., development capacity increases) to religious institutions seeking to build affordable housing on land they own or control.
This legislation was primarily created and lobbied for so that churches could create homes for members of their communities impacted by displacement and the skyrocketing housing costs in the Seattle area."
This is Kyle -- this is a zoning play. To reduce our rent to make the residential dwellings affordable, the go to strategy for developers is to include more units. More units = more rent. This is that top section on our pro forma.
But it's not quite that simple, if we're going to make an exception to the rule, we need more rules for the exception.
Gotta love regulation :)
...in order for anyone to build more units on their land (these "development capacity increases") the local municipality, Seattle, says you need to make the housing affordable.
And no problems so far. We're looking to loosen regulations in the community so we can create more affordable housing, we're a church, we want to build affordable housing. This is great.
However! On the floor, the bill was amended to change the threshold of affordability requirements from 80% AMI to 60% AMI.
And the bill passed with the amendment attached.
What does this mean?
60% AMI means the residential dwellings are going to be more affordable, yes. But it reduces the amount anyone will make in the top section their pro forma.
I don't know the intentions of Council Member Lisa Herbold.
Likely, in an effort to say if we're going to make housing affordable, let's make it even more affordable. Herbold has effectively made it impossible for anyone to leverage this legislation.
This is a perfect case study where we try to maximize affordability legislation and it actually means than no one will make the units. And it's not because they won't try it's because it actually becomes impossible. The numbers won't pencil out.
As a developer, the only place you really have flexibility in your proforma is in that top section. Interest rates are controlled by the fed. Banks want to see vacancy rates between 5-10%. When rent is significantly capped, the numbers don't work, and no units get created. Which continues to limit supply.
This bill was signed into law on July 9th. Critics of the amendment are working on a repeal.
What Lisa Herbold doesn't understand, and what I hope you understand after this episode, are these 3 keys:
- Affordable housing is a supply and demand issue. Any opportunity to increase supply is a good thing and should be as deregulated as possible.
- Going too far below AMI can be a bad thing. Leading to longer development times, magnifying a community's supply problem.
- Understand how a building makes money. Rent is just one of 4 important pieces. Vacancy factor, Operating expenses, and paying the bank are all big bills for whoever chooses to make more housing.
Talk to y'all soon
