Affordable Housing’s Elephant In The Room: Operating and Preserving Multi-Family Housing

John, you spoke recently at AIA-Los Angeles’s Designing for Dignity Forum, convened to develop actionable steps to address Los Angeles’ housing and homelessness crisis.  Give our readers a synopsis of what you shared at that forum.

John Given: I spoke to the AIA forum about the need for a paradigm shift.

Since the public housing and HUD programs from the post-war era and into the ’60s, the affordable housing industry has relied on a model of development that—for good reasons—prioritized the production of new housing. The product has evolved, and often, it is the best-designed housing out there. Affordable housing developers, both for profit and not-for-profit, have been early investors areas that hadn’t previously supported market development.

But in the present and for the foreseeable future, there are high barriers to building in both the low-cost sprawl and urban infill models. Urban neighborhoods are off the charts, and the inventory of now older urban rental housing has grown. If we continue to focus solely on production, we will miss the opportunity to preserve affordability that already exists.

The scale of the affordable rental-housing inventory in LA is staggering compared to even the most optimistic 5-10 year projections for production—of either market-rate or affordable housing. Around Hollywood and Western, for example, affordable housing developed over the past 20 years has been a success, yet is just a small percentage of the rental-housing inventory built up heavily in the past 30-90 years. This “market-rate” housing has for years been largely affordable, and viewed as a secondary location serving workforce, immigrant, and aging households. But no longer.

As we look for solutions to the affordable housing crisis, the elephant in the room is the operating multi-family housing market. The multi-family housing market is where more than 70 percent of low-income and/or rent burdened households live, and where the housing crisis plays out. But we run the risk of losing this resource. Factors like the pressure of demand against supply, changing demographics, and a growing preference for urbanized areas are all increasing property values across the city and resulting in huge rent increases. 

Combined with economic displacement, that could mean a permanent loss of affordability in many neighborhoods. The loss of naturally occurring affordability cannot be recovered, and for Los Angeles, it doubles the impact of our decades-long shortfall of production. We cannot overlook the opportunity to preserve the affordability of workforce housing by converting, over time, a wide range of mixed-income and permanently affordable housing.

Elaborate on why production is not a viable option to meet the need for affordable housing in Los Angeles.

The causes of high housing production costs are well cited, and frankly can only be chipped away at on the margins. I do not argue against production. In fact, the problem we have today is the outcome of ever-increasing barriers to infill development, amidst a backdrop of population growth and land scarcity.

It is certainly important that we restore our political and financial capacity to build housing. But in already urbanized locations, it takes three to five years and at least $300,000-$400,000 to subsidize the production of a single new affordable unit. Housing of last resort programs operated by PATH, OPCC/LAMP, LA Family Housing, the Skid Row Housing Trust, and SRO Inc have found a successful model to address homelessness through permanent supportive housing. They need a way to place people in housing today—not five years from now.

We would need to build robustly for more than 20 years just to create the supply needed for our future population growth, let alone close the deficit that already exists. In the meantime, we have an opportunity to become more proficient at structuring funding, incentives, and investment in the operating housing market.

Because the housing market is diverse and complex, I cannot offer a single model, nor should we wait for one to be proven. But we can have an immediate and long-term impact on housing affordability using the rental housing that already occupies much of our cities.

It’s time for social investors to get into the business. In the next 10 years, I’d like to see 20 percent of LA County’s rental housing stock under mission-driven ownership.

What does this look like in action today? Is money coming in already, and where is it coming from?

There isn’t enough money chasing this right now, but as we start acting, money will chase the actors. That’s what’s happens in capital markets in all forms of real estate.

In terms of public money, so much funding is currently dedicated to achieving rents affordable at 60-percent AMI and lower. These funds are awarded competitively based on need assessment that—not incorrectly—focuses on those least capable of finding housing and paying rent, but creates the fewest units per dollar of subsidy.

At today’s housing costs and rents, more funding is needed to sustain investment in a mixed-income building that includes rents affordable at 80-120 percent AMI, or for that matter below-market. This can be accomplished at 20-40 percent of the cost per unit, which means that even with current funding levels, it could result in more operating and new housing that is subject to long-term or permanent affordable housing agreements. As unregulated rents escalate, in 10 years hence the regulated rents will rise more slowly and represent increased affordability relative to market and AMI. 

Innovative solutions will continue to arise as developers grow more comfortable making out-of-the-box use of available housing funds and incentives. We should also seek new sources, such as documentary transfer taxes, linkage fees, housing bonds, or cap-and-trade funds. Otherwise, neither affordable developers nor for-profit developers will be able to do business in this area at all, and the housing crisis will just continue to get worse.

What are the tools that exist today, or that need to be created, to protect rent-sensitive households?

There are currently very few tools.

Those with the most teeth involve regulatory enforcement and tenant advocacy. But this is a reactive approach that, in most cases, targets bad actors—while the dynamic of rent compression and economic displacement is more organic.

The Costa Hawkins Act provides a legal framework to protect tenants against wanton, unjustified evictions. Rent increases during occupancy can be stabilized or slowed. The housing market subject to that framework is frozen in time, and since the effective dates of Costa Hawkins rent stabilization many more units have become stabilized in the marketplace but not subject to regulation. Perhaps it would be better if the vacancy decontrol/recontrol scheme of rent stabilization could be applied to all buildings after a reasonable period of stabilization after occupancy.  

Rental assistance is another tool that, for many years, had the full participation of private landlords. It remains an effective program for increasing the pool of affordable housing units, and is equally important for preserving essential household mobility, choice, and neighborhood economic diversity. But rental assistance programs are now hamstrung between federal funding cutbacks and market rents that exceed program limits.

The low-income housing tax credit is primarily production-oriented, but can also be used to acquire existing buildings, rehabilitate them, and convert them to affordable. But the requirement at the front end for substantial rehabilitation and conversion of the entire building to very low rents is a costly process with low yields in terms of affordable housing units created.

Most operating housing stock is safe, decent, sanitary, and habitable—and a large portion of it is operated at below-market rates. Something like 70 percent of rent burdened households live in buildings without any housing assistance or regulatory agreements on rent.  Shouldn’t a significant portion of dedicated affordable housing funds be prioritized to ensure these units remain affordable? 

There are more ways to invest in the operating market and preserve natural occurring affordable housing. One is by offering real estate tax abatements. For example, the City and County could agree to offer a tax abatement to an apartment owner—perhaps someone who just bought a building for three or four times its current assessed value—to gain an annual or long-term regulatory rent agreement on one unit or multiple units in the building.

In California, property tax rates are very low.  But this shouldn’t preclude a range of robust abatements on that increment of additional property tax. It wouldn’t incent a lot of units, but for one or two units in a building, you could get the deal done today and have it available for the most pressing needs of getting people housed.

How can this system be scaled up to reach your goal of 20 percent of LA’s rental housing stock?

The first paradigm shift needed in our industry is to recognize the scale of opportunity in the operating housing market. 

The second is to ensure that the initial underwriting and acquisition of a building relies on a market-based business/investment plan that optimizes adjustments to market as needed to establish a platform from which to keep some units affordable—and flatten the growth of rents going forward. With a long-term mission-driven business plan, a social investor can opportunistically freeze or reduce rents, and create permanent affordability across a broad spectrum of incomes below the median.

This leads to a third paradigm shift that is essential: inversion of the capital stack.

Affordable housing as we know it has such low revenue that commercial debt rarely exceeds 15-20 percent of sources. All other capital sources—from government funds to equity investors receiving low-income housing tax credits—are subject to a climate of diminished public funding against increased amounts of gap financing per unit.

However, a vibrant acquisitions business model can optimize commercial debt. There are a number of private equity funds, social equity funds, and endowments that will look at funding a large share of the balance of the purchase price. The cost of these funds is not low enough for the long-term business plan, but they can get the deal closed. 

Let’s take an example: A Class B or C building currently selling between $200,000 and $250,000 per unit rental could probably get a 70-80 percent loan to purchase price. The balance—say $50-75,000 per unit—would be funded by the private equity and social equity funds.

In one case that I know of, this structure was in place and the non-profit buyer needed to commit about $10,000-$15,000 per unit of its own reserves to close the deal. That is a risk, but one that can be mitigated. When put in perspective, it is actually an incredibly low cost of entry to a long-term partnership for a city or county housing trust fund, an institutional fund looking to create more affordability for employees, or a private endowment. 

The ULI Terwilliger Center surveyed several of these funds, and most require yields that will initially steer the operation to optimize revenues. So think of this is bridge financing. The non-profit social investor has a long-term view, and will look toward an expanding capital market of social equity and public funds that will allow the initial equity to exit at required yields. It would be a very small initial investment for the city to close that deal, protect the people who are at risk in those buildings, and operate the building like any other investor would operate it—but over time, bend the rent curve. Convert more of the units as affordability sources of funds become available. 

Then, you can finance the conversion and deliver cash flow to other missions of your organization that are less self-supporting.

With the right support, there is a possibility of an alternative housing model that begins in one-off deals, but moves to scale very aggressively and quickly.

A variety of bills and bond measures are being considered in the Legislature and around the state to deal with affordability, homelessness, and housing supply. If you could, what would you build into these public financing models?

I would like to see more research on the efficiency of using direct housing assistance payments to get people securely housed in operating rental buildings. We may find that multiple funding sources are needed to serve brick-and-mortar production, housing acquisition and preservation, and housing assistance that allow households to be free agents in the marketplace.

There needs to be a significantly larger share of housing funds—even funds held in a three-to-five-year advance program commitment for production—to be banked as a revolving fund, in order to boost available private and social equity with a gap-closer for private non-profit acquisition of affordable housing.   

It is important to recognize that the acquisition, preservation, and creation over time of a permanent affordable housing supply requires, in each case, a business plan created uniquely for a property and its submarket. 

Currently, funding approval and affordability are binary, and do not adapt well to circumstance and time. But with a different paradigm, the funding agreement could be based on a business plan and adaptive to unforeseen opportunity. We might see increased engagement and capacity in the housing market if the restrictions on the use of funds were raised to 80 percent AMI, or even higher.

This framework would also require adaptation of the property-tax exemptions granted to the entire property at the time a non-profit owner closes acquisitions with an agreement to a long-term preservation or conversion plan.

One of the few things that help keep the change in affordability under control is rent stabilization. But currently, it only applies to buildings 1978 and older. It’s time to update Costa Hawkins to some period of time 15 years after occupancy of the building. That would allow us to continue to building up a supply of housing that has got a little bit of a cap on the short-term for the people who live in those buildings.

The rest of the real estate industry also has to step up. For instance, we’re not making the best use of resources in terms of value capture from market-rate developers.

In a complex urban marketplace, housing costs and availability are more heavily impacted by the operating commercial and residential real estate investment and activity. The valuation of transactions in this sector is larger and more dynamic than housing production of all kinds. It has become too easy, although it is ineffective and empirically misdirected, to correct the shortcomings of the housing market on the activity of housing producers alone. Even in the best of times their product is incremental, and cumulative relative to the operating inventory.

Except in the case of direct removal of units and displacement, new housing does not necessarily cause rent escalation and displacement in the adjacent market. So less stock should be placed in a singular approach to inclusionary housing if it results in less production, or misappropriates resources that should be used to achieve the greatest number of permanently affordable housing units at the least cost per unit. The purpose is not well served if the applicant chooses not to proceed, or cynically agrees to conditions that cannot be fulfilled in current market conditions. A hard line should be reserved for a 1:1 replacement where a development site requires removal of below-market-rate rental units and the direct displacement of residents.

There are also more innovative options that are worth exploring, most of which can fund either housing assistance payments or revenue streams against which bonds can be underwritten.  A housing bond is great if it can be used on the most effective programs. It should have a wider base of collateral revenue streams, including a parcel tax, but also a documentary transfer fee on all commercial real estate activity and other, less cyclical revenue streams—such as a housing-occupancy tax or an inclusionary in-lieu fee paid by an annual lien on completed projects.

Perhaps cap-and-trade money could be put toward getting these deals done. Preservation of naturally occurring below market rate housing in a transit corridor serves lower-income households generates increased ridership and lowers VMT.

Do either of the two initiatives likely to be on LA’s November and March ballots—Better Build LA and the Neighborhood Integrity Initiative—contribute to the goals you’re suggesting?

Since the passage of Prop U in 1986, Los Angeles has been steadily rolling back its capacity to meet our long-term housing needs. Unfortunately, these initiatives are more of the same.

One further limits the capacity of this region to produce substantial supply. The other is, at least, better intentioned, and attempts to address affordable housing. But it continues to add cost to the production of market-rate housing, and that will inevitably limit overall supply. Reversing the supply/demand problem will require a long-term change in politics and capital markets. For now, we’re stuck in a bad situation.