Private Development, Public/Non-Profit Ownership: Recipe For Long-Term Housing Affordability

Apartments along Fountain Avenue in West Hollywood were sold to an investor for $293,000 per unit, and will be upgraded over time as residents move out—leaving fewer unsubsidized "market-rate affordable units" on the open market. Source: Azzi Advisors.

Like San Francisco, New York, and a host of other coastal U.S. cities, Los Angeles is in the midst of an affordability crisis.

To address the challenge, local leadership has recently committed to a number of initiatives: Mayor Garcetti intends to see 100,000 new homes built by 2021, and recently announced plans for a development fee to help fund low-income units; Councilmember Cedillo put together a package of seven motions intended to create new options for housing and expedite new development; Councilmembers Harris-Dawson and Huizar are planning to campaign on behalf of a $1 billion homelessness reduction ballot measure; and LA County Supervisors plan to set aside an additional $100 million for homelessness. This is all in addition to longstanding state and local programs such as the density bonus, rent stabilization, and the Low Income Housing Tax Credit, all of which seek to protect vulnerable residents and increase the supply of housing for low-income families.

While these commitments are admirable and well-intentioned, they are not unique to Los Angeles. And more importantly, they are not enough. Very similar programs are available in San Francisco—often with more stringent requirements and higher levels of funding—and yet the Bay Area is home to some of the most expensive real estate in the country. We can’t hope to be successful by pursuing exactly the same policies as cities that have failed utterly in their affordable housing goals. Our city and region must chart a new path if we hope to achieve the success that has eluded other booming coastal cities.

Our Current Affordable Housing Model

For decades now, affordable housing policy in Los Angeles and around the country has focused almost exclusively on the construction of new, income-restricted homes. Whether as standalone projects where all units are affordable, or mixed in with market-rate buildings, the city solution to affordability is to build more new stuff.

This strategy has been, by almost any measure, a dismal failure. As of 2013, for every 100 extremely low income households there were just 28 affordable units, down from 37 in 2000. And of those eligible for housing assistance, only about a quarter actually receive any help. Everyone else is on their own.

In Los Angeles County there are an estimated 490,000 households that pay too much for housing, and yet the City’s Regional Housing Needs Assessment seeks to allocate just over 40,000 units to low and moderate income households through 2021 [see page 79]. Constructing all of those homes would require $3 billion in local subsidies, so even that amount is extraordinarily unlikely to be built.

On top of all that, the City of LA will lose 20,000 existing affordable homes between 2013 and 2023 [see page 78], reducing the supply of affordable housing even further.

This last fact really illustrates the major shortcoming in our construction and covenant-based affordable housing system. Right now this system is structured around paying developers—usually non-profit developers—to build new housing and restrict it to households earning about 30 to 80 percent of the area’s median income. (Median income for a 4-person household in LA County is $64,800.) Those restrictions last 30 to 55 years, until they expire and the units revert back to market-rate. In a city like Los Angeles, that means rents go up about 200 to 400 percent. If the city doesn’t want to lose these units it has to subsidize them all over again, dropping a hundred grand or more on each home, every few decades, just to avoid falling behind.

An acquisition-based affordable housing program would be slow to grow at first, but would result in exponential growth over time. A construction-based building program would plateau without consistent funding increases.


So focusing exclusively on the subsidized construction of new affordable housing units isn’t working. What should be done instead?

Before I answer that question, let me ask a few more: Do we really need private, for-profit landlording? Do we need institutional, large-scale investors earning 5 percent returns each year on the places many of us call home? At its heart, isn’t the goal of long-term housing affordability fundamentally incompatible with a world in which housing is an investment vehicle that relies on its value increasing faster than inflation? And finally, can we really solve the affordable housing crisis by focusing the vast majority of our efforts on the 1 percent (or less) of housing that's added each year, rather than the 99 percent that's already in place?

We need private developers to build new housing—it’s just not realistic that the public sector can raise the capital or deliver housing efficiently, or at the scale necessary, and we should avoid crowding private actors out of markets that they're happy working within. If developers want to build, and new housing helps keep overall prices stabilized and provides funding for affordable housing, parks, streetscape improvements, etc., that’s all great. A profit motive may be essential to convincing developers to build the new housing our city needs, but is it important for managing what we’ve already got? I really don't think so.

So here’s my proposal for a new affordable housing model, in three parts:

1. The city should dedicate a share of its affordable housing funding to acquiring existing multifamily properties. This could be funded with dedicated funds, in-lieu payments on new development, or any number of other sources. Actual ownership and operation of these properties would not be in the hands of the city itself, but rather a non-profit (or consortium of non-profits) that could manage their housing with clear mandates but limited political interference.

2. Free of the profit motive of a typical private landlord, the non-profit owners should set aside a share of those units for low and moderate income households. The specific amount set aside would depend on the market-rate rents on the remaining units, because these would effectively subsidize the affordable units (rather than serve as the profit for a private owner)—I’ve done calculations that estimate about 20 percent affordability is feasible without losing money on the building as a whole.

3. The buildings should be held in perpetuity, using “profits” from the market-rate units to stabilize rents for all tenants and fund the continued acquisition of multifamily housing into the future. Because the owners are not motivated by profit, they would only be required to increase market-rate rents enough to maintain a positive financial margin and keep the buildings in good repair. And since acquisitions are permanent, they only need to be made once. No more spending millions of dollars just to tread water on the supply of affordable housing.

Assuming a relatively modest investment of $50 million per year, this is a plan that, over a 100-year period, would yield approximately 82,000 affordable units and 328,000 market-rate units. And as you can see in the table below, the growth is exponential.

An acquisitions-based affordable housing program starts slow, but grows exponentially, is fully self-sustaining, and exhibits a trend in which per-unit subsidies fall over time.

The difference in program sustainability really can’t be overstated here. If the city were to stop this program at any point, the units already purchased would remain affordable forever. If, by comparison, the city stopped funding its construction-based affordable housing program today, nearly every single unit’s affordability would eventually expire and we’d be left with virtually nothing reserved for low-income households. The below table shows what we would get spending the same amount, $50 million a year, on construction of new units.

A construction-based affordable housing program plateaus early, and long-term costs only grow.

In the construction-based program analysis, I accounted for the full cost of investment to make the comparison fair; my estimate is that about $300,000 per unit is subsidized through various sources. Affordable housing development is often sold as costing about $100,000 to $150,000 per unit, but that's just the city's share of the costs. County, state, federal, and philanthropic funds also play a major role in affordable housing finance, and if those could also be leveraged for acquisition of existing buildings we could make progress much faster.

Another important point: Using public funds to purchase multifamily housing doesn’t mean forcing property owners to sell to a non-profit. This is envisioned as a program in which the non-profits would compete on the open market for buildings that are already for sale. The non-profits could, in theory, have a competitive advantage over private investors if they had access to low-interest loans from the city or other public sector stakeholders.


Above I’ve described the general model, but there's much more to this than the units themselves. Comparing this proposal to the construction-based affordable housing program we currently rely on, there's a lot going for it. Below are a few key benefits.

Our money could go much further by purchasing existing units. The median price of a multifamily unit in the area is approximately $260K. By comparison, the average cost of an affordable housing unit in LA County was well over $300,000 by 2012 and is almost certainly over $400,000 today. In San Francisco, the average new unit costs a whopping $600K, and Los Angeles is headed in the same direction.

Median asking price for multifamily housing in the city is approaching $260,000 per unit—still far less than new construction.

Once a building is acquired, it could be used for affordable housing permanently—no covenants or expiration dates. Worries about the loss of existing affordable housing stock would be a thing of the past, and once a building was fully paid off it would continue throwing off profits to reinvest in affordable housing.

The program is self-supporting and sustainable, with existing properties helping to fund acquisition of future properties. Assuming a loan is used to complement a down payment on acquisitions, the non-profit owner can look forward to repaying the loan for roughly 30 years. Afterward, the building will be a source of profits that can be used either to fund more acquisitions or to set aside a larger share of the units for low- and moderate-income households. This is how we guarantee an ever-growing supply of affordable housing. It’s a sustainable program that doesn’t rely upon the unwavering largess of politicians and voters.

It gives renters something to cheer about when new housing is built. Every home that's built today is a home available for public acquisition 10, 20, or 50 years in the future. If the program is partially funded through in-lieu affordable housing payments on new development, the connection becomes even stronger.

Residents displaced through Ellis Act evictions or new development can receive priority placement in affordable units. A major problem with distributing affordable housing among thousands of property owners is that they can’t be easily coordinated. If you had one non-profit (or group of non-profits) managing thousands of units across the City, you could organize a single list of “priority placement” residents, with the non-profit owners required to offer their units to these residents as spaces open up. A single property owner with 4 low-income units might see an opening only every several years at best, leaving needy residents out in the cold. In comparison, an owner of thousands of units would have new openings on a daily basis. And since market-rate units would be indistinguishable from low-income units, they wouldn’t necessarily have to wait for a low-income unit to open up to rapidly re-house a displaced family.

It would distribute affordable housing units much more evenly throughout the city. Most affordable housing built today is either very concentrated or very sparse—typically either 100% of units in a development, or 5 to 15 percent, but rarely any number in between. On top of this, much new development, whether market-rate or affordable, is concentrated in just a few neighborhoods like downtown LA and Hollywood. Under this new proposal, each building would have a roughly similar share of units set aside for low-income families, and they could be purchased strategically to avoid concentration in specific areas.

It would protect older buildings from condo conversions and luxury “value-add” renovations. The worse our housing shortage gets and the more rents grow, the more incentive property owners have to convert their buildings to condos, renovate them with luxury amenities and finishes, or use them for short-term (AirBnB) rentals—all of which effectively removes “market-rate affordable” housing from the market. Acquiring these buildings for non-profit ownership keeps them affordable permanently, buffered against outside economic forces.

A common example of an existing building that is unlikely to be redeveloped, but will feel pressure to be renovated to appeal to a higher-earning demographic without an adequate supply of new housing—and which could be protected if it were purchased for non-profit ownership and management. This Koreatown apartment building was purchased for $7 million—$127,000 per unit—in 2015. Source: MultifamilyBiz.

By taking private buildings off the market, the City would encourage large investors to deploy their capital in more socially beneficial ways. Rather than investors acquiring older properties for value-add conversions to higher-end housing, it pushes capital toward investment in the development of new housing, which is sorely needed in Los Angeles at all income levels.

Small-time landlords wouldn’t be negatively affected, nor would redevelopment of underutilized properties. These acquisitions would target larger buildings—most likely those with 20+, 30+, or even 50+ units—so small-time landlords generally wouldn’t be competing for the same properties. There are a few reasons to pursue larger buildings, including the fact that it’s just more efficient to manage them, especially when a share of them are set aside for low- or moderate-income households. Acquiring larger buildings also avoids competition with developers who want build more homes on under-utilized parcels, since that’s something we’d still like to encourage.

Last, this represents a fundamental shift away from a zero-sum housing market—one in which housing is always expected to increase in value, creating winners who own property at the expense of all who rent. I've become convinced that we'll never solve the problem of housing affordability as long as there is investment value in housing. If housing is expected to go up in value, that's necessarily coming at the cost of the person renting it or the next person to buy it. Taking a large amount of housing off of the private market seems the best route to solving this problem, and this feels like the best way to do so without enacting draconian policies that forcibly take properties from their owners.

Concluding Thoughts

I could continue with even wonkier features of this proposal, but I’ll stop myself here. The key point I want to drive home is that this is a plan built for the long-term. Spending all of our money on new construction may get us affordable units faster, but it leaves us permanently shackled to a system in which we’re always playing catch-up. Acquisition takes time to ramp up to its full potential, but it is built on a sustainable model of exponential growth. For a business, it might be a foolish proposal. But for a city, which measures its lifespan in centuries (assuming it's successful), this is a prudent approach. We should pursue both acquisition-based and construction-based strategies concurrently, always the understanding that our housing challenges are decades in the making, and that fully solving them will take decades more.

There’s a lot to work out in this proposal, so I invite readers to comment and, if you like, to review the pro forma analysis behind this work. I’m not a developer nor do I work in the real estate industry, so I’m sure that there are some shortcomings in my financial analysis, but hopefully none so large that they would contradict the overall message here: buying units makes more long-term sense than paying someone to build them and operate them for a limited period of time.

This proposal also doesn’t deal with where the funds come from, the mechanics of non-profit ownership and property management, or a number of other important issues; this is an idea with a long way yet to go. If you have constructive comments about how any of those pieces might be implemented, please feel free to share. For example, right now I’m envisioning this as being primarily funded through in-lieu payments on new construction, which would allow developers to pay a fee in lieu of some on-site affordable units—in that respect it directly ties the production of new housing to preserving the affordability of older homes. If you have an alternative that you think would work great, or input on other aspects of the proposal not discussed in detail above, I’d love to hear it.

Some notes on methodology: Below is a list of assumptions made for the acquisition fiscal analysis:

  • Cost per unit (acquisition): $250,000 with 3.5% annual escalation
  • Annual public funding for acquisition: $50 million
  • Loan assumptions: 75% loan-to-value ratio; 4.5% interest rate, 30-year term
  • Share of units set aside as affordable in acquired buildings: 20%
  • Monthly rents: $1,500 for market-rate/rent-controlled units; $800 for affordable units
  • Annual rent increases: 3.0% for market-rate/rent-controlled units; 2.0% for affordable units
  • Expenses: $500 per month per unit, with 3.0% annual inflation
  • Capital reserves: 3.0% of Potential Gross Income