Note: This article has been sitting in draft mode for over 3 years. I wrote it in 2017, but never published it for some reason –– and kinda forgot about it.
When I saw it in DRAFT mode a few weeks back and reread it, it got me a little angry.
I was reminded of how predictable the market of today actually was, and how we could have done something about it –– yet chose to do nothing at all.
So here it is. Enjoy … well sorta.
Affordable Housing — Issues and Solutions
(original post written 10/21/17)
As the Richmond region continues to grow and the pressure on our real estate market continues to increase, the lack of affordable housing will likely continue to be an increasingly problematic issue.
With the current inventory crisis unlikely to abate (especially in urban markets,) the affordable housing problem becomes especially magnified in communities that border our urban core.
The health of any region is enhanced when all of its communities offer a balance of housing. And with one of the primary determinants of household wealth being homeownership, creating opportunities for buyers at the margin to own their own home is important to increase wealth and stabilize communities.
Disclaimer / Definitions
I will use the terms ‘margin’ or ‘marginalized’ throughout this piece. Note that I am using the term in an economic sense, not a pejorative or judgmental sense. And when I say ‘affordable,’ I am referring to buyers whose financial profiles border the minimum qualifications to purchase housing.
The term ’affordable‘ is in reference to the economic term that describes housing that is within reach of buyers who make the median income in a region. It is a legal term that generally refers to any housing that can be purchased with undue financial burden by an individual who makes 80% of the Average Median Income (AMI) in a specific region.
Furthermore, the use of ‘affordable’ does not include substandard housing. Substandard housing (or housing that is deficient in repairs, maintenance, or otherwise) introduces an entirely different set of problems. Substandard housing physically endangers occupants with an increased likelihood of structural failure, fires, etc. as well as financially endangers its occupants with the need for frequent expensive repairs.
Lastly, my solution is targeted at the ‘for sale’ segment of the affordable housing market, not the ‘for lease.’ I believe that one of the quickest ways to break the cycle of poverty, as well as the quickest way to help stabilize at-risk communities is through vested ownership. When residents make a commitment to ownership, tolerance for criminal activities and other issues associated with blight and poverty decrease sharply.
There are numerous problems that are impacting the availability of affordability housing, and they are not just the price of housing:
- The ability to create (i.e. build) a home that is considered ‘affordable’ in any community is next to impossible given current building codes, proffers, and material costs. These constraints have pushed the minimum expense of housing at or above ‘affordable’ levels, making ‘affordable’ new construction largely infeasible.
- Any home that is built to be affordable is likely to be built to the bare minimum of standards to decrease costs. Thus, the affordable homes that are built will generally have shorter effective lives than homes built to unconstrained market standards. This conundrum will manifest itself into a space where ‘affordable’ housing quickly degrades into substandard housing.
- Affordability will suffer as interest rates rise
- The median qualified buyer pool cannot afford the median home in the RVA market due to allowable DTI ratios and PITI calculations
- Affordable inventory is extremely low creating more competitive offers at lower price points — and the likelihood of an ‘affordable’ buyer winning a competitive bid are far lower than conventional and/or cash buyers
- The commissions earned on the lower-priced home are lower and thus, it tends to be more profitable for agents to focus on higher price points
- This is exacerbated by a more complex affordable mortgage process where denials are higher and appraisal risk FAR greater
- The time required to sell affordable housing is higher (for the reasons stated above) and thus the effective hourly rate earned by agents in the affordable segment is far lower than at the middle and upper price points
- Experienced agents who offer the most valuable advice tend to avoid the affordable markets out of necessity
My solutions are largely based on the creation of tax incentives targeted at the problem of creating quality new housing –– at scale –– that is within reach of the 80% AMI segment of homebuyers that is near the urban core and is close to public transportation and other urban infrastructure.
Having seen the Historic Tax Credit (HTC) programs transform our urban core at an astounding rate, I believe that we can create a similar set of incentives to not only help relieve the pressure on affordable housing, but to actually address other issues related to poverty and blight in many of our most at risk communities.
My suggestions are below:
Any NEW home that meets the legal definition for affordability (80% AMI, for example) within a community, the builder’s material and labor costs required to create the dwelling become a tax credit to the builder. Effectively, you would be creating an Affordable Housing Tax Credit (AHTC)
Standards for quality must be established to ensure that the homes are being constructed with effective lives that exceed the minimal standards.
If priced similarly to the HTC, the AHTC would create an incentive that would offset roughly 50% of the construction COSTS in the form of a credit.
This would allow:
- The quality of housing to increase through the use of better materials and better skilled labor and subcontractors
- The architecture of the housing to better match existing urban fabrics
- Incentive for more established builders to enter affordable markets
With construction costs currently in the $100/SF range (article from 2017, remember), a $35-50/SF incentive would drop the price of the home by anywhere from 15 to 30% and not sacrifice the quality of the home. This would go a long way to supplying a long term viable housing stock to affordable communities.
Yes, there are many lending programs created to assist marginal buyers who wish to own a home. These programs generally offer the following characteristics:
- Lower down payment options
- Higher allowable DTI ratios, lower credit profiles and slightly higher effective interest rates
- Minimal housing standards
And while these are incentives to an affordable buyer, they do not really address the underlying issues:
- Lower down payment options simply increase appraisal denial issues in a market where price acceleration is prevalent
- A loan that is denied due to an appraisal issue is financially damaging the denied borrower (lost loan fees, interest rate lock fees, appraisal fees, inspection fees, interim housing needs, etc.)
- A higher allowable DTI is, in itself, a higher risk and allows a marginal buyer to burden themselves with housing costs in excess of generally accepted levels
- Minimal housing standards (FHA) puts buyers at a disadvantage with sellers who are unwilling to take on certain repairs and thus removing a substantial section of the housing inventory to the affordable buyer.
- This also puts the affordable buyer at a substantial disadvantage in a competitive offer environment
So in lieu of offering loan programs as described above, adopt the following philosophy and establish a Lender Tax Credit (LTC) program as follows:
- For any loan that is issued to an ‘affordable’ buyer, Principal Interest Taxes and Insurance (PITI) is replaced by Principal Taxes and Insurance (PTI). In other words, create a 0% interest rate loan where the affordable buyer pays ZERO interest
- Depending on the interest rate, this nearly halves the mortgage payment
- LOWER the allowable DTI to a level that does not endanger the borrower
- Instead of a 28% front end ratio, drop to 15% or thereabouts to ensue lower default rates
- Simultaneously, offer a ‘dollar-for-dollar’ tax credit to the lending institution for the interest that is foregone as a part of the loan
- And you may want to consider an available repair fund that can be used to offset future repairs to either improve or help maintain the standard of housing
By doing this, you accomplish several things:
- Allows the borrower, as well as the lender, to accelerate the creation of equity
- Accelerates wealth building in the affordable community
- Creates an owner who is far less susceptible to market shifts and/or employment interruption
- Increases the sense of vesting in communities where issues of blight tend to be more prevalent
- Decreases pressure on new construction to be minimally built as the affordable housing market will qualify for better built homes
Realtors (at least for now) are paid via commissions. If we don’t sell, we do not make a living.
Furthermore, the effective rate of pay is a function of commissions earned x time spent to earn them. The economic goal for all agents is to sell homes at the highest price points and at the least effort in order to maximize efficiency.
- A lack of inventory
- A higher likelihood of substantial repairs needed
- A higher likelihood of loan denial
- A less experienced buyer pool
- Lower aggregate commissions
The expected value of commissions on a per deal basis is lower in the affordable segment than it is in the middle to upper-end market segments. Logically, agents tend to eschew affordable markets due to obvious economic reasons.
Furthermore, the costs to be a Realtor are somewhat fixed, which further erodes the income level of agents who work in the affordable segments, especially when compared to the middle and upper price points.
Lastly, I believe that there is a racial component to this issue as the more affordable communities, at least in our market, tend to be populated with a higher percentage of minorities. A minority agent is placed at a competitive disadvantage if their primary marketplace is an affordable one.
While the statistics are not readily available, I would suspect that both the number of minority agents, as well as the distribution of income earned by minority agents, is incongruent with the population in the aggregate.
Furthering the use of tax credit themes from above, I propose exempting commissions earned on affordable housing from income tax.
This accomplishes the following:
- Incentivizes agents to focus on the affordable markets and bring the necessary expertise to the table
- Incentivizes (and somewhat subsidizes) minority agents entering the real estate sales business
- Encourage more experienced agents to work with affordable buyers in lieu of ignoring them –– increasing knowledge and understanding in the segment
The affordable housing problem is relatively simple to define — we need more of it and it is hard to do.
But the cure is next to impossible, given the current tools available to communities who need the most assistance. This is evidenced by the fact that the rate of development of for-sale affordable housing is at a nearly infinitesimal fraction of the rate of affordable ‘for rent’ development.
The Historic Tax Credit program has been transformative and proven to be an economic engine that has helped to rebuild blighted urban cores at an unprecedented rate. And the taxes that have been foregone (via tax abatement programs) in an effort to aid redevelopment are already yielding massive returns as communities have been transformed from blighted and desolate into vibrant and sustainable in a matter of years, instead of decades (or longer.)
By applying the same basic framework, Tax Credit incentives for affordable ‘for sale’ housing can be used to help offset costs, increase the long term quality of our housing stock, and to help increase wealth within a population that desperately needs it.