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Financing Affordable Housing in California

Part I in this series about the failure of Senate Bill 50, laid the groundwork for understanding underlying causes of un-affordable housing. As noted in that article, our “affordability” issues are not unique to housing nor to the State of California, and are, ironically, less acute in our major job centers than in places we generally think of as being more affordable.

In prior articles, I’ve examined why an increasing percentage of our population is having a harder time making ends meet, not just for housing but for food, education, healthcare, and everything else, and how the socioeconomic institutions that are driving these trends are leading to increasingly dire prospects for our financial markets, taxpayers, and our planet.

The data presented leads to an undeniable conclusion. If we really want to address housing affordability, we need to broaden our thinking. To focus on planning and zoning may seem obvious, but it’s precisely the wrong place to look for solutions.

Public policy by catchy soundbites is popular these days, but its “solutions” are dumbed-down to the point of being dangerous.

As H.L. Mencken once said,

“There is always an easy solution to every human problem - neat, plausible, and wrong.”

Endless bickering

The public discussion about affordable housing has become extremely difficult because it has devolved into nonsensical talking points, racist tropes, and distortion of data by state senators and high-paid housing advocates. All that is being offered to us is what I’ve termed the “madman theory” of growth, planning, and development.

But, contrary to what is politically fashionable to believe, our current “affordability” problems are predominately an income and wealth inequality problem, not a housing problem. They are a result of subsidizing investment returns at the expense of wage earners and prioritizing the interests of corporations over individuals and even local government.

This is principally driven by national and state income and revenue tax policies. The naïve deconstruction of our progressive income tax system, since the 1980s, combined with endless jerry-rigging of official inflation statistics and interest rates, since the 1990s, has contributed to the situation we are witnessing today.[1]

So long as we continue to allow financial and corporate interests to offload the burdens of their growth and their single-minded search for increased profits onto local taxpayers (the costs of schools, infrastructure maintenance, roads, public services, environmental preservation, etc.), our lack of “affordability” will only get worse.

Similarly, the more the state focuses on sucking private capital into its coffers by increasing taxes and fees to fund top-down “solutions” by inefficient, state mega-agencies, the less affordable it will be to live in California.

Today, affordable housing has little to do with planning and zoning and everything to do with addressing how to finance it by creating tools and incentives to tap private capital for public good.

Show me what you’re doing with my money

Every time politicians and housing advocates speak about funding affordable housing, the only thing I hear are giddy discussions about schemes to increase taxes and fees. Why is government’s reaction to every problem to add taxes and fees, to grow big government bigger, and attempt to take top-down control of everything?

The confiscation of private capital through taxes and fees has proven to be wasteful and counter-productive because it adds disproportionate financial burdens on those most in need. So, why are bureaucrats and housing advocates so stuck on subsidizing big real estate investment and development interests through tax-funded “housing funds” or “redevelopment agencies:” things that have failed miserably in the past?

Could it have something to do with who’s making all those campaign contributions?

We’re going to need to make bold moves to address our affordability challenges. But, paradoxically, this is not a time for wide-eyed idealism. We need to focus on tangible, workable steps we can take right now.

As I recently discussed, real solutions will challenge the way we currently define social and economic “success:” a measuring system that is just not working anymore for the majority of people.

The truth is that the world is awash in stupid money. Yet, we can’t seem to summon much of it for social good and our tragedies of the commons. Other than the relative pittance that is provided by philanthropy (much of which comes with a huge price to the public from self-interested schemes, such as the Chan Zuckerberg Initiative) and the relatively small amounts private corporations offer local governments as bribes to get the growth approvals they need (e.g., the Amazon headquarters saga), the burden is increasingly falling on ordinary taxpayers and residents.

Yes, our failure to tax the very rich (those with incomes over $1 million a year) and trillion dollar corporations is part of that. But California's wasting of our tax dollars on endless social engineering failures and by creating more and more unneeded state and regional agencies and paying themselves lucrative pensions and benefits are equally, if not more, to blame.

California’s state government and its agencies are now a behemoth sucking up private resources at an alarming rate and providing fewer and fewer public benefits (on an inflation adjusted basis), due to their operating capital needs (e.g. unfunded pension liabilities).

And we’re not building any more affordable housing than we used to, in fact, we’re building less.

Meanwhile, funding for affordable housing is like Woody Allen’s character in the opening scenes of Stardust Memories, where the train car he’s in is filled with grim Kafkaesque characters, while the train car across the way is filled with champagne-drinking celebration.

There’s a party going on in our economy, with everyone getting stupid drunk, but affordable housing isn’t invited to the party.

Punishing already over-burdened local governments and individual taxpayers with more rules, less local control of planning, more mega-agencies to oversee them, more fees and penalties for noncompliance, and intricate schemes to funnel private capital into gigantic, unaccountable, politically controlled state “funds” is a counter-productive policy.

At the same time, giving away the store to private profit-driven interests and embracing “markets solve everything” beliefs in the hope that this will somehow result in someone doing the right thing – an approach so beloved to YIMBYs and Senator Wiener’s cabal and one that has failed so badly since it was first adopted in the 1980s – is just as disastrous.

Does anyone honestly believe either of these is a solution to anything? We need a better way going forward.

We need to make "markets" work for us, instead of against us.

Turning lemons into lemonade

If affordable housing is a national problem then real solutions are going to take dramatic changes to national tax and socioeconomic policies and priorities. But Washington DC is stuck in dysfunction, so what can we do by ourselves in California? How can we bring private capital to the table to address affordable housing?

Private capital will not participate in addressing housing affordability on its own, because investment capital (foreign or domestic) has no allegiance to any particular place or anything other than maximizing returns. It will go where the returns are and taxes and fees generally hurt returns.

Well, the bad news is California has the highest taxed population in the country.[2] But the good news is California has the highest taxed population in the country.

California is now the fifth largest economy in the world (more than $3 trillion per year in gross state product) and we have a population that ranks 35th in the world. Our base sales tax rate is the highest in the country at 7.25%. Our state top income tax rate of 13.3% is also the highest of any state in the country.

This means that any state tax benefits offered to those investing in affordable housing could be a very powerful tool. Yet, this concept remains largely untapped because we are grossly deficient in one thing: creative thinking.

Lessons learned?

Following the federal government’s abandonment of directly building and operating public housing, in the early 1970s (see the story of Pruitt Igoe), they began to experiment with creative tax incentives to stimulate private sector participation in the development of affordable housing. In the 1980s, these experiments took the form of offering Low Income Housing Tax Credits (LIHTC) to low-income housing developers, and loan “co-insurance,” whereby the federal government guaranteed a portion of private banking loans made to develop it.

Under these programs, developer profits were limited by statute, yet there was no scarcity of private developer participants. This was because significant risk was removed from the equation by federal guarantees of private sector loans and programs to support government subsidized, low-income tenants (e.g., Section 8) or outright project-based assistance.

These programs relied on private capital and public markets for all of the required equity investment. But as is so often the case with top-down government, the programs were not managed correctly, the political winds changed, the government reneged on its contractual obligations with private developers (e.g., they failed to honor inflation adjustments on government set rental rates to cover operating expenses), and the programs became so corrupted by politics that most were abandoned, leaving only the LIHTC remaining.

However, there are lessons to be learned. With the proper incentives, tens of thousands of units were built and tens of thousands of marginally profitable, existing market rate projects were converted into low-income Section 8 tenancy.

That is unheard of today.

Opportunity Zones

In January of 2019, I wrote about the federal government’s launch of the “Opportunity Zone” program. The program allows high net worth investors to avoid capital gains taxes by investing in “development” in Opportunity Zones, as designated on maps drawn by state agencies. But it is not an affordable housing program or even limited to housing development.

To sum up my appraisal of the O.Z. program is that opportunity zones are an opportunity wasted.

Designating precise areas on maps, based on U.S. Census income data, paradoxically, results in a new form of discrimination and segregation. Instead of incentivizing the integration of income levels in all neighborhoods, the maps separate the wealthy from the poor, and the profits go to the largest private developers. Low-income neighborhood leaders have called it a new form of “urban renewal” that decimated low-income communities in the 1980s, leading to more gentrification and displacement of the poor.

The government has proven to be very bad at picking winners and losers, or what and where to invest in real estate development. This is one thing the market does better.

Drawing private capital to the affordability challenge

It is axiomatic that as things stand, the only way private developers will engage in creating any affordable housing units is if the government showers them with free taxpayer money and zoning giveaways. History has shown this will end in disaster.

Over the past five years, I’ve spoken at public forums and written extensively on ways to incentivize private investment capital to serve affordable housing and public policy goals. Some of these suggestions to promote affordable housing development have included:

All these suggestions are available to us right now, for immediate implementation with just the stroke of a pen. None of these proposals add layers of costs to local government, as they do now in order to comply with the state’s top-down schemes. And all of them would have critical economic multiplier effects that could generate business growth and tax revenues that far surpass their financial costs.

But, I think we need to be even more creative than that.

Increasing private investment participation

In defending his recent legislative proposal, SB50, Senator Scott Wiener said, “I don’t care how much money developers make. That’s not my concern.” I would counter that by saying, “I don't care how much private individuals make.”

With all the talk about funding affordable housing, the government, state agencies, and housing advocates never talk about individuals, the 30 million adults who live and work and pay taxes in our state, other than to think of them as a source of funding.

But where is our seat at the table? How do we all benefit from the state’s housing plans?

What if the state started to look at us as potential partners, potential investors rather than just someone to exploit? As a group, we control more wealth than the state could ever imagine raising through their nefarious, regressive tax schemes.

The “white shoe” game for the Nike crowd

Equity investing as a third party, in real estate development, has always been the province of investment bankers and their private equity clientele: so-called “qualified individuals.”[3] But public securities markets have become exponentially more sophisticated, for better and for worse. And with regard to the potential to attract private investment capital to fund affordable housing development, they should no longer be ignored.

We now undeniably live in a world of “crowd-funding,” with online platforms raising billions of dollars a year for all types of business ventures. And online securities trading is now commission free and accessible to anyone.

I’m not suggesting that the State of California go on GoFundMe or Kickstarter to raise money for low-income housing projects, but there are now opportunities to connect with individual investors, large and small, as well as corporate, institutional, and private equity investors, to seek capital, in new ways.

Working with the best minds in the investment world, in a public/private partnership, the State of California has the opportunity to create investment vehicles in the form of Real Estate Investment Trusts (REITS), partnerships, and/or publicly-traded securities that offer the general public a way to participate in the financial benefits of development of low-income and affordable housing projects, or "components" of those projects by private for-profit and nonprofit developers.

This peer-to-peer public participation is not a wishful, trickle-down scheme. It's the exact opposite. It’s a level-the-playing-field proposal to allow anyone to participate in the financial benefits of affordable housing development: for all of us to have a stake in the program's success. These new securities can even be financed through IPOs (initial public offerings) of stock.

The various tax credit and debt insurance proposals noted here would work hand-in-hand with this initiative to ensure the credit worthiness of project proposals. Developer’s profits would be limited and tied to investor returns benchmarks. And by creating investment pools represented by tradeable securities invested in property portfolios, the state would avoid engaging in previously discredited, high-risk ventures, such as single project-based bonds.

There is no time like the present

Market cycles are inevitable, regardless of how many people now claim they are a thing of the past. But, apparently, government didn’t learn much from the 2008 debacle.

Artificially low interest rates and endless money printing are now causing deflation, low savings rate, outsized debt, increased speculation in public markets, and a paucity of capital investment that those low rates were supposed to cure. The current record high disconnect between corporate revenues and profits and equity pricing is not reassuring.

In the next downturn, the San Francisco Bay Area real estate may be hard hit and affordable housing will be even harder to build.

This is all the more reason to act now.

[1] Ironically, while Medicare raised its monthly premiums by more than 6% this year, social security payments rose by a paltry 1.2%, ostensibly because the government says there’s no inflation.

[2] Californians pay the highest taxes when the cumulative effect of all types of taxes that impact the average resident are considered: sales tax, business taxes, property taxes (including bonds and fees), service fees, income tax, etc.

[3] As defined in the U.S. Tax Code



Bob Silvestri is a Mill Valley resident and the founder and president of Community Venture Partners, a 501(c)(3) nonprofit community organization funded only by individuals in Marin and the San Francisco Bay Area. Please consider DONATING TO CVP to enable us to continue to work on behalf of Marin residents.