California officials and politicians continue to adhere to overly simplistic ideas about our state’s housing challenges. They to fail to acknowledge that housing affordability is a symptom of an overall unaffordability crisis that is the result of a myriad of complex, interrelated factors, some of which include supply and demand, the cost of funding, rising costs of living in general, and how investment capital has no loyalty or morality in a market-based economy.
But this also and possibly more significantly includes the effects of the ongoing impoverishment of the working middle-class, young adults, and seniors, all of whom are being crushed by a zero savings rate, rising inflation, and a post-2008 world where wages, social security, and savings returns are failing to keep up with costs of living.
At the same time, the state also continues to deny the fundamental fact that the “market” will not build affordable housing on its own, regardless of zoning changes or land giveaways. And it certainly has never and will never build any low-income housing for those most in need unless it is substantially subsidized by government financing.
The key word here is “subsidy.” It is simply a fact that without some form of project subsidy (and likely a combination of several subsidies), be it land, low-cost loans, tax credits, or grants, it is impossible to develop any significant amount of low-income, affordable housing. If that were not the case, the market would already be building it.
I also want to emphasize the term “most in need” because any sound housing policy should make low-income housing its top priority, serving our society's most disadvantaged populations first and foremost. Otherwise, what’s the moral basis of our housing policy?
All of this considered, there are several things our state legislature can do to help preserve existing affordable and low-income housing and increase the development of new affordable and low-income housing. I’ve written about ways to do this, in the past, but there are four things the state can and should do, immediately, to help address our housing challenges.
1. Reform RHNA Housing Quotas
Regional Housing Needs Allocation (RHNA) quotas must be based on actual data and a realistic method of projecting housing needs or cities and counties will continue to fail to meet the stated goals. A system based on punishment, fines, penalties, and lawsuits will not produce more affordable housing.
The recent audit of the California Housing and Community Development Agency (HCD) by the Office of the California State Auditor found, unequivocally, that the current RHNA "housing goals are not supported by evidence." The audit cites studies done by the Embarcadero Institute that demonstrate how HCD “double counts” the expected regional growth rates and housing needs for California cities and counties. In more than a decade of private conversations with senior staff members at the Association of Bay Area Governments (ABAG), they have confirmed, “off the record,” that the unit allocations for each region are pretty much made up by HCD.
Worse still, in the past five years, RHNA quotas have been weaponized as a politically motivated punishment tool that is doled out by a cadre of state and regional unelected officials to carry out an ideologically driven, social engineering scheme on a grand scale. This effort has been financially backed by a cabal of labor unions, tech companies, profit-motivated “nonprofit” housing developers, and for profit real estate finance and development interests.
The first profound fallacy of the RHNA concept is that 99% of the state’s cities and counties do not directly build any housing. They have no funding or capacity to build. All they can do and have been doing is giving away zoning incentives and bonuses and public land to private, for profit (and profit dependent "nonprofit") developers in the hope of avoiding penalties and lawsuits and not getting too screwed in the process.
The second profound flaw in the RHNA concept is that unless housing goals are tied to some method of financing its goals, it will never achieve anything other than increased gentrification and displacement of those most in need of housing security.
2. Change how Low-Income Housing Tax Credits are allocated in California
The Low Income Housing Tax Credit (“LIHTC”) program has been the most successful financial inducement to creating affordable housing since it was first introduced in 1986. It is estimated that LIHTCs are involved with almost 90% of all the low-income housing built in the U.S.
As it stands, the federal government allocates federal Low-Income Tax Credits (LIHTC) to The California Tax Credit Allocation Committee (CTCAC), within the State Treasurer’s Office. The CTCAC allocates both the federal LIHTC and California’s own version of the LIHTC to developers who apply and meet all the requirements. About half of the credits received by a developer are from the federal program and about half are from the California program.
Those credits are typically sold by developers to third-party investors (e.g., a major corporation) that can utilize their value to reduce taxes on their earnings or they are sold to intermediaries (syndication) who package credits into derivatives to be sold to institutional and individual investors.
One problem with the California Tax Credit program, however, is that to qualify one has to qualify for federal tax credits, first. This creates a bias toward the kinds of projects that qualify for and receive federal tax credit allocations (typically larger, new construction projects). However, the lack of land available to build larger housing projects in many smaller cities and the fact that developers in those communities tend to propose smaller projects (fewer units) decreases the chances of smaller, local developers being awarded any tax credits.
Yet another problem is that the tax credit application process is often too expensive and onerous for small, local developers to take on. The result is the vast majority of tax credits go to a handful of very large housing developers (who need to build large 100 unit + projects to make enough profit to appease their investors, which makes them shun small cities that don't have large parcels to develop or the population to support large projects). The CTCAC also prefers to work with large developers because small projects are harder for small developers to finance and if the project fails to be built CTCAC loses the tax credits for that year. Large developers with deep financial resources are a safer bet. The result of this directly contradicts the stated goals of California's housing policy, which is to promote affordable and low-income development everywhere (and particularly in smaller, under-served communities) so that every community does its “fair share.”
All this has resulted in making the tax credit granting process, the powers of which are presently concentrated in one state agency, highly politicized and influenced by well-paid lobbyists; again, favoring the biggest and wealthiest applicants. This impedes the equitable development of low-income housing throughout the state.
The simplest way to improve the LIHTC process is to grant local governments the power to allocate housing tax credits in their towns and counties. Have the CACTC allocate a “fair share” percentage of the total of both federal and state low-income housing tax credits to each city and county in California pro-rata, based on population. The application process and the allocation of tax credits to project proposals would then be decided at the local level.
This method has several major advantages. It (1) gives local governments the funding “carrot” they need to incentivize developers to build the types of low-income housing that are most needed, locally, (2) ensures that smaller, infill, low-income projects that are best suited to the unique requirements and obstacles that exist in each community have a better chance of being realized, and (3) vastly simplifies the time and costs involved in being granted tax credits.
In concert with this, the state should set up an electronic, online, public LIHTC exchange where developers and investors of any size can interact to sell or purchase LIHTCs; to facilitate and greatly simplify these transactions which are so essential to funding liquidity.
3. Change California 1031 tax-free exchange laws to allow “non-like-kind” exchanges
The Section 1031 tax-free exchange rule in real estate is heavily used by all types of investors, large and small, corporate and personal. It allows owners to exchange appreciated investment property for other “like-kind” investment property and avoid (defer) capital gains taxes on increases in value at the time of a sale / exchange. This applies to both federal and state income taxes (though California has no capital gains rate: all income is taxed as personal income). Its purpose is to add liquidity to the real estate markets and encourage re-investment.
It would be hugely beneficial if investors were able to do 1031 exchanges of “non-like kind” properties (i.e., personal property, financial securities, etc.) so long as the property one was exchanging for (investing the proceeds in) was low-income, affordable housing (new or existing). This means, for example, that an investor looking to sell stocks or other securities that have greatly appreciated in value could exchange that investment for a secured ownership position in income-producing, affordable, multifamily real estate without paying any California income taxes in the process. This would apply to developing new projects and preserving existing affordable housing.
Recognizing that our state only has the power to change our own laws on tax-free exchanges and can’t do anything about federal tax law, it would set a precedent and example for others to copy and as the highest-taxed residents of any state in the country, I believe this simple change could attract significant funding for affordable housing from the private sector with no significant hit to state government revenues.
This adjustment in the tax code would also want to include extending the period of time allowed to identify the property being exchanged for, which is currently only 45 days. Since affordable housing development typically takes longer to gain approvals than the purchase/exchange of existing real property.
4. Create a California Capital Gains Tax for investment in low-income housing
As it stands, California treats profits from real estate investment as ordinary income. Offering a lower tax rate on earnings from investment in low-income housing would provide an efficient and revenue positive way (increased investment increases taxable profits, whic increase total tax revenues from real estate investment) to attract capital to affordable housing development.
The beatings will continue until morale improves
To continue to pursue public housing policies that are built on a system of unrealistic quotas, usurpation of local zoning and planning powers, and draconian punishments for helpless cities and counties that fail, through no fault of their own to toe the line, is a fool’s errand. It will only result in more divisiveness, distrust of government, and counter-productive outcomes.
Making these relatively simple changes will help all participants focus on what can be done, right now, not what we wish would be done some day.
Bob Silvestri is a Marin County resident, the Editor of the Marin Post, and the founder and president of Community Venture Partners, a 501(c)(3) nonprofit community organization funded by individuals and nonprofit donors. Please consider DONATING TO THE MARIN POST AND CVP to enable us to continue to work on behalf of California residents.