The California Housing Crisis – Who is Responsible? – By Roger Sanders

It is time that we acknowledged that Bay Area housing regulations and development have failed to create housing for most people, whether that housing is for rental or home ownership.  The discussion on who is responsible for the overpriced market never acknowledges that everyone involved needs to accept some of the responsibility.  Whether it be developers (private or affordable housing), tenant activists or government officials.  Before a real discussion can proceed in developing solutions to housing affordability, all stakeholders involved must develop an understanding of the consequences of existing regulations and policies.  While we all may agree that housing affordability is a problem there are many housing facts that are omitted in the discussion around finding solutions.

RENTAL HOUSING MYTHS

Gentrification is Forcing out Existing Residents

Gentrification is a dynamic part of every city and most neighborhoods.  California’s population increased by more than one million people since 2010.  These new residents require housing and generally migrate to cities.  When not enough housing is created to accommodate them, then competition for existing housing increases.  Historically, no neighborhood has escaped gentrification in which specific racial and ethnic populations were replaced by new residents.  And no specific population has ever been given a right to claim a neighborhood.  In San Francisco, the Mission and Castro had large Irish populations and North Beach was predominantly Italian.  Indeed African American populations were forced out of the Western Addition in the 1950s and 1960s to accommodate other residents.

During the 1950’s and 1960’s housing focused on creating huge suburban developments offering relatively inexpensive homes for families when home ownership in cities was less of an option.  The major difference today is that not enough housing is being built anywhere in California.  And the less expensive housing available requires even longer commutes on congested transportation routes and these commutes can be expensive and time consuming.  Now when people are unable or unwilling to commute, San Francisco and most bay area cities are also unable or unwilling to meet the demand for housing.  In 2013 only 11,000 housing permits were issued in the San Francisco/Oakland/ Fremont metro area while Houston Texas issued more than 51,000.  San Jose metro area created even fewer units of housing.  And in terms of population growth, if you don’t build it, they will come anyway.  Gentrification will happen and housing policy must create a response 

Metro Area 2013 Housing Permits Issued

Houston Metro Area                            51,333

San Francisco/Oakland/Fremont                      10,922

San Jose/Sunnyvale/Santa Clara                        7,764 

Rent Control

Even though most people won’t acknowledge that rent control is a public subsidy, it is.  Rent control is merely transferring rental income from a property owner and giving it directly to a tenant.  This is a government program in which there is no accountability and unlike other taxes and fees the government does not record the transaction.  If a tenant pays $1,000 for a rent controlled apartment and the market rental is $2000, the public subsidy amounts to $1,000 monthly or $12,000 annually.  The property owner is not allowed to record the financial loss for accounting purposes and the tenant does not have to declare the income for tax purposes.  The most unfair element of rent control is that a significant number of residents are in rent controlled units even though they are ineligible for all government programs for low income people.  Secondly, while even employee benefits and other forms of indirect income are taxed, tenants in rent controlled apartments are receiving this monthly public subsidy of indirect income without having to pay taxes.  Additionally, rent control has significant economic drawbacks, i.e., in a city with 100,000 rent controlled apartment units that are priced at $1,000 below market, $100 million (100,000 x $1000) in economic activity goes unrecorded each month.  Finally, landlords are not the only stakeholder being penalized since long-term tenants are benefiting at the expense of newer tenants who have to pay higher rents to subsidize their lower rents.   It would be far more efficient and less harmful to housing markets if governments fund housing programs directly and provide housing assistance to “means tested” low income renters. 

Landlords Are Greedy

Rental costs are determined by both supply and demand and operational costs.  When not enough housing units are constructed to meet the demand of residents or population growth, the competition for existing housing units increase.  When not enough housing is available people are willing to pay more for the existing housing and often this displaces existing renters/owners unwilling or unable to pay the competitive rate.  Secondly, when governments create more regulations or higher taxes for property owners this creates additional costs to maintain the property.  Requiring property owners to have an on-site property manager, for example, can contribute to a significant rent increase.  Even at minimum wage with health care and employer payroll taxes this could increase a building’s annual costs by $50,000 or more.   Complying with energy efficiency and building code changes is a business expense that tenants do not see when rents are raised.  And, in many instances, ballot measures supported by tenants increase operational costs without tenants realizing the outcome results in higher rents.  Both San Francisco and Oakland have similar rates for county property taxes but Oakland property owners pay more than 10 times what San Francisco home owners pay for other property taxes, fees and voter approved assessments.  And Oakland is one of the few governments in California that taxes rental income.   

Table 1 provides a basic operational budget for a newer 20 unit rental building.  This is a minimum budget that assumes a tax valuation of $250,000 per unit with a mortgage of $150,000.  For tax purposes, although older rental property that has not changed ownership in 20 or 30 years and may be valued less, these older units may have significant labor costs associated with repairs and maintenance or even the replacement of appliances.  When upgrades involve permits and fees like wiring, plumbing, lighting or structural improvements then these improvements can involve a property reassessment that increases the tax burden.  Rental property mortgages are often financed over 25 or more years and generally require a down payment of 25 to 33 percent.  The amortization of this down payment and other purchase/construction costs are listed under construction costs in this table.  In both San Francisco and Oakland it is easy to see that one bedroom monthly rents of $2500 and more are not unreasonable when operating costs are $2500 or more.  Indeed, for new housing the rental income may be lower than the actual operational costs if the amortized value of the owners’ original investment is included. 

Affordable Housing Construction and Rehabilitation

Like rent control, affordable housing represents those housing units that are receiving one or more forms of public subsidies.  Historically subsidized housing was primarily a federal program that funded construction and operations of housing for low income tenants or provided direct financial assistance to renters.  Over time these programs evolved into providing “block grants” to cities and states to support housing developments.  Eventually governments, especially in California, began transferring the costs of housing programs to the private sector by requiring them to pay the program costs, again, without acknowledging that the transfer inflates the true costs of constructing and managing housing and that these program costs are passed on to the consumer in the form of higher rents, taxes and purchase prices.

In San Francisco, Oakland and many other California communities the public subsidy involves government grants and loans, tax exemptions, and transferring “affordable housing costs” directly to privately owned market rate housing.  Transferring of program costs occur when government requires private developers to either include affordable units in any new development which are set aside for low income renters OR to pay into a fund that creates “affordable” units at another location.  In either case the outcome is that the affordable unit is being subsidized when a private developer transfers the “affordable” housing unit costs to market rate renters thru higher rents or to condominium owners thru higher purchase prices.    And, again this represents a direct but unacknowledged transfer of government program costs to market rate tenants and condominium owners. 

The other major subsidies involve government grants and loans provided to non-profit housing developers.    While these non-profit developers operate housing projects at below market rents, without government direct or indirect subsidies these projects would neither exist nor be able to maintain their affordability.  In San Francisco, during the past two decades more than 100 housing projects (new construction or rehabilitation of older properties) have been completed by these non-profit developers. 

Table 2. Non-Profit Housing Developments provides information on government (taxpayer) subsidies for four of these.  In each case, the City acquired the site, transferred ownership to the non-profit developer, and supported the project with direct grants and government loans.  Even without including San Francisco’s cost for purchasing the Leland Hotel, the subsidy for rehabilitation for each unit is $169,042 ($355,000 grants plus $11,816,000 government loans divided by 72 units).  In most instances government funding sources represent most of the construction costs, and in most instances the loans are non-performing or forgivable.  And finally non-profit housing developments are exempt from all property taxes.  In terms of operating costs, the government grants and loans subsidize these housing units by substantially reducing or eliminating more than 50 percent of operating costs thru reduced mortgages and no tax burden.  It is easy to understand how non-profits can operate with below market rents while private owners struggle under rent control. 

San Francisco has at least five non-profit corporations who each own and operate from 1,000 to 2,500 units of housing.  Even at below market valuation each of these corporations own properties in excess of $1 billion.  And since all of these projects were made possible through government funding, this represents a significant transfer of public assets to non-profit corporations.  In San Francisco, non-profit housing corporations receiving public funds are even exempt from complying with ethics regulations governing lobbyists meetings with public officials.  It should be noted that none of the tenants in non-profit housing pay any of the tax burden that supports our schools, public safety, or neighborhood programs while tenants in for-profit buildings are taxed (through rents).  And most, if not all, of the buildings that were transferred to the non-profit corporations were formerly privately owned and taxed. 

Inclusion of affordable housing units in a market rate building rather than contributing to a fund that subsidized non-profit housing has a significant cost.  Since private property is taxed, including the units in market rate building incurs the tax costs even though an identical unit in non-profit housing development is exempt.  

Landlords are Irresponsible

Landlords are actually forced to accept more responsibilities today than at any time in California housing history.   Regulations governing tenants’ rights and housing have focused on transferring all responsibilities in rental housing from tenants to landlords.  Now, tenants assume that when they pay rent that removes them from any responsibility for maintaining the housing unit.  Recycling has a cost when landlords are required to post signs and provide government notices to the tenants and the LANDLORD is responsible for compliance.  Mandatory graffiti abatement has a cost.  Evicting the drug dealer or pimp is the landlord’s responsibility and government provides no mechanism for reimbursement of expenses.  Eradicating bedbug infestations may cost a landlord $300 to $700 per unit and one occurrence requires treatment of the infested apartment and adjacent units.  But although the tenant brought the bedbugs into the unit, the landlord is expected to clean the infestation without raising rents.  The responsibility for maintaining a smoke-free environment in multi-family housing is with the property owners.  For problem pets, whether it is a barking dog or animal urine/feces, the tenant assumes these are a landlord’s responsibilities.  Regulations that require smoke and carbon monoxide detectors are the responsibility of the landlord.  Tenants can maliciously destroy an apartment unit, yet it is not considered a crime and the landlord must accept the abuse and repair the damage.  Governments are aggressive in regulating housing but offer no support to property owners in disputes with tenants.   

Real Estate Speculation Increases the Cost of Housing

If San Francisco did not have a distorted housing market there would not be the current speculation where rental property is sold, rehabilitated and converted into ownership opportunity.  The valuation of rental property is primarily based on rental income and operational expenses.  In a building in which rental income falls below other properties in the neighborhood, either rental or owned, than the property is undervalued.  This is what happens when you have a building that has been “rent controlled” for many years and income from controlled rents fall significantly below fair market value.  The real value of the property has been transferred from the owner to the tenant who is receiving a monthly subsidy of the difference between the rent paid and the fair market value rent.  When the undervaluation is significant there is an opportunity created for someone who has the resources to upgrade the property.  And most often in San Francisco, the opportunity is not the existing long-term owner. 

What is commonly regarded as real estate speculation is actually a result of what happens when there is a transfer of wealth in an undervalued building back to an owner.  Small property owners, even if small property owner is defined as 50 units or less, cannot continue operating a building under rent control and the harsh regulatory environment especially when they do not receive any of the taxpayer support given to non-profit housing operations.  When properties become significantly undervalued because of rent control over a long period of time, and if the existing long term owner does not have access to funding to survive the process of turning undervalued property into market rate opportunities then the property may be sold to another buyer who has the resources to “flip” the property.  For rent controlled property, “tenant buyouts” are a substantial asset giveaway to the occupying tenant which again penalizes the property owner.  And, adding significant penalties by increasing transfer fees when a property is sold is not going to have any long-term impact.  The new buyer just needs to hold on to the undervalued property for several years.  The reality is that San Francisco is discouraging long-term ownership and penalizing existing long-term owners by creating the undervaluation of rental housing.    

Summary

Bay Area housing shortages are contributing to an environment in which most people are finding living space that either consumes most of a person’s income or forces them to other less expensive locations.  Current government policies and regulations are causing harm to the housing market and decisions are more often made based on a lack of understanding of the consequences of government actions.  Significantly, most of the funding supporting low-income housing is no longer paid for through tax revenue but rather by transfers of income from property owners to tenants.  And most of the income transfers are from owners of older rent controlled properties that are significantly undervalued. 

The private sector home builders and housing providers are critical to the quality of life in a city but government seldom recognizes the importance of their contributions and often penalizes them for the problems that government has created.  Public support of housing for low-income residents is necessary but it must be done with transparency. This support must be disclosed both to the public paying for the transfer of public and private assets to the non-profit sector, and to market rate buyers and renters for the transfer of the costs of inclusionary and subsidized housing.  Governments also need to recognize losses property owners of rent controlled housing units incur from rental income transferred to tenants and undervaluation of property.  

Roger Sanders was the former Finance Director of the San Francisco Mayor’s Office of Housing and Community Development.  He is currently retired.