The room closing in: Part 2, Halfway between society and the cemetery

February 22, 2017 | Adulthood, Aging, Apartments, Assisted living, charity, Elderly, Housing, independence, Innovation, Nursing homes, Regulation, Technology, US News | No comments 12 views

By: David A. Smith


[Continued from yesterday’s Part 1.]


Slowly he turned away from the railing and headed for the administration building. And for one brain-wrenching moment he felt a sudden fear-an unreasonable and embarrassing fear of that stretch of concrete that formed the ramp. A fear that left him shaking mentally as he drove his feet towards the waiting door.

– Clifford D. Simak, Huddling Place, 1952


In yesterday’s Part 1 of what has expanded into a five-part post (that has taken me a couple of weeks to read enough to fill in the chasm of my ignorance on the topic), we discovered that new regulations covering Medicare/ Medicaid-reimbursed nursing homes (nearly all of them) are the first updates in a quarter of a century.


It was so long ago he wasn’t married to a Czech


Sources used in this post


New York Times, January 27, 2017

The history of nursing homes, Foundation Aiding the Elderly, pdf, brick red font)


And that fact sent me back into the Google-archives to discover that like funeral homes, about which I posted at length, nursing homes are a residential modality from a time before – pioneered in Post-WW2 urban diaspora where the automobile enabled substantially greater inter-generational mobility, and as the Boomers’ parents fled the city for the suburbs, they left their elderly behind, giving rise in 1946 to the enactment of the Hill-Burton Medical Facilities Survey and Construction Act.



AHI multi-part posts on unusual emerging housing tenures


April 16, 2007: Mobile homes: how they got here (5 parts)

May 18, 2009: Outlaw in-laws (accessory dwelling units, 2 parts)

June 27, 2013: NORCs like us (mobile home parks as elderly housing; 6 parts)

January 6, 2016: Sprouting innovation (co-living; 3 parts)

February 9, 2016: The hipster’s mobile home (tiny houses; 6 parts)

September 28, 2016: Ask after me tomorrow (funeral homes; 8 parts)


“The most comprehensive hospital and public health construction program ever undertaken,” Hill-Burton authorized the creation of ‘health centers and mandated that states develop plans for creating enough beds to provide a continuum of care (I am paraphrasing into modern terminology). 


The impetus for Hill-Burton


By 1954 the regulated nursing home had emerged as an asset class, one that got a huge boost with the next game-changer, a part of LBJ’s Great Society:


Bringing America up from rural poverty, one handshake at a time: Appalachia, 1964


In 1965, the passage of Medicare and Medicaid provided additional impetus to the growth of the nursing-home industry, which, while it had been increasingly steadily since the passage of Social Security, grew dramatically. Between 1960 and 1976, the number of nursing homes grew by 140%, nursing-home beds increased by 302%, and the revenues received by the industry rose 2,000%.


Twenty-fold revenue growth is an explosion.  Medicare/ Medicaid, created the nursing home business out of nothing, and that business needed new facilities that were neither hospital nor apartment (as evidenced by the curious concatenation of calling the place a ‘home’ but its residents ‘patients’), and the results was a building boom:


To a great extent, this growth was stimulated by private industry. By 1979, despite the ability of government homes to provide care, 79% of all institutionalized elderly persons resided in commercially run homes.


Booms often lead to excess – especially when, as here, the customers lack either choice (shortage of nursing home beds) or the capacity to make better choices (because they’re failing and the government is paying):


What you could look forward to: Foothill Acres Nursing Home, Neshanic, NJ, 1965


According to investigations of the industry in the 1970s, many of these institutions provided substandard care. Lacking the required medical care, food, and attendants, they were labeled “warehouses” for the old and “junkyards” for the dying by numerous critics. The majority of them, proclaimed Representative David Pryor in his attempt to initiate legislative reform in 1970, were “halfway houses between society and the cemetery” (Butler, p. 263). 


Note desk plate: Arkansas Comes First


And, like the almshouses of old, people feared ending their days in the wards of these institutions and relatives felt guilty for abandoning their elders to nursing-home care.


Though the full history of nursing homes is a topic for another future investigative post when I find the right starting material (which might be this, but first I have to read it), in the 1980s nursing homes went through a consolidation (likely paralleling the consolidation of hospitals) as they became vassals of Medicare and Medicaid, and shortly thereafter, HHS issued the regulations that now, a quarter of a century later, have finally been updated.


The regulatory update was absurdly overdue.


In the last quarter century alone, American life expectancy has lengthened two or three years.  Hundreds of new life-extending pharmaceuticals have been invented.  The Web has revolutionized remote monitoring:


Cybex-Humac, 1981: it looked cool at the time


Microsurgery has become commonplace.  And I’m sure that I’m overlooking scores more innovations.


What the heck are those buttons, anyhow?


Medicare/ Medicaid have continued to expand, now consuming 23% of the Federal budget versus roughly 12% in 1992.



An ever-bigger bite


Along the way, nursing homes have become a $155 billion industry, housing over 1,400,000 very elderly people whose arc of independence has fallen and continues to decline. 


[The revised rules] emerged from a four-year process involving many meetings and almost 10,000 comments from interested parties.


Amending Federal regulations is a process that itself is governed by a statute – the Administrative Procedures Act – and its regulations, and as you might expect the APA emphasizes public hearing, public comment (both verbal and written), and structured written responses to comments.  Further, when Medicare/ Medicaid pay a nursing home owner/ operator, the regulations have to protect two constituency who are not present to protect themselves:


1.     The nursing home residents (whom the industry insists on calling “patients,” a term that is itself demeaning with its overtones of dependency and illness).

2.     Taxpayers, who are ultimately writing the checks.


In view of the billions at stake and the helplessness of both nursing home residents and taxpayers to [protect themselves against nursing home abuse, four years from initial overhaul notice to their new effective date seems if not speedy then at least reasonable.


Will the new requirements help improve care for the country’s 1.4 million nursing home residents? 


Age is not an illness, though the medical system treats it like one.


“Overall, we are really pleased with the focus on person-centered care, trying to transform the nursing home environment,” said Dr. Cheryl Phillips, head of public policy for LeadingAge.


Nursing homes should be homes before they are anything else, including nursing stations, and there should be oriented around five great principles of effective markets: freedom, choice, security, quality, and redress. 


[Continued tomorrow in Part 3.]

The room closing in: Part 1, The first updates since 1991

February 21, 2017 | Adulthood, Aging, Apartments, Assisted living, charity, Elderly, Housing, independence, Innovation, Nursing homes, Regulation, Technology, US News | No comments 18 views


By: David A. Smith


We say we fear death, but really we fear not death itself but its harbingers: pain of course, but even more than pain we fear helplessness, because in losing our independence we lose our adulthood.


Webster stiffened, felt chill fear gripping at his heart. Hands groping for the edge of the desk, he sat down in the chair, sensed the walls of the room closing in about him, a trap that would never let him go.

– Clifford D. Simak, Huddling Place, 1952


The worst of both ends: infantilized and decrepit


The independence of our lives is a broad arc with adulthood at its apex.  Born small, clueless, and helpless, we depend on our parents, and our childhood, adolescence, and young adulthood are all about prying ourselves free of parental dictation (if not from parental financial largesse).  Before us stretches adulthood, a heady time indeed, and as the years roll into decades and we accumulate partners, homes, children, careers we see our life as a purely upward path, an arc without a downward bend no matter what the optometrist, scales, and unforgiving mirrors say.



Sources used in this post


New York Times, January 27, 2017

The history of nursing homes, Foundation Aiding the Elderly, pdf, brick red font)


As we age, we unwillingly and randomly give back the faculties that we so proudly gained in growing up, and as we do, we lose the capacity for independence.  That loss is reflected in our shifting housing accommodations: from the homestead house (shovel your own parking space and sidewalk) to the condo (call the superintendent), to live with our children (in accessory dwelling units or customized tech-centric wings), to congregate living (dine together, socialize together), to assisted living (help with activities of daily life), to a nursing home. 



AHI multi-part posts on unusual emerging housing tenures


April 16, 2007: Mobile homes: how they got here (5 parts)

May 18, 2009: Outlaw in-laws (accessory dwelling units, 2 parts)

June 27, 2013: NORCs like us (mobile home parks as elderly housing; 6 parts)

January 6, 2016: Sprouting innovation (co-living; 3 parts)

February 9, 2016: The hipster’s mobile home (tiny houses; 6 parts)

September 28, 2016: Ask after me tomorrow (funeral homes; 8 parts)



Few of us take all these steps. Some of us tarry longer on some of them.  Some of us skip a step or two.  Many of us step off the staircase before we reach that a bottom riser.  And each step we take with great reluctance, but each step down costs us a bit of our autonomy – a little or a lot – which we trade for more service – a little or a lot – being provided to us by others, using the money we have accumulated in our lives to buy the services that we no longer wish to do ourselves or no longer can do for ourselves.


Just as our physical and spiritual independence is an arc that flattens and then declines, so too is our financial independence another arc, and depending on how much we made and how we age, it becomes a race to between them.  As our independence withers away, we would like to be protected by our spouse or our children – but many of us will lose a spouse, not all of us have children, and some of us cannot rely on our children. 


And will my teeth be serpent-sharp?


Where the family does not provide, the market will – but the market’s motivations are seldom those of the family.  When we’re adult consumers we can navigate the market, because we have choice and capacity to choose, but as we age, our capacity diminishes, and with that diminishes our choice and our vigilance.  We become vulnerable to exploitation – what is worse, by those whom we previously entrusted to care for us, and in what we have chosen as our home, a place from which we cannot escape.


For that among many reasons, most of us think about nursing homes as places we wish not to have to go, and we wish our relatives not to have to go – and, as reported in the New York Times (27 January 2017) by Paula Span, who has been writing about ‘the new old age’ (as she calls it) for years, our instinctive and under-informed impression is probably just, possibly even generous:


Ms. Span and her father in 2011


If you had to give the nation’s nursing homes a letter grade for quality, what would it be?


Experts tend to sigh at this question –


Bloggers sigh at badly-opened newspaper articles


– and point out, correctly, that the country’s 15,600 facilities are vastly different — rural and urban, for-profit and nonprofit and government-run, home to the reasonably healthy and the extremely sick, high-quality operations and appalling ones. 


Assigning grades can be folly.


Sorry, Ms. Span, that last sentence is utter nonsense. 


Let’s not give nonsense a bad name, shall we?


We assign grades to everything, from school child performance to Airbnb accommodations.  Of course nursing homes should be graded, possibly on multiple dimensions.


When prodded, they come up with decidedly middling assessments.


Not surprisingly, everyone talking to a reporter wants to hedge.


Dr. Cheryl Phillips, head of public policy for LeadingAge, which represents 2,200 nonprofit nursing homes: C-minus.


Offering the entire class a tepid C.


That C-minus is as revealing as a poker tell – Dr. Phillips thinks that nursing homes as a cohort are terrible, but she doesn’t want to be vilified for saying so.


Nicholas Castle, a health policy researcher at the University of Pittsburgh: B-minus.


Though Mr. Castle’s kinder, not so the next judge:


Robyn Grant, public policy director at the National Consumer Voice for Quality Long-Term Care [Not to be confused with Robyn Stone, SVP of Research at LeadingAge – Ed.], a leading advocacy group: No grade. 


In my long-ago school days, Incomplete was the most dread grade of all – it branded your failure so appallingly bad that your very attempt would be expunged from memory.  That is clearly how Ms. Grant intends her ‘no grade’:


“Far too many have a long way to go to give residents the quality of care and quality of life they deserve.”


Loss of capacity and loss of choice leads to loss of quality.  Who then protects us when we cannot protect ourselves? 

Enter the government, properly exercising its role as defender of those who need defense:


The Centers for Medicare and Medicaid Services [Confusingly, the acronym is CMS – Ed.] last fall issued a broad revision of nursing home regulations; the first batch took effect in late November, with the rest to be phased in this year and in 2019.


Readers may wonder where the Federal government gains statutory authority to regulate nursing homes, and the answer is simple: Medicare and Medicaid.  The regulations don’t cover every nursing home in America, it covers only those nursing homes that receive Medicare or Medicaid payments because they chose to admit Medicare or Medicaid residents – and that is by far the lion’s share of them:


Spending for freestanding nursing care facilities and continuing care retirement communities (CCRC’s) increased 2.7% in 2015 to $156.8 billion.


Yes, you read that correctly: between CCRC’s and nursing homes, housing the frail elderly consumes a sixth of a trillion dollars a year.


The slightly faster growth in 2015 (from 2.3% growth in 2014) was mainly due to the faster growth in Medicare spending of 5.6% versus 2.5% in 2014.


This seldom ends well


Medicare is rising because we Boomers are living longer (taking our gerontological revenge on every generation to follow us)


Financially, that is


They were long, long overdue:


“These are the first comprehensive updates to long-term care requirements since 1991,” said Dr. Kate Goodrich, the centers’ chief medical officer.


[Continued tomorrow in Part 2.]

What is efficiency? said jesting Pilate: Part 3, The judgment

February 8, 2017 | Affordability, Apartments, Condominiums, Development, Housing, Incentives, New York City, Real estate taxes, Section 421-a, Speculation, Subsidy, Tax abatement, US News | No comments 38 views


By: David A. Smith


[Continued from yesterday’s Part 2 and the preceding Part 1.]


As we’ve seen in Parts 1 and 2 of this surprisingly long post, seeking to reach a conclusion on the public-policy merits of New York’s section 421a tax abatement program, when applied to large condominium developments, Section 421a produces roughly 53-67% as much boost in development value as it gives up in foregone real estate tax revenue.



One side goes down by 100%, the other side goes up by 53% to 67%



Sources used in this post


Crain’s New York (30 January 2017)

NYC Independent Budget Office report dated January 30, 2017 (pdf; green Georgia font),


 Though not the best statistic to confront, having the public benefit be a 33-47% less than the subsidy cost isn’t by itself conclusive – there’s outsourcing of the activity (hence much lower administrative costs), risk transfer, and potential additionality. 



4. Does the program favor one form of tenure over another?


The focus of this study is strictly on the retail market for condos. In contrast, questions about land use and developer bidding behavior are related to the market for land and can only be answered using a different research strategy and data than IBO employs for this analysis.


Just as every drug has side effects, every subsidy, be it charity or incentive, distorts the ‘natural economic’ market to some degree.  (That is, after all, its purpose.)  Some of these are beneficial, some harmful.


That’s what happens when you give a market steroids


The program may also change the incentive to build one form of housing over another—rentals rather than condos, for instance. 


For what it’s worth, there’s no evidence presented to suggest the market is being deflected toward rentals, and in any case New York City has too little rental, too much ownership. 


Property tax subsidies are a solution when the policy goal is to encourage development of one form of housing over another (such as making rental housing a more attractive investment than condo development) even if the subsidy contributes to a general price increase for all real estate.


Like San Francisco, New York City can thank rent control for much of that.  The potential tenure deflection we can safely ignore –




– but there’s another feature we need to consider more closely.



5. Does 421a as applied to condominiums benefit the whole city? 

The answer is clear – so clear, in fact, that IBO author Geoffrey Propheter puts it in a complete throwaway line:


So cool I can make big points in small words


Manhattan condo sales comprise almost three-quarters of the sample.


At 1.6 million people, Manhattan is the third most populous borough (behind Brooklyn and Queens), home to a little over 19% of all New Yorkers – yet it consumes nearly 75% of the 421a abatements, which means that the rate of 421a abatement utilization in Manhattan is nearly thirteen times higher than the other boroughs [ (75%/ 19%) ¸ (25%/81%) = 12.75 ].


Forget everything else about the quantitative analysis – this figure alone is damning, for it reveals so much. Section 421a condo abatements are being successfully pursued predominantly in the most expensive borough, and the new condos going up are (by the laws of new supply) generally coming in at the highest end of the range.  Nor is the abatement needed to stimulate a lagging Manhattan condo market:


With the exception of mid-2014 through 2015, the market for Manhattan condos tended to clear more rapidly than other markets for residential properties.


Queens (in green) generally takes longest to clear)


Aside from the impressive fact that condos in all three boroughs clear fairly quickly, averaging 4-6 months – so much for the woe-is-me stories of a few years ago about softness in New York City’s condo market – Manhattan is the strongest market of the three.



6. Is the converted-cash reconverted back into additional affordability?


Here’s the big weakness in the IBO report – not what it investigated and found but what it did not investigate and did not remember to explain as important.


Remember, boosting the value of developers’ market condos doesn’t by itself create any affordability – affordability happens only if that boost in development value is converted into a commensurate amount of below-market prices or rents.  Further, Section 421a is a developer-driven program, meaning the developers decide when they buy a property and when they pursue a new development, condo or otherwise. That gives them control over the timing, and they would be fools to do development when the decreased affordable-housing sale price or value exactly equals the market value increase. 


More likely, developers are trading increased condo sales price into decreased affordable housing price at a ratio of (say) 80%, which means the effective discount is higher, as follows:



Section 421a’s multiplicative entropy

Converting density into affordability


+ 100% of lost revenue to the city

x 53-67% increased condo price to developers

x 80% of that increased price converted into

= 42-53% actual realized affordability



I just made up the 80% number, so readers shouldn’t rely on it (though I do have those four decades of experience with developers that I carry so lightly) – but if it’s even halfway close to being right (that is, a 20% discount), the subsidy entropy loss is significantly higher than even the IBO estimated.  Converting non-monetary foregone future taxes into present cash, the reconverting them back into potential foregone future rental or sales revenue from the resulting affordable apartments, puts the government’s efficiency in the hands of two external counterparties: the people who buy the condos, who care not a white about affordability, and the condo developer, who cares about profitability first and foremost.


“I don’t fare what you think about me.  I don’t think about you at all.” – Coco Chanel



7. What is waste, and who decides?


As New York policy makers look to revive 421a (or a similar variant), giving greater attention to the program’s benefit levels so as not to oversupply tax subsidies would help make better use of scarce public resources.


Any use of government incentives to privatize a socially beneficial function entails a balancing act:


It all depends on how the incentives are balanced


The government wants efficiency (high conversion of its resources into benefits) and it wants targeting/ impact (high value for the resources so converted).  It is never possible to do this perfectly so it’s essential to allow oneself some margin of error – which the subsequent analysts, from the safety of their desks and the convenience of retrospective certainty, may choose to call ‘waste’:


Based on this study, over the last 11 years a third to a half of the 421a tax expenditure committed to condos in Manhattan and about two-thirds awarded in the rest of the city is waste, or a total of $2.5 billion to $2.8 billion depending on the discount rate assumed. 


I chafe at the word ‘waste’, which connotes inattention at best and profligacy at worst – and having thrown down the W word the IBO then backpedals and explains that the word doesn’t mean what you think it means:


It represents wasted dollars because buyers are receiving more in benefits than they pay for


The issue isn’t that the buyers get some net positive, but how much net positive.


and the excess does not incentivize development, which is the program’s policy goal. 


Sorry, this is an invisible goalpost-move.  The assertion of no development incentivization is a hypothesis not grounded in any evidence in the report.  And this is a tautology:


The program’s inefficiency stems from its benefits being too generous.


Yes, if a program is too generous it is inefficient, and if it is inefficient it is too generous, but to reach that conclusion you make a subjective judgment: namely, that monetizing the benefit at roughly 55-65% of notional government NPV cost is more than is either good value for government or justified to make the market move.


While I happen to agree with the IBO’s conclusion, its logic is weak, so allow me to conclude this post with some stronger logic.


Your logic is so so weak you’ve lost your N



8. On balance, is this a good use of taxpayers’ money?


As I’ve previously posted, I’m not offended by the cleverly labeled ‘poor door’ discrimination (because that concession increases the number of affordable apartments built with the same quantum of 421a).  My evaluation of 421a for large high-end condominiums rests on the numbers and their impact:


A. Its monetization-reconversion loses a lot of value along the way.  Section 421a turns $1.00 of net-present-value foregone real estate tax revenue into roughly $0.60 of boosted condo price, and we presume it then reconverts that into perhaps $0.45 of reduced-rent/ sale price on the affordable apartments.  To me that’s a terrible conversion ratio – the Low Income Housing Tax Credit, by contrast, loses perhaps 10-15% of value along the way, in part because the market is national and LIHTC has additionality in that it monetizes the CRA investment-test benefit.


B. It stimulates production only in one submarket – Manhattan.  As I previously showed, Section 421a is 75-80% used in Manhattan, meaning it’s used about 13x as much per-capita as the other four boroughs.  And the Manhattan properties on which it is used are high-end.  To the extent the program is seeking to generate more housing supply, putting it into Manhattan will do little for spillover affordability, whereas market housing produced in Brooklyn or Queens would be inherently more ‘affordable’ (because less expensive) than Manhattan Upper East or West Sides.


C. Some of the higher value may be flowing back into higher land prices (in Manhattan), which would be pure deadweight.  If raising the price of Manhattan land is indeed a side effect of the program, that’s really bad additionality, because it’s contributing to the unaffordability that the subsidy was intended to address.


Advocates argue the program is necessary to make housing more affordable but the program itself likely contributes to higher land prices, therefore making housing more expensive.


From what I know of developer and land seller behavior, especially in supply-restricted environments, supply-side incentives absolutely monetize into land value at warp speed.  I’ve seen this directly with LIHTC properties in targeted census tracts, where developers would bid against each other for the vacant parcel that happened to be in the state allocating agency’s erogenous zone.


The tax incentive is thus contributing to its own existence.


This is really bad, and it’s an inherent weakness in the program, one that cannot be remedied because that would require suspending the law of economic pressure.



Section 421a’s multiplicative entropy

Converting density into affordability


+ 100% of lost revenue to the city

x 53-67% increased condo price to developers

x 80% of that increased price converted into

= 42-53% actual realized affordability



D. On balance, Section 421a isn’t good enough, better uses for that money can be devised.  Thus, if called upon to adjudicate the two key questions, I decide as follows:


1.     Was the subsidy converted into cash at a good rate?  No.  Not well enough.

2.     Was the extra cash realized from the subsidy converted back into additional housing affordability?  Not covered by the IBO study but on inference, only at some further leakage of efficiency.


When 421a expired, I thought to myself that the development community, advocacy community and organized-labor community had combined to do the worst thing possible for all three of them, because ponce a program is dead its revival is difficult.


Section 421a is mostly dead


Gov. Andrew Cuomo is working to revive the 421a tax break in Albany. While the current vision for the program only applies to developers of rental buildings and very small condo projects, a handful of Albany legislators are pushing for larger condo buildings to be eligible for the tax break.


Section 421a for condominiums is too expensive, too diffuse in its benefits.  That $1.4 billion could be better and more efficiently spent, even as a foregone-tax-revenue non-cash expenditure. 


I doubt it will come back, and at this point I hope it doesn’t. 


What is efficiency? said jesting Pilate: Part 2, The analysis

February 7, 2017 | Affordability, Apartments, Condominiums, Development, Housing, Incentives, New York City, Real estate taxes, Section 421-a, Speculation, Subsidy, Tax abatement, US News | No comments 36 views


By: David A. Smith


[Continued from yesterday’s Part 1.]


After all the paired comparisons and the careful quantitative analysis, is Section 421a for condominiums a good program for New York City?


We’re actually twins by different parents


Yesterday’s Part 1, scrutinizing paired-comparison of condo sales throughout New York City over the last decade, established that (as would be expected) the favorable tax abatement under section 421a capitalizes into a higher price for condominiums.



Sources used in this post


Crain’s New York (30 January 2017)

NYC Independent Budget Office report dated January 30, 2017 (pdf; green Georgia font),



To what purpose?  And with what effect?  With the factual data in hand, we can do what the IBO quite properly declined to do – evaluate the numbers and reach a judgment.


1. What was Section 421a designed to do?


Section 421a was designed to incentivize developers of high-value high-density properties to include some affordable housing within the development by spreading the abatement across the whole property and then concentrating its benefits in a subset of apartments.  If the cumulative net present value of the tax savings was (say) $50,000 per apartment, and the capital cost buydown needed to make an apartment affordable was (say) $400,000, then for every eight market apartments the City would have one apartment made affordable.


Now, once the apartments are in fact produced as affordable, new issues arise:


1.     Who gets these apartments?

2.     Must they be identical to the market apartments?

3.     Must they be sprinkled in with the market apartments?


What an outrage


These issues have little to do with economics and everything to do with politics and perception, and thus it is inevitable that they generated millions of pixels in the blame-developers vein (about which I posted my own analytical and unsympathetic views two and a half years ago) –


Summer is when GAIA stories most commonly bloom


– whereas the crucial issues of cost-effectiveness get relegated to the financial press and are greeted with ho-hum.


God, numbers, how boring


Likewise, as I reported in the previous part of this post, the City’s investment in 421a has an annual cost equal to its (failing) investment in anti-homelessness initiatives ($1.6 billion to $1.4 billion for 421a), so Mr. Propheter and his colleagues at the IBO deserve much greater recognition than they have.  Instead they are reduced initially to explaining the ABC’s of incentives to conclusion-jumpers:


Ignore that ‘warthog-faced baboon” part, all right?


When economic incidence diverges further from statutory incidence, development tax incentives increasingly stray from their stated purposes.  



Or, to put it in the language of Prince Humperdinck, When the condo buyer is visibly receiving the savings but the condo developer is gaining the subsidy benefit, elected officials can easily lose sight of the over-subsidy. 


The faster the divergence occurs, the more quickly policymakers must respond to modify program eligibility criteria and benefit levels to ensure the program is achieving its goal at the lowest cost.


For Prince Humperdinck, that previous sentence means The quicker developers figure out the game, the more important it is to recalibrate the benefits to reduce over-subsidy.  And this is hard:


Identifying the level at which benefits must be set so that a subsidy accrues entirely to the intended beneficiaries is challenging because developer behavior changes faster than policymakers’ adjustments of program benefits and eligibility criteria.


Not the last time I’ll have to use small words

2. Is the cash conversion rate reasonable?


Unlike many government programs, which give out cash up front in anticipation of benefits to be received over time, Section 421a reverses the time sequence: It collects cash (from condo buyers via the intermediary of condo developers), and it pays out benefits (in the form of foregone real estate tax revenues) over the ensuing 25 years.  Equating the stream of payments (revenue losses) with the up-front cash requires assessing (a) the time value of money and (b) the value of risk transfer. 


The IBO addressed that:


It is common to assume a discount rate between 4.0% and 7.0% in residential real estate research.


I am sure Mr. Propheter and his colleagues are right in this, but if I were discounting future streams from real estate, I’d use a higher discount rate (less present value from future benefits) because I’d regard the cash flows as risky. 


In certain extreme instances we may also find that property owners discount the future less than 3.0%. Therefore, we estimate future tax savings using three rates—2.5%, 4.0%, and 7.0%to gauge how sensitive our estimates and conclusions are to the discount rate assumed.


Today’s twenty-year Treasury is 2.80%, and no plausible discount rate could be lower than that.  Hence I would discard the 2.5%.  Further, any political benefit faces ‘discontinuous tail risk’, which is my own portmanteau construction: Tail risk meaning low-probability events (say, the election of Donald Trump as President) that occur beyond our perception horizon, and discontinuous meaning that the change could be abrupt (say, a Trump executive order with unexpected wording and consequences), and it’s a fundamental principle with me that discontinuous tail risk should be costly to take, because it cannot be hedged and it can seldom be anticipated early enough to avoid it.


Still, let’s ride along with the IBO analysis a little further:


You seeing the same statistics I’m seeing?


At all three rates we find that the 421a benefit is partially capitalized into sales prices on average, but the estimated degree of capitalization displays some sensitivity to the assumed discount rate. At a discount rate of 2.5%, condo buyers in Manhattan on average pay 53% of their 421a benefit to the seller upfront. At the 7.0% rate, the upfront payment for Manhattan averages 61%.  Based on these two extremes, it is reasonable to conclude that in Manhattan the average condo buyer pays anywhere from 53% to 61% of their future 421a tax benefits up front through the greater selling price.


Although as I said I’d disregard 2.5% as unrealistic, the relatively narrow band of value – 8% increase in ratio for a change of 4.5% in interest rate – suggests that even if we were to use a higher discount rate that I might choose, say 10%, the effective monetization rate would rise no higher than 65-67%, meaning that 33-35% of the NPV benefit. 



3. Does 421a contribute to higher New York City land prices?


Just as every drug has side effects, every subsidy, be it charity or incentive, distorts the ‘natural economic’ market to some degree.  (That is, after all, its purpose.)  Some of these are beneficial, some harmful.


That’s what happens when you give a market steroids


The side effects of reducing real estate taxation for certain post-development uses are easy to foresee:


While this study is not an analysis of 421a’s effect on land prices, the findings of partial capitalization in condo sales prices suggests that condo developers pay more for the land than they would if the tax exemption did not exist.


We know that the value of urban land is a residual – the leftover value of new development after subtracting the cost and risk of that development – and we know that in general (though New York City, with its anti-development mania, may be a counterexample) housing is less valuable than other forms of urban land use – so the attempt to push a subsidy into a supply-side intervention (boosting the number and affordability of actual homes, rather than increasing the home-buying power of targeted customers as would be done on a demand-side intervention) must inevitably spill over into pushing up land values.


A 421a benefit that increases condo prices would encourage developers to pay more for land, possibly leading to a general increase in land prices.


While not a statistician, I’ve had four decades’ experience with developers.  With my eyes shut I can tell you that absolutely, the residual benefit of the tax abatement will be priced into land values at some conversion factor.


Yes … yes, it is priced in


For this reason, owners of potential sites for 421a condo developments could be major beneficiaries of the 421a program.


They are.  Indeed, the biggest beneficiaries of all of New York City’s neck-tourniquet development policies are people and entities that own land in New York, particularly in Manhattan.


The tax incentive is thus contributing to its own existence.  It can be viewed as a problem or a solution, and depending on the policy question it can be both.


That leads to the idea New York City should raise its real estate tax rates, or have a significant property rate surcharge to be dedicated into a fund for affordable housing.



[Continued tomorrow in Part 3.]


What is efficiency? said jesting Pilate: Part 1, The evidence

February 6, 2017 | Affordability, Apartments, Condominiums, Development, Housing, Incentives, New York City, Real estate taxes, Section 421-a, Speculation, Subsidy, Tax abatement, US News | No comments 81 views


By: David A. Smith


Sources used in this post


Crain’s New York (30 January 2017)

NYC Independent Budget Office report dated January 30, 2017 (pdf; green Georgia font),


For governments, subsidies exist for only two purposes: charity or incentive. 


The 421a program is intended to spur new construction. It is not intended to serve as tax relief like many of the city’s other programs are designed to do, such as the senior citizen and veteran exemptions. 


Either we are trying to help those in need who cannot help themselves by themselves, or we are trying to reshape the private markets for greater public benefit.


[Acquisitions – purchases by government of goods and services – aren’t subsidy, because the government is transacting in the marketplace like any other participant.  When the government hires a construction company to build a bridge, that expenditure isn’t a subsidy, because the government gets value for its money – namely, the bridge.  Having built the bridge, if the government then makes it a free bridge rather than a toll bridge, the free transit is a per-use non-cash subsidy transfer back to the driver – who, we presume and hope, is a law-abiding taxpayer who’s bought his subsidy rights through his taxes.  That, at any rate, is the theory.  – Ed.]


This is a subsidy


This isn’t


In development-constipated environments such as blue cities, where inescapable land-use economic pressure militates against affordable housing, many a state or local government uses its power to tax to motivate development of affordable housing, and nowhere more so than my favorite housing innovations laboratory, New York City, where has seldom met a procedural obstacle it won’t cheerfully erect or a tax incentive it won’t selectively create – and when a government does this, the question naturally arises, Are we getting good value for money?  Is this an efficient use of taxpayer funds?


The 421a program is the city’s largest property tax expenditure, reaching $1.4 billion in fiscal year 2017. 


That’s almost as much as the city spends to try (and fail) to reduce homelessness, so we’re obviously dealing with serious money here.


Despite the program’s size, empirical evidence providing insight on how the housing market responds to the incentive is limited.


The answer can be murky, as reported in Crain’s New York (30 January 2017):


A controversial property tax break designed to encourage housing development also funneled an ‘extra’ $3 billion worth of benefits to condo buyers, according to a report released Monday.


At even this seemingly innocuous phrasing I have to smile, because Crain’s made the same mistake others do, confusing ‘economic incidence’ with ‘statutory incidence,’ as carefully and clearly explained by IBO analyst Geoffrey Propheter:


Our intuition confuses statutory incidence (i.e. who receives the tax reduction) with economic incidence (i.e. who benefits from the tax reduction).


A propheter with honor in his own city?


Condo owners may appear to be the sole benefactor of the tax break since the exemption appears on their tax bill in the form of reduced taxable assessed value –


In this case, though the condo owner receives the tax saving, the owner has paid for the privilege in a higher condominium price:


The now-defunct 421a program was designed to lower developers’ costs to help make more new apartment projects feasible in the city.


When I bought this condo, I thought I was saving money on my taxes


but because the owner had to pay a higher price for the 421a apartment than what they would have paid for a similar non-421a apartment, the benefit appearing on tax bills overstates the benefit actually enjoyed.


Although the Crain’s story initially drew me in to the topic, for this post I’ll mainly use Independent Budget Office report dated January 30, 2017 (pdf; green Georgia font), because by comparison with Crain’s quick summary, the report itself did a public service.  To begin with, it is written clearly, an increasingly scarce virtue in these auto-correct-Microsoft times, and before plunging into analysis it compactly but not condescendingly explains critical concepts:


Property tax exemptions lower the cost of ownership, increasing prospective buyers’ purchasing power, and as a consequence their willingness to pay for housing.


All other things equal, then, we should expect an increase in demand (technically the quantity demanded) for condos with a 421a exemption, and by extension a price premium for such housing.


When the value of an asset varies by its tax liability the tax is said to be capitalized.


Second, the report did a nice clear job of explicating its exploration of economic efficiency, and a commendable restraint in not leaping its conclusions beyond their evidentiary foundation.


A tax break can help condo developers by allowing them to sell an apartment for more money than the market would normally allow, since buyers would be willing to pay extra knowing their tax bill would be zero for decades.


Actually, when it comes to 421a, the question of efficiency is actually twofold:


You have to ask your policy markers two questions


1.     Was the subsidy converted into cash at a good rate?

2.     Was the extra cash realized from the subsidy converted back into additional housing affordability


Though the second question is neither answered nor raised in the IBO report (and completely overlooked in the Crain’s story), we’ll defer it until Part 2 of this post and instead concentrate on the quantitative analysis of the cash-conversion rate. 


If 421a were ‘perfectly calibrated,’ a buyer who would be exempted from $50,000 in [Net present value of, clarification added – Ed.] property taxes over 25 years, for example, would pay $50,000 more for the apartment.


This too is inaccurate:


So it’s inaccurate, it looks good, doesn’t it?


If the benefits’ net present value (NPV) exactly matched the up-front cash, the buyer would be swapping cash today for an unreliable illiquid cash stream in the future, and nobody would tie up their money that way.  The IBO report quite properly anticipated this:


Perfect economic efficiency is a moving target, and as such an entirely waste-free program is likely an impractical and cost-prohibitive policy goal. 


Allowing that some favorable arbitrage will be required, even at a reasonable discount rate (about which more below), one can assess the program’s relative efficiency only by some quantitative analysis, which the IBO undertook:


On average, buyers in Manhattan pay 0.43% of the sales price for each additional year of 421a benefit; in all other boroughs the size of the effect is 0.40%.


For the benefit of readers to whom the precision of that estimate may seem fanciful, I will allow author Propheter to explain just how much big data the IBO gargled to derive the estimate:


Can you say ‘repeat sales regression’ without spitting up?


We employed a repeat-sales regression, a statistical technique that reveals how two variables relate when holding other factors constant. In this case, we sought to explain the relationship between changes in condo sales prices and changes in the number of years remaining in the 421a benefit period for each apartment as of the year of sale while simultaneously accounting for other differences between condos that might influence changes in sales price.


To do this, the authors sifted a mountain of data – every condominium sale for the last ten years:


The data were drawn from the universe of 101,477 condo sales from 2005 through 2015 based on sales records maintained by the Department of Finance.


1.       Some transactions involved multiple properties [where] there is no way to know the sales price of each tax lot in the bundle. This step dropped 8,365 sales.

2.       The unit must be greater than or equal to 200 square feet and less than or equal to 10,500 square feet, the latter being the largest known condo on the market recently. This step dropped 800 sales.

3.       Sales where the inflation-adjusted price was less than $80,000 were dropped [assuming that these] were not arm’s-length transactions or non-residential transfers such as parking spaces. This step dropped 26,744 sales.

4.       Sales over $5 million were also dropped so as not to allow the few hyper-luxury condos receiving the abatement from skewing the estimated average price response. This step resulted in 780 fewer sales pairs. Thus, the final sample contains 17,717 sales pairs.


Such attention to detail is worthy of applause. 



Not only did Mr. Propheter and his team recognize they might be dealing with bad data, they adopted sensible rules to eliminate data that might be corrupted (bad entry), unreliable (non arm’s-length), or unreasonably skewing (buyers with other motivations, like live-in safety deposit boxes).  And they stat5ed their algorithmic adjustments and the impact on the data set.  That, gentle readers, is statistical science – open source, rules-based, verifiable.  Good work.


 With that hard work done, the rest was arithmetic:



At average sales prices and average years of exemption remaining, these estimates imply the average 421a Manhattan condo purchaser pays $35,500 more than the buyer of an otherwise similar, non- 421a Manhattan condo while the average 421a condo owner in all other boroughs pays $31,200 more.


With respect to the second question, IBO estimates Manhattan condo buyers spend on average $0.53 to $0.61 of every $1 in tax savings appearing on a tax bill in order to receive the remaining $0.47 to $0.39 over the rest of the tax benefit period. 


Outside Manhattan, our estimate is $0.42 to $0.50 of each benefit dollar is paid upfront at the point of sale.


While not versed in statistical methods, I am inclined to accept not only the veracity of Mr. Propheter’s reporting but the caliber of his analysis, because he quite plainly knows what he is talking about.


When your IQ rises to 28, sell!


There’s the evidence. What is our judgment?


Opinions first, then evidence!


[Continued tomorrow in Part 2.]