Affordable Housing Institute : US

Sustainable affordable housing always has a cost-value gap.

 

• Regardless of location.
• Regardless of configuration.
• Regardless of tenure.

 

 

As discussed in my other primer posts, because of the Law of Economic Gravity, in unregulated markets supply and demand will be roughly I equilibrium.  As applied to housing, in a pure market there will be enough market-quality housing to satisfy market demand.  For the housing to be at market-quality, it will in turn generally carry a market cost, which means that new supply (creation of additional homes) occurs whenever the Development Equation is favorable:

 

 

The Market Cost Equation is equally simple:

 

 

Because land value is a residual, when the Development Equation is just barely in balance, the price of land is rising and falling to keep it just barely in balance.  And since market value is set by what the observant herd of buyers is willing to pay, in practice this means that market value is derived from the median-income buyer.

 

(Technically, the market will further stratify into many equilibria, one for upper-median customers, one median, one for lower-median.  In housing this further translates into tenure and configuration alternatives which are influenced by a host of factors including government policy vis-√†-vis homeownership, rental, investment, and so on.)

 

Meanwhile, unlike Lake Wobegon, where all the children are above-average, in the real world half of our households are below median.  Those close to the median suck it up and pay more of their income for housing, but below some level, they simply cannot.  This brings us to the affordability value equation:

 

 

When we line up these two, we get the Cost-Value Gap:

 

 

The Cost-Value Gap Lemma is this: there is always a cost-value gap.  In equilibrium markets, it is inescapable. 

 

 

 

I am not one of those who believe that markets are evenhanded, because we can show that slums are economically rational. 

 

They are so because society is non-zero-sum, and it is entirely possible to have economic Lagrange points where mutual benefit among a subgroup equals aggregate cost to the whole group.

 

 

Markets are always sliding along economic contours ….

 

Nor do I believe that government intervention in shaping or influencing of markets invariably does harm.  Government does shape markets: sometimes it leads, sometimes it imposes large-scale change, and sometimes it incentivizes.  All of these ‘distort’ markets, in the same way that embankments and irrigation canals ‘distort’ rivers, by channeling them for better effect. 

 

Government can close the gap in several ways:

 

• Use cheap hard debt (government sovereign rate via credit enhancement).
• Deploy capital subsidies: soft equity, soft debt. 
• Use income subsidy to raise buying power.
• Use operating subsidy (e.g. real estate tax abatement).

 

Portrait of the housing financial consultant as a force of nature …. 

 

All of these cost money, one of government factory’s two essential products.  However, there is a big difference, in cost-value gap terms, between the capital subsidies (the first two above) and the operating subsidies (latter two), and that is in cost predictability.  Capital subsidies cost you up front — bad — but have known future costs – good.  Operating subsidies pay as you go – good! — but can never be perfectly costed because of the Heisenberg Funding Uncertainty Principle.

 

Meanwhile, other governmental actions have the unintended consequence of widening the cost-value gap:

 

• Low interest rates.  These drive up home prices, and land values. 
• Barriers to new construction which essentially raise total development cost of all housing while doing nothing to raise the buying power of poorer households. 
• Greenfield or other development restrictions because they take things out of supply.
• Incremental unfunded mandates that transfer government costs to property owners.

 

 

As against that, government or markets can, intentionally or otherwise, also narrow the cost-value gap:

 

• New supply coming onto the market, stimulated by low interest rates, development incentives, or conversion opportunities.
• Losing population or households because demand falls and supply does not.
• Eliminating development barriers which encourages development innovation.
• Government providing land for free in exchange for long-term affordability. 

 

“Mister President, we cannot allow … a cost-value gap!“

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