Affordable Housing Institute : US

“Holmes,” began Watson, “I’ve been reading Web Updates about proposed cuts in Section 8 subsidy funding, and I’ve been thinking” — how industrious, thought Holmes — “is not subsidy a form of money? One we have not treated? A fifth kind?”

“A fifth kind of money?”

Is subsidy a kind of money? “Subsidy is not a kind of money,” said Holmes, nettled, looking up from the agony column of the Financial Times, which he had been perusing with the silent glee of a short-selling contrarian.

“Doesn’t government pay out cash?” Watson asked innocently. As the straight man, he had few enough opportunities to score points on the Great Detective.

“That is,” Holmes hastily amended, “subsidy is not money in the sense we have previously used — unlike the four kinds of money, it is not a capital source for property development or acquisitions. But as it is indeed a form of cash paid out” — he refolded the paper and set it down — “we need to see it in its proper context.” He paused significantly, looking at the ceiling where giant fingers appeared to be drumming on the roof with a finishing thumb flourish for the space bar.

Watson felt he had at least put the Great Detective on the defensive

The four kinds of money we have previously addressed, Holmes began, are all sources of funds suitable for property development or acquisition. Conceptually, they are all expended at the initial closing. Each of the forms of government investment capital — soft equity, soft debt, and cheap hard debt — is structured so as to reduce the required ongoing debt service and hence to hold rents down.

But no matter how low the cost of capital is driven, the property’s income and expense budget will have to cover operating costs — administration, operations (e.g. janitorial), maintenance, utilities, hazard insurance, and replacement reserve deposits — so the rents must always be at some level.

Using subsidy to provide deep affordability. How can we provide affordability to people who cannot afford even the reduced rents?

“Is this question real or rheotrical, Holmes?”

“Oh, rhetorical, certainly, I’m doing the lecturing here.”

If we can no longer lower the required rents, but the households we are targeting cannot pay even that much, we must increase those households’ ability to pay the rent. In other words, a subsidy.

“Wouldn’t it be possible,” Watson asked, “to cross-subsidize — use excess rents paid by higher-income residents to provide an ‘internal’ subsidy for the very low income?”

One might think so, Holmes said with a smile of grim experience, but ‘internal funding’ always fails. It is hard enough to persuade market households to live in an affordable property, and it is impossible to charge them a premium for so doing. It is theoretically possible to imagine providing a capital subsidy to all the apartments in a mixed-income development solely to channel all the resulting savings toward the very low income apartments.

Implicit cross-subsidy is the fundamental principle behind inclusionary zoning. It works only when market development is contemplated and land has an enormous residual value, so large that reducing value through affordability can be absorbed by adjusting land purchase price. Inclusionary zoning is thus a disguised capital subsidy that is collected broadly (tax on all the homes thus built) and distributed narrowly (rebated only to the low-income households).

Income subsidy works by raising the earning power of target households.

“Like phlogiston,” said Watson.

“In a sense,” replied Holmes dryly.

We drift aloft on a breeze of budget deficits …

Defining subsidy among the types of money. Let us therefore have a proper definition.

 

Subsidy in affordable housing

A periodic supplementary payment that increases the Net Operating Income of a target home. It can be paid:

1. To the property owner — operating subsidy

2. To the resident — income subsidy

3. To the lender — interest subsidy

In rental properties, owners and residents are distinct; in homeownership properties, they are the same.

The key difference between the four capital sources, Holmes expounded, is that subsidy is by definition paid over time. The time dimension is distinct since it means that for subsidy to be effective, the property must already exist or its development must be independently assured. Subsidy by itself, he concluded, straightening his collar, is not a development resource.

The public-policy uses of subsidy. Though income subsidy is not a production device — by itself it builds no housing — it can complement capital sources effectively and can be used in several distinct ways:

 

Subsidy: situations when it is useful

Subsidy is useful in any of the following situations:

1. Buy down high interest rates. Subsidy can ‘buy down’ the interest rate from its market level to something below market. Section 236 used this approach directly with an Interest Reduction Payment (IRP).

2. Raise ‘affordable’ rents to (or above!) market. Subsidy can fund the gap between market rents/ property occupancy costs and what a target family can ‘afford’ (as defined). Indeed, if the subsidy is attached to the property, and assured for a long interval (say, twenty years), it can enable a property to be underwritten at rents above local market.

3. Provide deeper affordability within a property. A property financed to be affordable to residents at (say) 60% of area median income (AMI) will be unaffordable to those at (say) 30% of AMI unless subsidy is provided to make up the difference between a 30% AMI rent and a 60% AMI rent.

In rental properties, owners and residents are distinct; in homeownership properties, they are the same.

“Ah, ha!” said Watson. “If subsidy is used to buy down high interest rates, is that function not entirely analogous to the function served by favorable hard debt funded directly by government?”

“Indeed so,” Holmes replied. “And it was because of this that Lyndon Johnson, back in 1968, replaced the Section 221d3 Below Market Interest Rate (BMIR) program with Section 236.”

“So subsidy can be paired with production programs.”

“I’m happy to be a production program with subsidy doing all the work!”

“Quite. That was the theory behind President Carter’s Tandem program, pairing Section 221d4 mortgage insurance with long-term property-based Section 8 subsidy assistance. To this day, 221d4/8 Tandem has no peer when it comes to annual production volume.”

Subsidy’s importance. Subsidy thus is potent stuff — it can make any affordability level viable. For that reason, it is always popular with stakeholders, especially developers. Its utility and popularity mean it has been deployed in many situations — in the US today, for instance, income subsidy plays a role in over 4,600,000 households:

2.1 million households of portable Section 8 vouchers

1.2 million households of property-based Section 8

1.3 million households owned by Housing Authorities receive operating subsidy.

4.6 total households served (not counting Rural Housing Service rental assistance payments).

Income subsidy thus underpins the affordability of at least 4.5% of all 105 million American households (one family in 22) and 14% of all 32 million American rental households. (Calculated as 31% of 105 million.)

1 American household in 7 benefits from housing income subsidy

Subsidy is no less popular in Europe: in the United Kingdom, for instance, virtually all social housing residents (perhaps 15% of all households), receive Housing Benefit.

The policy issues. Subsidy’s potency and flexibility raise numerous public-policy issues:

1. Assistance-basing. Should the subsidy be tied to a particular apartment (property-based) or to a deserving family (portable vouchers)? Tying subsidy to the apartment makes it possible to underwrite the revenue stream but limits customer choice. Making it portable gives residents an economic key but offers no guarantee or even promise there will be a door that key will open. The best policy appears to use both forms in most markets.

2. Who is eligible? Subsidy should be targeted only to households that meet stipulated criteria to be deserving. Household income, household assets, type of family are all legitimate tests, and all have been used at one time or another.

3. Eligibility over time. Subsidy should be targeted only to households that meet stipulated criteria to be deserving. Household income, household assets, type of family are all legitimate tests, and all have been used at one time or another. But what happens if the Micawber family qualifies today but at some future point ceases to qualify? Do we take away the assistance? Scale it back?

4. Entitlement or waiting list? If a particular household meets our eligibility criteria, should it automatically qualify for assistance? That can be very expensive. (In the US, for instance, a Section 8 voucher costs about $7,000 per year (including generous administrative fees), and the $25.0 billion annual expenditure is about 78% of the total HUD budget.) If the subsidy is limited only to some households, which ones? First-come first-served?

HUD Fiscal Year 2006 Budget (excerpt)

	Actual	Budget	Budget
	FY 04	FY 05	FY 06
Tenant-based Rental Assistance	—	14,766	15,845
Project-based Rental Assistance	—	5,298	5,072
Housing Certificate Fund	16,413	-1,557	-2,500
Public Housing	6,275	5,017	5,734
Total income subsidy	22,668	25,081	26,651

5. Rents relative to market. Subsidy is intended to cover a gap between affordability and … something. Should that be market? True market? Should those who cannot afford their own home live in housing that is the same as, worst than, or better than the rest of us? What quality of housing should taxpayer money subsidize?

6. Shopper’s incentive. When subsidy is portable, it depends on the household finding an apartment to rent. In many with plenty of supply, there are rents at all price points. If the household seeks out a cheaper apartment, does the householder benefit (by a fixed subsidy with a reduced resident contribution)? Or should the government benefit (lower subsidy, same resident share)?

“Should I build in the shopper’s incentive?”

“These are called issues,” Holmes finished, “because they have no categorical answers. The right choice depends on circumstances.”

The policy challenges of subsidy. Beyond the issues, there are also policy challenges: problems that recur again and again in subsidy delivery. These differ from policy issues in that everyone agrees on what outcome we want, yet despite agreement on goals, we have enormous difficulty achieving the desired outcomes.

1. Means-adjusting resident rents. Should the amount a resident family pays be means-tested every year (or month)? In the US, for instance, Section 8 recipients generally pay 30% of their income. That’s compassionate — lose your job, your rent burden drops — but it’s also dependency-inducing — get a job, get a better job, and up goes the rent. Means-adjusted rent contributions can - and often do — trap people in unemployment and poverty. Structuring rent payments to prevent this is no trivial task.
2. Affordability duration and ‘what next’. Unlike capital subsidies, which can result in a property who embedded cost structure delivers affordability without further injection, subsidies are used principally in those cases where they are necessary to ongoing affordability. Take away the subsidy — or simply fail to renew it — and some resident immediately has an affordability problem. Should subsidies be evergreen? If not, how do we ‘wean someone off subsidy’? What happens when rents or properties are marked to market?
3. ‘Mission creep’ and the Sorcerer’s Apprentice. The converse of individual subsidy dependency is subsidy expansion. Once a subsidy is provided, it is all too tempting to increase its amount, provide it to more apartments, extend its duration, or target it to even poorer households. All these things increase program cost. What starts out as a modest-cost patch for a temporary problem can, like Section 8, gradually take over the entire budget. Housing Benefit, Section 8, and PHA operating subsidy all offer cautionary tales about mission creep.

Once we introduce the pilot program …

Its cost continues to mount

4. Quid pro quo’ for qualifying households. Households who qualify for subsidy are by definition politically deserving — they appeal to someone’s sense of fairness. Having demonstrated indigence, should the household then do something, on a continuing business, to ‘earn’ the subsidy? Enroll in job training? Substance abuse rehab? Educational development? Family counseling? What is the quid pro quo?

“What do I get if I underwrite your housing, Clarice?”

5. Subsidy dependency. Subsidy is supposed to promote independence; yet all too often, it promotes dependence.
   1. The household depends on subsidy for daily living.
   2. The property depends on subsidy for continuing viability.
   3. The owner depends on subsidy to underwrite the financing.

Dependency is never subsidy’s objective but all too frequently, it is the most common outcome.

6. Lose of market accountability. Beyond its role I providing affordability, subsidy is also a shock absorber for market changes — a generous and forgiving subsidy scheme can completely insulate a property from market downturns, or a household from economic hardship. Once again, this is no one’s stated policy goal, yet experience shows the longer a subsidy scheme remains in place, the less market-responsive its participants become.
7. Reorienting participant thinking. Plants orient their leaves to sunlight, but office plants soon orient their leaves to office lights. Owners and residents who enter a subsidy program gradually become hypnotized by its rules and regulations, to the point where have psychologically lost contact with the market. “Market-competitive” comes to mean for them, “Better than I did it before,” rather than meaning, “Better than anyone else in the marketplace.” Quality invariably suffers.
8. Affordability lasts only as long as subsidy does. Subsidy is the ultimate housing Red Queen’s Race: it takes all the subsidy you can provide just to maintain the affordability. Government pays, and keeps on paying, and can never stop paying unless it imposes a long-term use restriction with rents at or well below market.

“Faster! Faster! We have to get our annual appropriation!”

Conclusion. “And that,” said Holmes with the finality of one who has just compelled the blogger to expound for 2,500 words and ten images, “is why I have excluded it from our kinds of money — since it is only a means of temporary income support, not a permanent financing solution.

“Of course, my good fellow,” said Watson, and smiled quietly to himself.

 

The images go to eleven!