I have been working with a team that just submitted an application for funding from the Housing Trust Fund this week, and two things came up. First, our market study confirmed pretty much what real estate people have been saying a lot lately, apartment vacancies are down and prices are going up. That’s a trend that will continue for the next few years.
Second, monthly prices for rental housing—rent as it is more commonly called—are based the costs of construction and debt, and what the market will bear. The determination of how much a particular unit will rent for is made at the pro forma stage not after construction. Often in the public discourse about housing price and affordability the discussion proceeds as if developers build their projects then see what they can “get” for the units. Generally speaking, that isn’t how it works.
Why do these things matter when we talk about affordability of housing near transit or anywhere? Because the way we think about housing price should affect the interventions we make to affect it. That is, if we think housing prices are too high then how we change those prices requires understanding about where prices come from.
The first point is that housing price is affected by supply and demand. There is a stubborn resistance in some quarters to this basic economic principle rooted in culture and politics. Housing, some people argue, is different than anything else. Loosening regulation to allow more housing construction might lead to more developer profit, lower quality housing, and a windfall for the industry at the expense of renters.
But this perception—that allowing more housing construction will hurt renters—just isn’t true. Here’s a paragraph from the latest story highlighting real estate market studies that confirm the important relationship between supply and demand:
The Seattle and Bellevue downtown markets experienced sharper vacancy declines and stronger rent increases than the average. Seattle’s vacancy rate fell 0.74 percentage points to 4.8 percent this quarter, and Bellevue’s rate fell 0.35 percentage points to 4.09 percent, according to Apartment Insights. Both areas saw rent increases above $100 a month.
There you have it, when vacancy rates drop rents go up, a point repeated in market study after market study. It isn’t a radical concept, and it should lead to an easing of regulation to allow for more apartments to be built in Seattle, not less.
How are rents affected by construction costs, debt, and market studies? When a developer builds a project, whether she is a non-profit or for-profit developer, she starts with construction costs. How much will it cost to actually build on the site selected? Then comes an analysis of rents, size of units, and what the maximum-zoned capacity of the site will be. Then the developer has to figure out financing and whether the mix of unit size and rents will enable repayment of debt to lenders and investors.
When all this number crunching is done, decisions are made about materials, building layout, unit size, and how much each unit will command from renters. It is important to note that the price attached to each unit is completely a function of the cost of construction and operations, the debt service to cover those costs, and real estate studies about what the maximum rent could be reasonably charged. If a developer wants to charge too much (or too little), investors will balk, worrying about whether the building will stay vacant or not meet debt obligations.
Price for rental units are not set to fleece renters. Materials are not chosen to be “ugly” or out of character with the neighborhood. Every decision in a new development is a complex set of calculations based on costs, investor confidence, and what renters are likely to pay. If all goes well, a project will attract tenants and the rent they pay will enable payment of debt service, and yes, eventually, some profit or funds from rents in excess of operating costs.
Accordingly, if we want to have an effect on housing price the two policy objectives we ought to have is to increase supply and lower costs of housing production. The latter would make housing less scarce and the former would enable more units but also would enable more competition. A developer would be able to lower his rents in a way that would maintain investor confidence and draw more renters to his product for smaller rents.
Lisa Picard who is heading up the effort to build the Stone34 project in Fremont makes the great point in her presentations that bank funded projects always end up looking the same as the last bank funded project. Banks generally don’t like risk so building design and rents are largely driven by investor scrutiny, not a wealthy developers boat payment. Zoning and design review further limit what’s possible by constraining the number of units that can be built on a site, further limiting the revenues to pay back construction debt. Add conservative design review and it’s a lot easier to see why buildings look the way they do and why rents end up being what they are.
All of this is pretty conventional stuff. What is hard is the politics, and changing the way we permit and finance new development. Understanding where rental housing prices come from should open us to the idea that more is better when it comes to supply, and reducing costly regulations (like excess parking) will lower prices for renters. With more and more people staying out of the mortgage market and looking for better rental housing, now is the time to take action.