[Note: This is a longer version of the original, which was posted on AOL Housingwatch a few days ago. I'm crossposting it because Notorious ROB has no space constraints and my readers are used to 2,000 word posts, heh. :)]
In Part 1 of this series, where I laid out why I believe the 30-year fixed rate mortgage (among other features of contemporary homeownership) was on its way out, to be replaced by a far greater emphasis on rentals. So let’s take a brief look at what the future of rentals might look like, since many of you reading this now will be renting for a lot longer than you had ever imagined.
PETRA, TRA and Section 8
The United States, as far as I can tell, has never had a national policy on renting because its focus since the New Deal has been on homeownership. As the Congressional Budget Office noted recently, support for housing runs 4:1 in favor of ownership vs. renting: $230 billion for ownership vs. $60 billion for rentals.
In light of Obama Administration’s objective of changing the nation’s housing policy towards one of “sustainable homeownership”, we could expect those figures to flip-flop or at least draw even at roughly $145 billion apiece. Since the CBO highlighted that the home mortgage interest deduction represents $80 billion in lost revenues, I tend to believe that we’ll see the MID eliminated, and the resulting $80 billion spent on rental support.
So how would such a thing actually work? Since the United States has never really had a national rental policy, landlord-tenant issues and rent regulation have mostly been state and local matters. There are real Federalism questions on whether the Federal government even has the power to create a national rent regulatory scheme. Besides, national rent regulation might not prove popular with either the American public, or more importantly from the perspective of Democrats, to the AFSCME (American Federation of State, County, and Municipal Employees) which is the #1 contributor to the Party, and whose members might lose jobs if a national rent regulation scheme were created.
The answers are found, I believe, by looking at PETRA (Preservation, Enhancement, and Transformation of Rental Assistance Act of 2010) and the related HUD initiative, TRA (Transforming Rental Assistance). There are lots and lots of details here, but the essential mechanics are as follows:
- Expand private financing of public housing.
- Expand public payments to private landlords (the basic feature of property-based contracts of Section 8 housing).
- Finance the building of new multifamily units as a mixed public-private development.
There are a fair number of people and organizations upset at #1: they call it “privatizing” the public housing stock, and expect that the new landlords, greedy capitalists all, would soon be driving tenants out of their homes to rent them to wealthy stockbrokers and bankers. That led to Sec. Donovan of HUD publicly denying that PETRA would privatize public housing. More interestingly for our purposes, Sec. Donovan also pointed out during his Congressional hearing that HUD has significant experience in programs that provide affordable housing through private developers:
First of all, we currently have new affordable housing that is developed in this way. We have long experience on how to protect properties in foreclosure from losing that housing. TRA would enhance our ability to do that in a number of ways.
Of course, he’s talking about property-based Section 8 housing, that will all be transformed, streamlined, and strengthened if PETRA becomes the law.
Basically, Section 8 housing comes in two flavors: project-based, in which the government and the property owner enter into a contractual arrangement, and the subsidy stays with the property, and tenant-based, in which the subsidy goes with renters, who can rent in any building where the landlord is willing to take them. In both cases, the basic premise is that the landlord will get to charge “fair market rent” (as approved by the government administrator, either the local Housing Authority, or the people at HUD, or elsewhere), but the subsidized tenant only has to pay a maximum of 30% of income. The government will pick up the rest.
Section 8 For the Rest of Us?
If the goal of housing policy is to make homeownership more difficult (and therefore, more “sustainable”), then the big question is what you do about the millions of people who would have been first-time homebuyers. The obvious answer is to make rentals more attractive to those who will be priced out of buying a home.
Trouble is, the supply of Section 8 housing in the United States is low, and the waiting lists can be long indeed. And the income requirements, while not as severe as one might think, are not high enough to cover most of those who would have been homebuyers. The link above shows that for the St. Paul/Minneapolis region, a family of 4 may have a maximum income of $64,400 to qualify for Section 8 housing. That’s well above the median household income for Minneapolis of $53,315, but unlikely to place such families into the pool of potential buyers.
Plus, as support for homeownership declines, the demand for rentals would naturally rise, while salaries are not likely to keep pace — which makes government rental subsidies that much more expensive (remember that the government pays the difference between market rent and actual rent).
There is also the issue of getting various interest groups — like bankers, unions, activists, and the like — to go along with any scheme.
In that light, what makes the most sense from a policy implementation standpoint is property-based subsidies that kick in only when new units are brought on to the market. PETRA specifically allows such a mechanism, and once Giffie Mae (or some new agency that will swallow up Fannie Mae and Freddie Mac) starts to insure and buy up commercial multifamily mortgages, the money spigot for the sector will open up in earnest.
Based on conversations with real estate professionals, developers, and property managers, here’s how I think things will play out.
Giffie Mae will announce a major multifamily support program, based on PETRA: a developer or existing landlord must set aside some number of units (20%?) for low/moderate income families. Local housing authorities, of course, will need to determine what constitutes a “low/moderate income” (more on this below). That will make the building or project eligible for purchase by Giffie Mae. PETRA/TRA requires that the converted building enter into a 30-year use agreement with the HUD for those units, and imposes several other requirements as well. Local housing authorities, and state agencies, will be subcontractors to HUD for processing applications, reviewing the buildings for approval, and administering the subsidies — for which, of course, the state and local governments would receive payment from HUD.
The federal subsidy has an additional salutary effect for multifamiliy developers and their financiers: stability of income. Since the #1 risk for any multifamily project is vacancy risk, the fact that the full faith and credit of the United States government would guarantee market rent payments for 30 years on some number of the units would necessarily decrease risk. Lower risk makes that project a more attractive investment for banks, and soon developers will get the clear signal that if they want their applications approved, they’d better incorporate some Section 8 units, enter into agreement with HUD, and get approved. Naturally, the result would be explosive growth in multifamily building, conversions, and a flood of units coming on the market within a 2-3 year time period.
During this time, Giffie Mae would of course be scaling back its activities in the residential mortgage market, leading the banks who make the actual mortgages to decide if, and under what terms, they want to keep those residential mortgages on their books since the secondary market for RMBS would shrink substantially. This leads to the end of the 30-year fixed rate mortgage as discussed in Part 1.
Simultaneously, the income limits for Section 8 is likely to be raised to some point far above the median income for the area, in order to provide affordable housing solutions for the middle class who would otherwise be buyers. For example, if the more onerous purchase terms (say it’s 30% down, 15 year ARM, at prime plus 3% for applicants with solid credit scores) would make it impossible for the bottom 70% of the area population to afford to buy a home, then the income limits for Section 8 can be raised to cover household income up to 70% of the area. This determination is precisely what the local housing authorities will get involved in, since affordability is a local issue, dependent on local market and local economy.
To the aforementioned developers, such an increase in the market would naturally be a windfall. The stigma of public housing would be removed, and the pool of possible tenants would go up substantially, leading to even more development and conversion of existing buildings. The many empty condos that sit vacant today in places like Miami and Phoenix may be converted to Section 8 housing by the developers in short order, bringing even more rental units on the market.
In fact, after a few years, it’s difficult to imagine that there would be any non-Section 8 rental housing at all in the United States. Perhaps a few luxury rentals in places like New York City and San Francisco for the 20-and-30something urban professionals who make far too much money to qualify for Section 8, as they would be in the top 5-10% of the income bracket, but not have enough saved up for a 30% downpayment on a house?
National Rent Control? Well, Sort Of…
So far so good, no? Renters get to pay a maximum of 30% of their income towards housing, developers and banks get a brand new market to enter at lower risk, the public housing stock is not only preserved but vastly expanded, and the state and local government employees get Federal subcontracts to administer the whole thing.
It isn’t national rent control, or national rent regulation since any regulation is tied to a subsidy. A state or municipality is absolutely free to refuse the regulation along with the Federal subsidy — just like they are free to refuse Federal highway funds and set their drinking age or speed limit at whatever they like. Except, of course, so very few do. What governor wants to lay off 40% of the politically active and highly vocal government employees at the state Housing Authority, because she refuses to take Federal HUD money?
In practical effect, then, we will have national rent control. Since HUD, through its contractors the local housing authorities, would need to approve “fair market rents” to be charged by the landlord who has signed that 30-year use agreement, it can decide how much of a rent increase might be fair. Given that HUD would need to pay the difference between those fair market rents and 30% of the subsidized tenant’s income, HUD has every incentive to keep those fair market rents as low as possible.
The private landlords who have not taken any Giffie Mae/HUD/government money, and who haven’t signed any 30-year agreements, can set their rents at whatever they wish, of course. But the effect of PETRA is to increase the number of subsidized units, and to expand the pool of subsidy-eligible tenants to cover all those who would otherwise be homebuyers. The incentives are setup such that any new multifamily development would be heavily weighted towards Section 8 housing (i.e., stability of income, secondary market for CMBS via Giffie Mae, etc.). If 50% of all rental units in a given market are Section 8, with rents set by HUD, how much more could a private landlord charge in reality?
The League of Extraordinary Tenants
There are some other strings as well. I’d like to highlight just one from PETRA/TRA: strengthened tenant organizations. Basically, every landlord and public housing authority involved with PETRA/TRA (and the future expanded Section 8 under PETRA) will be required by law to recognize legitimate tenant organizations. This is a statutory provision that does not exist under current law. Furthermore, the current proposed language of the PETRA bill makes it clear that the subsidized tenants get to decide whether they want their own “legitimate tenant organization” or would just go under one organization for all tenants. More on this later.
PETRA also provides that such tenant organizations may work “through a combination of tenant organizations, including jurisdiction-wide or area-wide organizations”. So for example, a Greater Los Angeles Area Tenant Association might negotiate with every landlord who has any Section 8 units in his building. Whether such a giant tenants union could take into account the particularities of a specific building or not is left up to the reader to decide.
Finally, PETRA provides that HUD may fund such tenant organizations: “a portion of funds made available for renewal of rental assistance may be allocated to facilitate tenants’ rights to organize, subject to such terms and conditions as the Secretary may establish.” Surely, no tenant organization anywhere would be without a staff attorney, and a paid organizer (and staff of course) to coordinate the activities of said tenant organization with such funding available.
Take all of those and what do you get?
For one thing, the tenant’s interests are naturally at odds with the landlord even without any organization. The tenants wants to pay as little as possible and get as much as possible; the landlord is exactly the opposite. But in a free market, both sides eventually come to agreement. A tenant, then, may accept less from the landlord because he’d pay less; or, he may choose to pay more to get a better unit, etc. Under a subsidized Section 8 type of a market, the incentives are changed in some interesting ways.
The tenant’s payment is fixed at 30% of income. As long as his family qualifies as a “low/moderate income” family, the price of the rental will never go up. Naturally, he will demand the sky and the moon, but he’ll be doing it through the tenant organization.
Said tenant organization will be, in short order, controlled entirely by the Section 8 residents as it is their rights that are protected under the law. In fact, HUD will provide funds for these tenant organizations to hire fulltime staff, attorneys, and so forth. And because the Section 8 tenants have a direct financial stake (their rent is being subsidized, remember?), they will be far more active in any such organization than those who are not subsidized. It is inconceivable to me how a “private” tenant organization manages to survive over time when faced with such well-funded, well-organized alternatives.
The landlord has very little incentive to fight against these tenant organizations. The tenants aren’t the ones paying the rent; the government is. If the tenants’ demands means spending a bunch more money, requiring that rents be raised by 15% to cover the difference, the landlord’s real fight is with HUD and its local subsidiary as they would need to approve that rate increase. The tenant organizations — particularly those organized into large regional collectives, a super-union of tenants — are a powerful political ally for the landlord in the negotiations with HUD and local housing authorities.
What It Means
First of all, keep in mind that this is all just speculation. None of these things may come to pass. The Obama Administration may do none of these things, due to political pressure, or changed circumstances, or whatever. So let’s not jump to any conclusions.
Having said that, if you think this is even a possibility, strategic planning dictates thinking long and hard about the possible impact. Maybe it means boning up on rentals, if that’s going to be a much bigger part of a realtor’s business mix in 2012 and beyond. Maybe it means expanding into commercial real estate, particularly on the multifamily side, if you have a significant investor client base. Maybe it means getting up to speed on the various regulations that govern Section 8 housing.
It isn’t the end of housing; merely the end of housing as we know it. People will still need to live somewhere, and families will still need someone to help them through the maze of rules, regulations, and market conditions. Change creates its own opportunities, after all.
But I’d like to hear from you guys in the trenches. How likely/unlikely is this scenario? How would it, if it would, affect your local market? What strategies would you think about to cope with these changes?