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Multifamily Trends - November/December 2006 - Point of View

Workforce housing units are disappearing from the market, making clear the need for strategies to preserve the existing stock and increase the amount of available stock.

There Goes the Neighborhood: The Ongoing Loss of Workforce Housing

by John McIlwain

The pending sale of the largest single property in U.S. history dramatically highlights one of the biggest challenges to providing affordable workforce housing—namely, the accelerating sale and conversion of decent, affordable rental properties into pricey condominiums and upscale, expensive market-rate housing. This fall, Met Life announced the sale of Stuyvesant Town and Peter Cooper Village in New York City—the largest example of what has become a national trend. Why this is happening is not hard to figure out, as the prices of condos are far above current rental values.

What is hard to figure is what can be done to slow or stop this trend. The Preservation Compact, a group in Chicago organized by ULI Chicago and funded by the locally based MacArthur Foundation, has come up with a list of ideas to help preserve workforce and affordable housing, all of which are effective ways to slow or stop the loss of this irreplaceable resource—not just in Chicago, but in communities across the country.

Once Upon a Time, We Built Workforce Housing

The high point for developing workforce housing in the United States was the 1940s. By the beginning of that decade, the worst housing shortage in U.S. history had developed. Almost no housing was built during the Great Depression, and with the entry of the United States into World War II, virtually the only housing being built was for workers near munitions plants. Planners became concerned that when the war was over, millions of returning servicemen and women would overwhelm the markets, risking the kind of social unrest that had swept Europe before the war.

In New York City, Robert Moses, with the support of Mayor Fiorello LaGuardia, sat down with the Metropolitan Life Insurance Company in 1944 and convinced them to begin planning for a huge complex of apartment towers on the east side of New York that would have modest rents that would be affordable to teachers, nurses, police officers, and firefighters, as well as those returning from military service around the world at the end of the war.

The location was an old, run-down section of Manhattan then known as the Gaslight District, just south of where the United Nations is now located. The city actively supported the development, giving Met Life all the streets in the 18-square-block development and freezing taxes for 25 years. Assembling the site was still a major challenge as ownership was widely dispersed, which is usually the case in urban sites. It became a major urban renewal project in which the city used eminent domain in some instances, which is worth noting simply because of the current controversy over the use of eminent domain, sparked in part by the recent Kelo decision in the Supreme Court. The lesson to take away from the development of Stuyvesant Town and Peter Cooper Village is that often it is necessary for a local government to use powerful tools like eminent domain to provide the community with vitally needed developments such as workforce housing. Working without a public partner, the private sector all too often is simply unable to overcome certain obstacles.

The first residents—two veterans and their families—moved in on August 1, 1947. When the project was completed, Stuyvesant Town and its somewhat more upscale sister development, Peter Cooper Village, had a combined 110 buildings, 11,250 apartments, and more than 25,000 residents. On the first day, Met Life received 7,000 applications; it would receive 100,000 applicants by the time of first occupancy. In 1947, rents ranged from $50 to $91 per month, which in today’s dollars would be $456 to $830.

It was during the same period that the first Levitt homes were being erected in Hempstead on Long Island, New York. Construction of houses in Levittown, as the development eventually became called, began in 1947. When built out in 1951, it contained some 17,500 homes, which were initially priced at $7,900 (or $72,000 today). Again, the vast majority of the purchasers were returning veterans.

Stuyvesant Town/Peter Cooper Village and Levittown were only the first of a series of workforce housing developments built around the country at that time. The 1940s and the early 1950s were a unique and extraordinary time in the history of housing development in the United States. It was the last time any significant amount of workforce housing was built.

Over the years, however, a lot of market-rate rental housing has been built, such as the many garden apartment complexes in the inner and older suburbs built up through the 1970s and early 1980s. Many of these developments today still provide decent and quite affordable housing, though they may be in need of modernizing. Many, however, including most of those in neighborhoods that have grown more desirable with time, have been or are being converted to upscale, luxury rentals or condominiums, usually at a substantial profit to the owners. It is this trend that the current sale of Stuyvesant Town and Peter Cooper Village by Met Life exemplifies.

How Can We Save the Workforce Housing We Already Have?

Few locations in the United States have more intrinsic value than the east side of Manhattan. Given the value of the location, and the number of buildings and units, the sale price for Stuyvesant Town and Peter Cooper Village exceeded $5 billion, making it the largest sale of a single property in U.S. history. (On October 17, Metropolitan Life entered into a contract of sale for Stuyvesant Town and Peter Cooper Village with Tishman Speyer Properties and a unit of New York–based money manager BlackRock Inc. The announced contract price was $5.4 billion. No plans for the property were revealed, though experts predicted that, based on the high purchase price, the property would ultimately be converted to condominiums, a process that could take as long as 20 years.) Two-thirds of the units in the two projects are still under New York City’s rent stabilization program with rents at half the market rate; the rents on these units will remain affordable for the time being. Units in the project that have emerged from the stabilization program (which happens once a unit rents for more than $2,000 and either is vacant or occupied by residents earning more than $175,000 for two consecutive years) are likely to face steep increases in rents. And, over time, the project may be converted into a condominium, with prices far beyond the affordability of teachers and government workers.

The sale comes just when Mayor Michael R. Bloomberg has committed to stem the loss of affordable housing units in the city and instead add to them. Many are watching what the city does to keep at least some of the units in Stuyvesant Town/Peter Cooper Village affordable for the long term. This challenge is faced by cities and older suburbs across the country, though not in such a large and dramatic way. Most communities face a slow, almost invisible erosion of affordable worker housing, which undermines and even negates any benefits of programs designed to build new workforce housing.

Recognizing this challenge, ULI Chicago, with support from the Institute’s Washington staff and funding from the MacArthur Foundation, assembled a group called the Preservation Compact to develop tools to stanch the loss of an irreplaceable resource. After a year of meetings, a report was issued last fall that listed a series of excellent recommendations that can well be considered by any community facing the loss of workforce housing.

Each of the recommendations of the Chicago Preservation Compact won’t fit every city or community, but taken together they show how comprehensive the challenge is and how an all-encompassing response is needed to minimize the loss of a precious resource. Each unit preserved provides affordable housing at a far lower cost than a unit newly built and subsidized in order to make it affordable. Preservation does not take the place of building more new affordable housing, but it does complement such a strategy and is another tool in the tool kit. Clearly, it takes all the tools that can be created to meet the growing need for affordable housing today.

The Chicago Preservation Compact Recommendations

The best way to present the recommendations of the Preservation Compact is in their own clear words (modified simply to show them as applicable to any community in any state):

Operating Costs

A major barrier to affordability is the steady increase in operating costs, which necessarily drives up rents or leads to underinvestment in maintenance. Of special concern are property taxes, which have risen dramatically in recent years, especially in wealthier communities; and energy costs, in particular the prices of oil and natural gas, which are expected to increase in the future. Insurance also is among the top expenses for most buildings and is rising rapidly. Reducing or stabilizing operating costs is essential for both reinvestment and acquisition, because capital providers will lend more and at lower rates when owners can demonstrate that they have stabilized operating costs.

Tax abatements. Buildings could receive a tax rate reduction in exchange for a commitment to affordable rents for ten years or another fixed period. The building would have to pass initial and annual inspections and have no building code violations.

Valuation reductions based on affordable rents. If an owner agrees to maintain, for instance, six apartments in a 24-unit building at affordable rents, the value of the structure should decline based on the income method of valuation. A consistent valuation reduction by the assessor’s office, in exchange for a long-term commitment to affordable units, could help building owners control costs and increase the number of units available.

Restructure the state’s tax system to reduce reliance on property taxes. Many studies have shown a fundamental problem inherent in most state tax structures as they depend too heavily on property taxes (as opposed to a statewide income tax) to support local public education. This not only creates wide disparities in education funding, but also severely burdens taxpayers in communities with limited property tax bases. In tax-poor municipalities, this makes it difficult to provide affordable rental housing—and discourages development of new affordable housing—because property taxes are such a large expense.

Promote and expand energy efficiency and other “green” programs to help owners reduce operating costs. One-time investments in modern boiler systems, controls, energy-efficient lighting, insulation, windows, and other improvements to the building “envelope” can effect dramatic savings in energy costs. Some improvements can pay for themselves in only a few years, making them a sound investment for any building owner. A strong regional effort to promote and educate lenders, government officials, and building owners about energy-efficiency improvements could have a lasting impact on affordability. A model for this program would be the Enterprise Foundation’s Green Communities program www.enterprisefoundation.org/ resources/green/index.asp), a $555 million effort to improve building design and operations. Suggested approaches are as follows:

Create or compile cost-benefit studies for different types of improvements to show estimated savings, capital costs, and payback time.
Link to local green programs that reward efficiency improvements, such as fee waivers, expedited permitting, or eligibility for small grants. The single-family–oriented Chicago Historic Bungalow Initiative (www.chicagobungalow.org), for instance, could be a model for an efficiency program for small apartment buildings.
Develop a “one-stop resource center” for rental housing owners to help them choose the most proven and cost-effective approaches.
Develop a second-mortgage program focused on energy loans. An energy audit can identify building needs and the most cost-effective improvements. A program would require capitalization for grants and loans, possibly from government, foundations, and local utilities.

Investigate pooled insurance programs, self-insurance, or other methods to reduce insurance premiums for owners of affordable rental properties. Owners identify insurance as one of the major operating costs that drive up rents. Private and nonprofit building owners should investigate insurance pools and/or self-insurance programs to lessen these costs. The Housing Partnership Network, a national network of housing nonprofits based in Boston, for instance, launched in 2004 an insurance company owned and operated by its nonprofit members and covers 35,000 affordable units valued at almost $3 billion. Large real estate firms have used self-insurance as well to lower costs. A less ambitious approach would be to negotiate a favorable rate with insurance companies in exchange for bringing a large volume of business in the local market.

Property Acquisitions and Reinvestment

Prices of rental properties have risen sharply in recent years for various reasons, including speculation in hot markets; the prospect of condominium conversion; low interest rates; ample private capital; and regulatory incentives such as the IRS 1031 Like-Kind Exchange, which encourages reinvestment of profits in new properties after selling a similar property.

Develop an affordable rental preservation acquisition fund to provide predevelopment grants and below-market loans to housing developers who agree to maintain affordability. In recent years, prices of rental properties have been prohibitively high for operators who seek to maintain affordable rents; prices in many neighborhoods are driven by the prospect of flipping the building as values continue to rise or converting to condominiums. A substantial acquisition fund would provide low-cost capital to purchasers in exchange for a long-term commitment to affordability. New York City recently launched a $200 million fund. There is value in exploring how guarantees from foundations and the public sector can help leverage a larger pool of funds well suited to meeting local preservation financing challenges. ULI has begun working with the leadership of the Preservation Compact, funded by the MacArthur Foundation, to create such a fund for preserving affordable rental housing in Cook County.

Create a cross-sector/public agency working group with responsibility for identifying high-priority preservation opportunities/needs and establishing and applying common guidelines for channeling city, county, and state resources to the highest-priority preservation transactions.

Revise local tax sale regulations to support the creation of affordable rental units. Most local governments have systems that enable the sale of properties with delinquent taxes, but most could be improved to put properties back into use more quickly and to encourage affordability. Two approaches to explore are suggested:

Favor or restrict sales of multifamily buildings to buyers who commit to affordable uses. Priority would be given to purchasers who agree to provide affordable rents for ten years or more.
Add a time limit so that any property purchased at the tax sale is improved or resold within a fixed period of time. This would discourage a practice by some buyers of holding empty or deteriorated structures for many years, without new investment, while waiting for the value to improve. It would bring properties back into productive use more quickly and discourage pure speculation. An alternative method to incentivize investment would be to increase taxes on a building that remains idle or without investment.

Increase the availability of timely and usefully designed financing and subsidy for the preservation and improvement of affordable rental properties. This could be accomplished through the preservation acquisition fund recommended above and by increasing the scope and size of existing programs and creating new programs that provide small and simple subsidies in exchange for long-term affordability commitments.

Troubled Properties

Many existing affordable housing properties are at risk. Most of the properties considered “troubled” are often undercapitalized, have high vacancy rates, show severe deterioration, and are mismanaged. A danger here is that some buildings will “go dark” as vacancies rise and major systems deteriorate.

Recognize that all troubled properties may not be suitable for preservation; identify those that are most appropriate for continued affordable uses, and concentrate resources on those properties. All troubled buildings should not be treated in the same manner. Those in low-income neighborhoods with large stocks of existing affordable housing may be more appropriately converted to market-rate rental units or condominiums to improve the community’s economic mix. By the same token, a building in a community with few other affordable options should probably be preserved as affordable housing. Building condition also should be considered: severely deteriorated structures may be appropriate for demolition if limited funding could support a larger number of units elsewhere.

Support passage of federal legislation that provides relief from exit taxes for owners of tax credit properties who agree to reinvest. Federal legislation could create a mechanism for exit tax relief in exchange for reinvestment and continued affordability. A federal solution would encourage reinvestment in a number of structures.

Enforce existing standards of property maintenance for troubled buildings to force new investment in properties that could be lost to deterioration. Many properties are at risk of being lost forever because owners have not reinvested in them.

Create and/or expand availability of technical assistance and intermediaries that facilitate ownership transitions for troubled properties and high-priority preservation targets. The facilitation of property transitions can be applied not only in troubled HUD and LIHTC properties, but also in situations where a limited partner is interested in exiting a partnership and a building is at risk for leaving the affordable stock.

John McIlwain is a ULI senior resident fellow and holds the ULI/J. Ronald Terwilliger Chair for Housing.