How Mixed Income Cross Subsidies Work

There seems to be a lot of confusion about low-income and affordable housing in California and beyond. I was similarly confused, but learned a few things when I signed up to be a League of Women Voters volunteer and attended housing meetings at the regional and local level. 

I keep saying that I am not an expert, but people I consider to be true experts say I know more than 99% of CA voters. So I'll blog about a few things I learned, in no particular order except that it was at the top of my mind for some reason (usually answering a recent question). 

In 1950, California voters passed Proposition 10 that became Article 34 of our state constitution which bans construction of publicly-financed low-income housing unless a majority of voters approve. This helped fuel a rush of incorporation amongst small and midsize cities so that locals won't be overwhelmed by voters of a larger city. Why it’s been so hard to kill Article 34, California’s ‘racist’ barrier to affordable housing (LA Times link) does a good job of explaining the situation.

The wording of the Proposition binds our hands:

No low rent housing project shall hereafter be developed, constructed, or acquired in any manner by any state public body until, a majority of the qualified electors of the city, town or county, as the case may be, in which it is proposed to develop, construct, or acquire the same, voting upon such issue, approve such project by voting in favor thereof at an election to be held for that purpose, or at any general or special election. 

For the purposes of this Article the term “low rent housing project” shall mean any development composed of urban or rural dwellings, apartments or other living accommodations for persons of low income, financed in whole or in part by the Federal Government or a state public body or to which the Federal Government or a state public body extends assistance by supplying all or part of the labor, by guaranteeing the payment of liens, or otherwise. 

For the purposes of this Article only there shall be excluded from the term “low rent housing project” any such project where there shall be in existence on the effective date hereof, a contract for financial assistance between any state public body and the Federal Government in respect to such project. 

For the purposes of this Article only “persons of low income” shall mean persons or families who lack the amount of income which is necessary (as determined by the state public body developing, constructing, or acquiring the housing project) to enable them, without financial assistance, to live in decent, safe and sanitary dwellings, without overcrowding. 

For the purposes of this Article the term “state public body” shall mean this State, or any city, city and county, county, district, authority, agency, or any other subdivision or public body of this State. 

For the purposes of this Article the term “Federal Government” shall mean the United States of America, or any agency or instrumentality, corporate or otherwise, of the United States of America.

This guarantees that no new subsidized rentals can be built in wealthier, higher opportunity areas. It also explains why public housing in CA is so old. We have to hang on to old, decrepit and dangerous subsidized rental housing because we can't offer modern replacements. 

HUD used to help fund modest market-rate apartments (until about 1970) that have become "naturally affordable" as they rotted and became less desirable. That downward "filtering" of homes to lower income households no longer works with our severe housing crunch. Even older apartments can command high rents. This is why you now see families headed by two working PhD rocket scientists squeezing into 2 bedroom apartments built in 1969. My area has slowly become whiter and more affluent. (Anyway, this is getting off-topic and I'll save it for a separate blog post.) 

Today, low and moderate income housing is likely to be built without public subsidy by non-profits or by for-profit developers who are willing to build a few below market rate units in order to be allowed to build more units overall.  This is called a cross-subsidy. 

In the words of the Family Housing Fund: 

In strong housing markets, nonprofit or mission-driven for-profit developers who build affordable homes can use profits from the sale or rental of market-rate homes to subsidize the costs of affordable homes. For example, some developers have used the profits from market-rate condominium units to subsidize affordable condominium or rental units for working families within the same development.

Here's an example in North Redondo Beach, along a loud and polluted truck route called Artesia Boulevard. I'm using the satellite view option of a California Property Tax Map, which shows you how much taxes are assessed in a bunch of California urban counties, including Los Angeles County. Click the link to see this area.

Each balloon represents a parcel. A range means that there are multiple properties on the parcel (condos, townhomes). Yellow or black means they pay near average taxes. Red means they pay higher than average. Green means they pay lower than average. Proposition 13 allows people to pay much lower than average taxes, as exemplified by the single family home at the top center paying around $1,346/year while adjacent townhomes pay $4,490-$10,525 each (3-5 homes on the same size lot).

On the commercial side of the block, several lots were combined for a mixed-use project of commercial on the street level with 3 stories of housing above. There is a 2-level parking garage below and behind the commercial offices. 

Click the bubble with a range on that building and a spiral with all the assessments becomes visible. Note the 9 green bubbles among the 39 black ones? When the developer built this complex, they offered to sell 8 units below market rate and the buyers of those 8 units promised to sell only to income-qualified buyers at below market rate prices. 

It looks like one of the original 40 market rate homes is now paying lower taxes, perhaps an older person who sold another home and used Proposition 13 portability of lower taxes. Unlike the original 8, that unit does not have any limitation on who they can sell to and at which prices. (I'll explain that later because that is another mind-bogglingly inefficient and stupid system we use because we fetishize home ownership over affordable rentals. This is also rife for fraud and abuse.)

From the National Housing Conference's Policy Guide:

Under strong housing market conditions, the market-rate share of a mixed-income development can generate more income than is necessary to cover costs for developing these units. These profits can fill the gap between income and expenses for the portion of units that are rented or sold at affordable (below-market) rates. This “pure” cross-subsidy model is likely to be viable only in strong markets, where rents and/or home prices are high enough to generate profits to cross-subsidize the affordable units. 

As the federal funding available for affordable housing has declined in recent years, communities and developers have sought more cost-effective and market-based strategies for increasing the supply of affordable homes. The inclusion of market-rate units within a mixed-income development or community can make the development more financially feasible and less reliant on public subsidy through cross subsidization.

Anyway, the 30-second elevator pitches is that developers can sell a few homes as loss-leaders if they can command high-enough prices for the other homes to "pencil out".  How many homes is determined by their costs and the prices they can command for the other units.  The higher the prices in that local market, the more loss-leaders they can create.  

These mixed-income cross-subsidized developments require no public money for construction, which is why they can be built under the conditions of Article 34. But they do mean that new residents who share the building will have to pay higher prices than they normally would have (or the developer takes a lower profit). Usually, it's a bit of both. The higher the inclusionary minimum (more cross-subsidized homes), the higher the costs borne by the market-rate inhabitants of the new housing (who may be themselves housing-burdened). 

But, local governments can raise their costs by throwing impediments at developers until they can't afford to do so. This is why streamlining the development process is so important. If something can be built "by-right" without any additional permitting processes other than normal health and safety ones that apply to everyone, then CEQA challenges aren't possible.