Financing public housing: how a massive expansion of rental homes can literally pay for itself
In the face of a mounting housing crisis, what if BC could massively increase public investment in below-market rental housing—and if that upfront investment could literally pay for itself, with no increase to taxpayer-supported debt?
While this might sound too good to be true, it simply follows from the basic logic of rental housing development. When building new rental housing, the upfront costs of construction are offset by the stream of rental income the project generates over time. This is, of course, the premise on which private-sector rental housing developers base their business models. For them, building new housing is not a “cost”, but rather a way to generate substantial profits.
Similarly, when governments (or the non-profit sector) build rental housing, the investment can also be self-sustaining. But there’s a key difference: instead of generating profits, housing projects can operate on a break-even basis with rents set at below-market rates. My colleague Marc Lee did the math on break-even rental housing development in a recent report on affordable housing options in the Metro Vancouver market. Here I analyze what an ambitious, publicly led build out of self-sustaining rental housing would mean for government finances and debt (answer: surprisingly little).
When governments or the non-profit sector build rental housing the investment can be self-sustaining.
If we want to address the chronic housing shortage, rapidly build as many affordable homes as possible and expand the stock of valuable public land assets, this option is waiting at our fingertips.
To be clear, this approach of developing rental housing isn’t a complete solution to the housing crisis. For example, given how quickly land and construction costs have escalated in recent years, self-financing housing may still require rents that are higher than many people can afford, even if they are below-market. Further measures are needed to achieve deeper levels of affordability. The housing crisis is a multi-headed beast, and tackling it requires policy action in a range of areas including property tax reform and ending the exclusionary low-density zoning that dominates our cities.
The provincial government has taken some modest positive steps through its 10-year housing plan. But it is progressing too slowly and its new housing construction targets were too low from the outset. BC’s current plan doesn’t make use of the self-financing model described in this analysis, which could provide a foundation for a rapid and much-larger expansion of affordable homes in BC starting today.
Self-financing housing: how it works
Let’s consider the basic model for private rental development a little more closely. Different projects unfold in different ways, but the key sets of costs are the same from the perspective of the developer.
First, land needs to be acquired on which municipal zoning policy allows multifamily housing like rental apartments to be built (or on which the developer believes a rezoning for this purpose is very likely to be granted).1 Then the developer must engage and pay for contractors to design and construct the project. Third, there are the ongoing operating and maintenance costs for the building and its amenities.2 Finally, there is the cost of interest owed on the capital borrowed to finance the upfront investments.
A private-sector rental developer will only undertake a project if the anticipated income from rents will cover all these costs—land, construction, operating and financing—plus a healthy profit margin.
Public or non-profit housing projects can also cover their upfront costs with ongoing rental income. However, eliminating the developer profit margin can achieve lower break-even (or self-financing) rents. In addition, the government can borrow at cheaper interest rates than the private sector and can amortize those costs over a longer period of time (50 or more years, if desired), both of which can further reduce break-even rents.
In short, not unlike a private developer, the government can borrow money to develop new housing and use the rental income generated to fully cover the cost of servicing that debt over time, with no effect on the cash flow or tax revenue needs of the public sector overall.
Public or non-profit housing projects can cover their upfront costs with ongoing rental income.
There’s no real dispute about the basic logic of this. In fact, a recent report prepared by Coriolis Consulting for Metro Vancouver notes that government investment could be used to create “all the rental housing needed in this region” on a cost-recovery basis “depending on how rents are set.” The report points to jurisdictions like Vienna that have built public and non-profit housing on a massive scale. But like much of the housing policy discussion, the report assumes there isn’t the political will to go this route, noting that the idea would run up against the “willingness of government to pay” up front.
Just how much cheaper would the rents be for this type of self-financing public rental housing compared to an equivalent project brought to market by a for-profit developer?
Housing developer profits are often estimated to be about 15% of costs, plus there’s the benefit of lower interest costs for government.3 We can reasonably assume rents that could be set at least 15 to 20% below market rates. As discussed below, there are other ways rents could be reduced to deeper levels of affordability. Marc Lee’s analysis found that a new wood frame rental building with moderate land costs could achieve break-even rents of $1520 for a 1-bedroom home. These homes would also be protected from the whims of rising market prices, a key feature as long as the overall housing shortage persists.
What would the effect be on government finances?
What pressure would this type of massive, self-financing housing investment put on government finances and taxes? The short answer is very little. Investing in public housing need not affect the annual provincial budget balance or redirect tax dollars from other public policy priorities.
Several existing BC Crown corporations, the largest of which is BC Hydro, already cover their own capital and operating costs in much the way proposed above. Taking the example of BC Hydro, its borrowing is considered to be “self-supported debt,” since the servicing costs are covered by its own dedicated income stream (i.e., payments from its electricity customers). Accounting rules and credit rating agencies consider “self-supported debt” to be distinct from “taxpayer-supported debt”, the latter serviced using tax dollars. From the perspective of credit rating agencies, taxpayer-supported debt levels are considered to be one of the main debt metrics that would influence the province’s cost of borrowing. This metric is unaffected by BC Hydro borrowing as long as it has a credible plan to cover its costs.
A housing investment program could be structured the same way under a Crown corporation—either a new one created for this specific purpose or an existing agency like BC Housing. If it has a credible plan to cover the upfront costs of investment through rental income, the housing investment won’t affect taxpayer-supported debt levels.
To be clear, this is not some sort of accounting trick—it’s simply recognition that certain Crown corporations have dedicated income streams that cover their own costs. This is why the credit rating agencies, typically very conservative institutions, don’t balk at the practice.
Investing in public housing need not redirect tax dollars from other public policy priorities.
Furthermore, when the upfront costs of new housing are eventually paid off, the public sector is left with highly valuable long-term assets: the buildings themselves and the land acquired. When these rental buildings reach their end of life, future rounds of public housing can be undertaken with free land. Land wealth is a massive source of inequality in BC, and increasing its public ownership would help ensure these assets are harnessed for the public good, rather than serving as a huge source of passively accumulated private profit.
In addition to these direct benefits, ensuring access to affordable housing for British Columbians would strengthen the province’s economic and fiscal health in a variety of other ways for years to come.
Imagine that BC undertook the mission to build this type of public housing at a rate of 10,000—or even 20,000—new below-market rental homes per year. If we peg the upfront land and construction costs at roughly $500,000 per unit, the hypothetical Crown corporation would be undertaking $5 billion to $10 billion per year in borrowing in self-supported debt, backed by the rental income streams created.
This is a feasible level of investment. To put it in perspective, BC Hydro is projected to spend about $4.1 billion this year on capital investment booked as self-supported debt (overwhelmingly related to the Site C dam), backed by expected returns in the form of payments from electricity customers.
Achieving more deeply affordable rents
Even with break-even rents that are 15 to 20% below market levels for new buildings, that’s still out of reach for many British Columbians with lower incomes. The good news is there are a whole slew of ways to achieve more deeply affordable rents.
If the cooperation of the municipality can be secured (or required by the province), one way to achieve cheaper rents would be to build rental apartments on lower-priced land that is currently zoned for low-density detached housing. Because it is zoned for so little housing, this land can be acquired more cheaply than sites already zoned for multifamily housing (since the public housing agency would face competition from private developers for these multifamily scarce parcels). This would also help address unequal access to the city, since in most municipalities the large majority of residential land is zoned exclusively for the most-expensive form of housing: detached houses.
In addition, if municipalities were willing to waive the onerous parking requirements usually put on apartment buildings this could also lower costs substantially, allowing for further rent reductions. Parking adds hugely to the cost of new apartments—tens of thousands of dollars per parking stall.
Different levels of government could further lower costs by contributing land they already own. However, we shouldn’t think of existing public land as “free,” but rather as a scarce and valuable resource to be replenished and available for a whole range of public amenities—housing, child care, parks, among many others. If we want to expand public housing for the long-term, we need to steadily acquire new public land (preferably financed by taxing windfall gains to private landowners).
The good news is there are a whole slew of ways to achieve more deeply affordable rents.
Another option is to structure housing projects to cross-subsidize between units in a building. If half of the homes were rented at market rates, the other half could be rented at lower amounts while still achieving a break-even average. Ideally, this would mean adding units to a given project and thereby increasing the total amount of new rental homes created on a land parcel of a fixed cost.
Through a combination of these measures, public or non-profit housing could be built and run at break-even rents about a third lower than those of private rental housing, as Marc Lee has shown.
Finally, another important way to achieve more deeply affordable rents is to create a separate stream of operating subsidies or upfront grants for some public housing developments. The self-financing portion of the housing investment would remain separate under the Crown corporation structure (continuing to be designated as self-supported debt), while the grants or subsidies would represent a separate contribution supported by tax revenues to help lower rents. Indeed, there is a strong case for supporting this type of housing investment by creating a dedicated new stream of revenue from taxing the enormous land wealth windfalls this province has seen in recent years.
Creating affordable rental homes for all
BC has the ability to undertake a game-changing investment in public, non-market housing. The analysis here has largely focused on a scenario showing how the provincial government could invest in creating new rental homes at a scale that would fundamentally transform our broken housing system. But there’s no reason in principle that this type of self-financed public housing couldn’t be built by any willing level of government. The federal government could certainly do it and so could large municipalities (with the caveat that borrowing for capital investment is a slightly more complicated process for municipal governments). Governments can undertake this type of initiative on their own, in partnership with existing non-profit housing developers, or by some combination thereof.
There is simply no way out of the housing crisis without addressing the chronic shortage of homes overall and the shortage of dedicated, non-market rental housing in particular. A swath of recent research clearly shows that adding new housing “loosens the housing market in middle and low-income areas even in the short run… [and] is likely to improve affordability outside the submarkets where the new construction occurs and to benefit low-income people.” This is true of new market rental housing, but public housing has the crucial added benefit of creating new units that are themselves immediately more affordable. Public and non-market housing delivers the most affordability bang for the buck, if we are willing to make these investments at the levels needed to address the scale of the crisis.
The housing crisis sometimes feels beyond our control, but a massive effort to build below-market-priced, publicly owned rental homes is a policy option that’s achievable, affordable and waiting at our fingertips.
This research is supported by a grant from the Vancouver Foundation.
1. Acquiring the land is often the most challenging and expensive of these steps, since exclusionary zoning policies prohibit multifamily apartments in most places, which drives up land prices for these scarce sites. Even where multifamily housing is allowed, prospective rental housing typically must be able to compete with more lucrative strata housing for use of the same site. In part because homeownership is heavily subsidized in Canada, strata housing is typically more profitable than rental, which can push the price of scarce multifamily land higher. Indeed, over the past several years, municipal, provincial and federal incentive programs for rental housing construction have attempted to partly offset the long-standing tilt in the playing field against rental and towards strata.
2. A developer may sell off a project after completion to a long-term investor such as a pension fund, but for simplicity we’ll assume here that the developer holds on to the property as an owner-operator.
3. Note that I’m only referring to cutting out the developer’s profits here, not those of the building contractors. My assumption is that rental housing developed by the public or non-profit sector would still depend on private sector building contractors and their profits would be baked in. Having said that, one could imagine the case for the government directly employing a corps of skilled trades workers, who would be dedicated to the ongoing mission of building affordable housing for all.
Topics: Housing & homelessness, Municipalities, Provincial budget & finance