I once heard someone say that great urban developments begin with a compelling vision and end in a real estate deal.
Between the vision and the deal, there are often political negotiations around the acquisition of land, zoning, and sometimes for public subsidy.
In an era of budget constraints, the efficient use of subsidy ought to be an important topic of public policy. But it rarely is.
Real estate subsidies of one kind or another are part of the landscape of the American tax code and the mortgage banking industry. They operate at every level of government.
So what is it? A subsidy is a public grant, a tax credit, or some other financial mechanism (such as a low interest and higher risk loan) applied to a development project and sometimes its ongoing operation (as with rental subsidies).
Subsidies are non-market allocations because they do not receive a conventional return on investment, are often used to support the conventional returns of other investors, and frequently remain in the project in perpetuity, as with a grant.
The largest real estate subsidy is interest mortgage deductions for homeowners. And the largest mortgage banker in the country is the US government, which still owns and manages the portfolios of Fannie Mae and Freddie Mac.
In Philadelphia, subsidies become a focal point of neighborhood social conflict when homeowners resent the presence of low-income rental subsidies; when tax abatements for new homeowners create a tiered real estate tax system; or when there is a dispute about market rate versus affordable (subsidized) housing in gentrifying communities.
We are rebuilding much of the city through public assistance, layered together with private investment. There is nothing wrong with that. But we can do it more effectively and more fairly.
Those are the well-known disputes. But there are countless other questions about the use of real estate subsidies that are important to ask. Those questions involve fundamental issues regarding economic incentives and fairness.
Here are a few:Why does a new hotel get tax increment financing? Why do subsidized affordable housing units cost so much? Why did we fund the convention center expansion before we had a better labor agreement to allow it to profitably operate? How do we direct the distribution of affordable housing subsidies in ways that do not continue to concentrate poverty?
Politicians can influence and direct subsidies, so it is natural to ask elected leaders if they have a strategy for their use. What are we trying to incentivize and how do we best oversee the allocation of public money?
And just why do we allocate subsidies for real estate development? Is it because we are addressing a market failure? Is it because of our interest in social justice? Is it because the well connected are able to negotiate public resources? Is it because we want to compete with other places by attracting development? Or is it (as with homeownership incentives) that we think there is a compelling public value that ought to be stressed?
Actually, it may be any and all of these things, as well as other factors. At the root of a subsidy is the assumption that the transaction would not happen, or would be less likely to happen in the way we want, without the subsidy.
Why is that? It could be that the cost of development exceeds the capacity to profitably sell or rent the unit being developed. Or that private capital needs an incentive (to diminish risk or insure liquidity) to be involved. Or that early stage development risk is so great, that the public has to clear the path for anything to happen (e.g. land assembly).
Whether the subsidy really is needed, and at what level, is a different issue. To determine that requires policy strategy and operating diligence. There are examples at every level of government of subsidies outliving their social purpose or examples of subsidies paying for things that could be addressed more directly in other ways.
Some real estate subsidies are smarter than others. A smart subsidy has four rules that are fundamental.
- Obtain the lowest responsible cost for the highest possible impact: Think of a matrix that has an x-axis that represents social impact and a y-axis that represents the cost of the subsidy. We naturally want the highest social impact at the lowest responsible cost. Most projects will fall in the grey zone towards the center of cost and impact. And naturally we do not want low impact and high cost projects. But in thirty years of urban development I have rarely seen thoughtful measurements of subsidy allocation that go through this kind of simple logic. And yet, why wouldn’t we always want our officials to apply this rigor to the allocation of public resources?
- Do not use subsidies to mask inefficiencies: Public subsidies should not be used to cover up process inefficiencies that can be addressed in other ways. We always have to ask whether the cost of the subsidy could be reduced through other policies. Otherwise we end up reinforcing the wrong policies. Some of our housing subsidies make up for high transaction costs in land acquisition, outdated labor rules, the wrong tax policies, and regulatory costs that have very limited social value. Does the allocation of subsidy make it easier to avoid dealing with those and many other issues like them? If so, then the subsidy may be addressing the wrong problem and keeping us from a systemic fix.
- Seek a strategy for expiration: Real estate subsidies should have a market-building trajectory (where possible) so that there are logical points of subsidy reduction and expiration. I realize that for the poorest people in need of income supports this may not be possible. But in many instances, when a market is proven and value is created, the need for the subsidy ought to be either reduced or removed. This can mean different things depending on context, including asking questions like, how do we help people reach higher levels of self-sufficiency and when do we decide that the concentration of subsidized housing ought to be reduced?
- Identify the most direct path to solving the problem: Housing subsidies are often utilized to make up for deficiencies in income and housing values. But it is fair to ask whether that is the best way to proceed. Housing values, for example, are affected by a variety of social amenities, including schools and public safety. We have seen how strong schools shift a housing market and there are studies that demonstrate the impact of crime on real estate. Of course we cannot use a housing program’s resources in direct support of schools and public safety; but we can identify more integrated approaches that will lead to the declining need for housing subsidy. Why wouldn’t the housing offices, the police, and the school district have an integrated working group to reinforce each of their efforts?
How big of an issue are we talking about when we pose the importance of subsidy rules? It is huge. At almost every step in the physical redevelopment of the city, there are political and policy influences at work. And many of them do not originate in City Hall but are directed through national or state programs.
There is a niche-consulting industry that specializes in obtaining public resources for development projects. All real estate developers know which lawyers are most skilled at dealing with zoning variances. Most developers assume that council members will continue to control land allocation despite reforms like a land bank.
This is why people in real estate development are active in supporting political candidates. Businesses tied to a place and reliant on subsidies or public regulation stay connected to politics. It is also why those same developers work hard to maintain strong building trade ties. Whether cozying up to politicians or building trade leaders, they do not want to get shut out.
If you are in the affordable housing business, some of the toughest competition in the state involves getting a low-income housing tax credit allocation (provided by the Pennsylvania Housing Finance Agency based on Federal IRS regulations and Federal allocation formulas). PHFA also runs a number of bond programs in support of affordable housing, including a very successful first time homebuyers program.
And then there is the State RACP grant (the redevelopment assistance capital grants), which comes directly from the state budget and provides a large amount of capital each year to a wide range of building efforts. Of all subsidy programs, this one is the most politically directed and involved. The Wolf administration promises to review the way the distribution works. Making RCAP more transparent would be a major political achievement.
In Philadelphia there is competition for tax increment financing (TIF), which must be approved by the School District and City Council. TIFs use the incremental rise in property taxes spurred by a development to pay for certain project costs of that development or related amenities by capitalizing the stream of new tax revenue through a loan. The TIF packages are modeled by PIDC, the city’s economic development arm that also manages the Navy Yard.
Then there is public housing. The Philadelphia Housing Authority has been successful at obtaining federal redevelopment subsidies that have spurred the renewal of most of the older housing projects in the city, all of which were products of prior federal subsidies. The new housing developments have lower densities and are more income diverse than the former projects.
And PHA continues to exert a very strong influence in urban development as the manager of rental subsidies (Section-8) and the recipient of annual federal subsidies in support of their rental portfolio, the largest number of rental properties owned by any single developer in the state.
Then there are the city’s ten-year real estate tax abatements for new developments, first for new homeownership units but extended to the rehabilitation of existing units, and also to a variety of other uses (including a 30 month construction abatement). Those abatements have been credited with the renewal of the housing market in core sections of the city.
In commercial real estate, the Federal New Markets Tax Credit program, run by the Treasury Department but implemented by non-government groups from banks to community development financial institutions, is a major private sector incentive (subsidized by the federal tax code).
And some of the most important place based real estate subsidies flow through federal (empowerment) and state (KOIZ) tax zones, where businesses and developers are lured based on particular incentives. Among other things, the KOIZ spurred the growth of the Cira Center at 30th Street.
There are other sources of subsidy too numerous to mention: historic tax credits, Commerce Department commercial strip grants, community development block grants, and large one time grants for big ticket items like stadiums, cultural centers, or the convention center.
You get the idea. We are rebuilding much of the city through public assistance, layered together with private investment. There is nothing inherently wrong with that. In fact it is understandable after so many years of decline and in a city with such a high poverty rate.
But we can do it more effectively and more fairly. And how we do that will say a great deal about the type of city we are re-creating today.