As markets around the United States continue to grapple with housing affordability challenges and limited inventory, policymakers are beginning to expand on mandated affordability reform rather than loosening restrictions on new development and allowing the free market to solve the problem.
High interest rates and inflation continue to be primary drivers behind limited housing inventory. Homeowners lucky enough to lock in record-low interest rates during the pandemic are understandably reluctant to give then up, thus housing inventory is at an all-time low. Low inventory can negatively impact buyers and sellers. While sellers are unable to move, the limited inventory forces buyers to compete in bidding wars which drive up home prices.
New home construction is one way to solve the problem; however, because new homes require investment and time to build, developers can’t solve the problem overnight. Even as investment in new home construction continues to grow, homebuilders are facing a multitude of headwinds, especially in larger city markets.
To solve the inventory problem, city governments are considering imposing new restrictions on development — such as requiring that developers declare a certain number of new units as income or pay an opt-out fee which is used to fund affordable housing throughout the area. However, such fees can significantly reduce profitability of new development.
If instead, cities would reduce zoning restrictions, permit moderately higher density around urban neighborhoods, and ride market forces, the housing inventory challenge could resolve itself much more quickly. Builders would be able to increase the supply of homes within urban villages by replacing older single-family homes with new four-unit townhomes, which would quickly and dramatically increase housing availability.
This approach was taken in Seattle back in the mid-1990s when the city allowed for higher density in 16% of the city’s residential-zoned land. The result was 18,000 new townhomes over the next twenty years — an astounding accomplishment considering the reduced restrictions only applied to a small section of the city.
As more people moved into the new housing, older homes became more available and affordable. Despite this success, Seattle’s bureaucrats didn’t open zoning density restrictions elsewhere. Instead, they implemented a fee and income strategy to drive extra revenue from builders into the Mandatory Housing Affordability (MHA) Fund.
However, this strategy didn’t produce the results everyone expected. The MHA only funded the development of 1,178 affordable units over four years and around 3,000 affordable units over the next decades — a much slower pace than what the city experienced over the previous two decades and far short of the city’s 20,000 unit goal. Not to mention permit activity plunged following the implementation of MHA. At the end of 2022, MHA had only funded 30 for-sale condos. Instead, the policy made it more difficult and less profitable for developers to build.
These policy decisions are most certainly exacerbating the already grim inventory challenges that Seattle and other cities are facing today and lower to middle-income households will be impacted the most as housing costs continue to rise. The end result is likely to be housing affordability challenges for years to come, a decline in ownership, and less of an opportunity to build inter-generational wealth.
Another challenge introduced by the MHA fee policy in Seattle is that the smaller firms that primarily specialize in townhome construction struggle to navigate the complicated policy rules and paying extra fees significantly reduces profitability. A survey by the Master Builders Association of King and Snohomish counties indicated that the MHA project fee for an average four-unit townhome can be up to $130,000.
The situation in Seattle can serve as a valuable lesson for city governments across the United States. Mandatory affordability policies can significantly slow down new home construction. The alternative, which is permitting higher density without fees or restrictions will enable more homebuilders and developers to construct single-family communities.
As state and city governments weigh solutions for tackling housing inventory challenges in 2024, let’s hope encouraging and enabling developers takes priority over mandatory affordability policies.
