Does Pure Capitalism Fail the Housing Market?

Let me begin with a provocative observation. The very fact that Bridge Housing Corporation is a not-for-profit and public-benefit corporation gives you some clue that something is fundamentally wrong with our market economy. We don't have non-profit production of automobiles or air planes, but the production of housing—one of the necessities of life—has been increasingly relegated to the nom-profit area.

To give you an example, BRIDGE Housing Corporation started twelve years ago as a small, two-person company in the backroom of an insurance company. After several years of production, in 1990, we found ourselves, much to our surprise, ranked by Builder Magazine as the 125th largest home builder in the country. Last year we saw that we had moved from 125th up to 66th.

The latter is even more amazing because between 1990 and last year, our production bad fallen 15 percent. and our ranking had still moved halfway up in the rankings. That tells you what has happened to the apartment industry since the 1986 Tax Reform Act. I would guess that one-third of the apartments production in the U.S. are produced by non­profits using tax credits. 

Something is fundamentally wrong with our system of economic production: we cannot have a healthy economy and society unless the working men and women in the society are decently housed in safe, sanitary dwellings, reasonably close to the places where they work. 

We would expect that a main engine of the economy would be housing production. Instead, our economic system has left shelter to the non-profit sector, which is woefully under-capitalized and cannot compete with the private sector in terms of compensation. It is amazing to me that the non-profit sector should be counted on to provide any substantial portion of one of the most basic human needs in the society, especially when you have a market economy as robust as that of the United States. Why the non­profit sector, which does not pay taxes, captures a major share of housing production eludes me. 

Financing Affordable Housing 

I am here today specifically to discuss issues of affordable housing, and I'd like to talk about one of the issues near and dear to every non-profit's heart—financing. We, as would any non-profit developer, need four major sources of capital to produce even a single unit of housing.

The first financing we need is venture capital. We need to tie up a piece of land and perform the soils analysis, architectural, appraisal, legal, and the myriad of other pre-development activities needed to put together a package—a package that is completely at risk. When we are talking about affordable housing we're not only talking about risk arising from the opposition of NIMBYs (Not In My Back Yard), but also NIMTOOs (Not in My Term Of Office) and BANANAs (Build Absolutely Nothing Anywhere Near Anything). This is why venture capital is at such risk—projects can be blocked anywhere along the process. The issue in the real estate industry of toxics adds even more jeopardy, especially when we're building in the inner-city.

When we started BRIDGE in 1983, the idea of getting a land loan was entirely feasible. You had a piece of ground, and you borrowed on the land to finance your predevelopment expenses. That concept is now extinct as far as I know. Today's predevelopment and acquisition money has to be raised and put out there, and it's at serious risk.

The second form of capital we need is a construction loan. The developer has to spend all of this predevelopment capital, and we budget around $150,000-$250,000 on a typical predevelopment effort, to get a package we can present to a construction lender and to be in a position to secure a construction loan. In the last several years, to make it even more difficult, there has been a real credit crunch and construction lenders wanted to see at least 25 percent hard equity. Those of us in the non-profit sector that are undercapitalized don't have that equity. So while there is construction lending available today, only a few well-capitalized organizations can come up with that equity. 

There is nothing that prevents a non­profit from becoming well-capitalized by earning revenues on a deal in excess of costs. But beware of the non-profit that is well capitalized. The public benefit that we're promising the public and the Franchise Tax Board is irrelevant if we're starting to accumulate, as a company, significant net worth. You've got to look very carefully at the audits and tax returns of non-profits that can come up with 25 percent equity for a construction loan. We have to stay very thinly capitalized and put revenues we get in excess of our costs back into the public good in the form of lower rents and lower prices. 

So the non-profit bas to risk $150,000 to $250,000 to put a deal together and lay a construction loan package at the feet of the construction lender. The non-profit then puts on its knee pads and begs. If the non-profit can come up with enough equity and the lender doesn't pull the alarm bell, the non-profit may come out with a construction loan.

The third and fourths kinds of capital we need, go together. We need a long-term loan to take out the construction loan, and we need equity. We get most of our equity from selling tax credits. BRIDGE has sold over $100 million in the last several years. That allows the non­profit, by being able to raise quite a lot of equity, to get a permanent loan because only half the loan has to be financed. In theory, debt service on the other half is usually low enough that the rent roll will cover it. 

One of the problems we have today, with rising interest rates, is that we are talking about permanent loans where we need a forward commitment of 12 to 24 months. None of the lenders knows what rates will do, and that causes a rate risk. People are willing to absorb that rate risk, but rate insurance makes the deal less feasible. 

The Bottom Line 

The bottom line issue is that we need long-term lending, and well-oiled machinery capable of dispensing tax credits. The current tax credit round in Sacramento is an absolute disaster, riddled with problems—it's a scandal. You have people promising unbelievable rates of return to capture bonus points. These false promises knock projects out of the game that are playing by the rules. That is a scandal that bas seriously interfered with the orderly process of awarding scarce tax credits to the most sound real estate projects. 

As if those four elements of financing—venture capital, construction  loans, permanent loans and equity—were not enough, as a non-profit, cutting the margins thin, and not accumulating a lot of net worth, you must have a fifth stream of capital to cover your overhead. 

More Than Shelter Required 

And if that isn't hard enough, we have begun to realize that we can't just do housing, particularly when we're trying to work in an inner-city area. We have found that for our housing to be healthy, we've got to do some family and credit counseling, child care—a number of things that we don't know anything about as real estate developers. We have to add a whole array of supportive social services. We have to create the whole fabric of a community that has become frayed. 

On top of all these other issues, we also have to create jobs; the reason people have housing problems is because they are not earning enough money. We have to find and create jobs. 

The McNeil-Lehrer News Hour recently did a clip on one of our projects in Richmond. The only places for 28,000 families in this inner-city Richmond community to buy food were liquor and convenience stores. The last supermarket left the community 22 years ago. We realized that we also had to open a supermarket and a pharmacy, and a laundromat, a clothing store, and before long we were starting to build a shopping center. 

In Conclusion 

The aforementioned requirements and responsibilities explain why affordable housing development is so difficult, and the reason why the only people in our society that are likely to undertake these projects arc the non-profits—which have nothing to lose.