More is More: Embracing the Entire Shelter Spectrum
Two things can be true at once. We need more private housing and we need more public housing. Yes, we realize the latter will rub many of our more market-leaning readers the wrong way, but, please, suspend your disbelief for a moment.
Broadly, here are your options for building more homes:
Private housing funded by private companies who run for-profit businesses and raise capital via investors and/or access their balance sheets
Social housing that is usually run by non-profit or government organizations and raises capital via public financing methods (grants, bonds, tax incentives)
Unfortunately, private builders/developers are facing significant headwinds: labour costs are up, financing costs are up, permitting is taking longer, etc. Higher hurdle rates on new projects + higher costs = fewer projects that “pencil.” It’s not that these private players don’t want to build. It’s simply that the economic incentive isn’t there right now. This is especially true in cities like Toronto where all new construction can’t be +$1000 square foot luxury condos if we want to satisfy the broad and varied level of demand.
So, what happens when private markets seize up at a time when we desperately need new supply to offset rents that have accelerate well beyond real wage growth for many years?
Well, it’s probably worth thinking of this issue through the lens of the 2008/2009 GFC or the 2023 SVB run. When the gears of the private sector stall, the public sector (with its cost-advantaged capital) needs to fill the gap.
There used to be loads of social housing in Canada. In the 1950s and 1960s, housing affordability was getting challenging (much like today). Social housing projects saved the day to the tune of 20-25% of the housing stock for the following 25 years. This is a tool we've used before.
Chart by Brian Clifford (data from CMHC's Canadian Housing Statistics, multiple years)
Today, only 6-7% of Canada's housing mix is social housing. Why the relative collapse? In part the private sector took the lead as interest rates finally began declining in the late 1980s. In part the public balance sheets were stretched and required fiscal restraint.
Today, money is – relatively – expensive again and the private sector is simply incapable of doing the heavy lifting required. This is not a dynamic that will unwind anytime soon baring a quick reversal to the zero-bound (unlikely).
Chart by NBF Economics and Strategy (data via Fred and Statcan)
As a result (and assuming we don’t want a disorderly unwind), the public sector needs to (gulp) be embraced and we are indeed seeing the beginnings of a pubic developer renaissance.
One important, real-time case study is unfolding in real time in Montgomery County, Maryland.
Montgomery County’s Housing Opportunities Commission (HOC) established the Housing Production Fund (HPF) specifically for the purpose of building public a new standard of social housing. It’s first project, The Laureate, is a mix of affordable and market rate units and has an impressive list of higher-end amenities, including an outdoor heated pool and spa. The project leveraged federal subsidies and government loans and bandwidth from existing public agencies to essentially co-develop alongside for-profit-partners.
The innovation exists in the financing model - the county, via the HOC, issues AAA (tax exempt) bonds to raise a funds for the HPF. The HPF then issues ~5% construction loans that only need to be repaid once the project is fully leased-up at a “stabilized” state. These are far better terms than a standalone private developer would get from a private equity investor or bank and the savings can be passed along via a greater mix of affordable units (30% in this case). When the loans get repaid the project gets refinanced, freeing up the HPF to issue new loans on a continual, revolving basis.
The county retains control of the project to ensure its strategic vision (affordable units remain affordable) is realized while the developer can still earn an adequate rate of return commensurate with the overall lower risk profile of the project. It’s a win-win. And it’s beautiful.
What we’re trying to highlight is that high quality social/public/affordable housing is no longer an oxymoron. Financial engineering, risk sharing and tailored product offerings are not just for derivative traders. It can help unlock an important segment of the housing market that we desperately need. Is the public developer model perfect? Probably not. But supply is supply and we need it. Both private and public.