Affordable: the Incentive Framework

Disclosure

• Political standing. In the US political framework, my bias would be generally left-leaning.

• Knowledge limitations. I don't have a finance degree. I have only conceptual knowledge of financial tools and instruments. I invite feedback, suggestions, and criticism from those familiar with the details. I know I have a lot to learn.

Intro

Affordable housing is first an incentive problem. A good, affordable design in a bad incentive framework will fail to remain affordable, which is why so many well-designed, affordable schemes have failed. Unless there is a direct incentive to keep the housing affordable, it will become unaffordable as it generates more profit. Therefore, successful, resilient, affordable housing, in addition to being well-designed, must answer the following questions:

• What incentives drive building affordable housing?

• Who has the incentives to build affordable housing?

Incentive Types

Build-to-invest

Lately, Profit Machine is treating housing as an investment asset, to the great detriment of everyone living in it. Housing is packaged into investment portfolios, and shares are sold to investors. Since it is highly lucrative, it is unlikely to change.

In this climate, there is a strong incentive to tag your property as luxury, whether it deserves it or not, and inflate its value; everyone is doing it. However, this crowds the luxury housing market and increases its risk.

Luxury units for sale will sit on the market for years, competing for a very limited number of people with deep pockets. For the same reason, luxury rentals will offer one, two, and even three months of free rent.

• Fun Fact. There is an incentive to give away months of rent for free rather than lower the rent. The value of a commercial residential property stems from the number of units and their monthly rent. Lowering the rent will lower the property value. The fact that the property is giving away free months of rent and is less profitable matters less than the property's overall value. The jig will be up once it goes into the red and loses a big chunk of its value in bankruptcy, but that’s a tomorrow-us problem.

The luxury market is the first to be hit during a recession. With less disposable income, even true luxury properties struggle to attract clients.

Luxury is a higher-risk, higher-reward property that suffers in a recession.

What does affordable housing offer? At first glance, affordable housing seems riskier because residents are at higher risk of insolvency or squatting (though there were high-earning squatters, too). However, this higher risk is well compensated for by huge demand for affordable housing: there are far more low-income people than high-income people. The property will be permanently full. In a recession, there will even be a long waiting list. While luxury developments are giving away free months of rent, the affordable ones will be in a position to increase prices (whether or not they should is between the property owners and their pastors).

Affordable is a lower-risk, lower-reward property that flourishes during a recession.

Affordable housing can be a great lower-risk investment, especially for people most affected by recessions (such as architects). Such investments are also in high demand for anyone closer to retirement.

Build-to-sell

Small build-to-sell players can't touch the high-density, chronically fauxury sector, as it requires deep pockets. Small developers must choose between low-density and medium-density housing, fauxury vs affordable, high vs low risk. Most small build-to-sell players will likely be more risk-averse and gravitate to the affordable sector.

Build-to-own

Build-to-own is a great way to precisely match residents’ finances to their housing. This is perhaps the only model with no incentive to inflate perceived value during construction. The only ongoing challenge is keeping construction costs down. This model took a hit in the 2008 housing crash, which made many residential architects exit the profession and never return, leaving the market wide open for the build-to-sell players. Perhaps architects should stage a comeback for the build-to-own model and find a way to be less affected in the next recession.

Players with incentives

Religion

When we explored government affordability schemes, I mentioned a couple of workable ones, but none can happen in the US because of a harsh political climate and the US government's deep integration into Profit Machine. Luckily, a certain entity in the US has many of the same properties as the government and could fill the void the government left in the affordable housing sector. This entity is religion.

The influence of religion in the US has been in decline in the past century: 27% of the US population is now unaffiliated, up from 2% in the 1940s. Many churches fall into insolvency and shut down as their congregations dwindle. This is an existential threat, and religion is hoping to reverse that and adjust its position in the world dominated by Profit Machine.

Religion realized that providing affordable housing could solve its woes and that it is uniquely positioned to do so. Despite the recent setback, Religion remains a powerful entity with a presence in communities of all sizes and densities; it owns a combined 2.6 million acres of land (larger than the state of CT), often in prime locations and NIMBY strongholds; enjoys tax-exempt status; and has strong constitutional protections. Thus, the YIGBY movement (Yes In God's Back Yard) was born.

Religious organizations have set a few precedents for creating affordable housing. Some churches elected to demo their churches entirely and build affordable housing with a place of worship on the ground floor (See St. John's Lutheran Church in Maddison, WI). The legal framework is currently state-dependent, requiring anywhere from 10% to 100% of the project to be affordable housing, but it’s overall lenient and even allows religion to skirt some regulatory and zoning restrictions.

I don’t think that Religion should be the only provider of affordable housing: what about those unaffiliated with any religion? However, Religion could make a sizable dent in the problem or even solve it outright. Perhaps they could even inspire other market players to build affordable housing to save their souls or as a PR stunt.

I would definitely encourage you to bring this scheme back to your church, especially if you see it is struggling. This could be a great way to save the congregation and live by what you preach.

Non-Profit

Non-profits are founded on good intentions, which is a problem in a system where good intentions lose to good incentives. The incentive structure of nonprofits is built on individuals donating their time and effort to feel good about doing the right thing, and companies donating money to score PR points and dodge taxes. This shaky foundation gives nonprofits highly irregular, limited revenue streams, undercutting their reach and impact.  Nonetheless, I’d be remiss not to call out non-profits for building projects despite overbearing constraints.

For-Profit - large

While most large players prefer to play with fire in the luxury sector, some large for-profit players are satisfied with lower, steady returns. I looked into their work, and they seem to suffer from many government ailments, such as cookie-cutter solutions. Also, they love the Fauxury Minus Marketing formula, so housing is affordable because it is unmarketable and sad. That is a problematic tactic. I have doubts a large for-profit entity can pull off successful affordable housing, but they are free to pluck my research for ideas and prove me wrong. If there is one thing I want to be wrong about 10 years from now, it's this.

For-Profit - small

The last and most important player with the incentive and ability to create affordable housing is the small for-profit player. It is an individual or two shielding themselves from liability with an LLC structure. Let's discuss it in more detail below.

Found Middle Initiative

Individuals choosing to become developers quickly discover their limited borrowing power. No banker in their right mind will give an individual off the street $50 million for a typical five-over-one project, even with a perfect credit score and no bad debts. At a minimum, you must show up with a site you already own, a concrete idea (in the form of drawings and renderings) about what you plan to do there, and a history of owning and renting out properties (a mortgaged apartment or two that you successfully rented out for a number of years). Even so, in the best-case scenario, you get a loan ranging from the upper six to the lower seven figures. This will firmly limit you to medium- or low-density developments. Those with high risk tolerance will go for low-density speculative luxury detached houses (all the best to them); the rest will go for medium, naturally affordable density.

Still, the down payment is an issue. Luckily, the site and drawing set can be your down payment, since each costs $50k to $150k. That's a tall order, so you must be ready to chase some grants or fundraise in the community. As an Architect, you must see a window here: a drawing set as a down payment. You can just make one. And you can pepper it with visuals to make it easier to convince the banker.

Making a drawing as a down payment is using your expertise as a down payment. No one in the economy can do that.

Maybe you can convince some of your favorite consultants to do the same. You are in a unique position at Profit Machine that puts you in a pole position to be a small developer ahead of the entire market.

INCENTIVES FOR ARCHITECT DEVELOPERS

• Recession Insurance. Aren't we tired of being fleeced every recession? 2008 wiped out 40% of residential architects. We should never let this happen again. Developing and owning medium-density properties will even out the feast-or-famine cycle of our profession, since affordable housing is in highest demand during a recession, when other sectors slow.

• Political Standing. No money or properties weakens all our advocacy efforts in Profit Machine, from sustainability to equity. We are being heard less and less with every passing year, relying on our profession’s reputation, though it won’t be long before nobody listens to us at all. It is time to build a solid foundation to be heard. And if we won't get heard, we'll do it ourselves. Also, a higher standing will help us shake the government for grants and regulations to keep the ball rolling. In other words, we move our profession from mostly activism to mostly action.

• Negotiating power. Having something to fall back on gives you more power and confidence to negotiate higher fees, recession or no recession. Architects' fees across the profession have been in a death spiral for some time now. We should reverse this trend.

• PR. I talk to many people outside of my profession, and I have to conclude that we have a reputation of arrogant pricks who put aesthetics above all else, including livability and common sense. We've been consistently out of sync with the public for a while (arguably forever). Also, if you ask a layman what an architect does, they'll describe an engineer or a construction worker. We are overdue for a realignment with the public and for a PR win. Affordable housing is it. Also, we do have self-imposed ethical obligations to the community, something that frequently takes a back seat in day-to-day practice, and this effort could help us fulfill our obligations better.

• Investing in ourselves. The most secure stock to invest in is the company where you are CEO, because it gives you the most control over the outcome and the highest returns. It is a well-known fact. An index fund is great, but it is a black box. It may go up, it may go down, and you have no control over either outcome. If you want to bet on anything, bet on your professional expertise. At least you control how good or bad you are. If you want to have your retirement fund secure in today's very turbulent market, maybe affordable housing is it.

• Decentralized effort. My first idea was to turn AIA into an affordable-housing producer within Profit Machine. No matter how I spun it, I couldn't marry the two; they kept conflicting. I realized that the only sustainable thing within Profit Machine is many individuals independently chasing their financial interests. Anything else, large, centralized, built on good intentions, will be subverted or destroyed by Profit Machine. That is why I pivoted from trying to leverage AIA to talking to my colleagues directly and showing them a lucrative path they can take individually.

• Risk Management. Demand for affordable housing is massive. The missing middle is missing; very few offer it. We don't compete with large luxury and fauxury developments. We have our own lane on the market, and it is wide open.

INCENTIVES FOR LENDERS

It is important to understand the flip side and discuss why a bank or government would lend money to small developers when plenty of large ones exist. As with everything in the Profit Machine, it comes down to establishing the right incentives. Never ask the Profit Machine to be charitable or humane - it doesn’t have a heart, only a calculator.

• Risk distribution. Giving $50m to one developer is an all-eggs-in-one-basket situation. It is a single project, single location, single business plan, single idea, so either 100% of it works, or 100% of it fails. Giving $1m to 50 people gives you fifty projects, locations, business plans, and ideas, which greatly distributes the risk: some will definitely fail, but most won’t. Both strategies are valid, and none is inherently better for the lender.

• Higher Profit Margin. Small developers have little negotiating power, so they will end up with a high APR, which means more profit for the lender.

• Higher Taxes. Many individual property owners will earn most of their income in wages, not in dividends, which means much higher tax per square foot. Also, small developers aren't as savvy at dodging taxes as large ones, and they're likely local and easier to reach and squeeze. On the flip side, kickbacks from smaller developers are smaller, and their numbers make it likely that at least one is a snitch. Let’s just say, whether municipalities prefer smaller or larger developers will depend on how they prefer to do business.

CORE PRINCIPLES

Let's see how the proposal responds to the core principles of affordable housing outlined in the first chapter.

• Long-term outlook. Personal financial security has a long-term outlook. High reliability and low maintenance costs will be a priority. We wouldn’t want the roofs of our own asset to leak.

• Strong Design. Architect-driven development guarantees strong design.

• Strong Incentive Structure. Outlined above.

• Equity over Equality. Our retirement portfolio's success depends on the success of the affordable housing we create. We can’t afford to put the residents in positions of failure.

• Ongoing Innovation. Innovation is the foundation of all our professions, and the initiative's decentralized structure guarantees it. There are no nationwide scripts and no boss to report to, except yourself.

• Defendable. We have a direct incentive to defend our assets from destruction or tampering by outside forces. We have no incentive to sell assets so someone else can flip them into luxury, and we have no incentive to flip them ourselves, since it means entering a far more crowded, aggressive, and risky market. This would put us back at risk in a recession, alienate us in the eyes of the community, and undermine our political standing; the list goes on.

PRECEDENTS

• Talk to Architects turned developers about the path they took and their experiences.

• Affordable housing in Duluth. Architects putting their skin on the line is nothing new. Below is the winner of a 2022 AIA Minnesota/McKnight Foundation Affordable Housing Design Award. Benjamin Olsen and Ryan Huges developed it at Office Hughes Olsen. Josh MacInnes with 1LLC.

• Do you know other examples? Feel free to reach out to me and share!

Conclusion

Creating an incentive structure for affordable housing is half the battle. Good intentions always erode under the pressure of incentives, so perhaps it is time to put incentives first, but do it in such a way that good intentions become their inevitable outcome.

If we succeed, we can continue doing what we love, designing great, enduring buildings, while knowing we contribute to the solution, not the problem.

Our profession is risk-averse. Doing your own thing and taking risks is scary for everyone. However, knowing that middle housing is the likely solution for affordable housing, knowing that our profession had a big part in destroying it, knowing we are in the best position on the market to bring it back - is it ethical to remain risk-averse and do nothing?