How Government Affects Housing Economics

So far this series has treated the building's costs as if they arose on their own. They do not. Nearly every line of the pro forma we built in Lesson 3 is shaped by a public decision: how many homes may stand on a piece of land, what they must be made of, how long approval takes, what fees are owed, what taxes are paid, and what subsidies, if any, are available.

By the end of this lesson you should be able to take almost any housing rule and say which line of the budget it moves and in which direction. We will not tell you whether a given rule is worth its cost. Our job is to make the cost visible so the tradeoff can be judged rather than guessed.

One rule of thumb

Most rules act on the building through cost, and cost becomes rent through the arithmetic in Lesson 4. Under the publication's default financing assumptions, that arithmetic reduces to a single conversion worth memorizing.

The conversion is linear, so a rule that adds $2,500 per unit adds about $17 a month and one that adds $40,000 adds about $270.

Rules about what may be built

The rules in the zoning code decide the shape of the building before a single cost is estimated. Density limits set how many homes a site may hold. Floor area ratio caps the building's total floor space relative to the lot. Setbacks and height limits fix where the walls can go. A parking ratio sets how many spaces must accompany each home.

These rules mostly work through the land line. Land is bought by the site, not by the unit, so the number of units allowed determines how much land cost each home carries. In our illustration the site costs $2,400,000. At 100 units, that is $24,000 per unit. If the allowed density were 75 units instead, the same land would cost $32,000 per unit, and fixed costs such as the elevator, lobby, and approval process would be spread across fewer homes too.

Parking deserves its own mention because it works through the hard-cost line and can be large. Structured parking costs more per space than surface parking, and a required space is a cost with no rent attached. The launch article What Does a Parking Space Actually Add to Rent? applies the rule of thumb above to that question.

Rules about how it is built and approved

Building codes govern structure, fire safety, energy performance, accessibility, and much else. They act on hard costs. Each standard exists to prevent a specific harm, and each adds cost. The question a code change raises is never whether safety matters but how much a given increment of it costs, and who pays.

Approval timelines act on the financing and soft-cost lines. Winning an entitlement, the legal right to build a specific project on a specific site, can take months or years. While it does, the developer carries the land and the design work already paid for. The publication's canonical example is a 12-month delay carrying $6,000,000 of land and soft costs at 8%, which costs $480,000, or about $33 per unit per month on 100 units. Projects that qualify as by-right, meaning they meet the code and need no discretionary vote, carry less of this cost and less uncertainty.

Prevailing wage requirements set minimum pay rates for construction labor on covered projects, often as a condition of public funding. They act on hard costs, since labor is a large share of construction. Inclusionary zoning requires a share of units to be rented below market. It acts on the income side: the below-market units collect less, so the remaining units must collect more, or the project needs a subsidy or density bonus to compensate.

Fees and taxes

An impact fee is a one-time charge levied on new construction to fund the roads, schools, parks, or utility capacity that new residents will use. It is a soft cost, and it is paid up front, so it is financed like any other cost and converts to rent at the rule-of-thumb rate.

Property taxes are different because they recur. They sit in the operating expense line, in our illustration inside the $6,000 per unit per year of operating expenses, and every dollar of annual tax must be covered by a dollar of rent, grossed up for vacancy. An abatement or a payment in lieu of taxes agreement lowers that line for a period of years in exchange for something the public wants, often affordable units.

Utility connection charges and the cost of extending water, sewer, and power to a site also land in the budget; whether the public or the project pays for that infrastructure is a policy choice with a direct rent consequence.

Subsidies and incentives

Government can also push lines down. The Low-Income Housing Tax Credit brings in equity from investors who receive tax credits in exchange, reducing the amount of debt and conventional equity a building needs, in return for long-term rent limits. Tax increment financing lets future property tax growth from a project pay for infrastructure the project needs. A historic tax credit offsets part of the cost of rehabilitating an older building. An opportunity zone designation lowers the tax on capital invested in certain areas, which lowers the return that capital requires.

Each of these substitutes public money, or forgone public revenue, for private cost or private return. The useful question is the same one we ask of every rule: what does it cost, what does it buy, and would the building have been built without it?

The map

Notice that the levers pointing up are mostly rules and the levers pointing down are mostly money. A jurisdiction that adds requirements and then adds subsidies to offset them is, in effect, paying to have its own rules complied with, which is sometimes exactly the intent.

Every lesson so far has ended with a required rent. The last lesson asks whether anyone will pay it, and what happens when they will not. Next lesson: Lesson 8: How Supply and Demand Affect Rent.