Tuesday, October 27, 2009

Affordable Housing and Corruption at City Hall, Part II

If you’re trying to make money, then, as I pointed out yesterday, you need cheap land and you need volume. Most of the time, land is going to be cheaper in the poorer parts of Dallas. There is also less opposition to affordable housing in low income areas (remember here that I’m talking affordable housing, not permanent supportive housing for homeless people). That’s because it is often as nice or nicer than anything else in the immediate neighborhood. So in order to make money as an affordable housing developer, you are going to work in the poorer areas of the city, and they are overwhelmingly minority.

But you also need volume. “One offs” like CityWalk are expensive. You’re doing everything for the first time.

It’s much easier and faster to do the same thing over and over again—as Henry Ford taught us all. So a successful for-profit affordable housing developer builds as close to the same thing every time as is possible.

A successful for-profit tax credit developer also builds the projects themselves (like Brian and Cheryl Potashnik, pictured in the window of one of their projects, did). The reason for building the project yourself is pretty straightforward. You can get eleven percent of the cost of the project (6% for overhead and a 5% profit) for doing so. This is important because the profit on a tax credit deal is otherwise very marginal. There is the potential for a large profit way down the road, usually 30 or 40 years, when the rent limitations expire, but until then the margins are razor thin.

Building the projects yourself, in the same way every time, also mean that you get good at it. The same architects draw almost the same plans, which are then executed by your construction company using the same subcontractors and the same materials. This is the way subdivision builders make money; the way any mass real estate developer can keep prices down and still make money. It’s efficient.

There is a special problem with applying this method to tax credit projects. Even market-rate mass developers have a problem dealing with the vagaries of the market. In order to keep your construction team together, you have to keep it working. That means a constant stream of new projects. For a for-profit tax credit builder, that means winning awards of tax credits every year.

Tax credits are awarded on a competitive basis and a good for-profit builder should be able to win tax credit awards on a regular basis, if the builder has the support of the local community and political leaders. But that’s a big “if”. The consequences of failure are immense.

A for-profit tax credit developer may be going along building three projects per year for a long time, but then if an important political figure turns against the builder, that builder could be out of business in a single year. Without something to build, you have to let your construction people go. Once you let your team disperse, then you have lost your competitive advantage—that means no future awards and you are out of business.

Getting an award every year means making the political leaders happy, and when the choice is making the politicians happy or going out of business, the pressure to cross legal and ethical lines to do so is immense.

So, in short, the whole system is structured to encourage volume building in low income neighborhoods, which are often led by political leaders with limited means but the ability to put a developer out of business just by withholding their support. That’s a situation perfectly structured to encourage improper activity.

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