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October 30, 2014

Is Seattle’s housing market falling into the ‘San Francisco Death Spiral’?

  • The Seattle City Council wants to tax new housing in an effort to lower housing prices, but that will just lead to rampant housing inflation.
    Smart Growth Seattle


    When you see a “For Lease” sign on an apartment building, you might ask yourself, “where did that rent price come from?”

    Many people, whether looking for housing or not, ask themselves that question. The price reflects the cost to build, maintain and operate the building (including things like taxes and utilities) divided among the units or leasable square footage.

    The price is also based on how many people want that particular unit and how many units there are like it. Fewer of those kinds of units, and the price will be higher.

    When rents increase people wonder if someone is making a windfall, but rising rents are a measure of falling inventory, more people shopping for places to live, and rising operating costs. And with 120,000 people moving here in the next 20 years, we will need lots more housing supply to keep up with demand.

    But the Seattle City Council is considering putting a tax on new housing in hopes, ironically, of lowering housing prices. The logic is that new jobs create a demand for housing, and housing causes an impact on the city by creating a need for more housing. That’s right, new housing creates a demand for housing. If we tax it, then we’ll be able to use the money we generate to pay for, you guessed it, more housing.

    In a recent Forbes article I wrote about how Seattle is beginning to emulate our neighbor to the south, San Francisco:

    “When have adding fees and costs to something that is increasingly scarce suddenly caused its price to drop? Linkage fees are part of a chain reaction effect of complaints about high rents, followed by the declaration of an emergency, policies imposed that will act to raise prices, followed by another round of yelling about rising prices, with more policy that raises prices. This is what I call the San Francisco Death Spiral, a city with rampant housing inflation and where the supply of housing is 100,000 units behind demand and even billions of dollars in subsidies won’t help.”

    Taxing housing to lower its price will just add costs to housing and act as a disincentive to build. We tax things we want less of. If there were a shortage of baby formula would we impose a tax on efforts to increase production of it?

    Here are some costs already associated with new housing in Seattle.

    1. Current affordable housing surcharge fees. The city already charges an affordable housing fee on development for many downtown projects. These fees are in the range of $2.5 million and up for a 400-foot-tall residential tower in downtown Seattle.

    2. Sales tax. Unlike cities such as Portland that actually provide tax incentives for housing development as a means for encouraging density, developers in Seattle pay sales tax that approaches 10 percent.

    3. Entitlement costs. The “Seattle Process” is alive and well in the complexity, time and expense that it takes to get projects entitled and permitted: often over a year, sometimes more.

    4. Land costs. The cost of developable land in Seattle is at an all-time high, and in many cases pushing financial limits. While land costs fall into the category of “the basis” or soft cost financial underpinnings of a deal, extraordinarily high land prices are now challenging many projects. And no, land prices won’t just drop dollar-for-dollar to match the fee imposed.

    5. Cost escalation. The City Council’s proposal comes at a time when construction costs for both labor and materials are on the rise, with many projects already on the verge of “not penciling,” meaning that they are on the border of financial feasibility.

    It’s important to note that costs cited in 2-5 above also impact nonprofit affordable housing projects. That means that subsidies used to build affordable housing get chewed up by these costs too.

    Mike O’Brien as Robin Hood?

    Seattle City Councilman Mike O’Brien would impose a tax from $5 per square foot at the low end, to an astronomical $22 per foot at the high end. For example, a 100,000-square-foot, five-story wood-frame low-income housing project in what the council is calling a “low-cost neighborhood development” would have to pay a tax of $500,000. The idea is to grab developer profit on new development to pay for subsidized rents; taking from the rich to help the poor.

    However, there is no way to cover the tax without borrowing more money, incurring interest costs on it, and paying for that with increased rents. And if the rents get too high, the project won’t work. Imagine you are trying to close on a new house and someone hands you a bill that increases your costs by 5 percent; you either wouldn’t get the loan or you’d have to find a part-time job.

    Similarly, almost every housing project is financed and must generate a return; when costs go up, money must be found to cover those costs, and that means higher rents. Lowering the percentage of return to the bank or an investor is not an option. There is no “profit” line in a pro-forma that can be trimmed. O’Brien’s proposal doesn’t take from the rich to give to the poor; it takes from one hard-working renter to subsidize another.

    The best thing we can do to positively impact housing prices is build more housing, something that can be done by incentivizing innovation and production, not penalizing it. And we already have a great housing levy that fairly taxes everyone for affordable housing, and the Multifamily Tax Exemption program that lowers taxes and passes the savings on to renters.

    Adding more costs will simply tip us toward the San Francisco Death Spiral: high prices, with politicians adding more taxes to subsidize housing, which raises housing prices, and repeat. This is not a sustainable way to prepare for hundreds of thousands of new jobs and people coming to Seattle in the next two decades.

    Roger Valdez is director of Smart Growth Seattle, an organization that supports growth, more jobs, and more housing choices in Seattle.

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