Low Rent Projects Don’t Pencil Out

News Item:  According to the July 14^th edition of the Modesto Bee, Modesto’s newest public housing project will cost about $274,000 per unit to build. The Tower Project will be built at 17th and G Streets in the old water tower park. Will the project deliver good value for taxpayers?

Basic Apartment Finance

In the private sector, apartment buildings are constructed with an expected rate of return on capital of about eight percent or more. A return of five percent might be acceptable if the investor expects rents to rise. If rents rise, the rate of return increases over time, so the investor may be willing to accept a lower rate of return in the short run.

If the rate of return is inadequate, the apartments won’t be built. At $274,000 per unit, a private investor would not build it even if he could get fair market rent! Since taxpayers are footing the bill, no one in elected office seems to be concerned about whether the project pencils out. No one is looking to see whether the cost per unit represents a good value.

In Modesto, $274,000 today would buy a 4 bedroom home of over 2000 square feet. The apartments to be constructed will not be anywhere as large and would not be a comparable value. The Housing Authority would deliver a better product to the community if it purchased existing vacant single family homes and rented them out. Modesto presently has a large supply of vacant homes owing to depressed real estate values. If the law does not allow the Housing Authority to purchase single family homes, should the law be changed?

Simple Math

Simple calculations can determine how far out of whack the public housing project’s expenditures will be. At $274,000 per unit, with an 8 percent rate of return, net rental income on each unit would have to be $21,920 per year or $1826 per month AFTER expenses. If one figures that monthly expenses for property management, maintenance, and depreciation represent a minimum of twenty percent of rental income, the gross monthly rent on each unit would need to be $2191 in order to pencil out. Modesto does not have any apartment buildings that yield a rental income high enough to pencil out in this case.

If we do the same calculation with a rate of return of only 5 percent, the net rental income on each unit would need to be $13,700 per year or $1141 per month. Adding the twenty percent in operational costs, the gross monthly rental income of the project would need to be $1369. Modesto may have upscale apartment buildings that yield that amount of rental income. Many single family homes rent for less.

Why the Project Is Being Built

Low rent public housing projects are being built all over the United States and no one locally seems to care about the excessive cost per unit because the money is coming from the federal government. The Modesto City Council certainly doesn’t want to stop the project, even if it is a bad deal for the taxpayer.

During this writer’s service on the City Council from 1999-2003, he questioned the per unit cost of a low cost public housing project. He was told by a colleague to shut up because the project was being funded with federal money and if the council didn’t approve the project, the money would be lost to the community. Back in those days, the cost of construction per unit was much lower, but still seemed high. In recent years, costs per unit have risen faster than the rate of building construction and the value of existing real estate.

The City of Modesto is getting a project that will infuse a substantial sum of money into the local economy and provide some housing for its most economically challenged citizens. Taxpayers don’t seem to notice the high cost per unit and the programs have minimal oversight.

Defenders of the program state that the high cost per unit is the result of special government requirements, including union labor. However, this excuse does not justify the cost of the program.

The Never Ending Need for Public Housing

If one checks with the local Housing Authority, a long waiting list always exists for subsidized rents. The tragedy is that if every project built was cost effective, or if existing vacant properties were acquired, many more units could be put into service for the same amount of money. Many more people could be served with a better quality of life. Local property values would rise as public housing could soak up the surplus of existing single family homes. While we should all care, no one seems to.