Public Comment

Corporate Economics and Development

Steve Martinot
Friday October 09, 2015 - 08:58:00 AM

At a recent Zoning Adjustment Board (ZAB) session in Berkeley considering a proposal to build an 18 story apartment building in downtown ( Sept. 30, 2015), a claque of people called for “market rate housing” as the only way to resolve the current housing crisis. They prevailed over critics of the project.

Let's get something straight. The term “market rate” with respect to housing is not a "standard" or calibration of anything. It is a result. “Market rate” is the effect of other causes. It cannot be used to standardize a social category in the same way the notion “median income” can calibrate a community’s economic potential. Yet “market rate” appears as a number.

As an effect, and though it appears as a number, “market rate” is not an economic term. It is a political term. It refers to a political environment in which price structure is neither regulated nor controlled. That is a political environment because its opposite, rent control and housing regulation, are themselves political acts that relate housing rents and condo prices to residents rather than to landlords. Rent control, affordable housing, and subsidized rent are all attempts to rescue people from the being victimized by artificially high housing costs. They are all political issues, responding to an economic state. When a community calls for a "moratorium" on market rate housing development, as the San Francisco Mission district community has done, it is demanding a political change in the domain of housing. “Market rate” simply refers to that sector of the housing situation that is not under any control or regulation. It refers to what some people are willing to pay for unregulated and uncontrolled housing.

"Affordable" housing ties rent levels to income. It provides, through a government office or program, that a tenant family will pay only 30% of its income for rent. Thus, it stands opposite market rate housing. In Berkeley, the majority of people pay a lot more for housing than 30%. Indeed, tens of thousands of people pay more than 50% of their income for housing. For them, market rate housing belongs to a market to which they have no access. “Market rate housing” is an exclusionary term. And as such, it becomes a form of victimization insofar as housing is a human right and a necessity. To have a job, to get and education, to make use of social services, one has to have a place to live.

What was really at issue in the Berkeley ZAB meeting was economics. There were actually two different versions of economics presented by the two sides at the meeting. They were not only at loggerheads; they showed that they lived in different worlds. 

One side, proclaiming the advantage of “market rate housing,” said, “build the building, we need the housing, there is a housing shortage in this town.” And the other side said, “there is a critical housing shortage in this town. If you build this building, it will get worse.” The first had faith that if market rate housing is built, there would be housing for everybody. The critical side argued that if this building were permitted, it would set a precedent for similar buildings throughout the city, and property values throughout the city would be warped upward, leading to an elevated “market rate,” a shift in commercial infrastructure to higher priced trade, and a general increase in the cost of living. The effect will be that medium and low income families would be driven out of town. If, for the wealthy (executives and technocrats), this constitutes progress, for those on the low side of the income gap, it will mean massive dislocation. In other words, there is no "everybody." 

The Berkeley ZAB voted in favor of the first group, and rejected the arguments of the second. 

A tale of two economies

In this confrontation at ZAB (it was not a debate; real debate is prohibited by the very structure of these hearings), the first group (let us call them the traditionalists) held that merely building many housing units will bring down rent levels according to the law of supply and demand. As supply goes up, meeting and surpassing demand, prices will go down. In some bland innocent way, this means that providing housing for the top of the price pyramid will open up housing at the bottom. It assumes (in some weird trickle-up process) that people paying medium level rent will leave their housing and move up to the new higher rent housing, thus paying more, while leaving their medium rent housing for those who can afford it. One doubts that would happen. To consider it as a norm is probably to suffer from some condition described in the Diagnostic and Statistical Manual. 

The other side (the critics) contended that if housing is built for people at the bottom of the pyramid, namely affordable housing, it will be quickly filled (by the thousands who now pay more than 50% of their income for housing. And that will open housing units for residency at higher rent levels, namely those looking for housing that fits their higher income, who will thus find vacancies. 

The crux of this matter lies in why it is for the most part possible to find developers who will build high income or market rate housing, but not affordable housing. It is this economic fact that makes the traditionalists argument look realistic. But if we look deep inside that fact, we can see how it becomes a form of victimization, with attendant massive dislocations, increases in the cost of living, and general gentrification of the city. 

There are two economic levels to consider, the street level and the financial level. 

When high income housing is planned, speculators arrive and buy houses at above market rates in the knowledge that real estate prices will rise even further. They thus become an early factor in raising the market rate. When the new housing units are built, and rented or sold to high income people, commercial landlords will raise the rent on stores in that neighborhood, forcing out establishments that catered to low income people, in order to create space for stores catering to higher income people. Landlords do this because they can, and will profit from the higher rents they will collect. As commercial prices and real estate values rise, other property values will rise with them, leading to increased taxes on low income people in the neighborhood. Many will begin to sell their houses and move out. Thus, the specific shift from non-wealthy residents to wealthy residents initiated by market rate development becomes generalized throughout that community. Those who need affordable housing (the "everybody") will find no housing available to them; indeed, what housing had been available will have fallen prey to the general rise in rent levels. 

To see how massive the resulting dislocation can be, we have only to look at San Francisco, across the bay. Having built skyscraper apartment buildings with market rate housing, rent levels in that city are now the highest in the nation, and whole communities are suffering from massive evictions, as landlords seek to change the wealth levels of their tenants. In other words, this process will be felt as a disaster by the majority, though not by the wealthy. 

San Francisco is showing Berkeley what its future will look like. But beyond that, what San Francisco gentrification demonstrates is that every rent increase that landlords impose becomes tantamount to an expulsion order, a condemnation to exile. 

Now, let's look at the financial aspect of this, which is what really drives it. In a corporate economy, the law of supply and demand no longer works. When traditionalists invoke it, it is only as a statement of faith. To give an inkling as why this is so, let us consider an iconic statement so often heard from a corporate spokesperson: “we had to raise our prices in order to remain competitive.” Though this makes no sense in terms of supply and demand, it resides at the heart of corporate operations. 

Corporate economics focuses on financial factors, such as securities prices, debt structures and interest rates. Its actual production (goods, services, information, etc.) is wholly conditioned by these factors. The reason is, for publicly traded corporations, that when they finance on-going operations with debt, they generally use their own stock as collateral for that debt (security that the loan will be repaid). As corporations grow and become more complex, more debt is needed to finance operations. It is like the farmer who must borrow money to get through the growing season (to buy food, clothes, tools, etc.) until the crop is harvested and he can pay it back. But this use of stock as collateral means that the corporation’s principle focus must be on maintaining the value of its stock (and other securities) on the stock market. If that value drops, then the value of its collateral does also, a deficit for which the bank will demand restoration (with cash or other securities), or it will call in the loan. This possibility puts the corporation on the brink of a liquidity crisis (unable to pay its wage and salary bill), or in an extreme case bankruptcy. 

Most of the developers that a city deals with are small non-traded corporations (not traded on the stock market) called LLCs (Limited Liability Companies). The LLC form gives developers advantages over a private investor because it can handle risk better, it shields against liability, and it can call upon a wider range of asset forms – property, promisory notes from others, securities, asset acquisitions, contracts, and even itself – to use as collateral for loans. One incorporates to widen the spectrum of assets available to collateralize debt, and banks find it more desirable to deal with corporations than private individuals. Like a publicly traded corporation, an LLC’s primary interest is not in the product (a building) but in the financial dealings it opens up. 

For LLCs, a threat similar to traded corporations impacts them through their debt structure. The primary concern of a development corporation is its ability to recapitalize the project. That is, if the developer runs out of money, he must be able to organize the debt on the project in such a way that someone else will find it attractive (profitable) to buy the building. Some buildings have been sold a few times even before completion. Insofar as the building itself, before and during completion, is a major part of the collateral for bank loans, that recapitalization potential is critical. 

And this is where including affordable housing becomes a detriment. Affordable units are apartments that are regulated by the government to be rented at 30% of the tenant’s income. They not only cut into the profits from full rental of the eventual building, but sale of the building is more complicated (even during construction) owing to government involvement. It considerably lowers the potential for recapitalization. Thus, such a building has more trouble getting bank loans because it presents higher risk (of non-recapitalization). From a corporate standpoint, it is better to avoid including affordable housing (by paying mitigation or in-lieu fees) than including such units and being unable to recapitalize later. 

Now we can decipher that mysterious corporate statement that jettisons the law of supply and demand. When a corporation raises prices for goods or services in our human (retail) economy, it does so to increase earnings. Increased earnings will generally make its securities (stocks, bonds, etc.) more attractive to speculative money on the securities markets, “out-competing” other corporations for those same moneys. The competition to which it refers is not product competition but that on the securities markets. This also implies that this corporate financial structure is what fuels the unending inflation we experience. As speculative money raises securities price levels, it enables greater corporate debt, which also means higher interest payments. That and a rise in underlying asset value (means of production) is expressed in an increase in the price of goods. In other words, it has not been wage levels or union contracts that have driven prices up. It is the corporate debt structure, producing inflation through its need to increase the price of securities. 

Thus, corporate finance stands in opposition to affordability (rent tied to income percentage). And “market rate” housing reflects this corporate inflationary process, rather than a law of supply and demand. If affordability expresses government regulation, corporate operations require regulation to be minimal or non-existent. It is the absence of regulation that allows landlords to raise their rents to whatever level they can get away with. And low income renters are the victims of non-regulation. Only regulation will produce housing that low income families can afford, not development by corporations. Low income people will be housed only through political action – city council attention, neighborhood organization, or political movements to democratize society’s priorities. And that is because corporate interests are alien to human interests, despite the human need for shelter. 

Today, the city has given corporate developers free reign through its mitigation fees, its mismanagement of the Housing Trust Fund (now depleted and unreplenished), and its pro-development commissions. It even threatens our ability to go shopping – one of the impending casualties of development will be Grocery Outlet, which a lot of low income people depend on for their food. 

Gentrification is a result of market rate housing, its natural outcome. Only political regulation of housing, providing housing for everyone by providing housing for low income families first, will prevent the catastrophe of massive dislocation and the destruction of neighborhoods. Regulation is what stands opposite gentrification. In that context, to believe in the law of supply and demand is like believing in Santa Claus.