Housing Affordability

The lack of housing affordable to our residents comprises our region’s greatest challenge, one felt intensely by thousands of working families. It’s also felt by every employer who struggles to hire and keep good workers here. About half of all renters fit in the category of “rent-burdened” by traditional measures, and 70% of younger Americans say that buying a home will be harder for them than for their parents.^[1]

Despite the national scope of the housing crisis, Congress has largely abdicated any responsibility to do anything about it. Several federal tools—such as housing choice vouchers and Low-Income Housing Tax Credits—continue to be available since their creation decades ago, but Congress needs to step up with new ideas to address our current housing crisis.

The Rent Is “Too Damn High”

Renters have suffered disproportionately from our region’s housing crisis.^[2] Despite the very high rents, new multifamily housing construction has ground to a halt in the Bay Area, due to very high costs of construction and financing.^[3] Accordingly, we should expect already-painful rents to skyrocket in the years ahead, fueled by severe housing supply constraints.

The federal government, which has amounted to only a minor supporting player in the multifamily housing market since the 1970s, can and must play a role in addressing the dearth of multifamily housing. Why? Because this isn’t simply a crisis of affordability in the Bay Area but in nearly every major metropolitan area in the nation.^[4] Yes, this is a federal problem.

1. Revitalize Empty Downtown Commercial Buildings

In the Bay Area, the steep cost of construction and financing has stalled multi-family housing development, but there’s another real estate crisis afoot: commercial real estate. Nationally, almost 20% of office space sits vacant.^[5] In San Francisco, the vacancy rate is almost 40%, while in San José, the vacancy is almost 30%.^[6] This has spurred news coverage of downtown “doom loops,” as restaurants, retail stores, and other small businesses shut their doors in central business districts due to a lack of foot traffic and increases in crime, two mutually reinforcing phenomena.^[7] Hotels have similarly suffered, and retail vacancies persist in most markets.^[8]

We can find opportunity in this crisis, however, by rehabilitating some of those empty office, hotel, and retail buildings into apartments and condos. According to SPUR, if we converted just 40% of San Francisco’s vacant office square footage to housing, the city would see more than 14,000 new housing units.^[9] The struggles of office markets in San José, Mountain View, Palo Alto, and Redwood City present smaller but similar opportunities.

What are the advantages of focusing federal investment in our office-rich, occupancy-poor downtowns? Retrofitting already-built high-density buildings won’t ruffle the feathers of any suburban neighbors, so we can streamline approvals and public processes. The addition of thousands of new residents into Bay Area’s downtowns will revitalize many restaurant and retail districts. We’ll dramatically reduce greenhouse gas (GHG) emissions by repurposing existing buildings—better for the planet than building new—and ensuring that their new residents will live within walking distance to transit, retail, services, and jobs. We can add housing without adding to traffic.

So, why aren’t more folks doing it? The cost. Converting offices to housing—particularly on the West Coast—is prohibitively expensive. Installing plumbing in every apartment, retrofitting windows, separating utilities, and the like drive up construction costs. Even worse, regulatory requirements that accompany a change in a building’s use, such as seismic retrofits, fire sprinkler installations, and additional stairwells, bloat the project budget.

That’s not to say it’s too costly everywhere. In prior decades, with lower construction costs and interest rates, both Los Angeles^[10] and New York^[11] launched successful office conversion efforts, and lower-cost metros such as Cleveland and Cincinnati still do so today.^[12] Other commercial uses—such as hotels and retail—offer promise for conversion to housing as well.^[13]

Admittedly, only about 15 to 20% of office buildings in most downtowns can be feasibly converted into housing, for various structural reasons.^[14] But here’s the good news: it appears most feasible to rehabilitate the least desirable buildings for continued office uses—typically, the older, pre-1960s buildings with small floor plates and many small windows.^[15] Struggling hotels appear much easier to convert, so provide a strong case for federal focus as well.

That should be the focus for federal action. While the Biden Administration recently announced some regulatory improvements to facilitate more office conversions, there are no new resources to help builders bridge project funding gaps, especially in today’s high-interest-rate environment.^[16] There are also no federal tools that will incentivize local jurisdictions to streamline permitting or reduce fees.

Congress can dramatically reduce the financing costs by authorizing tax credits (similar to the existing New Markets Tax Credit and Low-Income Housing Tax Credit programs) to help builders finance the costly conversion of vacant office and commercial buildings to housing. Developers would supplant high-cost debt with the tax credits, and equity investors typically take a lower return in exchange for tax benefits.

It’s not simply the tax credit that would boost housing production, however. Congress could leverage these dollars to clear red tape, reduce construction costs, and accelerate production. Specifically, the law could require state and local governments to reduce regulatory burdens as a condition of receiving federal tax credit allocations. For example, the Treasury could condition any issuance of tax credits on the city and state’s commitment to streamline approvals, allow by-right zoning changes in downtowns, waive or reduce local fees, and exempt the downtown projects from environmental review processes like the California Environmental Quality Act (CEQA). Builders might even receive an abatement on property taxes by including a defined percentage of rent-restricted, affordable units.

If cities don’t want to participate, they don’t have to. Those willing to lean in on their local housing crisis will see their downtowns benefit from all of the new housing and private investment, typically $8 of private investment for every $1 of New Markets Tax Credit.^[17] Some low-income renters will benefit from the rent-restricted units, but all renters in the city will benefit from the injection of a new supply of housing that will help reduce rents citywide.^[18]

The program could be similarly utilized to repurpose long-declining malls and hotels, both industries that have suffered in the past decade. By rehabilitating existing buildings, we’ll eliminate blight, improve the climate, create jobs, and even reduce crime.^[19] Best of all, we’ll build housing.

2. Empower Homeowners to Become Housing Providers

We can expand housing supply in other ways that don’t require destroying hillsides or steamrolling single-family neighborhoods. For cities and towns that choose to participate, we can launch a federal program to help modest-income homeowners—those who struggle most to get financing for home improvements—to install accessory dwelling units (ADUs), also known as backyard homes or granny units. These homes enable naturally affordable rental housing while providing rental payments that can help struggling homeowners to pay their mortgage.

We’ve already seen how cities can dramatically expand ADU production by simplifying permitting processes and reducing fees for homeowners. In San José, for example, the planning department worked with prefabricated ADU builders to pre-approve two dozen models of different layouts and sizes, and homeowners could select any of those options online and receive a permit within a single day.^[20] As a result, our ADU permitting spiked from about a dozen per year in 2015 to 525 by 2022.^[21] In 2020, ADUs comprised one-third of our new housing permits.^[22]

Some of those permitted units didn’t actually get built, however. The obstacle for many homeowners is financing: if they lack sufficient equity in their home, they can’t get a loan. My team and I spent hours talking with decision makers at several banks and credit unions, seeking to find a way to facilitate lending. They all pointed to problems with recourse, where mortgage lenders already had a first lien on the home. They agreed that it was a “good risk” to lend to a homeowner who seeks to add value to their property and potential revenue to their income, but those lenders told us they couldn’t issue large quantities of such loans that would satisfy conventional lending standards.

Federal intervention can help. Government-sponsored entities like the Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”) have shown how to reduce risk and broaden access for the millions of homeowners they serve. Fannie Mae and Freddie Mac repackage diverse pools of conventional mortgage loans for investors, and then provide a “backstop” guarantee for this new, diversified pool of assets.^[23] This process reduces risks for lenders, reduces interest and financing costs for borrowers, and expands lending capacity in the market. Congress can establish a similar loan guarantee program for homeowners who want to add a backyard home at no or little cost to the federal budget.^[24]

Can this make a difference in housing supply? For California towns, ADUs can provide a community-friendly way of satisfying state mandates. A 2019 survey of San José homeowners revealed that nearly one-third of them would have seriously considered building a backyard home if they had financing to do so.^[25] If only half of those homeowners actually follow through, that would amount to 30,000 new homes—or more than have been built in a decade. Cities like Vancouver, where 35% of single-family lots have ADUs, show us what can be possible, at least in those cities that choose to support ADUs.^[26] We’d expect far fewer in more suburban towns.

Many ADUs might simply be used to permit more multi-generational living—to care for an aging parent, or to prevent adult children from being pushed out of the Bay Area. That’s certainly not a bad thing. To better target the program, federally-backed lending might be restricted to homeowners willing to lease their units for some minimum duration, such as five years, at a restricted rent affordable to a nurse or a teacher. Even at those levels of rents—a bit more than $2,000 today for someone who makes about 60% of our area median income in Santa Clara or San Mateo counties—a Bay Area homeowner could have ample rent to pay off the financing and still have something left to reduce living expenses. Regardless, backyard homes can provide a mechanism to produce thousands of units of rental housing in a housing-starved Bay Area and lessen the burden of mortgage payments for homeowners.

Reducing Costs and Expanding Access to Homeownership

Of course, most young families cannot buy a home in our region. To afford the median home price in the counties of Santa Clara or San Mateo requires an annual salary of nearly $360,000.^[27] Yet this is not merely a local problem. Typical home ownership expenses remain beyond the reach of average local wage earners in nearly 80% of America’s 578 largest U.S. counties.^[28]

Here are a couple of ideas about what the federal government can do about it, that could actually get passed in a divided Congress:

1. Boost Sales Inventory by Doubling the Exemption on Capital Gains Taxes

Many homeowners who might otherwise happily sell their homes to downsize have felt “locked in” in recent years by the steep tax consequences of that decision. This has left the market with a very thin inventory of homes for new buyers. High mortgage interest rates have exacerbated the problem, but even as they ease, most homeowners will still shun paying the tax on the capital gain of their home.

Decades ago, Congress created what’s called an “exclusion” from capital gains taxation for older homeowners up to $125,000, but it was eliminated in 1997. It instituted a universal $250,000 per individual, or $500 per couple, exclusion instead.^[29]

The problem: the exclusion has not changed since. If adjusted for inflation—and home values have increased far faster than inflation—it would be twice as high today. Since the exclusion hasn’t been adjusted for inflation in over two decades, many CPAs advise their older clients not to sell, and simply pass the home on to their heirs, who can sell the home without paying any capital gains tax at all, through what is known as “stepped-up-basis.”^[30]

As a result, the current system presents us with a lose-lose-lose. Younger home buyers encounter a much smaller inventory of less-expensive older homes, while the U.S. Treasury loses revenue due to fewer home sales and diminished tax revenue.

The last time that Congress updated the exclusion in 1997, the housing market saw a substantial boost in home sales.^[31] Congressman Jimmy Panetta proposed a sensible bill last year to double the exclusion with bipartisan support, but it has languished in committee.^[32]

We need to pass that bill to expand the inventory of older homes.^[33] We should also consider getting ahead of the next “freeze-out” by indexing the exclusion for inflation in the future, and “kick-start” the housing market by making the exclusion expansion retroactive.

What about the cost, and how to pay for it? The current exclusion will account for about $52 billion in lost tax revenues 2024, according to the U.S. Treasury Department.^[34] The Congressional Budget Office has not yet published an estimated cost of the Panetta bill, but there are several reasons to believe that doubling the exclusion will add only a fraction of that amount to the deficit.^[35] Congress could pay for it with a commensurate reduction in the exclusion for capital gains on death, which exempts estates from paying tax on the increased value of assets left to heirs. What is the impact of these changes? In the aggregate, U.S. taxpayers won’t pay anything more, but we’ll see more housing supply, improved affordability, and increased economic activity. That’s not a bad trade-off.

2. Stop Rubbing SALT in the Wound for Middle-Income Homeowners

In the last major changes to the tax code in 2017, President Trump sought to achieve corporate tax reduction as part of a larger tax bill, but needed to find ways of paying for it. He and Congress landed on several ways to do so, including imposing a limit on the income tax deduction for state and local taxes (“SALT”) to $10,000. Since married couples filing jointly remain subject to the same $10,000 cap, this provision is sometimes described as a “marriage penalty,” because two people individually could claim a $20,000 deduction.^[36] The SALT reduction was met with groans from many homeowners living in Silicon Valley, the Peninsula, and Coastside, where even homeowners with modest incomes have high property taxes to pay.

Eliminating the cap altogether, as some have proposed, would irresponsibly inflate the annual deficit by nearly $170 billion, and nearly 80% of the benefit would accrue to the wealthiest 20% of taxpayers.^[37] Both equity and fiscal sensibility argue for a more modest approach. By merely doubling the cap, and including all but the wealthiest 5% of home-owning taxpayers, the cost would drop to less than $2 billion annually, and provide many middle-class families with thousands of dollars of tax relief.^[38] A targeted restoration of the SALT deduction for married couples can provide fairness at a reasonable cost.

1. Kaysen, Ronda. “More Renters Than Ever Before Are Burdened by the Rent They Pay.” The New York Times, 22 May 2024. ↑
2. “Housing burden: Nine-County Bay Area vs. California.” Bay Area Equity Atlas. ↑
3. Cull, Ian. “Here’s why apartment construction has stopped in South Bay.” NBC Bay Area, 28 Aug. 2023. ↑
4. Schaeffer, Katherine. “Key facts about housing affordability in the U.S.” Pew Research, 2022. ↑
5. “Q4 2023 Preliminary Trend Announcement.” Moody’s Analytics, Jan. 2024. ↑
6. Budman, Scott. “Bay Area office vacancy rates hit all-time high.” NBC Bay Area, Jan. 2024. ↑
7. Karlamangla, Soumya. “How Did San Francisco Become the City in a ‘Doom Loop’?” New York Times, Nov. 2023. ↑
8. Mehta, Neil. “San Francisco Is Sinking in Bad Hotel Debt.” Wall Street Journal, 11 Aug. 2024. ↑
9. “From Workspace to Homebase.” SPUR and ULI San Francisco, Oct. 2023. ↑
10. Goodrich, Andrew Robert. “Heritage Conservation in Post-Redevelopment Los Angeles: Evaluating the Impact of the Community Redevelopment Agency of the City of Los Angeles (CRA/LA) on the Historic Built Environment.” USC School of Architecture, Dec. 2013. ↑
11. Beauregard, Robert A. “The Textures of Property Markets: Downtown Housing and Office Conversions in New York City.” Urban Studies, vol. 42, no. 13, 2005. ↑
12. “CBRE Analysis: Cleveland Has Highest Percentage of its Office Stock Targeted for Conversion.” CBRE, Sept. 2023. ↑
13. “The Rise and Fall of Office to Multifamily Conversions: A Real Estate Investigation.” CBRE, 14 Mar. 2023. ↑
14. Gupta, Arpit, et al. “Converting Brown Offices to Green Apartments.” National Bureau of Economic Research, 2023. ↑
15. Beauregard, supra. ↑
16. “FACT SHEET: Biden-⁠Harris Administration Takes Action to Create More Affordable Housing by Converting Commercial Properties to Residential Use.” The White House, 27 Oct. 2023. ↑
17. “New Markets Tax Credit Program.” U.S. Department of the Treasury Community Development Financial Institutions Fund, Sept. 2020. ↑
18. Li, Xiaodi. “Do New Housing Units in Your Backyard Raise Your Rents?” NYU Wagner and Furman Center, 2019. ↑
19. “New Study Finds that Providing People Experiencing Homelessness with Housing has Positive Impacts on Health, Crime, and Employment.” National Low Income Housing Coalition, 2021 ↑
20. “Preapproved ADUs.” City of San Jose. ↑
21. “ADU Permit Activity Dashboards.” City of San Jose. ↑
22. Klein, Nanci, et al. “Housing Crisis Workplan Update.” San Jose Legistar, Oct. 2020. ↑
23. Lee, Matt. “Are mortgage-backed securities backed by any guarantees?” Investopedia, May 2022. ↑
24. “Estimates of the Cost of Federal Credit Programs in 2023.” Congressional Budget Office, Jun. 2022. Noting, “The guarantees that Fannie Mae and Freddie Mac are projected to make in 2023…would save the federal government $33.8 billion but would cost $3.9 billion on a fair value basis.” ↑
25. “San José’s “Yes, In My Backyard” Affordable Housing Program.” Institute for Local Government. Accessed 2 Sept. 2024. ↑
26. Bertolet, Dan. “Why Vancouver Trounces the Rest of Cascadia in Building ADUs.” Sightline Institute, 2016. ↑
27. “Home Affordability Gets Even Tougher Across U.S. During Third Quarter As Home Prices And Mortgage Rates Rise Further.” ATTOM Team, Sept. 2023. ↑
28. Id. ↑
29. “Topic no. 701, Sale of your home.” IRS, 2024. ↑
30. “Step-Up in Basis.” Tax Foundation. ↑
31. Shan, Hui. “The Effect of Capital Gains Taxation on Home Sales: Evidence from the Taxpayer Relief Act of 1997.” Journal of Public Economics, vol. 95, 2011. ↑
32. “U.S. Representative Jimmy Panetta, Rep. Panetta Introduces the bipartisan More Homes on the Market Act.” U.S. Representative Jimmy Panetta, 2022. ↑
33. Klein, Robert. “Doubling the Residential Exclusion Amount is a Win-Win.” The Street, 2022. ↑
34. “Tax Expenditures FY 2024.” U.S. Department of the Treasury, Mar. 2023. ↑
35. First, there will be offsets with new revenue accompanying a boost in home transactions in the early years of the change, relative to the discounted future years of foregone revenue. Second, many selling homeowners won’t have capital gains of less than $250,000. Third, the U.S. Treasury will benefit from the reduction in the exempted capital gains for heirs if more homes are sold prior to the owner’s death. ↑
36. Shaw, Tim. “House Blocks SALT Marriage Penalty Relief Bill.” Reuters, 20 Feb. 2024. ↑
37. Wamhoff, Steve. “Weakening the SALT Cap Would Make House Tax Package More Expensive and More Tilted in Favor of the Wealthiest.” Institute on Taxation and Economic Policy, Aug. 2023. ↑
38. “Lifting the SALT Cap: Estimated Budgetary Effects, 2024 and Beyond.” Penn Wharton Budget Model, 8 Feb. 2024. ↑