John Edward teaches economics at Bentley and UMass Lowell. He’s a frequent contributor of columns on economic issues. Here is his latest:
America is the land of opportunity, isn’t it? Free-market capitalism, I thought, is the prevailing economic regime. Economics is the science of incentives. Profit is the ultimate incentive.
Why then, do some people begrudge modest profits when it comes to affordable housing?
A recent Chapter 40B rental housing application in Chelmsford raised this issue. Chapter 40B is a Massachusetts law that provides critically needed affordable housing. Disclosure: I serve on Chelmsford’s Housing Advisory Board.
One agitated opponent of the project claimed the developer was “getting fat, dumb, and happy.” Another expressed it as the developer “laughing all the way to the bank.”
Be aware that a construction company most likely made a profit on the house you live in. In general, successful developers do quite well when it comes to making money. Without profit, the only housing developed would be in government projects.
Chapter 40B enforces a cap on developer profit. For rental units, 40B limits the developer to dividend distributions of 10 percent of equity per year. Developers must have a large stake in the project because 40B regulations base the profit margin on equity. A monitoring agent examines project financials. Towns can recapture excess profits.
According to the Massachusetts Department of Housing and Community Development, the 10 percent profit cap for affordable rental units was set based on industry standards. Rather than “fat, dumb, and happy,” the metric is fair and reasonable.
In The Complete Guide to Investing in Rental Properties the author uses an example to illustrate calculating return on investment (ROI). In the example, the investor earns a ROI of 12.43 percent. The guide says: “This is not bad, but it is nothing to get excited about.”
Bankrate.com suggests a 15 percent rate of return as a benchmark for rental property.
An article from The Guardian reported on a failure to produce adequate affordable housing in the United Kingdom. It cited one developer’s objection to producing affordable units because it would make it difficult to make the “’industry-standard’ profit margins of between 17% and 20%.”
I found a closed-end mutual fund in the Value Line Investment Survey that invests in high-end and luxury apartments. Over the past ten years the fund’s net profit margin has averaged 16 percent annually. Value Line projects the profit for each of the next two years to be over 25 percent.
The developer of a 40B project faces considerable risk. They can spend a lot of money on proposals with no guarantee that local officials will approve the application.
Outside of Chapter 40B, homebuilders are free to make whatever profit the market will bear. In our market-based economy, the government rarely enforces a ceiling on profit. 40B caps profit.
Outside of Chapter 40B, owners of rental units can charge market rates. Most communities do not enforce rent control. 40B enforces strict controls over the rent charged for affordable units.
We need incentives to produce more affordable housing. Chapter 40B is designed to provide incentives. The incentive is not excess profit. The incentive is a process that allows developers to overcome obstacles that most Massachusetts towns put in place to discourage denser housing developments.
Some still refer to Chapter 40B as the “anti-snob zoning law.” In Massachusetts, most towns have very tight zoning restrictions on where they will allow building multifamily housing. Neighborhoods often muster strong opposition to proposed developments (as witnessed during public hearings on the Chelmsford project).
The need for affordable housing is dire in Greater Lowell. According to the U.S. Census, half of renters in the City of Lowell face housing costs considered unaffordable. Housing is considered unaffordable if the cost is more than 30 percent of household income. People living in these conditions often make difficult decisions about whether to pay the rent, pay the utility bills, buy enough food for the family, or visit doctors and fill prescriptions
In Chelmsford, 55 percent of renters face unaffordable conditions. One out of five renters in Chelmsford pay more than half their income toward housing expenses! In Carlisle there is almost no affordable housing.
In Econ 101, students learn that ceilings create shortages. If you put a ceiling on the land area available for affordable housing you will cause a shortage. If you put a price ceiling on rental units it will create a shortage. If you cap profits it will lead to a shortage.
Chapter 40B offers enough profit potential to encourage some developers to take on the obstacles and make an investment in the community. They are not “making out like bandits.”
A recent opinion column in the Boston Globe discussed opposition to a housing project in Hyde Park. The author observed, “People who make unconvincing arguments are usually good at listing lots of them.”
There are a lot of unconvincing arguments out there. Claiming that 40B developers are getting fat, dumb, and happy is one of them. Do not let anyone convince you otherwise.