Fat Dumb and Happy

 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.

3 Responses to Fat Dumb and Happy

  1. louis g marino says:

    You fail to mention that there is 2 types of 40b predatory and ones built by the town.9 times outta 10. The developor is in it for profit if a developor isnt in it for profit then the dont belongin bussiness. I speak though experince of sitting on a local zoning board of appeals. Also I as a town meeting rep stand by my fellow residents. I support the 40b on littleton road. I think what the developor in the mill road project fails to understand is the actions they take has impacts on the people around like increased traffic increased danger to our childern. Just like I stand witb the residents of the westlands on the glenview landfill issue and the issue of putting mcdonalds in the chelmsford mall. I have a vested intrest in the westlands area as my youngest daughter attends the westlands school. I dont think the residents are fat dumb stupid I have wrttenabout state mandates and the state cramming thing’s down our thorats. Our voters in this town are sick of the status quo. Thats why we had only had a 15.4% voter turn out. I will also support at town meeting this fall I will support. Making the zoning board of appeals elected and accountable to the voters of the town not a single person.

    Louis g marino
    270 littleton road
    Chelmsford mass.

  2. Jeff Apostolakes says:

    The 40b topic is one of which state laws and regulations make for an adversarial relationship between town, residents etc. Mr Edward point out some important information that many town officials even have difficulty wrapping their arms around. The key to these proposals is for everyone to be involved and do the best we can with the laws as written.

    It is mentioned in this article “Chapter 40B is a Massachusetts law that provides critically needed affordable housing.” While that may be the intended goal of the state, the end does not always accomplish the needs. There are some laws that should be looked at For example: The cited recent application that was approved in Chelmsford was for 108 units. The developer would not drop the number of units because it does not ” fit their business model.” I certainly understand business models. However of the 108 units, only 20% will be affordable with the remaining majority of units rented at “Market Rate” So if In Chelmsford, 55 percent of renters face unaffordable conditions, other than these 20 units how does it solve the problem. It doesn’t and the only way to really address the problem is to allow for more developers to build these Hi density projects. Additionally one should know that of the 108 units only 20% are truly affordable, and here is the fact that has not been disclosed…..As long as all 108 units are ” Rental units” all 108 apply to the 40b affordable housing stock even though they are not truly affordable. There are much larger , more complex issues involved.

    Te author of this column certainly has a concern for affordable housing and I commend him on his efforts. I certainly would like to work closely with Housing Advisory board to come up with real solutions that will address “Truly affordable issues” and help those 55% that face unfavorable conditions find a home. There are formulas that will calculate what Market rate is but in reality many in need do not meet the median income and cant afford market rates.

    It is a difficult situation that many towns face due to state laws.

  3. John Edward says:

    Jeff’s thoughtful comments deserve a response, in particular the issue of 40B units that are not classified as affordable. Jeff refers to units that do not solve the affordability problem. Others have called them units we do not need. Actually, the market-rate units do help with affordability, and there is a need.
    First, you can be sure (and the Housing Advisory Board asked) that developers conduct market research that shows a demand for the market-rate units. There are people in Chelmsford looking to downsize, there are people in Chelmsford looking to upgrade, and there are people who would like to move to Chelmsford. Market-rate rental units offer a good price point for those who can afford more than 40B affordability.
    Second, if you increase the supply of market-rate units, all else being equal, you will lower the market rate (i.e., the price of housing).
    Third, the business community of Massachusetts has been saying for at least a decade that one of the biggest obstacles, if not the biggest, to the growth of the state’s economy, is the lack of affordable housing. When the business community thinks of affordable housing they are not typically thinking about 30%, 50% or even 80% of median income. They are thinking middle class. Some companies that pay quite well have trouble finding workers who want to live in an area with such high housing costs, and some companies do not locate here for that reason.
    Finally, as the column says, 40B is about incentives. 40B offers an incentive for much-needed rental units, by allowing ALL the units to count toward the town’s goal of 10%. That means rental projects bring the town much closer to achieving control over where future development will occur.