Financial Feasibility - It’s Complicated
More homes in Palo Alto are good for sustainability, equity, seniors, schools, and retailers. This includes “missing middle” homes (like condominium townhouses, and apartments), at both market and below-market prices.
Don’t Make Me Do Math - “Penciling Out”
But new homes will not get built unless they “pencil out” – meaning construction is economically feasible to a builder. This complex arithmetic takes into account the cost of land, building materials, and labor. Interest rates and other borrowing costs are factored in the equation, since just about every housing developer borrows money to build housing. Future returns from home sales or monthly rents are assumed as part of the calculations.
Financial feasibility often turns on local government policy, as shown by “Making It Pencil,” a recent report from the Terner Center at UC Berkeley. The authors surveyed real estate professionals regarding the construction of one type of homes (market-rate, mid-rise rentals) in four California areas (including Oakland and San Jose). The report concludes:
There are some policy changes that could get these projects closer to feasibility. Specifically, policymakers have the ability to lower costs by reducing requirements for parking, lower impact and permitting fees, and allowing for increased density.
Palo Alto Forward has called for these policy changes, too.
Myth of the Evil Developer
When we talk about the economic feasibility of home construction, who’s holding the pencil? Often it is non-profit home builders. For example, Palo Alto is considering proposals from two non-profits, Alta Housing and MidPen Housing, to build new affordable homes on city-owned parking lots downtown. Further, for profit developers also build affordable projects - consider the affordable housing project for teachers that is proposed on El Camino Real.
Because our political and economic systems (i.e. capitalism) rely almost entirely on private developers to supply housing, investment in housing projects must be worth the economic risk.
This is true for many facets of the U.S. economy. For example, as part of our transition towards renewable energy, we pay companies for solar panels, wind turbines, electric bikes, and heat pumps. Likewise, to get new train service, we pay companies for locomotives. In public policy debates, it is uncommon to hear denunciation of clean energy or mass transit on the grounds that a private company may earn a profit by helping to meet our policy goals.
Of course, housing for all also requires government subsidies for affordable homes for those with very low incomes and those who are differently-abled. But in the end, the vast majority of housing is built by for-profit developers and that is unlikely to change in the near term. We need private development to pencil out if we want more housing for our kids, workers, and older adults.
What Can We do Locally?
Let’s ensure new homes can pencil out, right here in Palo Alto. To do so, the Terner Center suggests some great first steps: decrease parking requirements, decrease impact fees, and increase density limits.
These are all items Palo Alto Forward has been advocating for over the last few years, and we will keep it up!