Better cost recovery of apartments can assist affordable housing crisis

Better cost recovery of apartments can assist affordable housing crisis
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Affordable housing has received renewed attention lately because of the disparate impacts of the coronavirus on low income Americans, many of whom live in crowded multifamily housing units. The recent report by the Joint Center for Housing Studies of Harvard University cited some factors driving the lack of affordable housing, one of which is rising construction costs. Washington lawmakers could take action to reduce these costs by 11 percent by improving the tax treatment of all residential buildings.

The study paints an interesting picture of the rental market. New rental construction is at some of the highest levels in years, but much of that investment is going to upscale multifamily buildings. Construction costs have jumped by nearly 40 percent over the last several years. As a result, the median monthly asking rent for unfurnished units is $1,620, which is nearly 40 percent more than two decades ago. While the numbers and percentage of upscale rental units has grown considerably over recent years, the number of units charging less than $1,000 has declined.

The folks caught in these trends are not only poorer households, but also middle income working Americans. After years of decline because of the growing economy, the study found that the number of renters burdened by housing costs, which means they pay more than 30 percent of income on rent and utilities, has started to rise again. Not surprisingly, this case is most evident in the larger and more expensive metropolitan areas.

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What can lawmakers do to provide more affordable housing? Low income housing tax credits meant to incentivize construction and rehabilitation of affordable rental buildings in poorer areas. However, these tax credits are awarded by state housing agencies through a complex and often difficult to navigate process with restrictions that can limit their assistance.

Lawmakers can bring down the construction and maintenance cost of all residential buildings by improving the tax treatment of these structures. Developers must currently depreciate, or write off on their books, all the construction costs of new apartment buildings over the course of almost 28 years. Developers also have to currently depreciate the costs of major upgrades to older buildings over the life of the structures as well.

Requiring building owners to write off construction costs over time raises the costs of the investment because a dollar deducted in almost 28 years from now is not worth a dollar deducted today. This all means that fewer potential projects, especially those designed for low income tenants, are able to fully recover the costs. It means developers devote even more of their efforts to build luxury housing complexes with higher margins.

To remedy this, the tax code could allow building owners to claim all the costs of constructing apartment buildings in the same year they are built. In most cases, however, that is not practical because there is little income from which to expense those costs. A solution to this problem is to index depreciation schedules by just enough to offset their decline in value over time. This kind of index solution is known as neutral cost recovery.

According to the Tax Foundation general equilibrium model, the index of long term capital investments in this way could reduce construction costs by 11 percent, which would make low income apartments more profitable to develop. An increase in the number of such apartments provides low income tenants with greater housing options and, in some cases, more bargaining power to negotiate for better affordable rental prices.

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The added benefit of neutral cost recovery over subsidy programs such as low income housing tax credits is that it lowers construction costs across the board, not only for those larger developers that have the expertise to comply with all the regulatory restrictions on building construction. This raises competition in the rental market and pushes down prices.

Joe Biden proposes to move the tax treatment of residential buildings in the opposite direction. He would make the tax code even less generous by lengthening the write off period for residential buildings. This would likely make affordable housing even less attractive investments.

Americans need more affordable housing. One important step lawmakers can take to address this issue is to update the tax code to allow builders and developers to more fully recover their big investments by indexing depreciation schedules through a neutral cost recovery system.

Scott Hodge serves as the president of the Tax Foundation in Washington.