A Race to the Top for housing

By now, pretty much everyone acknowledges that the housing affordability situation on both coasts is a major cause of income inequality and, probably, a drag on growth.

Have been thinking about what the next administration could do to improve things.

The problem is obviously that cities control zoning and city governments tend to listen to home-owners, who, because they are effectively suppliers, favor laws / regulation that limit supply (and thereby drive up price).

Think I’ve found a useful analogy in education policy under the Obama Administration. There, the problem was that local governments have been captured by teachers unions, which do everything possible to improve the lives of teachers, even at the expense of students.

Under Obama, the federal government instituted “Race to the Top”, which was basically a contest among the states for extra education funding. To enter / win the contest, states needed to reform their education systems to improve curricula, allow some innovation, and institute systems for measuring student and teacher performance.

Imagine if Trump did something similar for housing:

  • Announce a huge pool of money to build housing that is affordable not just to poor people but to the middle class (perhaps even on a “for-sale” basis… to encourage home-ownership)
  • Direct the money to cities
  • Require that cities which wish to be eligible for the grants reform land-use to allow for greater density, particularly around mass transit

The above plan would have several benefits:

  1. Creation of a bunch of new housing in places where it is desperately needed;
  2. Create a bunch of construction jobs;
  3. Incentivize cities to allow for denser development, which will allow private developers to add even more supply

Now, if only I knew how to get this idea in front of Dr. Carson, our soon-to-be-HUD secretary…

Another ground-up going up

Thought you all would appreciate some pics of a small project we’re building ground-up.

The permitting on this one was an absolute bear, but now it’s done, the plumbing is in, the foundation is poured and we’re into framing.

Amazing how fast framing goes…




Maybe my favorite example of insane city land-use

Want to see insane city land-use in action?

Here’s a city-owned ~170,000 sq ft lamp-post storage yard:


Note its location, 1.5 blocks from a major Red Line stop and three blocks from Sunset Junction, the coolest part of Silver Lake:


[Map revised with help from PM – thanks!]

At 170,000 sq ft, if this property were re-zoned R4, you could build 170,000 / 400 = 425 units.

Add a 35% density bonus for including affordable housing, and you could build 573, all right near transit in a highly walkable neighborhood.

To a private, for profit developer, I bet the land is worth $20-40MM, easily. The city could use part of that money to buy a big industrial parcel in a much less desirable area and have PLENTY of money left over to fund, say, more affordable units elsewhere.

Or, it could do something really innovative and structure the sale so that ALL the units built need to be affordable. With the proper incentives (density bonus / property tax abatement / etc.) the city could get a developer to pay real money for the land (which would go to buying leasing replacement space for storage) and build a 100% affordable building.

Voila… lots of affordable units at no cost to the city.

Would 500-600 units solve our housing affordability problem? No.

But they would do a hell of a lot more good than our current, transit-proximate storage facility for idle lamp-posts.

Thinking through the implications of interest rate increases

Right now, the thing on everyone’s mind in real estate is the likely impact of increasing interest rates on asset values.

As the economy continues to improve, the stage is being set for the Fed to increase rates in order to manage inflation.

The Fed would probably have done this anyway, but Trump’s proposed combination of tax cuts and infrastructure spending are likely to be highly inflationary, likely leading to quicker and more forceful action.

Real estate values are highly dependent on interest rates. As rates go up, values go down, all things being equal.

So, the question is, are we in for a long period of rate increases and declining in asset values?

I think not, and here’s why: Interest rates don’t rise in a vacuum; they do so in response to rapid growth in the economy.

Rapid growth results in two things, both good for asset values:

  1. As businesses grow, they tend to generate more and more cash for their owners. These people need to do something with the cash… and some portion of it will end up in real estate, because other assets (like stocks and bonds) will also look expensive;
  2. As business grow, they employ more people for more money. This ought to result in increased demand for apartments and, therefore, increases in achievable rents.

The second factor is the one that is important to me (since I’m not a seller of real estate). The question is: How much do rents need to rise to counteract a rise in interest rates and, therefore, a rise in cap rates?

Assume you own the following building in:

  • Rents: $120k / year
  • Expenses: $35k / year
  • NOI: $85k / year

At a 5% cap, that building is worth $85k / 0.05 = $1.7MM.

If if interest rates move up by a full point and cap rates do to, then your building is worth $85k / 0.06 = $1.42MM.

But here’s the thing: If rents move up 15% (which is about two years worth of growth in a very strong economy), your building looks like this:

  • Rents: $138k
  • Expenses: $35k
  • NOI: $103k

And the value is $103k / 0.06 = $1.71MM… in other words, back to where you were prior to the full point increase.

Obviously the above example is a bit simplistic (expenses grow, too!). But it gets to the heart of the issue: Even a relatively sharp spike in rates triggering a 100 basis point up-tick in cap rates is swamped by a 15% rent increase.

Since rates generally only rise in response to strong growth, I’m not overly concerned about this new environment into which we’re heading.

Seeing the light at the end of the tunnel

In the beginning of Adaptive, we found ourselves in the annoying situation of having more deals than capital to do them.

We “solved” this problem by doing these deals on a fee-only basis (eg in exchange for cash fees but no upside in the deals). I put “solved” in quotes because this was a terrible solution from our perspective… the owners we helped made so much money on those deals that it makes me cry to think about it.

Over the past few years, Adaptive has moved into a new phase, one where we have sufficiently-strong relationships with capital providers that we can do any deal that makes sense.

I used to tell people that I wanted Adaptive to end up managing hundreds of millions of dollars of outside investor capital without having any idea how we would get there.

Now, mostly because we found wonderful capital partners and my partner executes the hell out of apartment projects, I can finally see how it will happen.

It’s not going to be by taking some gigantic leap. Instead, it’s going to be inch by inch, doing the same thing we’ve always done… finding under-managed assets, buying them for fair prices, avoiding making really stupid mistakes, doing high quality design, treating people with whom we do business fairly, under-promising, over-delivering, etc.

In other words, we’re going to keep chopping wood. But we’re going to do it secure in the knowledge that we are, indeed, going to get where we want to be.