Housing Affordability: Colorado's Atmosphere of Legislative Uncertainty Will Hurt Housing Affordabil

This past summer, millions of people added the term “Atmospheric River,” to their meteorological lexicon.

 
Just one of these flowing columns of condensed water vapor, gliding 10,000 feet overhead and extending over 2,000 miles long, can have an average flow rate 15 times greater than the Mississippi River at its mouth. Atmospheric rivers pass uneventfully by many regions, but where they make landfall, as an unusually large one did in California, they reshape entire landscapes.

 
Yet there’s an even larger river flowing above and around our communities. It’s invisible to both satellites and the naked eye alike, but it has the capacity to shape our cities for generations.

It is the great river of financial capital that swirls around the world ceaselessly seeking assets in pursuit of investment returns. One asset class, U.S. commercial real estate, managed to scoop up just under $400 billion of capital flow in the four quarters ending September 2023, according to CBRE Research.

 
But capital is fickle. It can effortlessly flow across borders and between assets classes. Indeed, the $400 billion invested this past year in U.S. commercial real estate was less than half the $928 billion that found its way into the same asset class during the prior year.

The flow of investment funds matters because the construction of new apartments – an essential component of housing affordability - requires a staggering amount of upfront capital. The builder of a 200-home apartment community in the Denver metro area today must typically raise over $80 million for their project.

 
Crucially, most builders can only afford to provide a small portion of the total capital required for their project, typically 2% or less. They raise the rest from the lenders and equity investors whose capital flows so freely around the globe.

 
Diverting the capital from that great atmospheric river is no small feat. A builder in Denver competes with investments of every type in every city around the world. The builder must convince savvy capital providers that, against the myriad alternative investments, their project is the best use of the investor’s capital.

This leads to the intractable conundrum that haunts builders, policymakers, and affordable housing advocates alike: new housing will only be built if it is expected to generate enough
revenue to pay for the capital required to build it.

In the case of apartments, those revenues come from the rents paid by residents of the new community. If the rents aren’t high enough to produce satisfactory returns, the capital in that
great atmospheric river will flow to some other investment in some other city and the project here at home will remain unbuilt.

 
Meanwhile, the unalleviated shortage of housing puts upward pressure on rents, leaving residents to grapple with higher living costs, and creating a ripple effect felt throughout the community.

But what determines how high the returns – and therefore the rents – must be to attract capital for new apartment construction?

Ultimately, that depends on the level of risk and uncertainty that capital providers perceive in the project. And one of the greatest sources of risk and uncertainty comes not from the project itself, but from a source entirely removed from it: the legislature.

 
Policymakers striving to address various issues in the housing market often create new laws and regulations. Paradoxically - and tragically - a legislative climate in which new housing legislation is continually introduced can hurt the very people the laws seek to help.

Part of the reason is that the effect of new laws takes time to work through any complex system and few systems are more intricate and complex than cities. As succeeding rounds of housing legislation are passed, uncertainty increases about the eventual effect of enacted laws, not to mention potential problems from pending proposals.

 
In response to an ever-shifting regulatory landscape, capital markets add an “uncertainty premium” onto the level of returns required to entice investors to risk their funds on commercial real estate projects. Higher costs, in turn, raise financial the bar for builders trying to secure funding for the construction of new housing.

 
As legislative risk makes projects become less financially attractive, capital diverts to other, seemingly less risky investments in other markets. This results in fewer new apartments,
a persistent supply-demand imbalance, and higher rents than would otherwise be necessary.

 
Evidence of this effect is abundant. Despite being short 340,000 housing units, New York City – inclusive of its five boroughs and 8.5 million residents – approved just 10 multifamily buildings with a combined total of 279 apartments units this past July. Manhattan saw zero new units approved that month.

 
In its article, “Why It’s So Hard to Find an Affordable Apartment in New York” the New York
Times bemoaned “an invisible web of constraints,” that prevented the production of housing and cited burdensome regulations as one of the main contributors.

 
In St. Paul, Minnesota, voters approved a sweeping rent control law in November 2021 to alleviate housing unaffordability. That change made it nearly impossible for builders to raise capital for the new housing units the city so desperately needed.

In the five months following the passage of the St. Paul’s rent control ordinance, new multifamily permits plummeted 82% while in neighboring Minneapolis new multifamily permits increased by 68%.

Addressing housing unaffordability is too important and too urgent to get wrong. By fostering a stable and predictable environment, we can encourage the flow of capital into the construction of new apartment buildings and the preservation of existing properties. This will lead to a greater supply of housing units, which in turn will help stabilize rents and make housing more affordable for everyone.

 
Like the phenomenon of atmospheric rivers, real estate capital markets are part of a complex,
globally connected system. By understanding the interplay between capital, uncertainty, and regulation, policymakers can develop strategies that promote sustainable housing affordability without hindering the development of vital new housing units.