A County in Maryland Came up With a New Way of Building Affordable Homes

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1:16Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal. And I'm Tracy Alloway. Tracy, let's do another housing episode. Why not? Let's do it. No, you know, I think I've said it before to you. I don't know if I've said it like on the show. One thing I like about housing episodes is like, no matter what, it is just like this permanent source of anxiety for everyone. Everyone has an opinion on it. Yeah. And everyone was born to short housing. You know, they need to cover their housing short at some point. And if you have, you know, if you don't have a house, you're anxious about rent and house prices going up.

1:51If you have a house that you own, you might be anxious about it going down, et cetera. Like there's just, there will never be an era of any market in which I don't think like some people are like anxious about housing in one way or another. Well, OK, so housing is a perennial source of interest for sure. But I also think we're kind of in this unusual moment for housing as well, because no one, as we've discussed on multiple episodes at this point, no one is quite sure what's going to happen to the market. And there's been this discussion of perpetual supply shortages of housing. But at the same time, there's this discussion of as interest rates go up, whether or not we're going to start to see an impact on prices.

2:28It just feels like there's a lot of uncertainty at the moment combined with these sort of long term structural issues. Totally. And it feels like there is something you said structural and it feels like one particular structural flaw in sort of the way we do housing development in this country, which is that, you know, and we see it right now, which is that, you know, the Fed has been trying to fight inflation, cool things down. a big source of inflation over the last few years have been rent prices. So you want to get down rent. So you raise interest rates and hopefully that cools things down and maybe that works, maybe it doesn't.

3:01But one effect that seems to have is it seems to impair the supply side as well. Right. And then you're like, OK, maybe in the short run, you cool things down and rents go down a little bit. But you actually set yourself back, it would seem, in the long term goal of having affordable housing abundance. Yes. So I remember Jerome Powell specifically said that they wanted to bring house prices down. Well, I don't know if he explicitly said that, but you know, something along those lines, they wanted to impact the housing market, bring prices down in order to bring inflation down, which makes a lot of sense.

3:35But on the other hand, people want affordable housing for obvious reasons. And if you're sort of crushing that market, you can imagine a lot of people are going to be upset. Right. There was a question of Powell. It was sometime early this year, maybe last year. I think it must have been last year. And someone's like, what would you say to someone who wants to buy a house and they see mortgage rates shooting up? And he's like, well, yeah, it's tough, but then we'll cool things down and then things will be better. But all that's really happened is prices are still really high. Supply is impaired.

4:04Rates are up. So housing affordability is basically the worst level in like five decades, maybe ever. So I think on record, according to Jim Egan over at Morgan Stanley. Yeah. Yeah. I think you're right. And so then the question is, what are we doing here? Do we need a different model of housing development beyond what we have in the country right now where we have like developers and home builders sort of fluctuating how much they build based on various market conditions? Well, absolutely. And I think historically there have been sort of two dominant ways of tackling the affordability problem in the U.S.

4:39housing market. And it's either we build more houses, more supply, which, as you just pointed out, can be difficult in the current interest rate environment. And even if we do build more housing, because developers are a savvy bunch, they tend to build more expensive houses for people who are going to pay a higher price so that developers can make more money. And then the other way we tend to deal with affordability is, I think, through voucher programs like Section 8 and maybe building public housing to some extent. But as you point out, there is a third way. There's a third way. There may even be a fourth or fifth wave, but let's at least talk about a third wave.

5:19So I am excited. We have two guests today who have been working for a while and thinking about are there other models for housing development beyond the two that Tracy just laid out. I'm very excited. We're going to be speaking with Zach Marks. He is the chief real estate officer at the Housing Opportunities Commission, Montgomery County, Maryland, as well as Paul Williams. He's the executive director for the Center for Public Enterprise, who's also working on these issues alongside Zach. A little bit of a personal disclosure that I have to get out off the bat right at the beginning of the episode.

5:53Paul and I are friends. We play music together. Oh, I thought you guys were joking. I didn't realize you were actually in a band. So you are actually a member of Light Sweet Crude. Yeah, yeah. Paul plays, he and I write songs and play guitar together. So if you want to just ignore this entire episode because you've perceived there to be a glaring conflict of interest, You're welcome to turn off the episode right now. Paul, do you know I've been forced to buy tickets for your upcoming show? Joe won't comp me. I had to buy them. That's fantastic. It's good for the economy. It hurts no one. Exactly.

6:26Zach and Paul, thank you guys both for coming on the podcast. Thanks for having me. Why don't we start with you, Zach? You've been working in this area. What does the Chief Real Estate Officer at the Housing Opportunities Commission of Montgomery County, Maryland do? Or if you just want to say, what is the Housing Opportunities Commission do? That's fine too. Yeah. You know, fancy name for really the housing authority for Montgomery County. So a fairly typical governmental entity. We also happen to be the housing finance agency, which is a lot less typical. Typically those are two separate governmental entities and these are both combined and contained under the HOC shingle, if you will.

7:01And so for a bunch of decades, HOC has been providing affordable housing in different ways. It started as a pure play public housing authority, so just building public housing in the 70s. But over those decades, because of where it's located, and we can sort of get into some of those drivers if you wish, but kind of because of where it was located, the combination of the housing authority and housing finance agency, it has sort of continually innovated around how to deliver affordable housing. And they've basically developed a large portfolio of real estate assets, which many public housing authorities across the country kind of own public housing and that's it.

7:41HOC owns, I think we're somewhere in the vicinity of 9 ,400 units. And it happens to be that Montgomery County real estate is very valuable. And so my job is really to figure out how to further expand that portfolio through acquisition, through new development, and to also make sure that the existing portfolio is continually reinvested in and maximized for its potential. I'm going to start with an even more basic question, potentially. But what is it that Montgomery County is actually doing that is different to the way we've traditionally dealt with housing affordability issues? Yeah. So Montgomery County has answered that question kind of a few times.

8:19And then the things that it's done have become more standard practice. It started as, I think, arguably the first to implement inclusionary zoning several decades ago. So that was an inflection point of innovation. They also were among the first to begin to use a condominium regime. This starts to get super technical, but a condominium regime in the way in which LIHTC, low-income housing tax credit equity, could be used to finance mixed income buildings. What's the word you said? Condominium? Condominium regime. Oh, condominium. A condominium regime. Yeah. Okay. So typically the low-income housing tax credit program, which is the standard way in which affordable housing is produced in this country at this point, generally speaking, because of the rules and the structure of the program, will generally force a building that's somewhere between 80 % and 100 % affordable.

9:07And what HSC did was it began to basically develop mixed income buildings where the majority of the units in the building were market rate. It would basically form a condominium for the market rate units and a condominium for the low-income housing tax credit units. and effectively execute two transactions, even though they're, you know, they're effectively in the same building. And so that was a really important innovation because it was a way in which to deliver HOCs, what's become HOCs mixed income model, where you have this affordability being delivered in what are otherwise class A plus majority market rate, socioeconomically mixed buildings.

9:42So let me make sure that I've got this straight. So historically, the government either built public housing or they encouraged private developers to build housing, a portion of which would then be dedicated to lower income households. But what Montgomery County is doing is somewhat different in that they're financing sort of a mix of private income and lower income residences. Is that right? Yeah, it's really the taking an ownership position in a building that has market rate units is not something that's widely practiced. And so it's really taking the position that we should also really be a majority or outright owner of these assets.

10:27That's really kind of what's at the core of what they did and what's at the core of this latest, I guess, innovation that we're, I think, here to talk about. So, Paul, let me bring you in here. So in addition to your music, you're also the executive director for the Center for Public Enterprise. Tell us from your perspective what it is about the work being done at Montgomery County that feels different to you and your work in sort of spreading the gospel to other public authorities that could do something similar. Yeah, the core way I look at the kind of innovative programs that HSC has come up with is that currently all affordable housing that gets built in the United States is funded with either the low income housing tax credit or Section 8 vouchers.

11:08That's it. And in basically every state in the country, every jurisdiction in the country, those programs are fully oversubscribed. Every dollar that Congress appropriates gets used to build that housing. And the wait list for eligible households, we have to build at the current level for 75 years to get there. It's not going to happen. So the tool that HOC has come up with is something that allows them to, in addition to using all of those current programs from the federal government, they can self-finance and build mixed income properties on top of everything that they're already doing. So a lot of times in kind of affordable housing policy circles, what happens is, you know, you want to take the same pie of federal subsidies and say, how can we chop it up a little bit differently to make it a little bit better for this person or that person?

11:56What this is, is it just a completely separate pie. And the model is essentially just going out and being a participant in the housing market, right, and building these mixed income projects because of the tools, access to capital, statutory authorities that an agency like HOC has. And that's what's kind of new and innovative that not very many people are doing. And so what my organization has been doing on this is essentially take, it's a really simple model, right? It's just not all that much work to do, not very many complicated financial pieces. And we can get into it, but it's relatively simple.

12:31Take this model to other agencies that are seeing the same kind of housing market constraints and say, this is a pretty simple approach you could be using to expand overall production, affordable production, and for really a kind of de minimis upfront investment. All you really need to do is kind of think a little bit differently about how you operate as a public agency, right? You might want to participate in the market and shape it a little bit.

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14:28Discover how at MasterCard.com slash commercial acceptance. Can we talk more about the money aspect of this and the financing arrangement? So you just used the term self-financing. It's government agencies, so I guess they can go out and raise money through the bond market and then just loan that to themselves. Is that the idea? Yeah. I mean, that really is generally the idea that I think Paul's right. Mostly what we're doing is conceptually very simple. It's really just sort of a tweak to how we're employing it. And so to start with, HOC as the housing finance agency is able to be a lender to its projects and has been for a long time.

15:06You know, the FHA risk share program is a really a standard tool provided by HUD to certain sophisticated housing finance agencies that, you know, is for the express purpose of producing affordable housing faster and more efficiently. And so HOC has been for a long time the senior permanent lender, sometimes construction lender on its projects. And so that was already a part of the toolkit. And so the next piece is really that equity piece. Where does that chunk of equity come from, the part that the debt won't cover? And effectively, what we worked with our local council to do was to use municipal finance as the source of our construction equity, which typically it comes from two places.

15:48One, the low-income housing tax credit. And as Paul mentioned, that's very limited. We're already doing all that, basically. Or it comes from the private market. And that is a particularly expensive piece of capital. Can you give us an idea of the difference in the cost of capital between public and private? And maybe if you could just sort of give us like a, I don't know if it's a stylized financial model. I mean, I get the different pieces, but I don't know. So maybe pencil it out in words, if it's possible, like what a deal looks like. So one of these essentially is taking the, it's really taking the conventional American private equity real estate model.

16:24And it's just pulling it over to the private side. So the way in which... The public side. To the public side, I'm sorry. Yes, to the public side. And so, you know, typically the private sector, conventional finance, is a private bank loan for the construction debt. And then a huge pile of equity because the bank's typically only giving you somewhere between 50 % to 60 % of what you need. And then maybe a private developer puts a tiny bit in of their own. Often not, but maybe a little bit. But for the most part, it's that big 35 % chunk that's going to come from all the folks that inhabit the big, tall buildings around the one we're in that fund those projects.

17:01And really, our thought was really take that model, pull it in. And instead of using that capital, we can use our municipal finance tools to basically lower the cost of that capital substantially. And most importantly, from our view, is to put HSE in the position as a majority or outright owner of the project, which has all the knock-on effects that everybody likes. And I think to stylize it a little bit more and to give some kind of examples, Zach sometimes talks about this project that was built six, seven years ago, where it was a mixed income project. HOC was involved in the deal. And this was before these new tools.

17:35And so you had a private equity investor who had, you know, wanted double digit returns and wanted a significant ownership stake and all of that. And that building performed very well. and HOC saw very little of the benefit of that really high performing building that they had put this money in and everything. And so they kind of went back to the drawing board. How do I get in a better position in a project like this that I'm building, right? Because I have these social goals. I want to provide these affordable units. I want to have this long-term permanent affordability. How can I further that goal by being in a better position on the deal?

18:08Well, the way to do that is to bring your own source of capital to replace that source of capital that's pushing you into a bad position. Bring your own. And so they created this housing production fund, which is the tool that facilitates this kind of new model of mixed income development. And really what it's doing is it's making short-term construction loans, essentially replacing what would be private construction equity in a conventional deal. But you loan it from your fund to yourself, to your project at a much lower interest rate. And so you're kind of taking on a little bit more of the risk, right?

18:43Like why does private equity want really high returns for their investment? Well, because that's what they price the risk at. That's their job. Right. That's their job and that's what they price the risk at. But as the public developer and owner, you're not just like eating that risk, right? You also bring things to the table that lower the risk of the project, right? You're a governmental agency. So a lot of the kind of barriers, regulatory things to some kinds of development, you can get past those sometimes in a little bit easier way. And the other really big thing is one of the biggest risks from the construction to kind of permanent operating phase of a building is the lease up period.

19:21Once you're done, how long does it take you to get people in that building and paying rent? And when you do a project like this, if you have a third of your building at these affordable levels, HOC has a line out the door of thousands of households who are waiting for affordable, like lease up for affordable units is like the snap of a finger compared to market rate units. And so you're reducing that lease up time risk, too. And there's other kind of risk reduction things that you bring to the table. I take the point about risk reduction and the lease up period and things like that. But my next statement is going to be somewhat facetious.

19:58But the PE pricing does seem a little bit ridiculous when housing at this point almost seems like a sure thing. Like, when do rents ever go down? I have yet to experience. Tracy has this question every time. No, seriously. I've yet to experience that phenomenon in my lifetime. You know, I actually saw a Bloomberg chart on Twitter this morning showing market rents going down, deflation in rents in some of the cities that had the highest supply increases over the past year. So not New York City. Not New York City, right. I mean, Boise rents went down something like 5%. Yeah, Sunbelt rents are coming down.

20:34So the answer is move to Boise. Okay. Wait, I realize there is something I should have asked at the beginning of this conversation, but can you describe the types of housing or buildings that you're creating in a little bit more detail? And this is just historically the way that HSC has approached things. We deliver affordable housing through what we call financing solutions, not construction solutions. And so the general idea is you produce a market competitive project. We need it to be market competitive because it's going to have a majority market rate component in it, but also because we want all of our residents to feel like they're living in a building that a lot of them don't even know.

21:11One of the refrains you'll see is that I didn't even know this was owned by HOC. It's a very common experience for our residents, both the residents of our rent restricted units and those in our market rate units. And so these are Class A buildings that are typically built to be competitive with the market. And I would say even in our more recent iterations, we are actually using the HPF platform to actually set some higher standards in the market around energy efficiency and even scale. So we really try to use the HPF platform for one of our things. But in general, these are just as nice as the Class A.

21:44It is a Class A rental building. It may be kind of the high density garden or four over one where you have, you know, four or five floors of wood frame over a over a retail or parking podium. But we also do mid and high rise as well. You mentioned that Montgomery County has sort of a history of housing innovation. And is the phenomenon essentially like we all know, like the D.C. economy has like boomed. But like there aren't a lot of like especially people working in government. Like they're not like a lot of those people, like they don't become rich. Like the economy is like boom, but they're not like maybe particularly high salary.

22:19So they need somewhere to live in a booming economy, but they also need to be like somewhere affordable. Is that sort of the general economic condition that is sort of like forced the hand of a county like yours? I mean, Montgomery County's challenge, it's one of the most affluent counties in the country. OK. But it is a it's also one of the most diverse counties, certainly in Maryland and in the country. And it's a relatively large county, certainly for Maryland. So I guess low bar, but, you know, it's got distinct parts of the county. And so you have, you know, a significant amount of immigration, obviously, in the D.C.

22:51area. And so you have, you know, first generation families that are looking for, you know, their first affordable home. And they've often looked at Montgomery County schools as that first leg up, you know, into this country. You also have, you know, lots of in many cases, progressively minded, but boomers who bought there. It's a relatively young county. In 1950, there were a lot of fields. And so it really was that expansion that you're talking about of the federal government where you have this wave of boomers who bought homes for, you know,$15. And, you know, now they're worth, you know,$1.5 million.

23:23And then everything in between is kind of the range of challenges that we have of housing. And we have very urban centers. You know, we have taller buildings in Silver Spring and Bethesda and Rockville than there are in D.C. So there are very urban locations where you have folks employed within a whole spectrum of different industries. So it's really trying to serve what is an extremely socioeconomically diverse environment and ethnically diverse, racially diverse and so forth. And there have been successes and failures around that over the course of the decades. But that's that has that has definitely been the trend for Montgomery County over the last 20 years.

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