How to make San Jose housing affordable

Scott Beyer, Founder of the influential Market Urbanism Report and author of the widely respected book: Market Urbanism, A Vision for Free Market cities, is a leading proponent of classical liberal reforms to address the national housing crisis. In Part I of an exclusive 3-part series for Opportunity Now, Beyer begins his analysis of San Jose's current policies, and what needs to change.

America is experiencing a housing affordability crisis - particularly these last 2 years. A combo of easy money Fed policy and Covid-induced inventory shortages caused a 31% spike in the Case-Shiller Index, the highest ever over a 2-year span.

But in San Jose the crisis came well beforehand, and it’s now the 2nd most-expensive U.S. city behind San Francisco. Its $1.44 million median home price is over 3 times the national median. The city’s average rent is $2,741, also well above the national median and ahead of peer cities like Phoenix and Las Vegas. At last count in 2019, nearly 7,000 residents were homeless.

In this 3-part series, we discuss why San Jose became like this and what it has done to address the problem. In parts 1 and 2, we analyze government-driven supply-side and demand-side policies. “Supply-side policies” are defined as subsidies that various levels of government use to get more housing built, as to increase overall unit count (think low-income housing tax credits or affordable housing bonds). “Demand-side policies” are designed not to increase the supply of housing, but to cool prices and improve affordability for the units that already exist (think rent control or tenant rental assistance). In part 3, we describe market solutions that would be cheaper and more effective than both these supply-side and demand-side measures.

The main reason San Jose - and the Bay Area - is unaffordable is its inventory shortage. According to Census figures crunched by Market Urbanism Report, San Jose had the 6th-lowest permitting rates of 20 large U.S. metros studied. It permitted housing at well below half the rate of famously affordable metros like Houston.

Census Data from *Market Urbanism Report*

There are various ways San Jose can ramp up production, which we’ll describe throughout the series. But we don’t view its approach thus far as good.

In 2018, mayor Sam Liccardo announced a plan to add 25,000 units by 2023, including 10,000 affordable ones, as part of a larger goal to guarantee that “15% or more of the new housing stock developed is affordable to low, very low-, and extremely low-income households.”

But according to an August 2021 report by San Jose Spotlight, only 3,348 units (including 506 affordable) have been completed. Another 14,000 are in the pipeline, although the city doesn’t appear primed to reach what was already a modest goal.

This sluggish production is due in part because, like every large U.S. city, San Jose uses poorly concocted “supply-side” subsidies to increase unit count in a cost-intensive fashion. This includes both leveraging federal low-income housing tax credits (LIHTC) and its own subsidy programs.

In America, the primary means of financing affordable home construction is LIHTC. The federal government allocates credits to state agencies, who redistribute them to qualified local private projects, which must generally set aside all or some units as affordable for renters earning between 30-80% of AMI. California requires no fewer than 40% of units be so designated, with the upper threshold being 60% of AMI (accounting for family size).

The LIHTC program was created in 1986 as a public-private measure to replace failed public housing and has at least outperformed that. But LIHTC’s ability to boost affordable production overall is dismal. One analysis found that it likely doesn’t increase housing supply, merely replacing unsubsidized units with tax credit-financed ones. Reporting by NPR found that despite an increase in the burden they put on taxpayers, from 1997 to 2014, the number of units built with these credits shrank nearly 16%, because the program is vulnerable to fraud.

Like every other big city, San Jose has its share of LIHTC projects - between 1998 and 2018, $108 million has been allocated annually to build over 14,000 units in San Jose and surrounding areas. There are also state, county and local subsidies to supplement LIHTC. In 2016, Santa Clara County voters approved Measure A, a $950 million affordable housing bond. The goal was to produce 4,800 units - amounting to a whopping $198,000/unit subsidy - but six years later has only produced 289 affordable units.

Measure E, passed by city voters in 2020, places a real estate transfer tax on property transfers of $2 million or more, and uses proceeds to fund homeless housing. But a pilot tiny home project that preceded and helped inspire the measure was slammed by Lee Ohanian of the Hoover Institution. The project’s $700/sqft construction costs are a figure sooner found in luxury condos.

Granted, construction costs are high across the board in San Jose, with Mayor Liccardo estimating them at $800,000 per unit. To address this, the city provides “gap financing” for housing construction in the form of subsidized loans and sometimes grants. In response to recent statewide legalization of small accessory units, the city also plans to provide zero-interest loans for their construction.

Another revenue source comes from impact fees assessed on market-rate projects. All projects that add 3-19 units must pay into the city’s Affordable Housing Impact Fee (larger projects must comply with the city’s inclusionary housing ordinance, to be discussed in part 2).

This is not an exhaustive list of all the housing subsidies provided for and by San Jose, which also includes Housing Authority grants and general fund appropriations. There is also robust housing philanthropy coming from Silicon Valley tech companies, to assuage public blame that they have caused the crisis.

So why, despite all these subsidies, do we still hear stories in San Jose about obscenely expensive affordable housing projects, such as the senior housing one costing nearly $605,000 per unit? And why does all the money not solve the larger affordability problem that inflicts almost all income groups there?

The answer’s a straightforward economic one: San Jose has high costs for land, labor, materials, permitting and more, meaning all the subsidies flooding into the city don’t stretch far - and may further inflate the market. Even Mayor Liccardo admits that “we can do everything right and we are still going to face this real challenge of seeing our dollars get consumed on fewer and fewer units.”

This is why supply-side subsidies - aka ones designed to increase housing supply - will work even less in San Jose than most places. The fixed costs going in are just too high, and these programs will never scale there, or in other area Bay Area locales, enough to produce the 160,000 units needed to end the regional shortage.

But misguided subsidies aren’t the only barrier to San Jose becoming affordable. In installment #2 we’ll describe “demand-side” regulations that are meant to cool prices yet backfire even worse.

This article featured additional reporting from Market Urbanism Report content staffer Ethan Finlan.