Lethal Interactions

Daniel YergerFinancial Planning 2 Comments

It is well known that many innocuous substances when combined, can produce unintended outcomes. For example, someone taking opiate painkillers who then drinks alcohol can end up with symptoms as mild as nausea and extreme as stopping breathing and going into a coma (assuming the former doesn’t simply result in death!) These issues are a large part of the specialized training that pharmacists undergo in their education to ensure they can counsel and coach patients to avoid potentially harmful, dangerous, out downright lethal interactions between their medications and even non-medicated lifestyle consumption. We bring up this dynamic because the same harm prevention is often absent in the financial and political space. For example, a client of a financial planner and tax preparer may inadvertently give uncoordinated tax planning advice if they don’t work together: “Open and fund a Roth IRA for the long term tax benefits” says the CFP® Professional, “Open and fund a Traditional IRA for the current year tax deduction” says the CPA; both pieces of advice are helpful, but they naturally conflict. So wherein do we see potentially significant and dangerous interactions more broadly? Well, this year we see it in the Colorado Legislature, particularly with the interactions of House Bill 23-1115 and House Bill 23-1190, and how they could devastate the real estate market in Colorado.

Good Intentions can lead to…

Some background is required on this interaction. Simply put, if you haven’t been asleep in Colorado for the past two decades, there is a housing issue in Colorado. Mountain towns engage in persistent NIMBYism (“Not In My Back Yard”) that has long prevented the building of new housing in mountain towns. In turn, in the Colorado Front Range, there is a persistent push-pull between the desire by local communities to have and preserve the open space around them, and the cost of living. The value of homes in Colorado has increased at a rate of around 6% persistently over the past two decades, even with the real estate market crash in 2008/2009, meaning it has risen well above inflation rates. Part of what drove this was a “Builder’s Defects” law passed in 2001, which made it much easier for residents of condos and townhomes to sue the developers who’d built the homes for defects in the construction. While originally intended as a strong remedy for the common occurrence that such homes had building defects, the unintended consequence was that the risks associated with the law dropped the production of new townhomes and condos down dramatically compared to the historic average. After the housing bust in the late 2000s, there was then a sudden stop in the building of new homes and construction, which then produced an even greater shortage of affordable housing. Combine these with strong local NIMBY restrictions on the building of additional dwelling units (“ADUs”) in back yards such as tiny homes, or small additions onto existing homes, and the cost of housing has increased dramatically in Colorado, causing a greater and greater shift in new home buyers moving east of I25 and reducing the inventory of homes in high cost of living areas such as Boulder, Denver, and Longmont.

The consequence of these shifts in market forces has been slow to evolve, but more recently, municipalities have attempted to address the affordable housing shortage through a number of avenues. Offering small carrots such as expedited permit approvals for developers to build affordable housing, threatening larger sticks such as requiring a ratio of new homes be reserved for affordable housing, and various other programs like state-funded affordable housing projects, such as The Spoke in Longmont. However, all of these have been insufficient to combat the issues of low supply and high demand for housing, and so the cost of housing has persistently risen over the years. Enter two attempted prescriptions for the problem.

Prescription One: Rent Control

HB23-1115 aims to lift a statewide ban on rent control. Colorado banned rent control over 40 years ago when it saw the consequences of rent controls in municipalities such as New York City, where rent controls led to blight and issues regarding tenancy and tenant rights, along with health and safety issues. Consequently, Colorado has had a largely free-market approach to housing since the 80s, which has led us to where we are today. The temptation then to lift a statewide ban on rent control is not then to implement rent controls everywhere, but to relegate the decision back down to the local city councils. In Longmont, the City Council has unanimously endorsed HB23-1115, as it would give them and the city the ability to insert rent controls into the Longmont housing market as a direct form of intervention to reduce current or future costs of housing in Longmont. However, rent controls have a nasty way of creating a donut hole in the affordability of housing. Those with the lowest income benefit from eligibility for rent controlled units. Those with the highest income can still afford to buy homes or pay elevated rent levels. But those in the middle to low but not low enough income can then be priced out of housing that isn’t rent-controlled while simultaneously not being able to afford the new inflated price of homes for sale. That said, there is no denying that rent control could mean the difference between being able to afford and not being able to afford to live in Longmont for many low-income residents.

Prescription Two: The Right of Refusal

Another measure, HB23-1190, is aimed at preserving affordable housing and could-be affordable housing in municipalities. The bill proposes that cities should be notified before a house goes on the open market, and have a first right of refusal against all other buyers in the marketplace. The bill comes with a minimum notification period followed by a maximum time to close for municipalities, but it effectively means that each city becomes first in line for the sale of every multi-family home (four doors or more) in each city, with the aim being that cities can collect ownership of multi-family housing and offer them below market rate to help with affordable housing. This of course not only increases the aforementioned donut hole problem from rent controls but also represents a potentially uncompensated “taking,” as the city doesn’t have to offer the best price to a seller, only a market-rate price, which in ultra-competitive real estate markets such as Longmont and Boulder could represent an opportunity cost in the hundreds of thousands and millions of dollars to sellers. Still, the bill is not without its good intentions, but that doesn’t mitigate the potentially lethal interaction we’re about to discuss.

…lethal interactions

Let’s play out a hypothetical future in which both of these bills pass in the House, Senate, and are written into law by the Governor, and in particular, let’s take it from the perspective of developers and existing multi-family property landlords. For many of us, this will be roleplaying, but follow along here for a moment. You are planning to build multi-family housing that your company planned to hold onto and rent out. However, you’re now faced with a regulatory environment in which every city in Colorado can decide what rent you’re allowed to charge and how much you’re allowed to raise rents (if at all). Perhaps some municipalities will distinguish themselves by not doing this, but if others plan on it and you’ve already invested money in land and contracts to build, your potential return on investment has potentially decreased by a lot, or possibly even gone to zero or negative returns on investment. So, you’re now faced with a choice: Do you build and risk that the city you’re building in will cap your return on investment? Or do you simply forgo the project, sell the land, and take your business elsewhere? Does this increase the availability of supply of housing to meet demand? No. Now imagine you’ve already built or you already bought multi-family housing. The city declares that your rents are too high and tells you to either lower them or stop raising them until otherwise given permission. This may not pose an immediate problem, but if the city is restrictive in its willingness to let you charge market rate for rents or to increase rents to account for inflation and increased costs of maintenance over time, you might soon find that your properties are netting a negative cash flow. At that point, it only makes sense to sell your property so you stop losing money on them. But wait, remember now HB23-1190, which also gave the city the right to buy your properties at market value. Of course, market value has now likely decreased given that you can’t make money on the properties, so you’re forced to sell your properties not only at a value reduced by the city’s policy but you’re forced to sell to the city itself. The city can then continue to offer your units at whatever rental rate they like with the aim of providing affordable housing, but in the meantime, you’re no more likely to try to build or expand your rental business because you not only can’t make money doing it, but you can’t even sell your assets at a pre-regulation fair market value.

The Law of Unintended Consequences

None of the hypotheticals above are to say that we shouldn’t attempt to tackle affordable housing. But these two laws under consideration by the Colorado House and Senate are clear examples of good intentions without considering the interaction between other good intentions and whether it could inadvertently harm the thing it’s trying to help. There is only so much housing available, period. If more housing is not built, there will not be affordable housing, regardless of what laws are passed to attempt to make existing housing affordable. Consequently, it is imperative that there be incentives to build affordable housing, such that the marketplace responds to the demand for that housing in a manner that makes it reasonably profitable to do so, but also that doesn’t result in luxury builds that don’t meet the demand for housing in lieu of building affordable housing. Yet, time and time again what we have seen in Colorado is the offering of paltry or rotten carrots, followed by heavy-handed applications of sticks to developers and real estate companies for failing to meet the demands of the municipalities for more affordable housing. Affordable housing is undoubtedly an ongoing problem that needs to be worked on aggressively, but the state is currently proposing to repeat new versions of the same mistakes that have gotten us to this point in the first place and should be cautious about failing to learn from history, as should we in consideration of those we elect to solve these problems for us. That is not to say that there are not good intentions and good arguments behind the proposals for these two laws, but sans a political pharmacist to protect us from lethal interactions, we must be vigilant and wary on our own.

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