Only In California: Housing Deregulation Increases Housing Regulations

Tuesday, December 3, 2019

This would be a head-scratcher anywhere but in California. Two years ago, state lawmakers passed legislation to expedite housing approval by exempting some projects from environmental lawsuits and zoning appeals. This legislation can cut the approval process by a decade or more and reduce costs enormously. So why is hardly anyone using it? 

Hint: this is California. With apologies to Gilbert and Sullivan, sometimes skim milk masquerades as cream.

What could have been a game-changing policy reform is so far just a footnote in California’s game of chasing its own tail in trying to reduce housing costs and increase housing supply.

To begin, just how bad is California’s housing crisis? The state’s median housing price is over $550,000, up 85 percent since 2012, according to Zillow.

The California Association of Realtors estimates that only about 30 percent of California households can afford the median-priced home. Affordability in the regions with the highest-paying jobs—Silicon Valley and San Francisco—is the worst in the state, as only about 20 percent of households in these areas can afford the median-priced home

Housing costs are so high in Silicon Valley that some tech workers making six-figure salaries are choosing to live in broken-down vans rather than pay $3,000 or more per month to rent a small bedroom in a shared house.

These affordability calculations assume that the hypothetical buyer has the hefty 20% down payment, which is about $110,000 for the median-priced home in the state and close to $300,000 in San Francisco.  

But housing affordability is even worse than the estimates cited above, because today’s down payments are much lower than the standard 20% assumed by virtually all affordability studies.

lower down payment means a larger mortgage, a higher mortgage rate, and possibly private mortgage insurance, all of which drive up the cost of owning a home.

Affordability is low because of lack of supply. McKinsey and Company consultants estimated last year that California needs an additional 3.5 million units by 2025 to make a dent in this problem.

Current construction trends are nowhere near what is needed. California is now building about 120,000 new homes per year, only about 25% of the annual flow estimated by McKinsey. Something must give if affordability is to improve.

This is where California’s recent legislation, SB 35, comes into play. It eliminates environmental reviews and blocks zoning appeals for some new developments. This is what could have made this reform a game changer, because these two factors drive up California housing costs enormously.

How much? How about 27 years of environmental lawsuits that tried to block the creation of one new community.  How about a six-year fight over transforming a laundromat into a multistory apartment building because it would have cast shadows on a preschool.

With this silliness out of the way, it should be much easier and less costly to build in California, yes?

Well, no. After two years, only about 40 projects—a drop in the bucket—have either been approved or are being considered under the streamlined review process. Why? Because legislators chose to include extremely burdensome new regulations while removing others. It appears that the net result is about a wash in terms of changing building costs. California’s “fast track” development approval process is like tossing a drowning person a life vest that is weighed down with lead.  

The new regulations include paying “prevailing wages,” which is a euphemism for forcing developers to hire union labor, and allocating 50% or more units to be rented at far-below-market rates.

The simplest economic analysis shows that these two requirements are about as bad as lawmakers could have foisted on new home builders and are the reason that the new legislation is a footnote and not a game changer.

“Prevailing wage” requirements hark back to the infamous Davis-Bacon Act of 1931. Ironically, the Davis-Bacon Act is celebrated by many liberal politicians today. If they only knew that the act was precipitated by whites who were upset that contractors were employing black workers.

The Davis-Bacon Act was a racially based minimum wage that was intended to raise employment of whites at the expense of blacks.

Various forms of the act were voted down 13 times before it was finally passed during the Depression.

 “Prevailing wage” requirements are about as far down the pork barrel as it gets and are probably the worst building regulation ever dreamed of. Any project needs to pay market wages in order to hire workers. It is absurd to expect otherwise. But “prevailing wages” is just an expensive payoff to organized labor, which is the most important political constituent within the state for most incumbent lawmakers.

The nonpartisan Congressional Budget Office’s recent report “Repeal the Davis-Bacon Act” estimates that the federal government could save about $14 billion through 2025 if the act were eliminated.

But the costs of union labor do not stop at above-market compensation, which is about 20% over market wages. The union cost premiums estimated produced by the CBO and others are likely to be much too low.

Federal Reserve Bank economist James Schmitz has shown that inefficient union work rules, which artificially raise union employment by restricting the scope of work that can be performed by workers, can depress labor productivity by as much as 50%, thus doubling costs over and above the 20% union wage premium.

Creating lower-cost housing requires reducing building costs, and prevailing wage requirements push the state far in the wrong direction of this goal.

The second negative new regulation is that developers must set aside units that will be rented to low-income families at rates that are far below market rates. This may seem like a good idea, but earmarking 50% or more units for below-market rates can kill a project.

A much better way to build low-income housing is to just build more housing. Period. More housing reduces rents for everyone and is the only proven way to make housing more affordable. After all, the reason that so few can afford California housing is because politicians failed to allow enough housing to be built.

California lawmakers took a great idea—removing environmental and zoning blockades to creating new housing—and loaded it up with enough new, destructive regulations to make it thus far nearly irrelevant.

This shows just how beholden lawmakers are to deep-pocketed political constituents, such as unions, and how lawmakers either don’t understand the economics of the California’s housing crisis or really don’t care whatsoever about the tens of millions of Californians who struggle every month to stay afloat in this state.