How High Rents Hinder Startup Activity
Three Tools to Help Solve the Crisis of Workforce Housing
The scientist Richard Hamming liked to ask friends and colleagues what they believed was the most interesting question in their field, and why they weren’t working on it. It’s a great question worth considering. Within the world of real estate, I believe there are two hugely interesting questions that address Hamming’s query:
1. How will we work in the future? Increases in telecommuting, hot-desking, co-working and the gig economy are all shifting the reality of “going to work.”
2. What types of housing can we build to support that world, and can we build enough of it?
Although not obvious at first, these two questions are tightly linked.
A 2010 study done by Enrico Moretti showed that the creation of a high-paying technology job creates a spillover of nearly five other jobs in that city. These new jobs are split between service workers (baristas, yoga instructors, etc.) and white-collar professionals (lawyers, accountants, etc.). An addition of a typical manufacturing job, on the other hand, creates only a multiplier of 1.5 new jobs. This dynamic explains why so many cities are desperate to have new tech employment (most notably seen in last year’s Amazon HQ2 process).
This multiplier effect is powerful for economic growth, but comes with drawbacks. Cities need to be prepared not just for the tech jobs, but for the five other resulting jobs. This is where Silicon Valley and Boston and, increasingly, smaller tech markets like Austin and Denver, are running into issues. Tech employees are flourishing, but it is not easy for a restaurant worker to live in these urban areas. Real estate developers love to build high-rise offices and condos for that tech worker, but are less excited (and often less incentivized) to build housing for the additional five, lower paid, employees. In all cities across the U.S., a majority of renters currently qualify as at least moderately cost burdened (rents taking up more than 30 percent of income) and in many cities close to one out of four renters are “severely burdened,” with rents accounting for more than half of their income.
While 70 percent of renters in San Francisco are burdened, the problem is actually larger in a number of “Rise of the Rest” cities. As shown below, there are seven cities in which 80 percent of all renters are burdened, and none of them are in the expensive, “superstar” cities. This is a serious, but under-discussed, hurdle for entrepreneurship.
If half of your income is going to cover rent, it leaves very little to invest in a new business, to say nothing of the stress that takes up significant mental space and energy. It is fair to assume these elevated rental burdens have depressed start-up activity.
So why don’t developers just build more rental housing? The costs of construction and land values has increased far more quickly than incomes over the last 20 years, making it hard to build for the mass market. More than half the rental stock under construction today requires incomes of at least $100,000 and 90 percent of new supply requires incomes of at least $75,000. Many of these five multiplier jobs don’t pay that wage, and without those jobs it’s hard to sustain future tech growth.
What is the solution? Many intuitively appealing solutions — such as rent control — do not work. Solutions need to either increase household incomes or increase rental supply. Incomes are generally a market force, so the solution needs to come on the supply side. I see three main tools to help solve this crisis of workforce housing:
1. Design
Projects built with a higher number of smaller units can achieve lower per unit costs. Utilizing shared spaces effectively can also decrease costs, as the increase in popularity of “co-living” shows. Co-living companies, such as Common, design units to get rental costs 20 percent below traditional rents by having small individual units and sharing some services such as kitchens.
2. Construction Technology
The construction industry has been notably slow to evolve and its productivity has lagged nearly all other industries. The process of finding a site and engaging an architect, general contractor and sub-contractor on a bespoke basis remains roughly how it was 40 years ago. However, today the confluence of high labor costs, low affordability, technology, and desire for sustainability creates a unique opportunity for modular and pre-fabricated construction technology. Anecdotal evidence suggests that the efficient manufacturing process can lower construction costs by 20 percent and construction duration by 50 percent.
3. Government Incentives
Various government initiatives exist to help burdened renters. Most notably, on the supply side is The Low-Income Housing Tax Credit (LIHTC), which offers tax credits as part of the capital stack to developers, making it more economical to develop for lower rents. However, the LIHTC program has been around for decades and it clearly isn’t a silver bullet. The Opportunity Zone program has the potential to be a significant part of the solution to this problem, as it helps lower the cost of capital for long-term investment into these markets.
I believe the best way to help solve the shortage of workforce housing in the U.S. is a combination of the above, done in scale. By utilizing efficient manufacturing processes and a repeatable design with relatively small, efficient units and sharing of indoor and outdoor amenities, unit rents can be brought down 20–40 percent from what is being built today. Additionally, the Opportunity Zone incentive motivates building in neighborhoods where land costs are not quite as high today.
