“An honest politician is one who, when he is bought, will stay bought.”
– Simon Cameron
“In politics, absurdity is not a handicap.”
– Napoleon Bonaparte
Recent years have not been good for the state of California when it comes to housing affordability. The ever-upward trajectory of prices, fees and regulations are wonderful if you already own a house. Not so much if you don’t. But just when you think that things couldn’t possibly get worse along comes a politician with a proposal that would do just that. Kansen Chu, an Assemblyman from San Jose has introduced a bill that, if passed, would make our current abysmal state of affairs look rosy by comparison.
I was first made aware of this bill, now known as AB199 last Thursday reading a blog post written by Borre Winckel, the President and CEO of the BIA of San Diego. Borre has been a housing advocate for a long time and says that in all of his years he’s “never seen a legislative proposal so ill-conceived, so ill-timed and so very misdirected.” Here’s the language from the bill (emphasis mine):
AB 199, as introduced, Chu. Public works: private residential projects.
(1) Existing law requires private residential projects built on private property that are built pursuant to an agreement with a state agency, redevelopment agency, or local public housing authority to meet the requirements for projects that are defined as “public works,” including, among other requirements, the payment of prevailing wages. Existing law defines the term “political subdivision” for the purposes of these requirements to include any county, city, district, public housing authority, public agency of the state, and assessment or improvement districts. Existing law makes a willful violation of specific laws relating to the payment of prevailing wages and the hours worked on public works projects a misdemeanor.
This bill would instead require private residential projects built on private property that are built pursuant to an agreement with the state or a political subdivision to meet the requirements for projects that are defined as “public works,” thus expanding the types of projects that must meet these requirements. By expanding the definition of a crime, this bill would impose a state-mandated local program.
Now, in English: Existing laws dictate that residential projects built under an agreement with state agencies, RDA’s or public housing authorities be built using a “prevailing wage.” This typically means hiring union labor to perform the work – which is much more expensive than hiring subs in the open market. As such, it drives the price of construction up substantially. Assemblyman Chu’s proposal would expand prevailing wage laws to cover ALL private residential projects built on private property whether a state agency, RDA or local public housing authority is involved or not. In short, it would include all new home construction in California.
As could be predicted, the California BIA, Business Roundtable and others have jumped on this, rightfully pointing out that it would exacerbate our housing affordability crisis by causing less homes to be built and pricing more families out of ownership, rightly pointing out that this would increase direct construction costs by 45%-50%. I’ll give you an example of the impact of this type legislation loosely based on a couple of projects that Landmark has sourced funding for in the Inland Empire. This example will be a 30 unit detached FHA compliant product in a secondary market. The product is what I call “California Affordable.” In other words, homes are priced well above the national median price but complies with FHA guidelines and are generally considered inexpensive for new construction in California where prices are well above the national median.
The first table is representative of construction pricing as it is today. I have base home prices averaging $345,000 and a builder margin of 12% which is on the low end of normal for a private builder in this type of project. The residual land value (Revenue from home sales, minus all costs, minus builder margin) is $1.185MM, meaning that this is what the builder can afford to pay for the land in order to make a 12% profit margin. I’ve used a simple residual model provided by my friends at Land Advisors.
Now, I’m going to run a new version showing the impact of AB 199 by increasing the Direct Construction Costs by 50% to $93/sf. The change in directs results in additional project cost of $1.75MM and drops the land residual to a negative $566,625. This means that the project wouldn’t work even if the land had a value of $0. For obvious reasons, this project would not get built.
In the final iteration, I increased the home sale price to get back to the same residual land value and builder economics that we had before AB199 prevailing wage standards were applied. The result? Home prices need to rise by 23% to $425k, pushing them well above FHA guidelines in order for the project to pencil. This means that sales will be much slower since less people can qualify or afford the larger down payment that is required outside of FHA.
Given the above why would an Assemblyman knowingly push a bill that clearly exacerbates an already awful affordability crisis? The answer is easy: money. As it turns out, many of Chu’s largest donors were labor unions. In fact, the bill is being fast tracked and pushed by the unionized Building Trades. In addition, Chu represents Silicon Valley, meaning that many of his constituents are NIMBYs and wouldn’t likely be opposed to a bill that would limit construction. The result of AB199 would be that a relatively small number of well-paid union members would make more money on fewer projects at the expense of an entire state suffering through an even worse housing affordability crisis, a terrible trade off.
Please note that I’m not against higher wages for construction. In fact, I’ve advocated for wage increases several times in this blog as a way to draw in more much-needed construction workers. What I take issue with is artificially high wages set by a legislature that result in less job creation, less economic growth and less middle class families being able to afford a decent place to live. Prevailing wage rules ironically lead to less jobs due to the economic realities laid out above. Rather than stimulating demand for construction workers by incentivising more construction, they create less jobs but higher wages at the top for the lucky few who work on the limited number of development projects that remain feasible. This isn’t a matter of under-payed construction workers getting a bigger piece of the pie while greedy developers and builders get a smaller piece. Land can’t sell for less than $0 and the numbers don’t work unless home prices rise substantially so the increase in cost would be borne by home buyers – not developers and builders.
I’m hopeful that the CA Assembly and Legislature comes to their senses and stops this nonsense. If not, hopefully Governor Jerry Brown will continue to show the same resolve that he showed last summer by standing up to the labor unions when they tried to insert prevailing wage language into his by-right housing bill, A stand that eventually led to the bill dying. But Brown’s term is ending in the not-too-distant future and the next governor of CA might not be nearly as much of an affordable housing advocate as he has proven to be. In the meantime, special interests will keep trying to push this type of harmful legislation through. My fear is that at some point in the not-too-distant future, one of these hair-brained, economically illiterate bills will actually stick and when it does, that will be final nail in the coffin of the middle class Californian.
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Chart of the Day
A bit of perspective:
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Sword Fight: A sword-wielding felon who was clearly high on something threatened customers in a Walmart parking lot because, once again, Florida (h/t Stone James).
Slip N Slide: A man got out of his car in the middle of the afternoon on a rainy day, stripped naked and started yelling that he was God before wrestling with several cops, because, you guessed it, Florida.
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