Carpenter Royce Vaughn works on a housing project in San Francisco in April. Interest rate hikes will put a squeeze on new development.
The Federal Reserve’s surprise 75 basis point interest rate hike last week — like all of its rate increases in recent months — was designed to bring down costs for American consumers. But in California, it will likely trigger the opposite effect: a collapse in housing construction and short-term and long-term increases in housing costs for middle-class families.
The roots of this impending problem lie in COVID-19. The pandemic set off a red hot housing market in the U.S., especially in California, with factors ranging from the option to work remotely to a desire for vacation getaways driving unprecedented housing demand. Prices responded accordingly: From May 2019 to May 2022, the median list prices for California homes rose from $577,000 to $759,500, a more than 30% increase, according to data from Realtor.com.
Typically, increased demand for something spurs more production of it. As the need for N95 masks spiked in 2020, producers like 3M scaled up production. Yet California’s housing market failed to respond in the natural way; new construction is has been flat.
One major culprit is local governments, which often restrict the height and density of new buildings and push demand to more low-density sprawl.
Now the Federal Reserve is poised to restrict our limited supply of housing even further.
While the broader consequences of the Fed’s most recent rate hike are still uncertain, California’s housing market will undoubtedly be a loser. Credit conditions have a powerful impact on private builders’ willingness to make investments. Over the last six months, rate increases have already led the average mortgage rate to nearly double, putting a stop to the home ownership plans for millions of working families, especially first-time buyers and lower-income households. As a result, home builders have begun slashing housing production across the country — by 14.4% in May, according to the most recent Census Bureau data. New home construction in San Francisco is particularly moribund: The number of new units under construction is less than half that of five years ago, while new completed units and permit approvals lag far behind levels of recent years.
This will worsen California’s long-term affordability crisis.
Fortunately, a solution is working its way through the Legislature that could break this economic impasse and prevent further damage to housing markets in the Bay Area and across the state. San Jose Assembly Member Alex Lee’s Social Housing Act, which has passed the Assembly and the Senate Housing Committees, creates a new, publicly owned housing agency to build mixed-income homes for all Californians. By using revenue from market-rate apartments to subsidize lower-cost apartments, it would significantly increase the availability of affordable housing in the state. It will bring public competition into California’s monopolistic housing market and would help lower the cost of housing statewide.
San Francisco’s leaders know these problems well — the city is currently hearing from developers who are feeling housing market pressures. In 2020, San Francisco voters approved two measures, Propositions I and K, that enabled support for social housing by authorizing and funding construction projects. But turning that funding and building authorization into actual housing requires another ingredient: a public developer. The Social Housing Act would authorize a newly created agency to work around the state, which could help bring the vision for Propositions I and K to life. In fact, early Tuesday morning, Supervisor Dean Preston announced that a deal was reached with the mayor’s office to put some local social housing funds to use. Now is the time to empower the state to help coordinate.
Passing the Social Housing Act is especially important on the eve of a home-building slowdown. In the present circumstance, the public developer proposed by the bill would be able to purchase incomplete housing projects from builders that suddenly find themselves in a financially precarious position. Because it does not have investors to please, the public developer can continue to develop these and its own original projects at a lower or break-even cost. Instead of falling to the wayside, languishing projects like many of those in San Francisco’s planning pipeline will be finished by the government, bringing new housing online and saving jobs.
In the wake of the 2008 Great Recession, California and the nation at large lost out on valuable housing stock and a generation of valuable, skilled construction labor. A public developer will make sure this does not happen again, and the state will have the healthy supply of housing it needs to accommodate a high-growth, high-wage economy.
The state should further consider implementing complementary public finance measures to the Social Housing Act. San Francisco and other municipal governments currently pay top dollar to Wall Street banks for crucial cash management services. But public banks could take over this role for less, freeing up funds for affordable housing projects. These banks could also use their not-for-profit mandate to issue low-interest loans for affordable housing projects.
For decades, housing has been stuck in a vicious cycle. High prices force the Fed to enact high-interest rates, creating a recession and curbing housing production before a healthy market can emerge. It’s time to think outside the box and consider the possibilities of a robust system of public enterprise to combat this dynamic. With the Social Housing Act, we can make sure California has the homes and workers it needs for years to come — and see what it’s like to have an economy that works for all of us.
Yakov Feygin is the associate director of the Future of Capitalism program at the Berggruen Institute. Paul Williams is the founder and executive director at the Center for Public Enterprise.