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Sunday, Jan 29, 2023

Cost Question

USC professor Stuart Gabriel has made the effects of Proposition 13 a focus of his professional life. As a graduate student at UC Berkeley, Gabriel wrote his dissertation on the unintended consequences of the property tax limitation measure. In a study of 90 Bay area towns, Gabriel found that Prop. 13 artificially restricted housing supply because cities wouldn’t approve new developments where property tax revenues didn’t cover the cost of increased municipal services. As a result, he said, there is a glut of million-dollar condos and luxury apartments and the lack of affordable rental housing. Gabriel, who is director of USC’s Lusk Center for Real Estate, calls it fiscal zoning.

Question: What are the consequences of the housing boom for Los Angeles?


The L.A. of the future is going to be a significantly denser L.A. It will be organized along rapid transit lines. The old model of building single-family tract homes without limit into the desert environment is not a model that is sustainable in terms of commutes, infrastructure investment or population preferences.

Q: Does that mean L.A. will be Manhattan-ized?


We’re seeing high rise projects in Irvine, Valencia and Santa Clarita places you wouldn’t expect. If you look at Tokyo, London, New York, the densities are profound in the central areas. We have a long ways to go before we look like those places. It won’t be overnight but as a trend, no question.

Q: Will demand to live in downtown L.A. be greater than, say, living on the Westside?


We are just at the beginning of residential development downtown and right now it’s still a relatively modest base. Gradually, downtown L.A. will be significantly more user-friendly when there’s an array of urban amenities. There may be very significant demand over time for a dense lifestyle. We have to test the depth of the market but in the immediate time frame there’s no doubt we will be densified.

Q: What are the odds that real estate prices will drop significantly in the near future?


Slim to none. And the consequences are great if the disparity between incomes and housing costs continues. Our youth will continue to move out of state at an even greater rate to more affordable states to raise families. At some point the demographics of coastal California could very well shift to very wealthy senior citizens, almost like one big, very expensive retirement community. Since housing prices have doubled in the last several years, we can expect some very modest adjustment but unless there’s some extreme economic shock, we’ll never see homes selling for what they did five years ago.

Q: How much of the current housing boom is being fueled by aggressive lending practices?


Lending institutions have been very creative in the last decade. There’s a whole set of new instruments that have supported housing demand. Many more people have qualified for more money because of the ease of underwriting by the regulatory community.

Q: Haven’t banking regulators begun signaling a possible crackdown with some of these new mortgages, especially the no-interest financing options?


Regulatory oversight can swing from lax to restrictive and back again. Regulators today have voiced concern about certain mortgage instruments that allow borrowers to qualify without documenting their income or that provide a significant level of negative amortization (which allows borrowers for a period of time to make monthly payments that don’t cover the principal). If housing begins to deteriorate and the market begins to ease, regulators will likely look closely at lenders who issued those types of loans and that could constrain housing.

Q: Wouldn’t a crackdown by regulators also stem the tide of mortgage innovation?


Over the last 50- to 100-year period, we’ve seen very significant evolution in mortgage and home finance. The tailoring of instruments to reflect borrower preferences and finding new ways of managing risk will continue. There could at some point be a shakeout in the mortgage lending community. Some have protected themselves from risk better than others, making it easier to survive. Truly, if we get slowing in housing cycle, some of the very rapid growth in the mortgage community will be flushed out and there will be industry consolidation.

Q: In the 1970s there was a run-up in property taxes as home values across the state escalated rapidly. That led to Proposition 13, which has limited property taxes. Has the measure been bad for California?


After Proposition 13, local development didn’t pay the cost of streets and sewers, for the extra fire and police protection, libraries and other local public goods. When towns now do a fiscal impact analysis or a cost revenue analysis, they ask the question, “If a project is high density affordable housing, what will be the local fiscal impact and what are the revenues?” Well, after Proposition 13 the revenues were halved, so the impact of building that type of housing became negative.

Q: You say California cities won’t approve affordable housing because the projects consume more local resources than they generate in revenues. This idea of fiscal zoning doesn’t sound legal.


What’s illegal is racially based zoning. But the California Supreme Court in 1978, in a ruling that became known as the Petaluma decision, upheld the right of local governments to engage in growth management and enforce very strictly decisions made at the local level controlling for the type and pace of development in a local jurisdiction.

Q: So if a town justifies it fiscally, it’s legal for communities to prevent poor people from moving next door?


Though it’s a subset of exclusionary zoning, which is illegal, fiscal zoning is where cities enact local land constraints for fiscal purposes. That’s allowed, even though it’s often done with a social or economic motivation in mind. Often it’s an attitude sometimes described as Nimby-ism, where residents don’t want to live near people of a different status or they want to live next to people who look like themselves.

Q: At the same time, there are more units of housing under construction now than in decades. If the supply of new housing continues to increase won’t prices come down as demand cools off?


Of course housing is being built, but why don’t we see more affordable housing going up or housing for lower income rungs? Because land acquisition costs today are not all that compatible with affordable housing. Given those costs, a developer would ascertain the highest and best use and the answer would never be affordable housing. With such high land costs, developers can afford to build condominiums but not apartments because rents, except in very high end luxury buildings, aren’t high enough.

Q: Is it just high land costs that prevent building affordable housing?


No. It’s also very hard to get affordable housing approved by local governments. One reason is that property tax flows are inadequate and so you’ll find in many suburban jurisdictions a resistance to approving them. Clearly most jurisdictions would prefer million-dollar condos or single family homes, all things equal. Or not to build residential at all. Most cities would rather have an auto mall. That generates a lot more revenue for local coffers than any housing development ever could.

Q: So where will lower-cost housing come from?


Socially, we can’t afford not to build affordable housing so it will be something that government continues to subsidize. But even that can only handle a mere fraction of demand.

Q: Is California in a real estate bubble?


There are good reasons for California housing prices to be higher than those in Arkansas or Cleveland, Ohio. Is California real estate bulletproof? No. And there’s no reason why the rate of positive increases has to continue to exceed that of the rest of the nation or to say that California house prices can’t dip for a certain amount of time.

Q: Economists at UCLA believe a housing downturn could severely hurt the region’s economy because so many people now earn a living off the local real estate market.


I’m not so convinced. People can adapt pretty quickly. Right now it turns out it’s not hard to sell a home. When it gets hard, some people will decide it’s not for them and they’ll find something else to do. People will adjust to the market.

Stuart Gabriel


Director, professor


University of Southern California, Lusk Center for Real Estate


December 1953


Bachelor’s, master’s and doctorate degrees in economics from the University of California, Berkeley.

Career Turning Point:

Being appointed staff economist responsible for domestic housing markets at the board of governors for the federal reserve system in Washington, D.C.

Most Admired People:

Abraham Lincoln and David Ben-Gurion


Cycling, hiking and reading


Married, two sons


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