Is the MHA program working?

Earlier this month, the City of Seattle’s Office of Housing issued its annual report on the MHA program, which requires developers to contribute to the city’s efforts to build more affordable housing. Now that the program has been running for a few years, it’s an apt time to look at how it’s doing.

Mandatory Housing Affordability, or MHA, is a program that requires developers of commercial buildings, market rate housing, and mixed-use projects to contribute to the city’s stock of affordable housing, either through “performance” by setting aside a certain number of housing units to be made available at discounted rates, or by paying a lump-sum to the city to be used for funding affordable-housing projects. In return for the contributions to affordable housing, zoning restrictions were eased to allow for larger buildings — calculated to approximate an equal value tradeoff. The first phase of the MHA program was rolled out in 2017, with ordinances covering the University District (February), downtown and South Lake Union (April), the Chinatown-International District (August), portions of the Central District (August), and Uptown (October). The rest of the city’s urban villages and centers were covered in phase two, which was passed into law in April 2019.

Click to access 2020%20OH%20IZ%20MHA%20Annual%20Report.pdf

As with all zoning changes, MHA applies only to projects where the permit application was submitted after the new regulations took effect. With advance notice of the passage of MHA’s phases, many developers rushed to get projects submitted before they took effect — though some voluntarily opted into MHA later in order to gain the extra zoning allowances. Still, with a spike in applications before MHA and a permit processing time of six to eighteen months (or longer), it was anyone’s guess how long it might take before the MHA program started collecting contributions, how large those contributions might be, or whether MHA would depress development activities.  Of course, there are confounding factors as well, including the COVID recession (though economists were predicting a high likelihood of a recession in 2020 or 2021 even before COVID), and the the end of Amazon’s building spree in South Lake Union.

At the time the final phase of MHA was passed in 2019, the city was predicting (or perhaps hoping) that it would generate about 6300 units of affordable housing over ten years: 1000 through developers taking the “performance” option, and the remainder through the city investing MHA payments (expected to be about $472 million). It attempted to design the rates for each to obtain around a 50/50 split of projects choosing between performance and payment, with the logic that each brings different value: the payment option allows the city to build more units by leveraging the MHA funds with other federal, state, and private grants; but the performance option co-locates affordable housing within market-rate and luxury housing, which helps to fight displacement and opens doors for lower-income households to live in more expensive (and often higher economic opportunity) areas of the city where it might be prohibitive to build an entire affordable housing project.

According to the Office of Housing report, to-date the MHA program has collected $96.1 million in payments, with 21 “performance” units opened up and another 83 “performance” units committed to in projects under development. “Performance” units are committed to when the construction permit is issued, but obviously don’t become real until the project is complete and the building is occupied. Payments, however, are made at the time that the construction permit is issued.

As you would expect, the amount of MHA payments has been growing as the backlog of “grandfathered” permits pre-dating MHA has been processed through. In 2020, MHA payments totaled $68.29 million. That’s a big number, and if that is what we can expect the MHA program to draw annually in contributions, it will far exceed the $472 million goal over the full ten years. However, the “performance” numbers are terrible: so far only 14 projects have delivered on or committed to the performance option, and 44 of the 104 units committed to came from a single mega-project: the 432-unit housing project at 2301 E. Union Street. On the other hand, if the payment option continues to far exceed expectations, we might not care.

Which leads us to ask: was 2020 a fluke for the MHA program, or can we expect more of the same? It was a big jump up from the $15.8 million collected in 2019, but as we discussed earlier, there are multiple factors affecting the construction sector at the moment that can be challenging to tease apart. Fortunately, we have some data available to help us understand what is going on: permits for new construction.

The Seattle Department of Construction and Inspections (SDCI) graciously supplied data on both permit applications and issued permits. I narrowed it down to just new construction permits for projects valued at over $500,000, and for the three types of projects that generate the vast majority of MHA payments: commercial, multifamily housing, and mixed-use. SDCI combines commercial and mixed-use projects together in some of its reports, so we’ll do the same here.

To understand whether 2020 was a one-off for MHA payments, let’s begin by taking a look backwards at the trends for issued permits since payments are made at the time the permit issues. Between 2016 and 2020, the annual count of new construction permits was fairly consistently between 260 and 350; however, the total value of those permits dropped dramatically starting in 2019: from over $3 billion in 2017 to under $700 million in 2019 and 2020. For the purposes of predicting MHA payments, we care a lot about that total value, as payment size correlates with the size of the project (MHA payments are based on square footage, but generally speaking the greater the square footage, the more expensive the project).There are two things going on here: timing issues, and differences between commercial and housing projects. To understand them, we will need to look at more granular data: month-to-month statistics, as well as breaking out the project types. Here is a graph of the monthly count of issued permits:

As you can see, the month-to-month data can be very volatile: it looks more like the downtown Seattle skyline than the Cascades. To help us see the trends more clearly, we’re going to smooth it out just slightly by looking at three-month averages instead of individual months.

Now we can see clearly that commercial and multifamily permits are behaving very differently: multifamily housing was consistent within a certain range and grew slightly going into 2019, but the number of issued commercial permits went from a peak in 2017 to a lower plateau in 2018 and 2019, before dropping to almost zero last year. The data on the total value of those permits is even more instructive:

Through mid-2018, the value of commercial projects far outstripped multifamily housing — right up until it fell off a cliff. Since then the permits have been almost entirely housing projects. There were always more housing projects than commercial projects, but the commercial projects were substantially larger. Now there are even fewer commercial projects being issued construction permits, and the size of the projects also has dramatically decreased.

Let’s drill down into the commercial permits, since clearly there’s something going on there, and we’ll add in the data on permit applications. In the absence of other factors, what we should expect to see is issued permits lagging applications by 6-18 months — so if we see a spike or drop in applications, we should see a similar one (though more spread out) in issued permits several months thereafter.

We can see very clearly the 2016 peak in applications turn into a 2017 peak in issued permits, and likewise the 2017 drop-off in applications also reflected in issued permits in 2018. But there’s more going on here that’s worth talking about. First, the peak in applications in 2016 and the drop-off in early 2017 correspond to the passage of the downtown/South Lake Union MHA legislation in April 2017. And there is another spike and fall when the city-wide MHA was enacted in April 2019. Both are obvious signs that the commercial development market in Seattle reacted to MHA. But you’ll also notice that the 2018 spike in permit applications didn’t have a corresponding increase in issued permits.  We see this even more clearly when looking at the value of the permits applied for and issued:

Here we see the value of the big pre-2017 application frenzy translate into the value of issued permits through mid-2018… and then suddenly it just stops. Since July 2018 there have been several periods of increased value in applications, and none of them have translated into more valuable commercial permits issued. In the last two and a half years, commercial development has all been small projects; while the value of projects being applied for has gone up — a lot — the value of permits actually issuing has crashed.

Let’s contrast this with the multi-family housing permits. Despite all the ups and downs of permit applications, the number of issued permits is remarkably steady.

The value of the permits, other than a bit of a jump up from mid-2017 to mid-2018 after the downtown/SLU MHA went into effect, has also been consistent. No matter how many applications are filed, only a certain number of permits, worth a relatively fixed amount, get issued; the rest are abandoned along the way, for any of a number of reasons. The consistent number of permits issued suggests that financing may be the controlling factor.

But it is very interesting that unlike with commercial development, MHA seems to have made no significant impact on multifamily housing development in Seattle. Of course, nothing else has either: since mid-2019 both the number and size of the multifamily projects being applied for has grown, but neither is reflected in the permits being issued.

At a recent committee hearing, representatives of SDCI told the City Council that there is a bit of monkey business going on with permits: knowing that once a permit is issued the developer must begin the project within 12 months, some developers are stalling on completing the final required changes to their plans in order to push out the permit issue date. As the economy picks up again this year and financing becomes more available, we may see more of those permits issue — especially if the federal and state government come through with housing and infrastructure funding.

Tomorrow the city’s budget office will be presenting its economic forecast, and it has come to largely the same conclusion on the construction sector — especially the commercial segment.

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But to return to our original question: was the $68 million in MHA funding in 2020 a fluke? It seems that the answer is “no.” The vast majority of the dollars spent on major new construction was for multifamily housing, which now has a long-established steady stream of 300 small projects per year (give or take 50). At least for the moment, that trendline seems to be impervious to external factors, such as MHA, economic downturns, Amazon’s love/hate relationship with Seattle, and COVID. And with the permit applications we know to be in the queue, there is every reason to believe that the issued multifamily permits in 2021 will match 2020; if anything, the total value might be even higher.

On the commercial development side, even though applications have ticked up again in the past few months, there’s no reason to expect a change from the now-well-established pattern: issued permits for a small handful of small commercial projects. Those suggesting that post-COVID workers may not rush to reinhabit the downtown office towers lend even more credence to the view that the demand for additional commercial space may not recover for quite a while. All that leads us to conclude that MHA is unlikely to see much revenue from commercial development; it isn’t seeing much now, and it’s hard to be optimistic for upside.

In fact, given that the MHA program at the moment is already almost entirely dependent on revenues from multifamily housing projects, and yet still seems to be raising enough to meet its goals, the city could even consider a temporary pause on the commercial MHA requirements as a financial boost to the commercial development sector. It’s clear that MHA had a big effect on the commercial development sector (though perhaps not the only factor in its steep dropoff). Not only is a fiscal stimulus in the sector’s best interest, it’s also in the city government’s: beyond MHA, the city depends on the construction industry for a large chunk of revenues through a variety of taxes. And with the limited current MHA revenues from commercial projects, the city has little to lose.

The city also needs to grapple with what to do about the underutilized “performance” option for MHA: tweak the formulas again with the hope of making it more attractive (or payment less attractive), or abandon it altogether and place its bet on what is clearly the winning horse.

In an interview, Emily Alvarado, the Director of the Office of Housing, emphasized that 2020 was only the first year with the full MHA program in place. “We’re still early in this process, and there are a multitude of factors for a developer in going forward with a project.” Among the factors she highlighted were some of the broader economic ones, including the availability of financing, as well as booking tenants in advance. “Commercial developers need some level of certainty on who their tenants will be,” she said.

Alvarado also asserted that it was too early to pass judgment on the split between payment and performance, while observing that the shift to smaller projects has contributed to the preference for payment over performance.

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There’s another side to the MHA program that also requires some analysis: how the Office of Housing is investing the program’s revenues. To begin, though, we must recognize that MHA is one in a portfolio of city programs to create affordable housing, including Incentive Zoning, the Multifamily Tax Exemption, and the Seattle Housing Levy. Earlier this month the Office of Housing issued a report showing the combined output of all those programs.

That said, there were some promises made about MHA investments, in particular assuring that money generated in one part of Seattle is re-invested back into that neighborhood. In practice, however, that’s impractical to in the short-term, since the Office of Housing tends to aggregate the revenues into investments in a smaller number of complete housing projects rather than a plethora of granular investments. Their commitment is that while in any given year they can’t cover every section of the city, over the long term they will work to make investments in every community.

To-date, the Office of Housing has re-invested $84.7 million of the $96 million it has gathered. Here’s a table from the MHA report with the geographic spread:

Of that, about $53 million was spent last year:

There are some obvious gaps that these tables point out, including the University District, South Lake Union, the Aurora/Licton Springs/Bitter Lake area, Ballard, Queen Anne/Uptown, and West Seattle. Some of these areas have generated a significant amount of MHA revenues from the program already, which is an issue since the City Council included a guideline in the program that over the long term the revenues from MHA should be re-invested back in the communities that generated them.

Alvarado again emphasized that it is still the early days of the program, such that there simply haven’t been enough projects (or funding) yet to cover all parts of the city. At the same time, she highlighted some of the efforts underway: she said that talks are currently underway with property owners in the University District and Ballard. Alvarado also explained that her office is scaling up its investments in smaller development projects; that allows for more spread, but also enables her office to utilize small pieces of publicly-owned land to fit into different kinds of neighborhoods and locations. She said that the smaller-scale investments tend to be in home ownership opportunities, which “help achieve some equity outcomes.” Resident ownership is very low in many underserved neighborhoods in Seattle, which tends to increase gentrification and displacement. Alvarado said that overall she is happy with the outcomes of the investments so far, including on some of the other metrics they use to measure success such as creating family-sized units.

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It’s clear that the MHA program, four years after its inception and two years since full implementation, is hitting the mark in some ways and missing it in others. The good news is that it is collecting and investing a substantial amount of money for affordable housing. The bad news is that not only is it at the whim of the local property development sector, but it might be a drag on it as well. In many ways it is still too early to know how it will fully play out, but at the moment there are signs that it is on track to meet its goals.  But with a shift to smaller projects — both those that MHA draws revenues from, and those that it funds — it will be interesting to see how the program evolves in the months and years to come.

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