Market Rate Affordable Housing Development Gaining Steam In Los Angeles

By Peter Ciriello CCIM, President of Development Sight

February 27, 2024

Unprecedented in L.A.

In the past, the concept of an “market rate 100% affordable project” was considered contradictory. However, under Mayor Karen Bass, Los Angeles is now approving numerous of these projects.

One such proposed 7-story apartment building on West Court Street in Echo Park, Los Angeles, does not seem logical, especially if you are familiar with the challenges of affordable housing in California. The project has 190 units that will only be available to individuals earning less than $100,000, making it a designated “affordable housing” development in Los Angeles. However, unlike most affordable housing projects in California, this development is not funded by taxpayer dollars.

That’s thanks to ED-1, an executive order from Mayor Karen Bass. In December 2022, just after taking office, Los Angeles city planning department has received over 16,000 plans for affordable housing units. This is higher than the total number of approved affordable units in Los Angeles during the years 2020, 2021, and 2022 combined. 

The city has faced legal challenges and political debates about making the mayoral decree (ED-1) regarding housing policy in Los Angeles a permanent decision, rather than one that is only in effect as long as the current mayor desires.

The policy was created to expedite the approval process for projects that are entirely affordable. However, it unexpectedly has also encouraged private developers, who typically focus on maximizing profits from building new homes rather than affordable housing, to reconsider the benefits of following state laws that support affordable projects.

A significant change in affordable housing policy.

Andrew Slocum and Terry Harris, the two developers working on the 7-story project on West Court Street, are examples of developers who have recently entered the affordable housing market in Los Angeles. They are not associated with nonprofit organizations or charities and do not have websites with sentimental mission statements. Both of them have backgrounds in the profit-driven world of luxury housing development.

“We are focused on our mission of providing housing,” explained Slocum. However, he is also undertaking this affordable project, in addition to two others, because it is the more financially advantageous choice.

Harris, a former college basketball player transitioning into a career in Southern California real estate, put it more straightforwardly.  He stated that he was simply trying to be as “greedy” as he could be.

According to a report from the housing advocacy group Abundant Housing LA, around 75% of the affordable housing units suggested through the policy are being built without any government funding. Developers, like Harris, are choosing to completely abandon proposed “luxury” apartment projects and instead resubmitting the plans as 100% affordable housing.

It is difficult to emphasize enough how different all of this is in the world of market rate housing development.  Normally, market rate developers try to get away with as few affordable units as possible.

Scott Epstein, policy director at Abundant Housing LA and one of the authors of the analysis, expressed surprise at the unexpected development. He mentioned that in terms of 100% privately funded projects, the scale of this particular initiative is unparalleled.

In coastal California, the high cost of constructing new apartment buildings and the limited returns from rent cause a significant shortfall in funding for 100% affordable housing projects. The land, which becomes deed restricted also becomes immediately less valuable even if a developer paid market rate for the parcels.  This gap between rent returns and construction costs is typically filled by public subsidies, which can come in the form of low-interest loans, municipal grants, bond financing and tax avoidance from various levels of government. However, these financial aids often come with conditions that result in increased costs and setbacks for the projects.

The new type of affordable housing in Los Angeles avoids these issues – at least theoretically. While none of these units have been constructed yet, discussions with advocates and industry professionals in Los Angeles the novelty of this approach. Many described this as a significant change in the way affordable housing is created in the state, noting that it is unprecedented.

Two Strategies Combined

Private developers who are funded by their own resources and aim to enter the affordable housing market in Los Angeles typically adhere to a common approach.  Initially, they refer to ED-1, or “Executive Directive 1,” in order to ensure and expedite the procedure.

The ED-1 decree establishes a 60-day deadline for the city’s planning department to either approve or deny a proposed project. If the project meets certain requirements, it must be approved without the need for city council hearings, community meetings, or environmental impact assessments. It also implies that less time will be spent gaining approval for a project.

As a broker working in development, I can tell you that the idea of opening and closing escrow on the acquisition of a lot to starting construction in less than a year is quite uncommon. Most escrows take a year to close.  Developers also feel that spending less time on repaying debts, managing payroll, and reassuring nervous investors about the project’s success leads to savings in the initial stages of projects.

Another important point to note is that the Los Angeles law, unlike many other statewide laws, does not mandate developers to pay construction workers higher “prevailing wages” which are similar to the wages earned by unionized construction workers on public infrastructure projects.

Next is the following stage. Many projects referred to as “ED1 projects” use a mix of statewide “density bonus” laws that permit developers of 100% affordable housing projects to increase the number of units and floors on a specific lot beyond what local zoning rules would typically allow. These laws also give affordable housing developers the option to select from various incentives that reduce costs and facilitate denser development. This results in limited parking spots, restricted open space, smaller rooms, and fewer trees.

The increased number of units allows developers to decrease the rent while still being able to cover the construction costs and, potentially, make a profit.

Bass’ regulations and state density bonus laws are attracting privately funded developers to the profitable affordable housing sector, but economic factors are causing them to leave the luxury housing market. Waiting for municipal approvals that may never arrive has become a very expensive situation. The recent implementation of a tax on multimillion-dollar real estate deals in Los Angeles has only added to the financial burden, also known as the ULA. The luxury apartment development industry has experienced a cessation in most areas and a slowdown in areas of excessive wealth.

Developers who typically focus on market rate housing are now beginning to explore the affordable housing sector.

How inexpensive is housing that is considered affordable?

Just because something is considered “affordable” in Los Angeles, it does not necessarily mean it is inexpensive.

In order to be classified as a 100% affordable housing development according to the city of Los Angeles’ expedited process, a studio apartment with no parking and very few amenities can rent around $1,800. This is significantly higher than the price of $650 for the same unit in a typical publicly subsidized project.

But this strategy is not without risk, developers who are participating in the city’s new program are gambling that housing costs in Los Angeles are so high that even individuals making over $70,000 annually would be interested in renting a more basic and affordable housing option. This bet involves offering a pared-down rental option without all the added features, in hopes of achieving a slight reduction in rent.

This new product is designed to target the middle to lower end of the market, which was not previously being addressed by other companies.

Simply constructing an apartment building that is affordable for those with slightly lower incomes should not be viewed as a major achievement or require immediate action.

Six Peak Capital, a development firm based in New York, known for it’s portfolio of co-living apartment buildings in Los Angeles, purchased a 28,000 square foot development site with the help of Development Sight in May of 2020, located at 2859 Francis Avenue.  We asked Chris Aiello, Managing Partner of Six Peak Capital, what he thought of this new wave of development in Los Angeles. 

“The question is when will the equity show up.  I was sitting in Goldman Sachs headquarters last week.  They are very aggressive on ED-1 deals in Los Angeles and want to finance many projects right now.  The problem is equity right now is tough.  Francis will be our test case.”

For more information about this site or other sites we are representing in the area, please contact Peter Ciriello CCIM.