Is the new 421 A the answer to New York City’s affordable housing problem?

By Ron Lagnado

In a city in which resolving competing interests often results in inertia, the recent rapprochement among the city, real estate developers, unions, and Governor Cuomo has caused the extension of the 46-year old 421 A provision, which had been in limbo for two years. It brings hope to all stakeholders—including residents for whom the prospect of additional affordable housing seemed nonexistent.

Inaugurated in 1971, 421 A was put in place largely to stem residents’ flight to the suburbs. The program gave incentives to builders to construct affordable housing, primarily in the form of real estate tax abatements. Without such abatements, real estate taxes could be as much as 30% of top line revenue annually. Although the exact number of developers who participated is murky, many residential buildings were constructed under 421 A’s aegis, with 20% of units set aside as affordable housing and 80% targeted for market-rate tenants, as long as the amenities for each were identical. Developers who participated by building on either vacant (or mostly vacant) land enjoyed a period of much lower taxes during the construction period, for up to three years[i]. Then a ten-year exemption period kicked in, during which it became an abatement, which then was reduced by 20% annually in the last five years of the abatement period. In return for the city’s largesse, developers were supposed to pass along some of their tax savings to tenants in the form of subsidized rents.

In the 1980s, concluding that the program was too generous to developers, the city carved out Geographic Exclusion Areas (GEAs), which kept developers from benefiting from these tax abatements in what were considered prime residential areas, such as in Manhattan from 14th Street to 96th Street, expanding to Brooklyn’s Greenpoint and Williamsburg neighborhoods.

The advantages of 421 A were obvious: Developers had a reprieve from paying real estate taxes and could take advantage of additional exemption periods, ranging from 15 to 25 years. The taxes were assessed at the same rate as the land’s existing use, rather than on its ultimate intended use. For example, if a $50,000,000 project was built on land that housed a parking lot, the developer’s annual taxes were based on that land’s existing usage value, which for illustrative purposes, was $30,000. The tax was in sharp contrast to the usual tax of 30% of top-line revenue, or $2,000,000, let’s say, which could be the norm for a 20-story residential apartment building. Additionally, in some circumstances, the tax abatements could even be extended beyond 25 years. It should also be noted that developers received the benefit of Federal low-income housing tax credits for a period of ten years from the date the property was place in service.

But it wasn’t a perfect system. For one thing, rent increases had to align with rent-stabilized percentages, which applied throughout the abatement period. That may not have presented a problem when the increase percentages permitted under rent stabilization were in line with maintenance costs, but in recent years, costs have far outpaced what landlords can pass along to tenants.

And it wasn’t long before a confluence of competing interests surfaced: Construction workers in buildings with 15 or more units wanted to be paid union-level wages, along with prevailing health benefits, retirement contributions, life insurance, and paid leave. It was a move that was touted to cost the city $2.8 Billion in construction costs[ii], according to the city’s Independent Budget Office (IBO), although various groups have debated that figure. Nonetheless, the 421 A plan expired in 2015, but Governor Cuomo gave the developers and unions six months to come to an agreement to extend it. It never materialized. For one thing, developers saw little value in a plan that couldn’t keep pace with costs. For another, constructing condominiums that could command much higher prices made more economic sense, particularly if developers had to pay current market prices for land.

Fast forward to May 2017, when Governor Cuomo announced a new plan, Affordable New York Housing, which is supposed to create 2,500 new units annually[iii], and appears to have something for everyone. Among the highlights are wages of an average of $60 an hour for union workers, although developers aren’t required to prove they paid those wages until the project is complete[iv]. That provision raises the ire of the Building and Construction Trades Council union, which claims the rule runs counter to ensuring “workers get paid appropriately while they are working.”

The plan also allows longer abatement periods, extending to 35 years, versus 25 years in the prior plan. Additionally, developers now must set aside more units considered to be affordable: 25% to 30% of the units (rather than merely the 20% that was required under the older 80/20 program) must be for people whose incomes are 40% to 130% of the Area Median Income[v] (which varies based on family size). And these income limits must stay in place for 40 years. Also, under the old program, one-half the affordable units had to be offered to nearby residents, and it included set asides for veterans, government employees, those with disabilities, and families currently residing in homeless shelters. Affordable New York Housing is exempt from those provisions[vi]. Although the city can add its own local requirements, it could invite U.S. Department of Labor examination. The plan coincides with New York State’s $2.5 Billion of funding for affordable housing[vii]. Even condominium builders benefit, so long as those projects are outside Manhattan and have fewer than 35 units.

But the plan raises a debate as to whether tax abatements are the best vehicle to address the city’s affordable housing needs. On one hand, if the city were collecting its fair share of real estate taxes, rather than allowing the abatements (which run around $1.4 Billion annually, as Nonko’s ny.curbed.com article cited above notes), it easily could fund affordable housing. Nonko’s article goes on to point out that although few would dispute that affordable housing stock is declining, the advocacy group Association for Neighborhood and Housing Development claims that “79 cents of every 421-a dollar [will be] spent going to luxury development and only 11 cents going to support affordability.”

But the program’s rent increases of only 1% to 2% (which are to be finalized in October 2017) are an impediment to landlords whose maintenance costs have skyrocketed. Without the 421 A program’s stringent requirements to maintain rent increases in accordance with rent stabilization guidelines, landlords could more comfortably cover rising maintenance costs. In addition, requiring an auditor’s verification that construction companies actually paid the prescribed union wages creates another financial burden on developers, as do the higher wages themselves.  According to Blinderglass’s ny.curbed.com article previously cited, the IBO found that in the 57 projects it analyzed, costs were expected to rise by 13%, on average, although the union’s president disputes the figure. And union wages aren’t the only barrier: the number of tony development projects lets workers cherry pick available jobs. Add in the rising land costs, and it’s understandable that developers are seeking creative solutions, such as partnering with landowners in joint ventures[viii].

A better path forward could encompass bids for affordable housing, which could lower costs (as competition always does), rather than relying on tax abatements for funding, which creates gaps in the city’s already strained budget. And the jury is still out on whether the program will actually produce more affordable housing. Before the plan expired in 2015, a wave of developers filed construction permits for 56,000 new units, plunging to just 15,700 a year later. And now that the rental market is softening, the demand for luxury housing may decline, giving developers less incentive to build residential units, whether they are luxury or affordable, Zimmer’s DNA Info.com article points out.

In summary, the restoration of 421 A through Affordable New York Housing may meet some stakeholders’ wishes, but for others, not so much. It might not be the most economical way for the city to supply affordable housing. Tax abatements are not a panacea: ultimately, they result in a budget gap that the city must find other revenue to fill, namely tax increases for residents who already pay among the highest taxes in the country. Incentives for developers must be balanced with the reality of rising maintenance costs—otherwise, why would they build only to lose money subsequently? One solution is to consider alternative sources of capital, for example, private equity firms, whose investors may be attracted by tax credits. The future of the program remains uncertain—only time will tell whether its noble intention—creating more affordable housing stock—actually materializes.

[i] https://ny.curbed.com/2016/1/15/10846176/everything-you-need-to-know-about-nycs-421-a-tax-program-poised-to

[ii] https://www.dnainfo.com/new-york/20160112/kingsbridge/city-could-face-extra-28b-construction-costs-under-new-421-a-tax-deal

[iii] https://commercialobserver.com/2017/01/does-cuomo-have-the-answer-to-421a/

[iv] https://therealdeal.com/2017/07/17/construction-groups-have-some-big-concerns-with-421a/

[v] https://www.dnainfo.com/new-york/20170501/long-island-city/421-a-tax-break-affordable-housing

[vi] https://www.bisnow.com/new-york/news/affordable-housing/new-421a-no-local-resident-preferences-77022

[vii] https://ny.curbed.com/2017/4/11/15257926/nyc-affordable-housing-revival-developer-incentives

[viii] http://nypost.com/2017/08/02/new-yorks-affordable-housing-program-has-a-flawed-model/?utm_campaign=iosapp&utm_source=mail_app