Adam Bergeson is a Strong Towns member sharing today's guest article about an interesting proposition for mitigating the impacts of conflicting priorities for renters and homeowners.
A lot has been written, at Strong Towns and elsewhere, about the conflicting outcomes that our cities are expected to deliver to a diverse range of oft-frustrated stakeholders. Property owners, business leaders, and public officials love to see their city’s economy expand through new investment, but the area’s renting population — often younger, poorer people — are justifiably afraid of being priced out of their homes and pushed further away as a consequence of that investment.
Relatedly, renters would greatly benefit from the construction of new, affordably priced housing inventory in their city. When new investment gets a little too close for comfort, however, the aforementioned property owners quickly transform into NIMBYs that oppose any project that poses the slightest risk of decreasing their property values or quality of life as new residents further congest existing infrastructure and public services. For many homeowners, their house is the most valuable asset they will ever buy and a significant proportion of their total net worth, making it completely rational for this group to be skeptical of, or downright hostile toward, anything that may diminish their asset’s value.
With such palpable real-world consequences for citizens on either side, trying to balance these opposing concerns and motives would appear to be an exasperatingly complex zero-sum game that our cities are being forced to play. But is this really the case? The societal tug-of-war caused by our modern housing market can be exasperating, certainly. But complex? Maybe not.
The way I see it, the winners and losers of this game are fundamentally defined by their relationship to the movement of a single variable: property values. As a city gains momentum and property values rise, owners win. If that same city tempers unmet demand by expanding the housing supply, especially that of affordable apartment units, renters win and the existing property owners lose. Because prices can only go in one direction (up or down), someone has to lose – that may never change. How then, can we make it less painful, or nearly painless even, to lose? Cities can look to Wall Street to find the simple answer: through hedging our bets.
Investopedia defines a ‘hedge’ as “an investment to reduce the risk of adverse price movements in an asset." For our purposes, the ‘asset’ would be the collective real estate values in a given city, and what constitutes an “adverse” price movement depends on your perspective as either a renter or a homeowner. Like an insurance policy, an effective hedge would help the losing population cope with any losses caused by the other’s gain.
A Hedge for Renters
Most people are familiar with Gross Domestic Product, or “GDP”. This is a measurement of a country’s total consumption and investment. Many also know that, by assuming the economy is a balanced transaction (every dollar spent is, for someone else, a dollar earned), we have another statistic called Gross Domestic Income, or “GDI” – a nation’s total earnings.
When talking about cities, the U.S. Bureau of Economic Analysis takes GDP and swaps “Domestic” for “Metropolitan” and voila, you have a measurement for the dollars spent within a city’s economy (GMP) and, conversely, the dollars earned (GMI). This latter statistic, Gross Metropolitan Income, is the figure cities should focus on for the purposes of limiting the financial hardship that growth may cause for renters.
GMI-linked bonds are not an entirely novel idea. Yale economist Robert Shiller, a Nobel Laureate and the co-creator of the Case-Shiller Index, has discussed the benefits of GDP-linked bonds for sovereign nations since the early ‘90s. In a number of papers, and briefly in his 2012 book Finance and the Good Society, Shiller describes a unique debt instrument that would behave like a corporate stock due to its indexation to the issuing country’s level of GDP. Simply put, investors in these bonds would own something analogous to “stock” in that country — an investment whose value would rise and fall in step with the economic performance of the issuer.
Shiller is not alone. A quick google search of “GDP-linked bonds” will demonstrate the growing interest this proposed financial asset has drawn from other economists and major financial institutions. In 2015, the Bank of England hosted numerous workshops that produced an overview of the concept, actual investor feedback, and even a potential payment structure if this innovative tool were made a reality. If you investigate GDP-linked bonds further, you will find that much smarter people than me have articulated a host of benefits that a country (or city) could enjoy by taking this approach to debt.
But we are not here to discuss “Strong Countries”; this is a place to discuss Strong Towns, and more specifically, what can be done about the housing crisis that many of our cities currently face. While GMI-linked bonds could have numerous benefits to cities, I will only focus on their relationship with housing affordability.
Arguments have been made against using statistics like GDP (and presumably GDI, GMP, and GMI) as measures of economic well-being. These concerns are valid, as a lot that goes on in a complex, real-world economy cannot be captured in a simple formula — yet these measurements continue to be used and widely accepted. Furthermore, a silver bullet for America’s housing crisis may not exist, so waiting on a perfect solution is counterproductive. That said, I selected GMI because the things it does account for are all that is required to create an effective hedge against rising home prices.
In very simple terms, GMI can be expressed by the following formula:
GMI = Wages + Profits + (Taxes – Subsidies)
For an apartment renter and future homebuyer searching for a hedge against soaring housing costs, a big takeaway would be the formula’s inclusion of local taxes. From a revenue perspective, property taxes — reflective of property values — are the meat and potatoes of most municipal budgets. In addition, the profits made by local landlords (incorporated or not) are captured by GMI as well, offering another layer of correlation to rental rates. So, if ‘Taxes’, ‘Profits’, or both were to increase in a city while all else remained the same, GMI would increase — and the renter who purchased the city’s GMI-linked bonds would see their investment grow.
Returning to the formula for GMI, the variable ‘- Subsidies’ presents another set of implications that would require an article of its own. (Hint: Subsidies are concessions made by a local government to private entities, so those familiar with the sacrifices cities make in the pursuit of a Growth Ponzi Scheme may see where this leads)
Obviously, a community’s poorest residents are, by definition, in no position to use a creative investing strategy to combat the risk of displacement — but this does not have to be the end of the conversation, nor should it be. Asking a more specific question like “How do we get these assets to those who need them most?” is substantial progress relative to wondering, “How do we solve gentrification?”
The other main group that typically falls within the ‘renter’ category is young people, including those with new careers and the 401ks to prove it. As a working 23-year old living in Atlanta, there is no shortage of units that I cannot afford. Atlanta has amazing urban neighborhoods that would be excellent places to raise a family, and it’s for that reason that property values in those neighborhoods are sharply rising. Like a lot of 20-somethings, I often do not have two pennies to rub together, but I do have a 401k through my employer. If I planned to eventually buy a home here in Atlanta and the city issued its own GMI-linked bonds today, it may be wise to add these hypothetical investments to my portfolio.
What about homeowners?
If I have failed to raise your eyebrows so far, this next bit may do the trick. I have described both sides of the housing conflict, what a hedge is, why we should seek to soften losses rather than attempt to make everyone a winner, and how the current losers of the housing crisis (renters) could purchase their city’s debt as a hedge against rising property values. But what about the existing homeowners that do not want to see the value of their property fall? What is their hedge?
Perhaps counterintuitively, I would argue that the exact same instrument — their city’s GMI-linked municipal bond — could act as a hedge for this group as well.
Now, if a city’s economy and housing market decline across the board, individuals owning property and ‘stock’ in that city would lose on both fronts. While rent might go down, renters would also lose in this instance because they would be living in a city with a shrinking economy and the value of their GMI-linked bonds, indexed to the shrinking economy, would reflect that reality. The only silver-lining GMI-linked bonds would produce in a situation where the entire city is struggling would apply to the city itself, whose debt payments to investors would decrease in proportion to its economic struggles. But this is worst case scenario.
As Strong Towns has noted before, the “adverse price movement” that NIMBYs fear will result from nearby housing construction is only a hyper-local concern. A new apartment complex in one neighborhood will not impact property values across town. From a broader perspective, new residents are beneficial to the city as a whole, and therefore to the concerned citizens as well. The new residents mean more employment, more spending, and more tax revenue for the community. The apartment building itself has tax value and serves as an employer and economic engine as well.
If those opposed to a new project were to buy, or be gifted, their city’s GMI-linked bonds prior to the project, they would soon have tangible evidence that, while their home’s value may temporarily fall, there is a real financial incentive to allow growth. As before, investors from this group would watch their bonds become more valuable as a function of the ‘Taxes’ and ‘Profits’ increasing from a city-wide perspective. In addition, this group would benefit as the ‘Wages’ variable in the GMI formula also received a boost from each of the new, working residents of the proposed project.
This leads me to perhaps the most important product of implementing this solution, which I will end on. If the potential hedging benefits I have described were to hold true for each group, two populations that are currently at complete odds, then cities would suddenly have access to a tool that builds a bridge across the housing divide by leveraging a mutual financial interest in the city’s economic success. If GMI-linked municipal bonds could work, conversations around housing, growth, and community would be transformed.
(Top photo by Johnny Sanphillippo)
About the Author
Adam Bergeson is a Strong Towns member and a Project Analyst at Brailsford & Dunlavey, where he serves as a trusted development advisor to the institutions that advance our communities. An unapologetic cyclist, urbanist, and a student of Finance, Adam is fascinated by the built environment and how it might be improved. Connect with him here