Form Follows Financing
More than anything, financing determines how our cities are built. It’s not the fancy documents planners put together or the blueprints architects draft or the street layouts engineers sketch out, it is what the financiers are willing to fund that gets built. The layout and designs of our roadways, the type of retail that is built, even the structure of our homes is determined by financing.
Most communities have some type of plan documenting their vision for the future development of the community, some type of General Plan, or Master Plan, or Community Plan. They also have zoning and development standards that restrict what can be developed on any specific parcel of land. All of these documents and regulations may envision a wonderfully balanced community, with a lively compact town center and retail tailored to the local businesses, a community with safe and slow roads, and that would be be fiscally solvent. However, if those plans don’t align with what can be financed, they will not be built. Communities have the option to either modify their plans to match what can be financed and built, find local sources of financing to construct an environment that meets the needs and desires of the community, or simply go without building anything new.
Most cities don’t fund new roadway construction through tax revenue. Roadways are either funded by grants from the state or Federal government, or during the development of adjacent property. When roads are funded by grants, the roadway standards are set by the people providing the grant funding.
My hometown of Anaheim, CA provides a perfect example of the way grant funding creates design requirements. Anaheim has been awarded a $10 million grant from the Orange County Transportation Authority (OCTA) to widen Lincoln Avenue, which is a major east-west thoroughfare through the heart of the city. The OCTA Master Plan of Arterial Highways identifies Lincoln Avenue as a six lane divided roadway, although this section of Lincoln is currently “only” a four lane divided roadway. The City of Anaheim has been moving forward with widening Lincoln Avenue to add an additional travel lane in each direction, despite considerable community opposition, simply because the money is available to do so. There are many residents of Anaheim who would like to see something else done along this section of Lincoln Avenue with this grant money, but if the end result isn’t a six lane divided roadway per the OCTA plan, then the money can’t be used for the project.
The development of retail space is similarly beholden to the demands of financing, although it’s not quite as apparent as with the grant funding for roadways. New retail space is typically built to Class A standards. This isn’t because communities need more Class A retail space, it is because Class A is all that can be financed.
Most real estate development is financed with substantial amounts of debt. Similar to how most Americans buy homes, developers put a little money in as a down payment (their equity) and borrow the rest from banks (their debt). However, banks often require signed leases from national credit tenants prior to funding construction loans for retail space. National credit tenants are the large chain stores that are the most creditworthy; who, even if they broke a lease, won’t leave the property owner holding the bag. This helps ensure that the retail center will be a success and that the bank will be repaid the money it loaned.
Of course, national credit tenants have certain requirements for the retail spaces they occupy, requirements that are at odds with the needs of small local businesses. Often national credit tenants want retail spaces that are considerably larger than what local businesses can fully utilize or afford. National credit tenants want ample parking with close proximity to their door, so customers don’t have to walk long distances, which also means that customers aren’t walking by the storefronts of other businesses who might not be destinations in themselves and instead rely upon that pass-by traffic. National credit tenants also expect a certain level of maintenance and freshness for any shopping center where they are located, which drives up rent throughout the center, making it un-affordable for most locally owned businesses.
It is due to the demands of financing that most new commercial space is hostile to small local businesses in these ways.
In large parts, residential real estate is similar, the only homes that are built are what can be funded. The big difference is that the residential real estate market is much more skewed by national political policy. The only reason for the prevalence of the 30-year mortgage in America is that the government underwrites and often purchases 30-year mortgages through Fannie Mae and Freddie Mac. In other countries, the 30-year mortgage doesn’t have the monopoly that it enjoys in the United States, other terms such as 15- and 20- years are much more common.
The terms of our residential financing isn’t just limited to the types of mortgages we can get, but the very form of our homes as well. The United States Department of Housing and Urban Development (HUD) provides underwriting for multi-family buildings up to 4-plexes through their FHA 203(k) loan program. (Freddie Mac has a new loan product that is somewhat similar called Home Possible.) This makes it easier to finance the construction of a 4-plex over something larger, which is partly why so many communities have a lot of 4-plex apartments.
Many of these specialized loan programs are somewhere between difficult to impossible to use for mixed-use developments. This creates a market bias in favor of single-use buildings, instead of allowing for a freer market that might find a preference for buildings that are more diversified through a mix of uses.
To change what is built in our communities, we must align the availability of financing with our desired built environment. At the local level, it is difficult to influence the direction of national policy or to change the underwriting requirements for large financial institutions. The option local communities have is to create their own sources of financing. To invest their local wealth into the community by making it available for building the community they want to live in.
[Note: This is one article in a longer series on finding local solutions to global problems and to build a better world, including solving issues related to climate change, housing affordability, the local economy, the fiscal solvency of cities, and public health.]
