Linkage Fees: Will Seattle Start the San Francisco Death Spiral

The Seattle City Council is at it again. Councilmember Mike O’Brien wants a “linkage fee” on all new development in Seattle to raise money for subsidized housing. This new tax being discussed today in the Planning, Land Use, and Sustainability (PLUS) Committee is supposed to lower rents. When have adding fees and costs to something that is increasingly scarce suddenly caused its price to drop? Linkage fees are part of a chain reaction effect of complaints about high rents, followed by the declaration of an emergency, policies imposed that will act to raise prices, followed by another round of yelling about rising prices, with more policy that higher prices. This is what I call the San Francisco Death Spiral, a city with rampant housing inflation and where the supply of housing is 100,000 units behind demand and even billions of dollars in subsidies won’t help.

What is Mike O’Brien proposing to solve perceived rent increases? He wants to impose a tax of anywhere from $8 to $22 per square foot for any new construction in Seattle. So a 10,000 square foot development in Capitol Hill, for instance, would pay a fee of $120,000 to $150,000. As we pointed out when we were asking to keep microhousing out of the design review process, all the extra fees just end up getting folded into rents. There is no other way to make up the costs. No, taking less “profit” isn’t an option, because lenders and investors set Net Operating Income (NOI). When the ratio of costs to income goes up, banks and investors expect it to be off set with more income: that means higher rents.

When projects don’t pencil out because the rents get too high (yes, that happens) then projects won’t get built. Some projects just won’t be able to charge rents high enough to offset O’Brien’s tax. That means fewer units, less supply, and, yes, higher prices.

But wait, say housing tax advocates, the fee will lower the value of the land. So if that 10,000 square foot parcel was selling for $1,000,000 the price will go down (boom!) to $850,000. The landowner, according to O’Brien and his paid consultant, will just lower her price exactly the same amount as the fee. Problem solved. She loses the money, the builder can build the same project and the lower land price off sets the fee so rents don’t go up.

Anyone who actually works in real estate chuckles and shakes their head at this idea. Most say, “it just doesn’t work like that.” Owners of land will not just lower their asking price by 12 to 15 percent. Prices for land are like all other prices: negotiable. If it’s too high or low the transaction won’t happen.

But let’s take a trip down the Yellow Brick Road with O’Brien. What if his tax lowers land a values?

First of all, many sellers simply won’t sell. If my property with a parking lot on it just lost 15 percent of it’s value, why not just leave it a parking lot. After all, the income from selling parking is good money. If buyers all demand a discount there’s nothing that O’Brien can do to make me sell. So what could have been a bunch of new housing units just disappeared. That means less supply and, drumroll, higher prices. Rimshot.

And get this, because our state applies taxes to the total value of land in a taxing district, O’Brien’s tax doesn’t just raise rents, put a damper on housing production, but it also raises everyone else’s property taxes, including angry, entitled, single-family home owners fighting growth. You’d think a policy that simultaneously lowered people’s property values and increased their property taxes would have everyone up in arms. But this seems lost on everyone, especially the people suggesting the policy.

Here’s how it works in Washington, where we use a “budget based” system for property tax. If the budget of a taxing district is $100,000 and it’s splitting the property tax it assess among $1,000,000 in value, each dollar of value pays $.10 in taxes. A property worth $5,000 would pay $500 in property taxes.

When O’Brien’s scheme lowers property values an average of 15 percent, it would look more like this: $100,000 tax divided among $850,000 in value, or about 11.8 cents on the dollar of each dollar of value. The property tax for the same property would be $501.50 (this is discounting the original value to $4,250 and applying a new rate of .118 cents on the dollar.

Doesn’t sound like much does it? But that small increment when applied to a more real world value, like an $850,000 craftsman in Wallingford adds up (i.e. $2,500 per year). Is that O’Brien’s goal? To raise everyone’s property taxes? He’d say no, but his argument leads there. And guess where rental properties find the money to offset the higher property taxes impact on their operating costs? Yes, you guessed if, higher rents.

So, taken together, O’Brien’s proposal

  • boosts costs for new housing;
  • raises rents for new housing;
  • raises property tax rates for everyone;
  • raises rents for all renters as property taxes go up;
  • lowers property values which disincentivizes new housing which constrains supply, which means higher rents; and
  • increase risks, costs, rents, and time to market for all housing, which isn’t coal trains or cigarettes, but a good thing.

So there you have it, The San Francisco Death Sprial: more rules, fees, punitive measures against new housing with resulting higher prices, rising demand, lower supply, which leads to higher prices, which increases the calls for more rules, fees, and punitive measures, which raises prices, which means more inflationary rules.

Perhaps we Seattlites can warm our homes this rainy winter in the glow of the inflationary furnace created by these policies while we warm our progressive insides with blame for greedy developers and landlords for “sky rocketing rents.” We can invite the City Council to bring the marshmallows and graham crackers.

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