Public housing is way cheaper than rental subsidies

First published here on 3 Nov 2021.

Discussions about the best way to provide below-market-priced housing regularly pop up on Twitter. Peter Tulip has noted many of the limitations of such systems—queuing, quotas, qualifying criteria, etc—concluding that a cash payment to residents to help pay market rents is the most cost-effective way for governments to get the policy outcome of reducing housing costs to low-income households.

Peter Tulip @peter_tulip

Michael, People agree there is a housing crisis; the question is what to do about it. Review after review finds that the public housing you advocate is bad value for money. Rent Assistance is more cost-effective. For lower prices, we need to increase supply. Let builders build.

Michael Pascoe @MichaelPascoe01

Michael Pascoe: "There’s the odd Band-Aid and plenty of platitudes, but no govt wants to admit the scale of the crisis, no govt wants to take responsibility for it, no govt is prepared to reverse decades of failed policy to deal with it" | The New Daily https://t.co/rPUaxlyHCH

I am not against providing such cash payments. They are better than nothing. But the reason I believe governments should build and own housing is that it provides a better bang for your housing subsidy buck.

Consider the two alternatives over a “tenant life” of say 30 years.

With cash rental assistance, the government pays, say for the sake of argument, $13,000 per year the first year. But to have a meaningful effect this must grow over time to reflect growth in rents and incomes. At a 2% growth rate, by year thirty the subsidy is $23,000 and over 30 years the total subsidy paid is $527,000. The present value of this 30-year flow of subsidy payments at a 2% discount rate is $374,000.

With public housing ownership, the government builds or buys a dwelling worth $500,000 today to supply that dwelling at a rent that is currently $13,000 below market rent per year (i.e. the same rental subsidy to the resident). The remaining rent paid by the tenant covers ongoing costs only. Like the cash rental subsidy, the gap grows over time to be $23,000 in the 30th year. Instead of $374,000 in present value terms, this option costs $500,000 today to build or buy the dwelling (much less if built on under-utilised publicly-owned land).

At first glance it looks like public housing is the more expensive option at $500,000, rather than $374,000 for the rental assistance.

However, with public housing ownership, a government agency owns the property at the end of the 30 years. Over this period, the asset value grows. Even if it grows in line with the 2% growth of local incomes it means that the property is worth $890,000. In reality, because incomes at a fixed location usually rise faster than the average (because cities expand), it is likely to be more. For reference, this is only a 76% rise in three decades, a conservative figure when compared to the 143% price rise seen in Australia’s capital cities in the past 18 years. 

The table below shows a comparison of the two alternative ways of providing the same value of housing subsidy to a resident over 30 years. Although the public housing ownership option costs $500,000 upfront, today's value of the final sale price is $490,000, leaving a net economic cost of just $10,000. This approach gets 40x better value for the budgetary spend. If capital growth is closer to historical norms then public housing can more than pay for itself.

What we learn from this is that 

• The cost of rental assistance over the long term is not much different than simply buying a dwelling and giving it to the household ($374k vs $500k). 

• The cost of rental assistance over the long term is much more than providing the same rental subsidy via owning the property ($374k vs $10k) 

• Getting out of the housing ownership game over the past three decades and shifting towards rental subsidies has cost government budgets billions.

[UPDATE] I've updated the figures to reflect 2% growth of incomes and rents and 2% interest and made the spreadsheet available here. Play around with the numbers. 

[UPDATE] People seem to think that interest payments need to be taken into account somewhere. They do not. Prevailing interest rates are incorporated via discounting. 

[UPDATE] Thanks to Jago Dodson for letting me know that a 1993 review by the Industry Commission (now Productivity Commission) ranked public housing first in terms of efficiency and cost-effectiveness out of a variety of alternative housing subsidy approaches they assessed. 

[UPDATE] Thanks to Vivienne Milligen for letting me know that the 1989 National Housing Policy Review found similarly—that public ownership of housing is the lowest-cost strategy for housing poverty relief.