COMPARISON OF THE LONG-TERM COST OF SHELTER ALLOWANCES AND NON-PROFIT HOUSING

Transcription

1 COMPARISON OF THE LONG-TERM COST OF SHELTER ALLOWANCES AND NON-PROFIT HOUSING Prepared for The Fair Rental Policy Organization of Ontario By Clayton Research Associates Limited October, 1993

2 EXECUTIVE SUMMARY A study prepared by Clayton Research in June, 1993, The Cost of a Shelter Allowance Program in Ontario, has raised questions about the relative cost of this alternative means of providing housing assistance compared to the current non-profit housing program. Supporters of non-profit housing have argued that comparison of one-year costs is not appropriate since the costs of non-profit housing will, over time, decline and the projects are an investment in lowcost housing in the future. The Fair Rental Policy Organization therefore commissioned this study to examine the longterm costs of the two approaches - taking into account the investment aspect of non-profit housing - in order to determine the relative costs of shelter allowances versus non-profit housing. The study compares the cost of assisting 1,000 needy renters with non-profit housing in Toronto versus shelter allowances over the next 50 years. The average capital cost of non-profit housing is assumed to be $112,000 per unit and incomes average $14,000. For the shelter allowance estimates, the same mix of assisted tenants and average rents of $670 per month in the first year are assumed. For the future, inflation is assumed to be 3 percent annually and all incomes, rents and costs are assumed to increase at that rate. Since non-profit housing provides for a mix of both market and rgi (rent-geared-to-income) tenants, a total of 1,335 non-profit units are required in order to provide housing for the 1,000 needy tenants in the analysis - the market units are assumed to have market rents. The main findings of the study include the following: Shelter allowances are significantly less expensive than non-profit housing throughout the first 35 years of the analysis. This is the period over which the mortgage on the non-profit projects must be repaid. After 35 years, the non-profit projects yield a slight surplus on operations. The difference in costs for the two programs totals $8.8 million in the first year and declines gradually each year but still totals $1.8 million by the 35th year. In the 36th year, with the repayment of the mortgage, the non-profit units generate a small surplus and the overall difference in costs between the two programs is $8.7 million in favor of the non-profit projects. The interest charges on the higher non-profit costs are very substantial. By the 36th year, when the non-profit mortgage is finally repaid, the interest charges on the accumulated difference in total costs between the two programs totals $63.5 million per year. This is well above the relatively small ($8.7 million) advantage in current year costs enjoyed by the non-profit projects in that year. By the time the mortgage on the non-profits is repaid, the cumulated difference between the costs of the two programs (with interest) totals over $910 million. Even without any interest charges, the cumulated value of the differences in costs over time totals over $175 million.

3 -2- After 50 years, when the non-profits will have not only repaid their mortgage but will have had 15 years of mortgage-free operation, the cumulated difference between the two programs (with interest) totals $2.2 billion. Estimating the value of the non-profit projects in the future is very difficult; however, no matter what assumption is made, their ultimate value is well below that of the accumulated difference in costs. Even if it is assumed they rise with inflation (highly unlikely since properties depreciate rather than appreciate over time), they would be worth a total of $655 million after 50 years - much below the value of the cumulated difference in program costs. The analysis assumes that no additional investment is required to renovate or upgrade the projects during the 50 years (another doubtful assumption). To the extent that such investments are required, the differences in program costs would be greater still. One of the reasons why shelter allowances are much less costly than the nonprofit program is that the assistance is less generous than for non-profit housing. The formula for shelter allowances used in this analysis is that they equal 75 percent of the difference between rent and 30 percent of a tenant's income. In contrast, tenants in non-profit housing currently pay 26 percent of their income in rent though this will rise to 30 percent over the next four years. This difference accounts for only a relatively minor share of the total difference in costs between the two programs. An alternative analysis considered the difference in costs if both the shelter allowance and the non-profit assistance utilized the same rgi ratios of 30 percent. The total cumulated difference in program costs for this analysis was $1.6 billion after 50 years - compared to $2.2 billion for the base analysis. Another alternative analysis was conducted which incorporated a substantial increase of 10 percent in market rents in the first year. This was to test the sensitivity of the conclusions to such a rise in rents which some observers (though not the authors of this report) believe could occur if a significant shelter allowance program was introduced. This would, of course, reduce the difference in costs between the two programs since it would raise the shelter allowance costs. However, it is nowhere near sufficient to alter the overall conclusion - after 50 years the cumulative difference in program costs is almost $1.4 billion using this assumption. Shelter allowances are clearly a much more cost-effective means of providing housing for needy tenants than non-profit housing. The main reason why shelter allowances would be less expensive is that they provide assistance to needy tenants within the existing housing stock - most needy tenants are already adequately housed, their problem is that they cannot afford the rent. Rents in the existing stock are much lower than the costs of building new nonprofit housing. Also, there is no need with shelter allowances to provide subsidies to house non-needy tenants in order to provide for income mixing - as is the case with non-profit housing.

4 -3- COMPARISON OF THE LONG-TERM COST OF SHELTER ALLOWANCES AND NON-PROFIT HOUSING A study prepared by Clayton Research in June, 1993, The Cost of a Shelter Allowance Program in Ontario, has raised questions about the relative cost of this alternative means of providing housing assistance compared to the current non-profit housing program. The study indicated that a shelter allowance program targeted at providing assistance to those in core housing need (i.e. tenants unable to afford adequate, suitable rental accommodation at a cost they could afford) would cost an estimated $275 million annually. 1 Shelter allowances allow needy tenants to receive assistance while occupying units in the private rental market rather than have to seek accommodation in the limited stock of social housing as is the case with the nonprofit housing program. The study drew the comparison between the estimated $275 million annual cost of shelter allowances (which would assist 200,000 needy renters) and the $200 million annual operating subsidy required for the 20,000 non-profit housing units announced in The annual cost of the non-profit projects is three-quarters of the full cost of a shelter allowance program but would yield only one-tenth the number of units. In responding to the study, supporters of non-profit housing have indicated that a one-year comparison of costs is not appropriate since the costs of the non-profit projects will, over time, decline and the projects are an investment in low-cost housing in the future. Shelter allowances, on the other hand, make no such investment for the future since they provide assistance only to meeting tenants' current housing costs. A recent article in the journal Housing Policy Debate focuses attention on this issue by referring to a previous report by Clayton Research which demonstrated the long-term financial advantages of home ownership to families and individuals: "Instead of any conclusive evidence about the comparative long-term cost-effectiveness of alternative subsidy options (analysis that is very difficult to perform in a convincing and conclusive fashion), common sense arguments, in the end, have greatly influenced the public debate. In Canada, the argument that has generally prevailed is: If it is financially advantageous over the long term for individual households to become homeowners, why should not the same logic apply to public-sector investment in housing?" 2 This is a fair comment. The Fair Rental Policy Organization therefore commissioned this study to examine the long-term costs of the two approaches - taking into account the investment aspect of non-profit housing - in order to determine the relative costs of shelter allowances versus non-profit housing.

5 -4- The Approach - Comparison of the Costs for Providing Assistance for 1,000 Needy Tenants with Non-Profit Housing Versus Shelter Allowances There are three types of tenants in non-profit housing: deep subsidy, shallow subsidy and market rent tenants. From discussions with Ministry of Housing officials, the broad breakdown of tenants in a typical new non-profit project is as follows: Deep subsidy tenants - roughly 55 percent; Shallow subsidy tenants - roughly 20 percent; and Market rent tenants - roughly 25 percent. Therefore, to provide 1,000 units for needy tenants with non-profit housing would require a project with about 1,335 units (735 deep subsidy tenants, 265 shallow subsidy tenants and 335 market rent tenants. All three types of tenants receive subsidies since even the market rents do not generally cover the costs of building new non-profit housing. Based on estimates from Ministry of Housing staff, the monthly mortgage and operating costs for a typical new non-profit unit total over $1,150 per month - well above the typical market rent ($875) for these units. In contrast to the non-profit approach which requires the government or third sector to build or acquire housing, shelter allowances provide assistance to tenants who seek their own housing on the private market - often in the dwelling they already occupy. The calculation of the assistance is based on the tenants' income, family size and rent (subject to maximums which are based on market rents for typical types of housing). The formula for shelter allowances used in the previous Clayton Research report is the most commonly discussed approach - the shelter allowance payment would be 75 percent of the difference between the rent and 30 percent of the tenants' income. One of the advantages of shelter allowances compared to non-profit housing is that they do not need to provide subsidies to market rent tenants. With non-profit projects, it is desirable to have a mix of tenants since the experience of the past is that concentration of needy tenants in non-mixed projects increases social problems. With shelter allowances, such a mix of tenants is intrinsic to the program and subsidies to non-needy (market rent) tenants are not required to achieve it. The remainder of this study presents a comparison of the estimated costs over time associated with the provision of 1,335 units of non-profit housing -1,000 shallow and deep subsidy units for needy tenants and 335 market rent units (25 percent of the total) and the assistance which would be provided for the same 1,000 needy tenants using shelter allowances. The comparisons relate to costs and rents of typical nonprofit and private rental projects in Toronto.

6 -5- Initial Year Costs Very High for Non-Profit Housing According to information from Ministry of Housing staff, the average capital cost of non-profit housing in the Toronto area for the most recent program is roughly $112,000 per unit. According to Ministry sources, operating costs are roughly $5,500 and mortgage rates for nonprofit housing have declined to the 7 percent range. This interest rate seems low, however, in order not to overstate the costs, this 7 percent rate has been used for this analysis of the costs of non-profit housing. With loans amortized over 35 years, this yields an annual financing cost per unit of $8,494. The total annual cost per unit in the first year is therefore roughly $13, Rents in non-profit housing depend on the income of the tenant. According to Ministry sources, incomes in the rgi (rent-geared-to-income) units average in the $12,000-$16,000 range - firm data are not available so an income of $14,000 is used to illustrate the likely situation. For this level of income, rents would be $3,640 -assisted rent is set at 26 percent of income under current policy. Therefore, the initial year per unit subsidy required for the assisted tenants in non-profit housing would be $10,354. Shelter Allowances Cost Much Less in First Year In the previous Clayton Research report (The Cost of a Shelter Allowance Program in Ontario), the average annual per unit cost of a shelter allowance was estimated at $1,373 for all Ontario in This includes the full range of core needy tenants, including a large number of non-elderly singles - not a priority group for housing assistance. This estimate of the average cost of shelter allowances also relates to all of Ontario in 1991, while the non-profit cost estimates presented above relate to Toronto in Therefore, for the comparative analysis of the costs of nonprofit housing versus shelter allowances presented in this report, adjustments were necessary to the estimated cost of shelter allowances from the previous report. These adjustments were required in order to reflect a mix of shelter allowance tenants, which would be comparable to those in non-profit housing, as well as rents appropriate to Toronto in The average rents required to obtain suitable rental accommodation in Toronto in 1993 were assumed for the purposes of this analysis to be $8,040 per year ($670 per month). 4 Combined with the same $14,000 estimated average income used for the analysis of the cost of RGI non-profit units, this estimate of rents results in annual shelter allowance costs of $2,880.

7 -6- The chart at left summarizes the estimated first year subsidy costs for RGI tenants in non-profit housing and for tenants with a shelter allowance assuming the $14,000 average income. Clearly, the first year costs for the nonprofit housing are much higher than for shelter allowances. in non-profit housing. Of course, part of the reason for this reduced subsidy cost for a shelter allowance program is the formula of the shelter allowance (75 percent of the difference between rent and 30 percent of income) which is less generous for tenants than the 26 percent of income which is currently used Average effective rents for a tenant with an income of $14,000, for example, would be $303 per month in non-profit housing and $430 per month with a shelter allowance. Some of this difference will disappear as the share of income required for rent in non-profit housing rises to 30 percent ($350 per month for those with incomes of $14,000) - as currently planned over the next four years. Therefore, it is clear that subsidies for the non-profit rgi units are much higher in the initial year than for a shelter allowance program - partly due to less generous assistance but mainly due to the high costs of accommodating tenants in high-cost new buildings rather than in the (lower-rent) existing stock. This comparison relates, of course, only to the first year of operation (other years will be dealt with later). Non-Profit Costs Higher Still When Market Rent Units are considered The above comparison considers only the rgi units. However, non-profit projects also include market rent units for which rents are not sufficient to cover mortgage and operating costs - at least in the early years. In Toronto, average monthly rents for the market units are estimated at an average of $875 per month, whereas costs are estimated at $1,166. Assuming an average 5 percent vacancy rate, the average subsidy for these units in the first year would be over $4,000 per unit. The subsidy required for these market rent units needs to be taken into account in the assessment of the comparison of the costs of shelter allowances and the non-profit program.

8 -7- An estimate of the total costs of the two approaches is provided at left. This compares the cost of providing 1,335 units of non-profit housing (1,000 rgi and 335 market rent) with the costs of using shelter allowances for 1,000 tenants with the same income as those in the non-profit rgi units. This is essentially a comparison of the initial year costs required to house 1,000 needy tenants under the two programs. The initial year costs for non-profit housing are, of course, much higher - $11.7 million compared to $2.9 million to house the same 1,000 needy tenants with a shelter allowance program. initial year. Shelter allowances are clearly less costly in the Future Costs of Non-Profit Housing and Shelter Allowances The relative subsidy costs of non-profit housing and shelter allowances will, of course, not remain constant over time. The remainder of this study outlines the expected changes in these costs (and the resulting required subsidies) over the next 50 years. This is long enough to pay off the mortgage on the non-profit project (after 35 years) and for the project to enjoy a significant mortgage-free period of operation - with all the financial benefits that entails. The analysis requires assumptions about future trends in costs, incomes and rents. In general, the assumptions used in this analysis are similar to the assumptions used by Clayton Research in Homeownership as an Investment (cited earlier) which examined the financial merits for a family of purchasing a home versus renting over the long-term in a low-inflation environment. The key assumptions used in this analysis include the following: 3 percent inflation - all of the variables subject to inflation (e.g. operating costs, rents and incomes) are assumed to increase at the rate of 3 percent. 5 Mortgage interest rates for the non-profit project are assumed to be the current rate of 7 percent for the initial five-year period. If inflation stays low at 3 percent, which is assumed, there is little room for further substantial reductions in this already extremely low rate (conventional fiveyear mortgages are 8.75 percent). However, a further decline to 6 percent is assumed for the period after the first five years. The long-term Provincial government bond rate is currently about 8 percent. This is assumed to continue for the first five years of the period and then be reduced to an assumed 7 percent for the remainder of the period.

9 -8- The rent-to-income ratio on the non-profit rgi units is assumed to rise by one percentage point per year from 26 percent in the first year to 30 percent and remain constant after that - in line with current Provincial policy. This will erase much of the difference between the effective rents paid by shelter allowance recipients and the rents paid by rgi tenants in non-profit housing. Annual Subsidy Costs of Non-Profit Housing Decline Gradually Over Time Using the assumptions outlined above, the subsidies required for non-profit housing decline gradually over time. However, there continue to be substantial subsidies throughout the period until the mortgage is repaid in Year 35. The analysis assumes that no major renovation costs are necessary during the period - i.e. that the reserve funds will be adequate to meet all such costs. This is a questionable assumption but, in the absence of firm estimates, it was adopted in order not to overstate the costs of non-profit housing. Clearly, while the difference between total costs and revenues declines gradually over time, the required subsidy is still very high throughout the mortgage repayment period. In the final (35th) year of the mortgage, an estimated $9.7 million subsidy is required for the 1,335 units (1,000 rgi units). After the mortgage is repaid, a slight surplus is generated by the non-profit housing. Shelter Allowance Subsidy Costs Rise Over Time But are Lower Than Non-Profit Costs Until the Mortgage is Repaid For shelter allowances, the annual costs rise over time as inflation affects rents. However, not until Year 36 (a year after the mortgage on the non-profit project is repaid) does the annual cost of 1,000 shelter allowances exceed the cost of the comparable non-profit units. In Year 36, the non-profit generates a surplus of $600,000 while the shelter allowance costs $8.1 million - a net difference of $8.7 million.

10 -9- Thus, the "investment" in non-profit housing begins to pay off after Year 35. However, this has come with an enormous cost to the size of the Provincial debt and interest costs. Interest Payments on Increased Debt a Critical Factor in Comparing Non-Profit Versus Shelter Allowance Program Costs To compare the long-term costs of the two programs, it is necessary to include the interest costs on" the higher public borrowings required to finance the difference in the annual costs of the non-profit program versus the shelter allowance program. In today's era of high deficits, any increase in program spending must be financed - currently the long-term Province of Ontario borrowing rate is in the 8 percent range. Factoring in the value of these interest payments (which also must be borrowed), it is clear that the very high initial costs of the nonprofit program (relative to shelter allowances) more than offsets the potential for future savings once the mortgage is repaid. The interest payable on the extra borrowings rises gradually over the period to the point where, in Year 36, it totals $63.5 million - far greater than the $8.7 million in projected savings achievable with non-profit housing that year - the year after the mortgage is paid off. The cumulation of the differences in program costs (plus these interest costs) is truly staggering over time. It reaches over $900 million by the time the mortgage is paid off in Year 35 - but continues to rise after that since the interest payments far outweigh the cost advantage of nonprofit housing once the mortgage is repaid. By Year 50, the value of the accumulated difference in the costs of the two programs (plus interest) is $2.2 billion.

11 -10- Clearly, the long-term costs of the non-profit program are much greater than those for shelter allowances. Next, it is illustrated that the ultimate mortgage-free ownership of the properties does little to alter this conclusion. Ultimate Ownership of the Property Insufficient to Offset the High Costs of the Non-Profit Program One of the advantages cited for the non-profit program is that the property is ultimately owned by the third sector and therefore can continue to provide inexpensive housing services in the future - once the mortgage is repaid. This is a serious issue - it is a critical factor on which the conclusion that homeownership is a good long-term investment in the Clayton Research paper Homeownership as an Investment (cited earlier) is based. Forecasting the future value of real estate, particularly rental properties, is extremely difficult. For the purposes of the comparison of the long-term costs of non-profit housing versus shelter allowances, two scenarios are used regarding future increases in the value of the non-profit projects: A rise in property values at the rate of inflation (i.e. 3 percent); and No rise in property values. The first scenario is considered to be unreasonably optimistic (properties generally depreciate over time rather than appreciate) but it is included here to provide the limiting upside case of the possible future values of the properties. It should be emphasized again here that no allowance has been made for renovation costs or any additional investment in the non-profit properties beyond those which could be financed through normal operating costs - or from the build-up of reserve funds. 6 If additional investment will be necessary (as seems likely), the costs of the non-profit program will be greater than those estimated here - or ultimate values will be lower. VALUE OF EQUITY IN NON-PROFIT PROJECTS 2 SCENARIOS OF PROPERTY VALUE APPRECIATION The initial value of the housing is $112,000 per unit - almost $150 million for the 1,335 units. In the early years, there is little equity in the properties due to the initial 100 percent mortgage - particularly in the scenario where property values do not increase with inflation. Over time, the mortgage is repaid and equity in the properties rises. Ultimately, with repayment of the mortgage after 35 years, equity in the properties reaches just over $400 million under the (unlikely)

12 -11- VALUE OF ACCUMULATED DIFFERENCE IN SUBSIDY COSTS PLUS INTEREST AND VALUE OF EQUITY scenario of property values rising at a rate equal to inflation - after 50 years, the properties would be worth roughly $650 million. As large as these amounts are, however, they pale in comparison with the accumulated differences in the higher costs of non-profit housing compared to the shelter allowance alternative. Even at the optimistic scenario, the value of the non-profit properties is still only $650 million after 50 years. But the accumulated value of the differences in costs between the two programs (with interest) is over $2.2 billion. Clearly, the eventual equity build-up in the non-profit properties is nowhere near sufficient to offset the higher costs of operating the projects in their early years and the interest cost on the borrowings required to finance these higher costs. Less Generous Assistance Under Shelter Allowances Responsible for Only a Small Part of the Difference in Costs Between the Two Programs As noted earlier in this paper, the proposed shelter allowance program is less generous to the needy tenants than the assistance available from the non-profit program. The proposed shelter allowance formula is to provide assistance equal to 75 percent of the gap between 30 percent of income and the rent on an adequate unit. Assuming a $670 per month unit ($8,040) and an income of $14,000, the shelter allowance payment would be $2,880: 0.75 [$8, x $14,000] = $2,880. Thus, this tenant pays $5,160 per year in rent. The current rgi assistance available from nonprofit housing limits a tenant's rent payment to 26 percent of income - in this case it would be $3,640. Under a new policy announced this year, however, the rgi rent is scheduled to rise to 30 percent of income ($4,200 in this example) by The reasoning behind the design of the shelter allowance formula whereby assistance is limited to only 75 percent of the gap between 30 percent of income and the rent is to encourage tenants to seek inexpensive housing - since they would share in the benefit of lower rents. Tenants to be similar to those available to non-profit rgi tenants if the formula were adjusted, for example, to 75 percent of the difference between rent and 25 percent of income could achieve this same incentive while allowing actual rent payments. The other formula is used for the purposes of this

13 -12- analysis because it is the one commonly used in Provincial programs in Canada - and was also used in the previous analysis of the costs of shelter allowances. The actual shelter allowance formula used does not significantly alter the conclusions of this analysis of the relative long-term costs of a shelter allowance program versus non-profit housing. To illustrate this, the analysis was reworked to reflect the situation where tenants in both the non-profit rgi units and the shelter allowance recipients pay the same proportion of their income in rent - in this case 30 percent of income ($14,000). This assumption does reduce the difference between the costs of the two programs - but only by a fraction of the total. The cumulative higher costs of the nonprofit program, plus interest, total $1.6 billion after 50 years under this assumption compared to the base case of $2.2 billion using the other formula. Significantly Large Cost Differential Even if Rents Rise It has been argued that rents would rise if shelter allowances were freely available to tenants. While this has not been the experience in areas where shelter allowances are in use, this has been raised as a concern if a large scale program were introduced and rent controls were relaxed. 7 To examine the potential for such rent increases to affect the relative costs of nonprofit housing versus shelter allowances, the analysis was adjusted to take account of a 10 percent increase in market rents in the initial year - and assuming thereafter that rents rose 3 percent annually with inflation. This in no way should be interpreted as a belief on the part of the authors that market rents would rise to this extent (it is considered highly unlikely), however, the analysis was undertaken as a theoretical exercise to assess how a very large increase in rents would affect the analysis.

14 -13- The chart at left illustrates the cost difference between the 1,335 units of non-profit housing and 1,000 shelter allowance recipients over time assuming that the initial rents of the market rent units in the nonprofit housing and the initial rents of the shelter allowance recipients were 10 percent higher. Rents are then assumed to rise by 3 percent annually with inflation. While the difference in costs between the two programs is less if one assumes this large increase in rents, the long-term cost of the shelter allowance alternative is still substantially lower than the cost of non-profit housing. At Year 35, the cumulative difference in costs (plus interest) totals $635 million -compared to just over $900 million in the base case scenario (without the large initial increase in rents). After 50 years, the cumulative difference in costs is $1.4 billion as the interest charges on the higher costs of the non-profit program in the early years continue to mount. While less than the $2.2 billion outstanding after 50 years in the base case scenario, this is still a very substantial difference in long-term costs in favor of the shelter allowance approach. Conclusion - Clearly Both the Initial and Long-Term Costs of Shelter Allowances are Significantly Less Than the Costs of Non-Profit Housing Shelter allowances clearly are a much more cost-effective means of providing housing for needy tenants than providing non-profit housing. The non-profit program builds up a stock of housing which, once paid-off, offers the potential for cost savings relative to shelter allowances - assuming no significant renovation costs are required. However, over the 35-year period while the mortgage is being repaid, the costs of nonprofit housing are significantly higher than the costs of a comparable shelter allowance program. The accumulation of these higher subsidy costs, plus the substantial interest costs required to finance them, more than offset the value of the non-profit projects in the long-term. The fact that the shelter allowance approach offers cost savings is due in part to the less generous assistance provided - though much of this difference will be eliminated as the non-profit program moves to rgi rents equivalent to 30 percent of income over the next few years. However, as is demonstrated in this report, this accounts for only a relatively small portion of the cost difference between the two approaches. The shelter allowance program could be designed to ensure the rents paid by needy tenants are the same as those offered by non-profit housing and still be much less expensive than the non-profit alternative. The main reason why shelter allowances would be less expensive is that they provide assistance to needy tenants within the existing housing stock - most needy tenants are already adequately

15 -14- housed, their problem is that they cannot afford the rent. Rents in the existing stock are much lower than the costs of building new non-profit housing. Also, there is no need with shelter allowances to provide subsidies to house non-needy tenants in order to provide for income mixing - as is the case with nonprofit housing.

16 -15- APPENDIX COMPARISON OF THE LONG-TERM COST OF SHELTER ALLOWANCES AND NON-PROFIT HOUSING

17 -16- COMPARISON OF THE LONG-TERM COST OF SHELTER ALLOWANCES AND NON-PROFIT HOUSING ($000) Assumptions: See description in main body of report

18 -17- ADDENDUM In reviewing the report when it was first released, some commentators questioned why the cumulative value of the differences in the subsidy costs of shelter allowances versus non-profit housing was used rather than discounting the differences to present value. This approach was used for two reasons: To present the results in the same manner as was used in the report cited earlier, Homeownership as an Investment - as noted, that report has been used by some to conclude that non-profit housing must also be a good investment so, to facilitate comparison, the same approach was adopted. Many observers are not familiar with the concept of discount rates and present values. For those who are interested in examining the results in present value terms, these have been calculated and are presented here. For the purposes of these present value estimates, this analysis uses the long-term government bond rate used in the report (8 percent for the first five years and 7 percent thereafter). The present value of the differences in the annual costs for the two programs to provide 1,000 units for needy tenants over fifty years are presented in the chart at left. In the initial years, shelter allowances are considerably less expensive than non-profit housing. Discounting, of course, reduces the present value of these differences significantly over time. CUMULATIVE PRESENT VALUE OF ANNUAL DIFFERENCE IN SUBSIDY COSTS After the mortgage is repaid in Year 35, the non-profit projects generate a surplus. Thus, the balance shifts so that the annual costs of shelter Allowances exceed those of nonprofit projects. In present value terms, this surplus is small. The cumulative value of these differences is substantial. By Year 35, the cumulative present value of the difference in annual costs of the two programs totals $84 million - an average of $84,000 for each of the 1,000 units of assisted housing.

19 -18- This is reduced slightly in subsequent years due to the operating surpluses of the non-profit housing (assuming no requirement for additional investment to renovate the non-profit projects) and totals $75 million after 50 years - $75,000 per unit of assisted housing. To bring this into perspective, a difference of $75,000 or $84,000 per unit in the present values of the subsidies for the two programs represents over two-thirds of the initial $112,000 per unit capital costs of the non-profit projects. PRESENT VALUE OF CUMULATIVEDIFFERENCE IN SUBSIDY COSTSAND EQUITY AT YEAR 35 Bringing in the present value of the equity in the non-profit projects does not alter the conclusion that non-profit housing is much more expensive than shelter allowances. Even using the unrealistically high assumption that the projects rise in value at the rate of inflation, the present value of the projects after 35 years totals only $40 million. This is $44 million less than the cumulative present value of the difference in subsidies between the two programs. Therefore, even allowing for a very optimistic estimate of the value of the projects themselves, the present value of the differences in the costs of the two programs after the mortgage on the non-profit housing is repaid totals over $40 million for the 1,000 units of assisted housing (1,335 units including the market rent units). In per unit terms, the present value of the excess of subsidy costs for non-profit housing compared to shelter allowances totals over $40,000 per assisted unit This excess cost of non-profit housing compared to shelter allowances actually widens (in present value terms) to over $50,000 per assisted unit after 50 years as the present value of the future equity in the non-profit units diminishes using the discount factor. Therefore, the use of present value analysis does not alter the conclusion reached in the analysis using the cumulative value of the differences in subsidy costs plus interest: non-profit housing is a much more expensive approach to providing assistance to needy tenants than shelter allowances. Put another way, per dollar of expenditure, many more needy tenants could be assisted through shelter allowances than through provision of non-profit housing - in both the short-term and the long-term. October 26,1993

20 -19- COMPARISON OF THE LONG-TERM COST OF SHELTER ALLOWANCES AND NON-PROFIT HOUSING ($000)

21 -20- ENDNOTES 1 Clayton Research Associates Limited, The Cost of a Shelter Allowance Program in Ontario, prepared for the Fair Rental Policy Organization of Ontario, June, the study used CMHC"s core housing need model to provide information on tenant characteristics, incomes and rents and a shelter allowance equal to 75 percent of the difference between rent paid and 30 percent of tenants' income (subject to a maximum rent based on market rents for suitable accommodation). 2 Peter Dreier and J. David Hulchanski, "Role of Non-Profit Housing in Canada and the United States", Housing Policy Debate, Volume 4, Issue 1, page 58. The article refers to a report (Homeownership as an Investment), prepared by Clayton Research for the Canadian Home Builders' Association in 1992, which concluded that homeownership was a good long-term investment 3 These non-profit cost estimates are much lower than earlier estimates of the typical cost of non-profit units (e.g. those contained in the 1992 report of the Provincial Auditor) because they relate to the costs of new projects at present rather than the costs which prevailed over the past few years. The estimates used here are based on discussions with Ministry staff regarding the costs of the current round of non-profit projects and they also incorporate consideration of the reduced interest rates which currently apply. However, they are still estimates since hard data are not available from the Ministry for much of this analysis. 4 In the previous report, the average shelter cost on which the Provincial shelter allowance estimates were based was $6,300 per year (the average for all tenants in core housing need in Ontario in 1991 as estimated in CMHC*s core housing need model). The $8,040 estimate for Toronto used in this report is much higher. It was derived by taking the average shelter costs in the earlier analysis with several adjustments to reflect the higher housing costs in Toronto, inflation since 1991 and a different mix of tenants. The mix of tenants was assumed to be 30 percent seniors and 70 percent families. Therefore, no non-elderly singles (which are not a priority group for housing assistance) were assumed to receive shelter allowances in this analysis. Non-elderly singles were included in the previous analysis since they are included in CMHC's definition of core housing need - since they have relatively low rents, their exclusion from this analysis led to an increase in the estimated rent for tenants with shelter allowances. The analysis here, therefore, yields a much higher average shelter allowance because it assumes both a higher rent and a lower income than were used in the estimates prepared in the previous report on the cost of shelter allowance for the Province. 5 This is higher than the 2 percent inflation rate assumed in Homeownership as an Investment since the earlier document deliberately understated expected inflation in order to demonstrate that homeownership was a good investment even at low rates of inflation. Based on the experience of the past three decades, there is little doubt that homeowners gain from higher inflation. 6 Most rental buildings (both private and public) face substantial renovation costs as they age. This includes regular replacements and upgrading as well as major renovations which are generally required over a long period - such as the 50 years used in this analysis. Assuming that reserves will be sufficient to cover this work is particularly doubtful given the current moratorium on these reserves in non-profit housing. 7 Several research studies have concluded that shelter allowances do not result in an increase in rents. See, for example, Marion Steele, Housing Allowances, An Assessment of the Proposal for a National Program for Canada, January, 1985, pages 18-20; and the U.S. Department of Housing and Urban Development, Experimental Housing Allowance Program, Conclusions, The 1980 Report, page 50.