LACMTA Bus Ridership Update – January 2015

Another three months has passed, so it’s time for another LACMTA bus ridership update. Apologies for the slow posting and delayed updates; March ended up being a very busy month; hopefully things will be back to normal now.

First, the raw data. Highlighted cells represent the top 10 months for that route (since January 2009).

Here are the 12-month rolling averages.

Ridership from November to January is always a little goofy due to holidays. With the exception of the Silver Line, which continues to improve, all routes saw a decrease in ridership. For Vermont & Western, this continues previous trends. With Venice, Santa Monica, Wilshire, and the Orange Line, these dips are small enough that no larger trend appears.

Here’s the Saturday and Sunday rolling 12-month averages.

Saturday and Sunday ridership largely reflects the weekday trends.

Lastly, here’s the percentage of trips on each arterial being served by the rapid route.

The share of riders served by the rapid routes continues to slowly rise on most corridors. I wouldn’t read too much into the spikes in Venice and Santa Monica data, because they were caused by large drops in local route ridership on those streets. However, it is interesting that the rapid routes were more resilient to ridership changes – the ridership losses came disproportionately from local routes.

As always, it’s hard to say what’s causing ridership changes. Possibilities include the improving economy making cars more affordable, cheaper gas, and Metro’s recent fare increase.

Metrolink ridership next, I swear, and don’t think I’ve forgotten about SF Valley bus ridership!

How Prop 13 Discourages Affordable Housing

Thanks to @devin_mb for help on this post.

From the day it passed, Prop 13 has sparked intense debate over its impacts on city finances and land use decisions. For readers outside California, the chief provisions of Prop 13 are that it (a) caps property taxes at 1% of assessed value and (b) caps annual property tax increases at 2%, a value frequently less than inflation and almost always less than the annual appreciation, until the property changes ownership. There are, of course, a lot of complicating factors, but for our purposes, good enough.

Most commentary on Prop 13 focuses on the distortionary effects that accrue over time when a property does not change hands, due to the 2% increase limit. Because the land is assessed well below market value, owners pay little in taxes, and are given a disincentive to redevelop, which would trigger reassessment at a much higher value.

However, the 1% of assessed value cap might work to set an artificial floor for the price of new housing construction, and that’s the mechanism I want to examine today with a highly simplified model.

Consider a two-city world, where all households are the same, and all housing units are the same. House value appreciation is constant, as is the rate of housing turnover. Also assume there is no need-based state assistance to cities. Housing prices vary only by location. One city is by the ocean, so it has high housing prices, while the other is inland with a hotter climate, and has low housing prices. Now suppose that each new housing unit must generate $4,000 in taxes, as of initial sale, to pay for its city services.

In a normal region, cities would raise the revenue by setting the tax rate as needed. This typically means that cities with cheaper housing have higher tax rates, so as to raise the same revenue*. So, to cover public services, the beach city with $500,000 houses would set its tax rate at 0.8% and raise $4,000 per house, while the desert city with $200,000 houses would set its tax rate at 2.0% and raise $4,000 per house.

Now let’s impose Prop 13’s 1% cap. The $500,000 house city is fine, but the $200,000 house city can only raise $2,000. They’re hosed: new housing that sells for $200,000 is an inexorable drain on municipal finances. To survive, the city must do everything it can to discourage construction of houses at $200,000 and drive the cost of housing units up to $400,000. One way to do this is with minimum lot size zoning or minimum housing unit sizes.

The California Legislature supposedly gave cities a way out of this problem with Mello-Roos fees. In essence, Mello-Roos fees are like a business improvement district: properties within the district pay an additional fee to fund new infrastructure like new schools. So theoretically, if you want to offer houses at $200,000, you can tax them at 1%, slap on a Mello-Roos fee equivalent to an additional 1%, and you’re good to go.

In reality, this only works if your entire city is one giant Mello-Roos district, which it’s not, because the city almost certainly includes already developed areas. Suppose then that our desert city is half developed, and half under construction today. The old side has taxes capped at 1%, while the new side of town is a Mello-Roos district and so pays 1% plus the Mello-Roos rate. Suppose for now that the Mello-Roos fee is set at 1% for a 2% total tax on new houses.

From a property tax perspective, a $400,000 property paying 1% is the same as a $200,000 property paying 2%. But from a buyer’s perspective, the math is different; the additional tax devalues the property only by the present value of the amount of the Mello-Roos fees. For example, a $400,000 30-year mortgage at 5% will cost you $26,000/yr; add in an annual 1% tax and that’s $30,000/yr. For the same $30,000/yr, assuming a 2% tax rate (1% property tax plus Mello-Roos), you could only get a $353,000 house.

Back to our example. We’d like to find an equilibrium where tax revenue averages $4,000 per household. If we add a 1% Mello-Roos fee, then house prices will have to rise for both old and new houses: the equilibrium that satisfies everyone in this case is for the old houses outside the district to be priced at $289,500 and the new houses inside the district to be priced at $255,500. The cost to the buyer (in mortgage and taxes) is about $21,900/year in each case, so households are indifferent between the new and the old homes. The house outside the district pays $2,895/yr in taxes and the house inside pays $5,110/yr, so the city collects $8,005/yr in total, or about $4,000/yr for each household.

In this example, we’ve raised the requisite tax revenue, but houses are alarmingly expensive: up over 25% from the base of $200,000. Charging a higher Mello-Roos fee to the new houses can bring prices back down. If you make the Mello-Roos fee 2%, the equilibrium is $237,500 and $187,500, and the combined housing and tax burden has been driven down to $17,800/yr, about what it would be in a city with $200,000 houses and a 2% tax rate.

While it might seem like we’ve got a Prop 13 workaround figured out, note that this example assumes there is one house inside the district for every one outside the district. This is only plausible for a young, rapidly growing city, as an established city will have many more existing houses outside the district and Mello-Roos districts expire over time. If we assume a 2% Mello-Roos fee and 20 houses outside for every one inside, the equilibrium is $376,000 for an old, low-tax house outside and $296,000 for a new, high-tax house inside. This equates to a combined housing and tax burden of $28,200/yr – almost as high as in a city with $400,000 houses, a 1% tax rate, and no Mello-Roos.

In other words, it doesn’t matter that Mello-Roos fees make it possible to have $200,000 houses that generate enough tax revenue. A city can’t allow the houses outside the Mello-Roos district become too affordable without ruining municipal finances. Newer cities with rapid growth and a large percentage of houses covered by Mello-Roos districts can make the math work, but legacy cities can’t, and in time, all new cities become legacy cities. Thus, Mello-Roos makes it possible to fund new master planned suburban growth in the urban fringe, but offers little help to infill and affordable housing in cities.

Note that in this post we have treated Mello-Roos fees as a perfect substitute for property taxes, but in fact, they are more restricted in what they can be spent on. If anything, this simplifying assumption skews the analysis in favor of affordability, because it allows Mello-Roos fees to cover shortfalls in revenue raised on properties outside the district. In fact, I see no reason to believe that relaxing all of the simplifying assumptions in this model will yield different results.

*In reality, rich cities will raise more money so they can buy things like rabbit statues, but for now, assume they both target the same revenue.

LACMTA Rail Ridership Update – January 2015

Another three months has passed, so it’s (belatedly) time for another LACMTA rail ridership update. I’m splitting out the bus ridership into a separate post, and will also be putting together a post for bus routes in the San Fernando Valley.

First, the raw data. Highlighted cells represent the top 10 months for that line (since January 2009).

The January data is very suspicious; there’s no way the Green Line dropped that low in one month, and the Blue & Expo are questionable too. Weekday ridership for February was available and the Green Line bounced back to almost 40,000, so not sure what’s going on there. The Gold and Expo Lines continue to be near all-time high ridership for weekdays and weekends.

Here’s the rolling 12-month average of weekday ridership:

The rolling 12-month graphic always provides the right context. Most lines are pretty flat, while Expo Line continues to creep up. The Red/Purple Line seems to have had a surge in 2013/2014 but fallen back. The relentless 20-minute headways during evening hours can’t help. We should also note that recent weakness in the Blue Line may be due to ongoing work, such as the shutdown of the Long Beach loop for track and station refurbishment.

Still, we’d probably hope for ridership to be growing a little faster. Maybe we could make it easier to build a ton of housing, office, and retail near high quality transit?

Here’s the Saturday and Sunday rolling 12-month averages.

And lastly, here’s the update for the rolling 12-month average of boardings per mile:

The Expo Line is still closing in on the Blue Line in that graph, but it’s going to have to see a surge in ridership this spring to keep rising in the 12-month average, having broken 30,000 riders in May 2014. For now, we patiently wait for the Gold Line and Expo Line extensions to open. (My prediction: Gold Line will make boardings per mile fall, Expo Line will make boardings per mile rise.)

Stay tuned for bus and Metrolink ridership.

Gentrification Watch: Palms Edition?

Gentrification is a tricky concept: not easy to define, but people know it when they see it.

If you ask me, I wouldn’t say Palms is gentrifying. As of 2000, median incomes in Palms were similar to some other neighborhoods you might consider to be under gentrification pressures, like Leimert Park and Highland Park. However, Palms lacks what I’d consider one of the definitive markers of gentrification: a cycle of decades of public and private disinvestment followed by a boom. Palms has always been one of the Westside’s outlets for growth; apartment construction has been robust since the 1950s. In the last 15 years, the pace of development in Palms has slowed, simply because the neighborhood is running out of easily developable sites.

Still, a few recent anecdotal incidents got me thinking about neighborhood changes on the Westside, what that means in Palms, and how it relates to the city as a whole.

First, as part of its Micro Week series, Curbed LA ran a story about a small apartment in Palms, whose renter described the neighborhood as “rapidly gentrifying”. Second, a current resident had recently been looking for a new place in the neighborhood, and found the available apartments at about the same rent to offer a lower level of amenities. (If you live in a rent-stabilized apartment, it’s easy to lose all perception of the current state of the rental market.) Third, while walking down Motor Ave recently, a friend described disliking the new buildings there (Palms Point and M Lofts) for “all they represent”.

Well, what do the new buildings in Palms represent? They’re called luxury, but that’s a slippery term; property managers in Palms call their 1980s podium buildings luxury too. Certainly the M Lofts includes a level of amenities not found in older buildings, but the same could be said of new cars compared to old cars. Anyway, that’s partly a function of needing to secure higher market rents for the market-rate units, as some of the units are reserved affordable units.

A change in our environment is often hard. Perhaps new construction makes people feel like the neighborhood is shifting, away from a place that has the kind of amenities we like, towards a place that has the kind of amenities someone else likes. And it’s possible that the new amenities will appeal to people with more money, who will bid up rents.

This isn’t a plea for sympathy. These anecdotes refer to people who are not without means. People like me certainly don’t deserve any sort of housing subsidy, direct or indirect through regulatory policies.

The important thing to see is how all these housing markets are connected. New construction in wealthy areas of the Westside is prohibited by zoning, so new buildings are only put up in places like Palms. As demand to live on the Westside keeps growing, this development starts to skew towards the high end. Some residents of Palms will move to other neighborhoods, either to find the amenities they like or to keep housing costs down. That, in turn, will start putting upward pressure on rents in those neighborhoods.

We don’t call it gentrification until we get three or four moves down the chain, in places like Boyle Heights. If you want to live in Venice but can’t afford to do so, it’s unlikely you’ll go directly to Highland Park as the alternative. But the connections are real. The process starts with the lack of construction in wealthy areas on the Westside, and that’s where it needs to be attacked.

Housing as a Utility and the Limits of Redevelopment

In some interesting and spirited discussion on Twitter (like a week ago, I know, ancient history), Daniel Kay Hertz brings up the idea of regulating housing like a utility. First, I’d like to explain why I think housing is not a utility and should not be regulated as such. Then, we’ll look at what issues comprise the real barriers to development, and the implications of those barriers.

Development in built-up cities is hard. There’s little vacant land, and construction is more complicated than on empty sites in the suburbs. In fact, development is so difficult and barriers to entry so great, says Daniel Kay Hertz, that development can’t keep up with demand; therefore, we should simply nationalize places like Manhattan. All rents – residential and commercial – would be regulated.

Is Housing a Utility?

In the economic sense, a product or service is considered to be a utility if it is most efficient in the long run for production to be concentrated in a single firm. This is most likely to be the case in an industry where it would be difficult for a new company to enter the market (“high barriers to entry”) due to very large up front capital costs. For example, consider the water supply for Los Angeles. In order to have two or three firms compete to provide water, you’d have to build two or three water systems.

Note that unlike industries that are naturally competitive, to compete with a utility, you have to build a lot of redundant infrastructure. To compete for your smart phone business, Apple and Samsung do not both build you phones, of which you only use one while the others sit idle. However, to compete with LADWP’s water supply, a new provider would have to build another water system and another water pipe to your house. You’d have two water connections, but only use one. That’s a lot of redundant water pipes, and it would cost a lot of money, so it’s much more efficient to have one water company with regulated rates.

Natural utilities almost always end up being heavily regulated private firms or heavily regulated public agencies. When they are not, such as broadband internet services, it creates the potential for monopolies that Wall Street analysts call “comically profitable”, but the rest of us might opt to call criminally profitable instead. Therefore, if a product is a natural utility, it’s important to recognize that and regulate it as such.

However, housing does not meet this definition of a utility. While housing development has considerable capital costs – millions or tens of millions of dollars even for relatively small projects – it’s an order of magnitude less than the billions or tens of billions of capital dollars that would be needed up front to compete with LADWP or Time Warner Cable.

In addition, there is little efficiency to be gained from concentrating housing production in a single firm (or government agency). If developers want to compete for your housing business, they do not build you redundant apartments. Most cities with tight housing markets have low vacancy rates, that is, very little idle housing infrastructure, suggesting there is little inefficiency in having multiple firms compete to provide housing.

Lastly, note that utility-type regulation is not intended or well-suited to address the types of issues we have with housing. The primary problem we have with housing is scarcity, a lack of housing. Utility regulation, in and of itself, address only natural monopoly problems; if there are problems with scarcity and allocation, additional regulations such as tiered utility rates much be introduced.

Therefore, while we can see the need for policies to address the impacts of housing scarcity on low-income households, there’s no compelling reason to regulate the entire residential (or commercial) sector of Manhattan. This is important, because simpler solutions are almost always better. The central administration needed for a nationalized Manhattan would be very complex, and the potential for unintended negative consequences would be large. For the costs of nationalizing Manhattan, we could almost certainly implement a more effective program of improved transportation and housing benefits for low-income households.

Are There Limits to Redevelopment?

Nevertheless, it is undeniable that in a place like Manhattan, redevelopment of land is much more difficult than in the suburbs. Almost any project will entail demolishing an existing building and displacing the revenue-generating uses currently occupying the site. Let’s take a closer look at the implications of increasing difficulty of redevelopment. In this analysis, we’ll ignore regulatory barriers like zoning, which can be changed, and focus on theoretical economic and technological limits.

Empirically, we can guess that once the existing building on a site reaches a certain size, redevelopment is impractical. Demolition of large buildings is rare, even in places with extremely high land values and lack of regulatory barriers like zoning. The tallest building ever intentionally demolished by its owner to make way for a larger structure is the Singer Building in New York City, which was 47 stories tall, though the bulk of the building was only 12 stories. The Morrison Hotel in Chicago was 45 stories, but again, much of the building was considerably shorter. Beyond that, there’s the City Investing Building in NYC (33 stories) and a few high-rise hotels in Las Vegas.

To see why, consider that every property owner has three development options:

• Do Nothing: continue to operate the property as is. This is the lowest risk option. Future revenues and operating costs are relatively certain.
• Refurbish: maintain the existing building, but make internal improvements that increase value, such as refinishing apartments. This is the medium risk option. Construction can be staged, but some revenue will still be lost during that time period. Future revenues are expected to be somewhat higher. Operating costs may be higher or lower, depending on relative efficiency of the new units and the impact of taxes.
• Redevelop: demolish or largely demolish the existing building and replace it with a newer, larger structure. This is the highest risk option. All existing uses will have to be removed during construction, resulting in significant loss of revenue during that time period. Future revenues are expected to be much higher, and operating costs will likely increase due to larger size and higher tax value.

Graphically, the cash flows for these options look like this:

In deciding what to do, owners must consider the present value (PV) of each option. The second and third options offer higher revenues, but further into the future. Due to the time value of money, these future revenues are worth less to today’s PV. These options require the owner to forgo revenue during construction, which takes away from their PV. In addition, the owner must consider the risk of a real estate market downturn between today and the completion of the new project, which further devalues the future revenues in today’s PV.

With this framework, we can see why redevelopment is harder in built-up areas. For vacant land, the existing revenue is probably zero, and the site can be developed quickly, so risk is lower. If a tall building already occupies the site, the existing revenue will be large, and the construction period longer. Building technology might limit the additional density that could be developed on the site. At some density of existing development, it will no longer be profitable to redevelop the site.

This implies that once a city reaches a certain density of development, the only development option possible is geographic expansion of the city, and improved transportation to reduce the time cost of distance. For example, in 1890, the Lower East Side was probably close to this limit. Skyscraper technology was new, so buildings were limited to the height allowed by masonry construction, and tenements were carried up to such height accordingly. The inability to traverse longer distances in a short time at reasonable cost resulted in those buildings being occupied at very high population density.

This also implies that, quite logically, rents per unit floor area will always be higher in places where potential development sites are already occupied by existing buildings. Some price premium will be required to induce redevelopment of an occupied site versus vacant land.

With today’s building technology, it’s probably impractical to redevelop most sites that are occupied by buildings taller than 25 stories. (Note that some grad students with some time and funding could do the research to find real results. And if it’s already been done, someone please point out where!) That means that if an entire district is already developed to that height, further redevelopment will be difficult and it is unlikely that the market will be able to provide significant new supply locally. The proper solution to this problem would be to improve transportation to reduce price pressures by making it easier to travel from districts with more redevelopment potential.

Where Are We Today?

However, for the US, the nature of this theoretical limit is just that – theoretical. With the possible exception of a few small parts of Manhattan, nowhere in the country is developed to that intensity. Everywhere in Los Angeles County has land with low intensity existing development that, at least theoretically, has low barriers to redevelopment.

Regulating housing like a utility would be trying to resolve regulatory failures – zoning and permitting – with further regulation. If regulations are not producing the desired results, it’s a much better approach to reform the failing regulations than to try to resolve the negative outcomes of the first set of regulations with a second set of regulations. It is not hard to see that nationalizing Manhattan, or any other city, to resolve the failures of existing land use regulation might result in even worse negative outcomes. For the cost of any such program, we could devise less complicated housing subsidies and transportation improvements that would have a better chance of achieving the desired results and less chance of negative consequences.