The undisclosed, very risky HOA – Housing consumer partnership

How privatization of community development wastes your money and compromises your rights

By Deborah Goonan, Independent American Communities

 

This week, I read two fascinating and informative articles that, combined, help to explain, in a nutshell, the fundamental reason why buying into property located in association—governed, common interest communities is becoming one of the most financially risky investments in the U.S.

The first article, written by nonprofit national media organization Strong Towns, explains Public-Private Partnerships, and what differentiates “good” from “bad” partnerships, from the perspective of government leaders.

Strong Towns’ mission, according to its website:

The mission of Strong Towns is to support a model of development that allows America’s cities, towns and neighborhoods to become financially strong and resilient.

 

While the article never mentions Homeowners’ Associations (HOAs), it occurred to me that the modern association-governed, common interest community is, in essence, a Public Private Partnership between real estate developers (and financiers) and local governments, creating significant liabilities for private individuals, especially homeowners.

Below, I’ve included some excerpts from the article — I have emphasized certain passages in bold. I’ve also inserted some personal commentary in blue italics.

I think you’ll agree, the parallels to the HOA industry — consumer relationship are astonishing.

 

4 QUALITIES OF A SUCCESSFUL PUBLIC-PRIVATE PARTNERSHIP

FEBRUARY 5, 2018
BY CHARLES MAROHN, Strong Towns

The concept of a public-private partnership is certain to be a large part of any federal infrastructure bill passed this year. On the surface, the idea is solid: leverage private dollars with public dollars to accomplish infrastructure improvements that would not be possible with only one funding source. When put into practice, however, the results are decidedly mixed.

Google suggests that a “partner” is:

A person who takes part in an undertaking with another or others, especially in a business or company with shared risks and profits.

Shared risks and profits. Most public-private partnerships are merely public handouts by a different name. Here are a few examples:

Contracting with a business to construct an asset or perform a service that the government could otherwise do, but lacks the wherewithal, clout or desire to do it. This should be seen as a missed opportunity, particularly since the transaction is almost certainly profitable.

(The above paragraph accurately describes the agreement — or mandate — that has led local governments to build virtually all new housing neighborhoods in the past 20-30 years. It explains why practically all homes built after 1980 or 1990 are governed by HOA or Affordable Housing schemes, sometimes in addition to Development Districts and special tax districts initiated and controlled by developers.)

1. LIMITED AND QUANTIFIABLE RISK

To enter into a public-private partnership, a local government has to know the absolute level of risk, particularly risks that feel like outliers. What is the absolute amount that can be lost — the greatest amount that the city and its taxpayers can be found liable for? Understand that humans are prone to severely underestimate tail risk (infrequent events). This is even more likely when it is a project we particularly desire; our human passions blind us to the risk.

When entering into a public-private partnership, cities need to get someone disconnected from the project to give an actuarial-like assessment of the risk— and not someone who will be compensated only if the project goes forward, like a bond counsel. Risk must be quantified. And unless the risk is as limited as the private sector investment is, there is very little compelling reason to enter into an agreement.

(Risks and liabilities to housing consumers of properties in association-governed common interest communities — HOAs — are neither objectively quantified or disclosed, either at the time of sale or during the course of ownership. Furthermore, housing consumers are often emotionally invested in the dream of homeownership, creating a tendency to dismiss the downsides of buying into a PPP community.)

2. MUTUAL SKIN IN THE GAME
Later this month, the Patron Saint of Strong Towns Thinking, Nassim Taleb, is releasing a new book. It’s titled Skin in the Game: Hidden Asymmetries in Daily Life, and it’s going to be fantastic (much of it has been available on Medium as he’s been working on it). You don’t need Taleb’s insights, though, to understand the basic concept here: Risks must be shared mutually. A true partnership never allows a situation of heads-I-win-tails-you-lose. If the deal goes poorly, it needs to go poorly for each player in the partnership, at least to the degree that the upside gain is proportional to each player, too.

(And in the case of housing consumers, the partnership and the risk need to be disclosed up front. But the next paragraph says it all…)

“It is not acceptable in any public-private partnership (or HOA-consumer partnership) for the local government (housing consumer) to take on the losses while the private sector partner (developer, majority investors, AND, to some extent, local government) is able to walk away.”


3. A REALISTIC CHANCE FOR A POSITIVE RETURN

Our cities need to stop participating in projects that don’t offer a solid chance at a positive return on investment. Nebulous justifications like “it will create jobs (we hope)” or “it will grow the tax base (but only over the short term)” are not good enough — not when so much money is on the table.
No business would enter into a partnership which they knew they (sic) would lose them money. Local governments (housing consumers) should not enter such partnerships either.

(The most unrealistic promise made to HOA housing consumers — that, somehow, covenant-restricted property will “proptect” or “keep up” property values. There’s simply no solid evidence to support that claim. And, in fact, poorly-managed, insufficiently-funded HOAs often experience significant reductions in property values.)

4. A PROPORTIONATE SHARE IN THE GAIN
Whatever proportionate share of the risk a local government (housing consumer) assumes, it should also be in line for a proportionate share of the gain. That’s real money they should receive, not some abstract social gain that may or may not have any real, tangible value. If things go really well for the private business, (developer and private community investors) they need to go really well for taxpayers (housing consumers) as well. Share in the risk, share in the reward.

Source:
https://www.strongtowns.org/journal/2018/2/4/public-private-partnership

 

In short, consider that HOAs (and Development Districts) are Public-Private-Partnerships, where private entities (developers and real estate investors) fund and construct infrastructure and, in some cases, social housing for lower-income or workforce households.

But, in practice, the bulk of construction costs and future financial risks of the developer, and, quite frankly, local government, are passed onto private owners and/or, to a lesser extent, tenants.

Local governments think they benefit from these HOA / Tax District / “Affordable” housing partnerships. And sometimes they do, in the short-term. They collect additional property, sales, and income tax revenue from “growth” of the municipality or county. There may be political gains, some tangible (votes, campaign contributions), some intangible (positive public image).

But…in the long term, as these privatized community development schemes struggle and fail — often long after the developer is gone — local governments lose when their constituents lose. The tax base suffers, and, at the same time, the need for social services, health care, and welfare programs increases. Homelessness increases. Consumer spending decreases, businesses fail due to lack of customer base.

When communities struggle, it’s inevitable that constituents approach their local governments and their state governments seeking financial and administrative assistance. The pressure upon state and local governments is mounting, and will only increase in the next few decades.

At first, government officials will often claim there is nothing they can, or should do, to help a “private” community. But most constituents will not be satisfied with that response. If they do not get what they need, the most financially able homeowners and tenants can and do move and take their tax dollars elsewhere.

This is why I am noticing and reading more and more articles about local government annexations, or local governments taking on certain private services as public services, or working with homeowners to establish publicly-initiated tax districts to help spread out the cost of much-needed infrastructure improvements.

No matter which way you look at it, the biggest loser in this undisclosed “partnership” between housing consumers and developers (and the HOAs that they create, to continue in perpetuity) is the housing consumer.

Furthermore, the risk is not equally shared. The largest finanicial liability falls to property owners who are owner-occupants, rather than well-funded investor-landlords, who often recoup a return on their investments through rental income.

Power is also distributed unequally.

Each privately or PPP-developed HOA community creates a power hierarchy based upon property ownership status.

The HOA hierarchy, from top to bottom:

Developers/original land owners/bond holders and investors that finance development

Institutional or “bulk” investors that own multiple land parcels or properties in the community

Small landlords or passive investors, collecting rental income

Property owners who occupy their homes, or own them for personal enjoyment (the “true” homeowners)

Non-owners and tenants.

 

The social implications of this hierarchy are destructive, because it creates a legal entitlement to a better return on investment for those at the top of the hierarchy, while shifting the bulk of financial risk to housing consumers near the bottom.

Even more damaging to the social fabric is a sense of entitlement and empowerment that is directly tied to the quantity of property one owns.

And that brings us to the second article of interest this week.

The New York Times addresses what they see as a disturbing trend: corporations such as Facebook, Google, and Amazon creating what would appear to be modern-day “company towns.”

 

 

These are blatant examples of local governments relying too heavily upon corporate giants to finance economic growth and community infrastructure for their workforce.

I won’t delve into the details of the article —  I highly recommend that you read it for yourself.

But keep in mind that the “company town” model is but one highly publicized example of questionable PPP models used to create new and redeveloped communities large and small.

Consider that master planned communities designed for retirees, active adults, or the affluent vacation industry are built upon very much the same foundation of private funding with the blessings of local governments.

Also consider smaller, less visible lakeside, beach, or mountainside communities, university housing, corporate housing, or privately-built and managed affordable housing.

In many cases, private developers or sponsors of these communities directly benefit from providing ongoing management of property, amenities, or rentals.

Does the housing consumer reap any direct benefit?

Rarely.

By continuing to issue permits for new real estate development and community infrastructure, without any quantifiable long-term return on investment to taxpayers and citizens, are local governments truly serving all of their constituents, or merely those few constituents willing to sink significant private capital into real estate development?

The answer is painfully obvious.

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