A Simple Idea To Ease The Housing Affordability Crisis

Here’s a big idea to address America’s worsening housing affordability crisis: Let more Americans own their home without buying the land underneath it. 

If that sounds crazy, it shouldn’t. It’s been a widely used and successful model in commercial real estate for decades. Many of the commercial buildings you see in urban areas sit on land that is being rented by the business owners. The ground rent model gives businesses more flexibility by reducing their cost of capital while giving landowners a guaranteed income over decades.  

There’s no good reason why the same model couldn’t be applied to residential real estate projects, yielding similar mutual benefits for home buyers and landowners. 

Surging mortgage rates since last year have priced millions of people out of buying a home, exacerbating the effects of a long-term lack of housing supply. Monthly rent payments are gobbling up an ever bigger chunk of families’ earnings, rising to 30% of the median income from 25.7% in 2020.

But if homeowners don’t have to buy the land – in effect if they can lease it – that’s about  20-25 percent of a property’s value. That means buyers would need significantly less money to become home-owners. They’d pay 3-4% of the land value annually in rent with built-in increases for inflation over time.

That’s a far more affordable proposition than millions of home buyers are facing today. Because few families can afford the standard 20% down payment required by banks, many have taken out high-interest-rate home equity loans as a second mortgage, inflating their monthly housing costs.

Let’s do the math on a $300,000 home. A second mortgage home equity loan covering 15% of the value, or $45,000, might cost the homebuyer around $5,000 annually in interest payments. Combined with the payment on the first mortgage, that comes to around $33-34,000 per year. 

Under a ground lease model, the buyer would only need to spend $240,000 to own the home, resulting in an annual mortgage payment of around $24,000. Separately, they pay a monthly rent payment of $150 based on a 3% rate. That makes for a total annual payment of $25,800, at least $7,000 less than the conventional model. 

That can make an enormous difference to low-income families, putting them within reach of homes that mortgage providers’ income requirements would otherwise disallow. Under the scenario above, a family would only need about $95,000 in annual income to qualify for the house based on banks’ standard 28% mortgage cost to income rule, compared to $120,000 under the conventional model.

So why hasn’t the ground-rent model taken off in a big way? One reason is that commercial banks have traditionally been reluctant to lend on leased land. But Fannie Mae and Freddie Mac have long had a policy of lending on leased land, so it’s not much of a stretch for banks to get into this market with some encouragement from regulators and policymakers.

Another drag on perceptions has been the poor reputation of mobile home communities where the ground rent system has long been a feature. But there are now many examples of upscale mobile and manufactured home communities using the ground rent model that are challenging people’s old assumptions.

Well established manufactured home communities, boast large, high-quality homes with shared amenities like swimming pools and fitness centers. These costs are usually covered by the ground rent, and the residents also don’t need to worry about property tax.

To be sure, there are some disadvantages to the ground rent model. A house on rented land will usually appreciate less than a conventional home and can be tougher to sell because of the smaller pool of buyers. But for many families those downsides will be vastly outweighed by the lower cost of capital and the ability to get more home for their dollar. 

So far, much of the innovation and investment in response to the affordable housing crisis has come in the form of single-family rentals. Blackstone’s $6 billion purchase last year of Home Partners of America, which owns and rents 17,000 affordable homes, was the highest profile example of that trend. But this fails to provide the stake in their home’s rising value that most homeowners want and which they get with the ground lease model.

I expect the biases against ground-rent housing to dissipate in the coming years as more real estate innovators enter the space. 

There’s enormous potential to expand the model from planned communities to stand-alone single-family homes, and no shortage of investors who are happy to earn a guaranteed 3% return that keeps pace with inflation. Big pension funds like Calpers and university endowment funds are looking for exactly the kind of long-term, steady, inflation-beating returns that ground lease contracts provide.

Big homebuilders could team up with land developers to create the projects and then bow out when the homes sell, leaving the homeowners and landlord in a long-term ground rent contract. 

If there was ever a time to think big about housing, this is it. Banks, regulators, and politicians should give the ground-rent model a second look and give the real-estate industry a chance to create more affordable housing for families.

Jim Small is the CEO of SANTÉ Real Estate Investments.