Proposition 37: No Recommendation

by Max Dubler

Introduction

Providing down payment subsidies for first-time homebuyers is a good idea on the merits, but is problematic in a severely supply-constrained market like California. 

Prop 37 authorizes the state to issue up to $25 billion in revenue bonds to fund a second mortgage program to help qualifying homeowners afford a down payment on a new home.

It also establishes a new construction defect paradigm for homes purchased with Prop 37 loans.

Analysis

How Would the Down Payment Assistance Work?

The bonds would support a $25 billion fund that will offer second mortgages that cover up to 17% of a home’s purchase price (to qualify for a mortgage, homebuyers often have to provide a 20% down payment to get the best rate). The downpayment assistance would be paid back as part of the homeowner’s mortgage payment.

Prospective homeowners who use the fund will have to have lived in California for at least a year, make under 200% of area median income, provide a down payment of at least 3% of the purchase price, and move into the new home as their primary residence within 60 days of closing. The home price cannot exceed 125% of the county-level conforming loan limit under the Federal Housing Finance Agency standards.

The interest rate for these second mortgages will be dependent on the interest rates for the bonds that finance them, which means they may be higher than typical mortgage rates. While the program can deliver some modest savings to homebuyers by allowing a smaller downpayment without private mortgage insurance, larger savings would be heavily dependent on the ability to sell the secondary mortgage bonds at discounted rates.

Prospective buyers will be required to retain a licensed California real estate agent or broker “to ensure that the homebuyer receives adequate representation and consumer protection throughout the homebuying process.”

What Does California YIMBY Think Of This?

California YIMBY’s mission is to make California an affordable place to live, work, and raise a family. We advocate for supply-side solutions to the housing affordability crisis because housing prices are set by supply and demand; so building new homes at scale is the only way to address the housing shortage that is driving up prices.

Historically, homebuyer subsidy programs like downpayment assistance have exclusively worked on the demand side, often worsening overall affordability by injecting more money into already-competitive markets with a limited number of homes.

Proposition 37 is different in that it can only be used for new homes, including single family detached, townhomes, condos, manufactured homes, or newly-converted, adaptive reuse projects. In theory, this means it would drive housing demand specifically toward new construction, which aligns with our goals of expanding the housing supply.

Would it work? One possible mechanism is that Prop 37 would make prospective homebuilders more confident in finding buyers, and thus more willing to build. We view this mechanism as quite unlikely. There is no shortage of buyers for newly built ownership housing in California (in fact, bidding wars are quite common).

Another possible mechanism is that Prop 37 would, like other downpayment assistance, drive up prices, but only for newly built housing. This would then induce homebuilders to invest in building more housing. Supply effects would be strongest in places where homebuilding is currently marginal: “second tier” neighborhoods/cities and exurban areas where demand is not as strong.

It’s worth thinking through the winners and losers of that scenario. Buyers using the program would benefit by being able to buy a larger, better located, or nicer home than they could otherwise afford. Buyers of new housing not using Prop 37 would lose out, paying higher prices. Indirect benefits would flow to some mix of buyers for older housing (who might face less competition bidding up the price) and renters (who might see more available rental stock to the extent Prop 37 moves people from renting to homeownership). Savings for homebuyers using Prop 37 would be muted by the associated price increase.

How well that price increase translates into new homebuilding depends on the price elasticity of housing. Such an estimate is beyond our scope, but we can look to what happened when home prices spiked from 2020-2022 in California as a reference. There is a downward blip in 2020 (the pandemic) and an upward one in 2021 (most likely shifting of permits from 2020), but overall the numbers are flat, consistent with our belief that constraints other than demand are the most important limit on development of new ownership housing.

How efficient a program for homeownership would this be? Proponents have estimated that it will build 190,000 new homes (if buyers are found for all the bonds, which is not guaranteed). That would place the bond revenue per new home at approximately $130,000 (not counting interest on the bonds!), repaid over the 30 year span of a mortgage. This estimate, however, assumes that 100% of homes purchased through the program would not otherwise be built. For the reasons discussed above, we find this assumption unlikely, and the bond cost per newly built home is likely to be higher than the average secondary mortgage. To be fair, that bond cost is not public money, but it still represents a substantial commitment of state administrative capacity.

What else could the state do to advance homeownership with the administrative capacity and potential resources (proponents have argued they will sell bonds at reduced rates to foundations and other philanthropic buyers) of this bond? Programs to bring down construction finance costs for builders, such as a revolving loan fund or loan credit enhancement reserve, would likely be much more effective. Like the secondary mortgage, they would only need to cover a share (10-20%) of total cost. But because construction loans have much shorter terms than mortgages, such programs could recycle the initial investment 6-10 times in the period a mortgage turns over once. And by directly reducing the cost to build new housing through lower cost financing, such programs would likely be much more efficient at converting their subsidies into a net increase in homebuilding.

Most of the legislation California YIMBY has sponsored in the past has been oriented around making it easier to build “infill” housing in existing neighborhoods, rather than the new single-family subdivisions on undeveloped “greenfield” that is often referred to as sprawl. Given the current regulatory constraints on new home deposits; on building new condos; and the resulting shortage of new infill housing for ownership, it’s likely that this program will primarily benefit people buying new homes in greenfield subdivisions until the legislature addresses constraints on new infill ownership housing. 

While we understand that many of our grassroots YIMBYs are committed urbanists with strong commitments to environmentalism, and a dislike of sprawl, some greenfield is going to be part of ending the housing shortage.

That said, due to the ongoing housing shortage and continued constraints on home building, this program will probably not make homeownership more affordable, except in fairly limited cases. New homes tend to be more expensive than older homes. While downpayment assistance might help families with solid incomes and limited savings to buy homes more quickly, their monthly payment will be substantially higher to cover the 17% down payment assistance. Buyers will also have to pay a fee to the licensed real estate agent or broker that the law requires them to retain, increasing prices by 2-3%.

Recommendation: Neutral.

If we are going to subsidize demand for homes, this is one of the better ways to do it. However, given the ongoing shortage, such subsidies are unlikely to reduce costs for prospective homeowners.

Further Reading

Ballotpedia analysis of the measure (with the measure text), Legislative Analyst’s Office analysis, California Budget and Policy Center analysis (with useful comparison to other downpayment assistance efforts).