A recent ruling by the Department of Industrial Relations regarding labor rates for subsidized housing projects might be an advantage for affordable housing development, especially in rural areas. However, the situation regarding “prevailing wage” requirements might best be described as fluid.

In late February, Department of Industrial Relations (DIR) acting Director John Rea ruled that a 120-unit affordable housing project in the City of San Marcos that is being subsidized with federal tax credits and tax-exempt bonds is not subject to prevailing wage requirements. The State Building and Construction Trades Council of California (SBCTC) has asked Rea to reconsider and has suggested it will take the matter to court if Rea declines to change his mind.

In the meantime, housing developers have asked DIR to rule that projects financed with more direct subsidies - such as Community Development Block Grant funds, federal HOME funds and local redevelopment monies - also are not subject to prevailing wage requirements. A DIR spokeswoman could not say when a decision would be reached in that matter, or on the SBCTC appeal.

“It's far from over as a topic of public concern. It's about as clear as mud right now,” said Jeff Loustau, executive director of the California Housing Consortium, an umbrella group of for-profit and nonprofit developers.

The issue is this: In 2001, state lawmakers approved SB 975 by Los Angeles state Senator Richard Alarcon, a champion of organized labor. The legislation expanded the definition of “public works” to include nearly all development projects that receive any direct or indirect subsidy (see CP&DR, September 2002). A public works is subject to prevailing wage requirements. Affordable housing projects - which often rely on multiple public and private sources of capital - were exempt from the new mandate, but only until 2004.

Traditional public works projects, such as the construction of roads and courthouses, have long had prevailing wage requirements. The 2001 legislation extended the wage rules to private development projects that get public money.

The DIR establishes prevailing wage rates. It is the basic hourly rate paid to a majority of workers in a particular trade or craft within a defined geographic area. However, the setting of prevailing wage rates is nearly as much art as science. The agency looks to large labor markets, such as in San Francisco or Los Angeles proper, and then relies heavily on contracts reported by labor unions for commercial projects. Thus, the established prevailing wage - which the DIR applies to broad geographic areas - is often toward the top end of the scale in the most expensive labor markets. The system is great for roofers, tile-setters, dry-wallers and others working in the construction trades, but not for developers and financers, and cities trying to provide affordable units.

Depending on the project and the location, the prevailing wage requirement can raise the cost of an affordable housing development anywhere from 5% to 40%, according to developers. In general, for-profit developers oppose the wage mandate, while the nonprofit community is divided. Some nonprofit developers want to create as many housing units as possible, while others say they do not want to build at the expense of laborers.

Interpreting the law

The case decided by the DIR was brought by a for-profit developer called RSF Village Partners. The project is a 120-unit apartment project for seniors with incomes of 60% or less of median. The occupancy restrictions would remain in place for 55 years. Development is to be funded in part by federal low-income housing tax credits, which are awarded by the California Tax Credit Allocation Committee. The amount of tax credit is based on the cost of constructing the units. Another source of funding is tax-exempt “conduit bonds” issued by the California Statewide Communities Development Authority. The term conduit bonds comes from the fact that CSCDA acts solely as an intermediary. The Authority issues and sells the bonds at the same time. All proceeds go a private trustee for the bondholders. The trustee advances the money to the developer, which is responsible for repaying the bondholders.

These details were important to Rea's ruling. In interpreting the statute (Labor Code § 1720), he had to determine whether the financing amounted to the payment of public funds or to a reduced a contractual obligation of the developer. Rea said no.

With regard to the federal income tax credits, Rea wrote, “[N]either the state nor a political subdivision is making any payment to the owner [RSF Village Partners]. Moreover, a tax credit 'involves no expenditures of public money received or held … but merely reduces the taxpayer's liability for total tax due,'” Rea cited Center for Public Interest Law v. Fair Political Practices Commission, (1989) 210 Cal.App.3d 1476.

Quoting the statute itself, Rea continued, “While the tax credits may reduce owner's federal income tax obligations, these are not 'obligations that would normally be required in the execution of the contract.' The execution of the contract entails expenditures by, not income to, owner.”

Rea concluded that the bonds are not public funds. “[N]either the conduit bond revenues nor the loan repayments ever enter the coffers of a public entity, nor are they collected for the public entity,” Rea wrote. The loan to the developer “is made by the bond trustee, so even if the interest rate were below-market, neither the state nor a political subdivision thereof is charging interest at less than fair market value.”

The Trades Council contends that a financing tool that reduces a developer's tax liability is a subsidy, as are low-interest loans facilitated by a state agency.

“The director ignored economic reality in concluding that this project did not get a substantial public subsidy,” said Scott Kronland, attorney for the SBCTC, which has asked for reconsideration.

If the ruling were to stand - and just about everyone expects it to - the full impact is uncertain. Gary Downs, the attorney for the developer, said the decision “clarifies the rules” and sets a precedent for the entire state. Any developer may rely on it in good faith, he said.

Kronland declined to go that far. “People look to the director's opinions for guidance for the future,” he said. However, only the courts can say what the law means, Kronland said. And court is almost certainly where the issues is headed.

What's Next?

Affordable housing developers are trying to figure out how to proceed, said Loustau, of the California Housing Consortium. State agencies, he said, are sending mixed signals. The Tax Credit Allocation Committee, for example, is requiring applicants to submit project applications with and without prevailing wage costs.

The prevailing wage requirement has caused trouble for a number of affordable housing developers, Loustau said. “It has meant there's been a falloff in applications for low-income housing tax credits and projects where tax-exempt bonds are used,” he said. Those financing tools are used in almost every affordable housing project, he added.

In fact, the number of applications to the Tax Credit Allocation Committee during 2004 decreased by 30% from the year before to 135. The number of units financed by the tax credits dropped by 23% to 4,349 during 2004.

These figures reflect a dilemma for developers. If labor costs for a project go up, a developer either has to find an additional funding source or build fewer units, said Rob Weiner, executive director of the California Coalition for Rural Housing.

“Unlike in market-rate developments,” attorney Downs said, the affordable housing developer “cannot pass along the costs for paying prevailing wage to the tenants.”

Some cities - including San Marcos, the site of the disputed development in the DIR case, and Redding - have offered to increase their subsidy to help offset the higher labor costs.

If the DIR ruling stands, Weiner said, “It means considerable cost savings in some markets. That's especially true in the more rural and suburban areas of the state.”

While some nonprofit developers have cheered the DIR ruling, Weiner said his organization is comfortable with a prevailing wage requirement. The problem, he said, is with the way rates are established. Applying a commercial project rate from San Francisco to a residential project in, for example, Yuba County makes no sense because the markets are entirely different, he said.

Two major players - the Southern California Association of Non-Profit Housing (SCANPH) and Housing California - are trying to work with organized labor and the DIR to create residential prevailing wage rates for specific jurisdictions. SCANPH has had some success: Unions for 14 trades now report a residential prevailing wage rate for Los Angeles. In exchange, SCANPH tries to steer more work to those unions.

Weiner doubts that unions will be willing to establish residential rates in suburban and rural areas because too much money is at stake. The rates SCANPH has helped create are not substantially lower because of the Los Angeles labor market.

Jan Breidenbach, executive director of SCANPH, said that the organization did not take a position on SB 975, and her members are divided over the prevailing wage issue. “I'm assuming in the long run, affordable housing is going to have prevailing wage,” she said.

One of the biggest challenges in implementing the prevailing wage mandate is ensuring that the workers get the money, said Breidenbach. The handful of general contractors in metropolitan Los Angeles who build most affordable housing projects have grown accustomed to the regulation and the accompanying paperwork. However, subcontractors often make off-the-books deals with workers or pay in cash, and then keep the surplus that they get from the general contractor. These shady arrangements might be getting easier to pull off because a growing number of construction laborers are recent immigrants or illegal aliens.

“The amazing thing is that nobody knows what people actually get paid on construction sites,” Breidenbach said. “They only tell you what people are going to be paid.”

This cheating by subcontractors is something of a side issue, but it is potentially important. If prevailing wage requirements are supposed to help workers, but workers are not benefiting, something will have to give.

Breidenbach said that labor costs are only one worry for affordable housing developers. Real estate prices in urban areas continue to increase dramatically, and skyrocketing materials costs have stung everyone in the building industry.

Still, there is nothing that the government can do about the cost of concrete and two-by-fours, and only a limited amount it can do about real estate costs. What the government can influence is labor costs. State lawmakers have not taken up the issue publicly this year, but legislation is a possibility.

“This issue will not stop being contentious,” Breidenbach said.

Jeff Loustau, California Housing Consortium, (415) 677-4436.
Jan Breidenbach, Southern California Association of Non-Profit Housing, (213) 480-1249.
Rob Weiner, California Coalition for Rural Housing, (916) 443-4448.
Gary Downs, Pillsbury, Winthrop, Shaw, Pittman, (415) 983-1000.
Scott Kronland, Altshuler, Berzon, Nussbaum & Rubin, (415) 421-7151.
Department of Industrial Relations decision: www.dir.ca.gov/dlSR/coverage/2004-016.pdf (PDF).