Joel's Jambalaya #5: Cooperative Ownership, Part 2

Happier, Healthier, and Wealthier - Where do I sign?

Intro

In the last issue we talked about the model of housing cooperatives, and at the end I wondered how that model might be extended from the scale of individual buildings to the scale of whole neighborhoods or cities.

This series is quickly becoming a multi-part endeavor. I love it! This topic only gets more fascinating as I explore it more. I think I will continue to explore some of the elements of cooperative ownership and governance over the next few issues.

This issue will be a look in some more detail about the benefits of cooperative ownership (using real numbers) and how that might solve some more of the misaligned incentives that plague cities today.

Part three will look at a broad level of how some specific elements of a cooperatively owned city would work differently than they do today.

Let me know your thoughts in the comments!

The Point of Cities

Cities will always exist.

Cities are the stages where individuals live out their lives. No matter what happens in the world, no matter what work looks like or how the economy functions, individuals must spend their days somewhere. Humans are inherently social - we will always need to exist around groups of other humans of some size.

Maybe everyone works remotely. Maybe nobody works and all of our physical needs are taken care of by super-intelligent robots. It doesn’t matter. We are still human and have the same needs as ever - the need to socialize, to have food and shelter, to work on something meaningful (even if not to earn a living).

(You can probably guess how I feel about the thesis that we’ll spend all of our waking hours in the metaverse - what does it say about our current physical environment that a leading vision for the future is to simulate a virtual world to allow us to escape the one outside our home? Why not build something better?)

Cities should aim to provide essential goods and services for their residents in the most equitable, parsimonious way possible.

This includes things like housing, essential services like fire and public safety, and infrastructure for transport, water, and electricity.

It also includes things that are just as fundamental to a good life but are often ignored in the design of cities: adequate social interaction, recreation, and opportunities to pursue whatever ends the individual finds meaningful in work or leisure.

Much of the suburban growth in America has provided affordable housing (at least on the surface) and essential services, but at the cost of the health and social lives of individuals and the financial stability of the city.

Other cities (particularly in the US) provide beautiful, walkable urbanism at a price that is simply not affordable to nearly every American.

A well-designed city would be designed to keep all of these things in a healthier balance.

Further, the design of a place doesn’t just mean the layout and appearance of buildings and streets. Just as important is the design of incentives and economic structures. A beautiful, well-planned city that is unaffordable to all but the wealthiest individual is just as much a failure as a cheap, uninviting one.

First, is this type of ownership really better?

My last issue got a little long before I was able to use a specific example, so let’s get down into the nuts and bolts of how this would actually work, and why it offers advantages over traditional real estate ownership. Further, it can offer benefits like lower transaction costs, but we’ll set those aside for now.

In a housing cooperative, instead of individuals owning a particular unit outright or paying rent to someone who does, individuals own shares in a company that owns the real estate. Below is a quick and rough model of how this works in practice.

Let’s assume that all units in the building are the same size to keep it simple. Purchasing $45,000 of cooperative shares entitles you to a perpetual lease on a 750 square foot 1 bedroom apartment.

This still presents a problem in the sense that most people don’t have $45k lying around, but this is where share loans come in - it is a modest amount to borrow. Further, it is easy to obtain because the loan can be secured by your ownership interest in the cooperative.

What’s happening here? How is the co-op 30% less expensive than renting the same unit?

Well, investors only invest in things where they are sure of an adequate return on capital. In this scenario, the investor is expecting an 8% return on his equity, so that provides us with the number he will ask the tenant to pay in rent. All the other costs still apply - we are assuming here they are just passed onto the tenant in both cases.

Instead of providing a return to the landlord, you’re the one getting the return on your money. The profit margin on the real estate moves from the landlord/owner to you.

Not only that, you benefit from any appreciation in the value of the property and building. The longer you live there, in theory, the more it’s worth.

Rather than being some socialist fantasy, it is actually more capitalistic than the current “Capitalist” landlord/rent-seeking model. Rather than there being one individual with capital charging rent on his or her asset, there is more “competition” for ownership of that asset because of how it is structured, and more people are able to accumulate capital.

Rather than one individual benefitting, all 40 individuals do.

The economic difference this shift in ownership makes is significant. Housing moving from nearly 43% to 30% of an individual’s income drastically changes their financial situation and outlook. Further, when the effect is multiplied across thousands of individuals, it becomes even more significant.

Instead of a small group of individuals getting very wealthy, every individual involved earns an adequate return on their capital. This is more important than it may seem at first glance, because for most people their residence is a majority of their wealth. Individuals who would otherwise rent and accrue no wealth can now participate in the wealth building effects of real estate.

Note: there is certainly a place for rental real estate in the US, depending on the stage of life and circumstances, it often makes a lot of sense to not commit to ownership. This is just to highlight how the economics change when the ownership structure changes.

Why is Ownership Important?

Still, even if it is a little better financially for residents, is it really worth going through all this trouble to allow individuals to own a portion of the places they live?

I think it is, and it reflects a broader trend towards making individuals owners of more products they interact with daily. Below is an excerpt from Li Jin’s excellent piece on the Ownership Economy. She focuses on ownership of consumer internet products, but the idea is universal:

Ownership has long been embraced by Silicon Valley startups to align incentives among employees through option grants. Still, the vast majority of internet users own exactly 0% of the services they contribute to. Creators don’t own their content, developers can’t control their code, and consumers can’t influence the policies or decisions of the platforms they use. This scenario, which once went unquestioned, looks increasingly archaic.

I would add: tens of millions of Americans have no stake in any sort of real estate, and millions more own suburban real estate that may prove to be more of a liability than asset in the decades to come.

The reason to give people ownership comes down to a single word: Incentives.

“Show me the incentives and I’ll show you the outcome”

Charlie Munger

Much of the failure of cities to grow in a sustainable way, or adequately meet the needs of their residents reflect their current incentive structures. Nobody involved in the governance or management of a city has much incentive to behave with any sort of efficiency or responsiveness. In fact, he has a disincentive:

If a city leader tries something risky and succeeds, he gets very little credit and see very little upside for his actions.

If he tries something risky and fails, however, he will be publicly criticized, and possibly even face legal action.

So what do city officials do? As little as possible. Lots of ideological posturing, little action and no experimentation. The current model specifically discourages experimentation or innovation of any kind. This is especially alarming when you consider that innovation/experimentation is the only way anything gets better, ever.

Further, thanks to having no real skin in the game, there is very little incentive to do things in a financially sustainable way. It’s fine to float 30 year bonds for a project that makes no sense, because repayment of it won’t be that city official’s problem!

Contrast this to a manager of a fast-growing company with a lot of skin in the game. She is incentivized to try lots of risky things. Even if there is some risk of embarrassment, the possible upside is much, much greater. Investments that look good in the short term but harm the company 5-10 years down the road are less appealing than the inverse (if the company is set up correctly - many public companies behave like municipalities today.)

She will naturally try to balance investments in things that have a limited downside but large upside, resulting in innovation.

Extending The Model

So we know how cooperatives enable affordable housing and how ownership can benefit individuals. Now let’s start to extend the model beyond just housing.

Imagine that instead of individuals purchasing shares in one particular building that they instead purchase shares in an entire city. The cooperative doesn’t own just a building, it owns all of the streets, sidewalks, parks, infrastructure in the city.

It also owns all future income streams the city has access to in the form of tax revenue, licensing revenue, and so on.

On the stock market, if an individual purchases shares in Google, they are buying the right to all assets the company owns today PLUS all cash flows the company will generate in the future.

The city would work exactly the same way. Cities own assets today, but most of their value lies in cash flow in the future that varies according to city growth, tax rates, revenue sources, and so on. This is most of what one would be buying in a purchase: a share of all the future revenue the city generates.

It seems like this would resolve many of the issues with traditional municipal governance and management incentives described above. If people are rewarded for their cities innovation, wouldn’t they take steps to ensure leadership is in place to experiment with innovative ideas?

Further, wouldn’t there be an incentive for ambitious and curious individuals to cluster together in this place, at least some of the time? I know I would love to live in a place that directly rewards me for the economic activity I contribute to the area, and wonder if others feel the same.

Further still, instead of rejecting growth and new housing (a large driver of housing becoming increasingly less affordable in cities today), residents would be incentivized to welcome many new residents and construction projects to the city since they stand to benefit directly from the social, economic, and cultural activity of these new residents.

Is There an Ideal Growth Pattern?

This idea is new, somewhat unusual, and it raises a lot of questions.

First, what would a city like this look like as it grows? Basically, take how American cities have grown the last 80 years - it would be the opposite of that. YouTuber Not Just Bikes and Strong Towns provide a great summary of America’s development pattern. Here is a summary from the video:

In the late 1940’s the US embarked on the suburban experiment.

Instead of incremental development around existing infrastructure, huge neighborhoods were built from scratch on the edge of town. Instead of a mix of uses, residential neighborhood were completely separated from commercial buildings, requiring a car to get between them.

This probably seems normal to most people living in the US Or Canada today. The suburban experiment began several generations have grown up not knowing anything different.

But understand that this was a drastic change from thousands of years of city evolution that we’ve had to date. We’ve now had over 70 years of the suburban experiment and we now know the experiment has failed. And it’s not just because these suburbs are ugly, devoid of life and soul crushingly sterile. It goes deeper than that.

For the rest of the explanation, I suggest watching the whole video. In two images, a healthier growth model is less like this:

This is the End of the Suburban Experiment

And more like this:

In a nutshell, if a city is owned and governed by its residents and they face both the upside and downside of decisions, there is one development pattern that becomes likely than others: the gentle density, mixed-use, human-friendly development that has existed worldwide for thousands of years, and was practiced in the US up until the late 1940s. This type of growth tends to strike a good balance in the access/space tradeoff.

Note: there is a lot of room here for other development patterns and densities - for example using Christopher Alexander’s pattern of Density Rings to provide more housing options for people based on lifestyle. It would be interesting to see what density evolves naturally if growth is mostly market-driven, without subsidies for any particular type.

Suburban development persists today because of insane state and federal subsidies for infrastructure. While those subsidies help build infrastructure, municipalities are starting to reckon with the fact that the tax revenue generated by suburban development is insufficient to pay for the long-term maintenance liability that it creates.

The mixed-use, gentle density pattern is not only financially sustainable, but more suitable for human life. People who live in these environments are healthier, wealthier, happier, and more civically engaged. The buildings are flexible and adaptable, rather than fixed and prone to abandonment and decay like so many suburban big box stores.

A cooperatively owned city would grow in a financially sustainable way, both for the individual resident and the city as a whole. It would mean, finally, the death of the suburbs.

Okay, I’m mostly kidding. The suburbs aren’t going anywhere. The subsidies will continue and cities will continue to borrow from future generations to pay for it.

But I feel confident that a new model can emerge and offer a better way of living for millions of Americans. It’s not a challenge to anyone’s lifestyle, it’s simply another choice for people - and isn’t that the ultimate American Dream?

For the good of individuals and the stability of future generations, we need a viable alternative to cheap subsidized suburbs or expensive walkable areas. We need walkable, human-scale neighborhoods available to everyone who wants to live in them. The cooperative ownership model is a strong contender for how to create that alternative.

Until next week,

Joel