There are a variety of ways to build affordable housing, but implementing these strategies has become an increasingly difficult proposition in 2023. Affordable housing projects seem to face challenges on every front. Generally affordable housing developers will:
- Obtain an operating subsidy that helps residents afford market-rate rents (Section 8)
- Inject low-cost capital to defray the cost of building new or substantially renovating housing, thereby allowing an affordable housing developer to charge lower rents (Low-Income Housing Tax Credit [LIHTC] program or other federal, state or local capital subsidy programs)
- Reduce the operating costs of housing, allowing the affordable developer to increase affordability by charging slightly lower rents (real estate tax exemptions or abatements)
- Reduce financing costs in exchange for renting to low- and moderate-income residents (affordable financing provided by Federal Housing Administration (FHA)/Freddie Mac and Fannie Mae)
Despite intensifying renter demand for new units, developers are struggling to make their projects financially feasible, says John Ducey, chief production officer in the affordable lending group at Walker & Dunlop.
“Affordable housing developers are facing some of the toughest headwinds I’ve seen in more than 20 years in the industry,” Ducey says. “That means developers are forced to work harder than ever to structure deals that stretch scarce housing subsidies and maximize agency financing.”
Challenging Conditions
One impediment to affordable housing efforts is reduced future rent levels, related to area median income (AMI) caps the Department of Housing and Urban Development (HUD) imposed recently on LIHTC properties in many markets in the United States. The unexpectedly restrictive caps forced developers to slash revenue projections, scuttling some transactions and forcing many loan applicants to renegotiate or seek alternative financing to salvage deals.
On the expense side, inflation and the labor crunch continue to drive up costs for new construction, renovation of older affordable units or conversion of market-rate properties to affordable units. Furthermore, increased labor costs put pressure on property operations and maintenance, making it difficult for owners to maintain affordable rent levels. At the same time, soaring interest rates have made conventional debt and equity financing more expensive.
The resulting squeeze has many affordable housing plans stalling out this year because the developer or owner is unable to create financially feasible affordable housing projects.
Although the government-sponsored enterprises (GSEs) are permitted to lend billions of dollars to affordable housing borrowers in 2023 via their lending caps imposed by their regulator, the Federal Housing Finance Agency (FHFA), they have been slow to make underwriting adjustments that would help borrowers close deals. Fannie Mae and Freddie Mac each can lend up to $75 billion in the sector this calendar year but had placed only 49 percent of those amounts as of September, Ducey says. At that time, HUD had loaned out only $9 billion toward its $35 billion cap.
“Freddie Mac has been marginally more aggressive on the affordable side than Fannie Mae this year, but affordable housing is a major focus for them both, so they should be more aggressive,” Ducey says. “It’s a bit of a head-scratcher that the GSEs are not lending as much as they can in this crisis.”
In the meantime, Walker & Dunlop is helping affordable housing clients combine agency loans with funds from a variety of other sources to reach their financial objectives. The company is the nation’s largest agency lender, a major provider and syndicator of LIHTC financing and offers its own affordable housing products. Walker & Dunlop has helped clients leverage a variety of solutions.
“Developers need to consider a range of options if their affordable housing project is going to succeed,” Ducey says. “Certainly, you need to bring in debt financing, but you also need to bring in subsidies — and there are multiple ways to do that.”
Winning Combinations
How are successful developers navigating today’s headwinds? Most are using one of three proven strategies that supplement agency financing with other resources, Ducey says.
Apply for LIHTC Financing. The sale of federal tax credits can provide an important influx of equity financing without increasing a developer’s debt. State government housing finance agencies award these tax credit allocations.
A client used LIHTC financing to complete a substantial rehabilitation of the 294-unit Park Shirlington Apartments in Arlington, Virginia. The work upgraded the building envelope, systems, unit interiors and amenities, including construction of a new community center that greatly enhanced the project’s value. Walker & Dunlop had provided the developer with a $60 million bridge loan to acquire the market-rate complex for conversion to affordable housing in 2021. The firm then arranged $46.6 million in long-term Federal Housing Administration 221(d)4 financing from HUD that was complimented by valuable LIHTC equity invested in the project.
Reduce Property Taxes. One way to offer affordable rents and maintain positive cash flow is to minimize property taxes, which form a substantial part of operating costs. Many state and local jurisdictions seeking to promote affordable housing can provide tax exemptions that lower the owner’s operating cost and allow them to reduce or keep rents affordable. The reduced operating expenses combined with affordable rent levels make financing these projects feasible.
“Real estate tax exemptions are a powerful vehicle for making housing more affordable,” Ducey says. “We’re seeing lots of affordable housing being created this way and have financed over $700 million in deals that included real estate tax exemptions in 2022 and 2023.”
Access Alternative Financing. Agency loans are essential to most affordable housing communities, but some projects benefit from additional, specialized funding from a variety of sources. Clear Blue Co., for example, is using a low-interest loan from the Amazon Housing Equity Fund in the capital stack to develop a 238-unit affordable community northeast of downtown Nashville, Tennessee. Walker & Dunlop arranged the project’s senior financing, a $24.8 million Fannie Mae MBS as tax-exempt bond collateral (MTEB) loan, that maximizes the benefits of tax-exempt bonds allocated by the State of Tennessee and keeps financing costs low.
“Developers facing today’s headwinds should be working with highly experienced companies like Walker & Dunlop that offer trustworthy advice on how to finance projects multiple ways,” Ducey says. “Borrowers need to choose the combination that is most efficient for their project and maximizes available financing. With a full agency lending platform, strong investment sales team and deeply experienced LIHTC platform, we are well-positioned to help clients make that happen.”
— By Matt Hudgins. Walker & Dunlop is a content partner of REBusinessOnline. For more articles from and news about Walker & Dunlop, click here.