By Taylor Williams
The fundamental forces of job and population growth that drive demand for market-rate multifamily properties are hard at work on the affordable housing sector in Texas, and it doesn’t appear that a supply-demand equilibrium is in the cards anytime soon.
In addition, a perpetual shortage of low-income housing tax credits (LIHTCs) and other government-issued subsidies that are required to finance new development of affordable housing are working to keep supply growth in check.
Throw in a global pandemic that has cost millions of people their jobs and depleted their savings, potentially forcing them to seek less-expensive housing, and you have a supply-demand dynamic that is far from balanced.
The situation is further exacerbated by the fact that there is some overlap between workers in industries hit hard by the pandemic, such as leisure and hospitality, and the types of renters who need or qualify for affordable housing.
Texas is hardly the only state facing these lopsided market conditions. According to a 2020 report by the National Low Income Housing Coalition, when it comes to housing that renters whose income levels are at or below 30 percent of their area median income (AMI) can afford, the United States comes up about 7 million units short. On average, for every 100 extremely low-income renter households in the country, there are only 36 affordable housing units.
According to the U.S. Census Bureau, the Texas population has grown by about 4 million people over the last decade and now measures just shy of 30 million people. In addition, the Texas Workforce Commission states that prior to March 2020 and the COVID-19 outbreak, the state had posted 31 consecutive months of positive job growth, culminating in 43,000 jobs added in February 2020. Following the pandemic’s disruption of the national economy in April 2020, Texas posted eight straight months of positive job gains to close the year.
Furthermore, the state has made national headlines in recent years for recruiting major companies like Oracle, Hewlett-Packard Enterprise, CBRE and McKesson Corp., all of which have announced plans to relocate their corporate headquarters from California to Texas.
Hundreds of smaller companies have made similar decisions, while equally large companies like FedEx, Liberty Mutual and J.P. Morgan have consolidated their regional workforces in major Texas markets to take advantage of a low-regulation environment and the absence of a state income tax. And while most of the transplants who work for those companies earn enough to afford market-rate housing, the arrival of these firms spurs new development of retail, restaurants and other ancillary businesses whose employees are more likely to demand affordable housing.
For all of these reasons, Texas appears to be facing a more acute version of the affordable housing shortage. Consequently, when developers do deliver new projects, they typically receive fervent levels of immediate demand.
“Demand for affordable housing will continue to be inelastic regardless of broader market conditions,” says Ryan Harden, president of Dallas-based development firm RightQuest. “There’s a huge need and a waitlist at almost every one of those communities.”
“In the past, developers could do these projects that targeted a broad segment of renters without subsidies,” Harden continues. “The economics worked in those days because hard costs and interest rates were low at the same time, and you could build affordably. But with where costs are now, particularly with lumber, you just can’t build that product type without subsidies.”
According to the National Association of Home Builders, lumber prices have risen by 130 percent over the last year or so. Prices peaked at $950 per 1,000 board feet in September of last year before dropping to $550 per 1,000 board feet at the end of the year, when the federal government slashed duties on imports of Canadian lumber.
Competition for Subsidies
Securing tax credits or other subsidies needed to move forward with new construction is equally competitive in Texas. The process of allocating and awarding these subsidies begins at the federal level, with each state receiving an annual LIHTC allocation in accordance with federal law. Typically, each state’s housing finance agency then carries out the administration of the tax credit program.
The allocation of tax credits for a given state increases as its population grows. But despite the strong population growth that Texas has posted over the last decade, there are still not enough of these subsidies to finance the volume of new affordable housing product that is needed, sources say.
“Even the most populous states like Texas don’t have enough tax credits available each year to meet demand, and it’s unlikely we’ll ever have enough to meet demand under any scenario,” says Rachel Edwards, vice president of investments at The Davis Cos., a Boston-based developer that is actively expanding in Texas.
“Texas only has so many credits to go around, and even in a market like Houston with low barriers to entry in terms of zoning and new construction, there are still high affordability issues,” she adds. “But we’ve since figured out ways to invest in this asset class without the public piece.”
To grow supply without public subsidies, The Davis Cos. recently formed a joint venture with Hayden Glade, an owner-operator exclusively focused on affordable housing that is also based in Boston. The partnership is focused on preserving existing affordable housing properties without the use of public subsidies and recently purchased a 250-unit community in Austin as its inaugural acquisition.
The joint venture is planning an extensive capital improvement plan at the property, which was originally built in 2006 as Rosemont at Hidden Creek. The program will upgrade common areas and unit interiors while still preserving the affordable status of the property, which was set to expire under the terms of the LIHTC program that was originally used to finance construction. Davis and Hayden Glade will also rebrand the community as Eryngo Hills, named after a flower that is indigenous to the region.
With materials and labor costs for new construction perpetually on the rise, preservation of affordable housing has become a key method for growing — or at least not losing — supply.
“Preservation is extremely important; these assets are extremely valuable once built, and when their restrictions expire, they’re at risk of becoming market-rate housing,” explains Edwards.
Beginning in 1990, new properties that were developed using LIHTCs were required to preserve affordability for 30 years. During the first 15 years, known as the initial compliance period, owners must maintain affordability.
The second 15-year spell, known as the extended-use period, is when owners can leave the LIHTC program through a relief process. Once the 15-year affordability period is over, LIHTC owners that seek and are granted regulatory relief from the program can convert their properties to market-rate assets.
“Our platform is buying them, post-year 15, putting fresh capital in for new systems and appliances to meet modern standards and provide a quality living experience for residents,” says Edwards.
Excluding the public sector from a deal has its pros and cons, notes Elliott White, CEO and managing partner of Hayden Glade. He points out that properties that are nearing the end of their compliance period — the duration for which they are officially subject to income restrictions — usually don’t qualify for tax credit subsidies to provide for the renovations they likely need.
“Buying these buildings, fixing them up, dealing with deferred maintenance and still preserving affordability — that’s a pretty delicate balance when you’re working with your own capital,” he says. “It allows us to move very quickly, but it also means we’re not tied to the massive drawdown on scarce resources. Not every deal works for us, but we’ll never buy a property unless we know we can meaningfully improve the quality of residents’ lives.”
Policy: Austin vs. Houston
City leaders in Austin, a market renowned for its rapid growth, gentrification and escalated cost of living over the last decade, are also wrestling with inclusionary zoning mandates as a means of growing its stock of affordable housing.
According to the Austin Monitor, Texas State Rep. Gina Hinojosa recently launched an effort to repeal a state law that outlaws inclusionary zoning, a practice in which cities and municipalities require developers to designate a certain percentage of units in a new project as affordable.
But regardless of how the legal battle unfolds, Austin is still seeing its share of new ground-up affordable developments. Examples of recent projects include Bridge at Turtle Creek, a 307-unit community by JCI Residential, and Heritage Estates at Owen Tech, a 174-unit complex by Dallas-based Generation Housing Development and Tide Hill Partners. These projects are being developed in partnership with the Housing Authority of the City of Austin the Austin Affordable Housing Corp., respectively.
The flip side of this approach is embodied in Houston, a market infamous for its lack of zoning, although some neighborhoods have deed restrictions. These agreements are enforced by private neighborhood organizations instead of formal public agencies, but can still serve as barriers to entry for developers.
In addition, the affordable housing market in the Bayou City has another unusual market force acting on it: the impacts of Hurricane Harvey in 2017.
“Financing for new affordable housing projects in Houston is really driven by two major sources — the LIHTC program and the disaster recovery funds from Hurricane Harvey,” says Mary Lawler, executive director at Houston-based nonprofit developer Avenue.
“Those two agencies have policies and goals in terms of where these properties are sited, and those policies really guide developers with regard to where they supply more affordable housing,” she explains.
“With some units that were damaged by Harvey, it’s become clear that replacement housing was needed, and that’s where the city’s disaster recovery funding has been most active in creating new affordable housing,” she continues. “This new product should be of higher quality and arguably in better locations since the rebuilt housing won’t be in areas that are subject to repeat flooding.”
Avenue recently broke ground on Avenue on 34th, a mixed-income project that will add 70 units to the supply of Houston’s Oak Forest neighborhood. The location targets a submarket within the urban core that is close to employment clusters, but which has seen its housing prices rise at an exceptional pace in recent years.
The project is being financed with 4 percent LIHTCs provided by the Texas Department of Housing and Community Affairs, with regional lender Amegy Bank representing the private-sector side of the capital stack.
Other project partners include the Houston Housing Finance Corp., the City of Houston Housing and Community Development Department and Hunt Capital Partners. General contractor Block Cos. expects to complete the project in late 2021.
— This article originally appeared in the March 2021 issue of Texas Real Estate Business magazine.