Financing Affordable Housing

When homebuilder and developer Granger MacDonald was putting the financing pieces together for a low-income rental housing project in Kerrville, Texas, last year, he was having a hard time trying to make it pencil out.

He truly wanted to make the development work for Kerrville, he recalled in a recent interview, because the city of around 25,000 in the Hill Country about 65 miles north of San Antonio is his hometown.

However, President Trump’s tax reform efforts — some of which MacDonald continues to support — derailed the project: The controversial Tax and Jobs Act of 2017 (which went into effect in 2018) cut the corporate tax rate from 35 percent to 21 percent and made the Low-Income Housing Tax Credit (known as LIHTC and pronounced Lie-Tech) program much less attractive to corporations, decreasing their financial incentive to make equity investments in tax credits. The program encourages investment of private equity in the development of affordable rental housing. Tax credits are issued by the IRS and distributed to housing projects in each state. In 2018, they provided roughly $10 billion in funding for affordable housing.

MacDonald, head of the MacDonald Companies and former chairman of the National Association of Home Builders, campaigned against parts of the tax reform legislation. In late 2017, he wrote:

“The House bill… severely diminishes the effectiveness of the Low-Income Housing Tax Credit, which is essential to spur the production and rehabilitation of affordable rental housing."

“With the nation already in the midst of an affordability crisis, undermining the LIHTC will deal a crippling blow to keep housing affordable and available for those citizens who are most in need.”

“We had a project that wasn’t very close to making sense financially,” said Granger. “And when it lost 5 cents of credit on the dollar (the equivalent of $500,000), it just didn’t function anymore. Right now we are seeing the price of tax credits at around 90 cents on the dollar. Prior to the passage of the tax bill, you could get in the high 90s routinely. That makes a substantial difference on a 150-unit project, where you can figure about a 1-cent change will mean about $100,000 less equity."

“I was very disappointed. You really hate having to stop a project, especially when you’re doing something like that in your own backyard and it’s going to help your own community, because we need workforce housing horribly here in Texas.”

According to a recent study by the American Community Survey, the number of renters facing housing cost burdens (i.e. paying more than 30 percent of their income for housing costs) has risen to 21.3 million, which is just about half of all renter households in the nation. Worse, the number of people facing severe cost burdens (devoting more than half their income to housing), has also reached a new record of 11.4 million.

“We’ve got a strong demand for jobs with all the growth here in the state, but no place for these folks to live economically, and prices keep going up,” MacDonald said.

“Because of the rising costs of materials, land and labor, new market rate (apartment) rents are now close to $1,800 a month to make sense financially. And that’s hard for a lot of working people to afford."

“But with the tax credits, you can drop that number down to around $1,100, which is a substantial difference in affordability,” said MacDonald, who built his first affordable housing development in 1997 using LIHTC."

“We’ve always done really well with LIHTC product and we are very proud of it. We own, operate and manage them and have kept most of those we’ve built.”

MacDonald is currently working on another low-income house project that he hopes to build, if he can get the financing through LIHTC and other sources, and another 100-apartment unit development in Bastrop, Texas, on the southeast side of Austin, that was on the ropes because of reductions in corporate taxes, is now going forward.

“We ended up being able to use LIHTC for the Bastrop development and it was very close, but we got it done by finding a secondary source of financing through a private investor. Those units will average $1,000 a month, a real bargain for the Austin market, which is booming.”

MacDonald said the tax reform that went into effect last year “certainly forestalled the recession that was right around the corner for this year or next.” And that was good. Sunshine (yup, that’s his given name) Mathon, head of the Piedmont Housing Alliance in Charlottesville, Va., said the appetite by big companies for LIHTC tax credits began to wane before Trump’s inauguration because one of his main platform items was reducing the corporate tax rate to as low as 15 percent.

Still, he said, the primary mechanism for financing affordable housing in the United States remains the LIHTC program.

“Roughly 90 percent of affordable housing projects that get built every year in this country uses LIHTC. But that in itself is insufficient to fund affordable housing on its own and requires additional sources. Usually that includes local municipal or county-based fiscal support.

“Depending on the nature of the project, there might also be philanthropic dollars, foundations contributing money or there might be federal home loan bank funds in there. And there is usually some debt as well.”

Mathon said there were projects in the preliminary stages of being negotiated all over the country that stalled soon after Trump was elected, “based on the uncertainty of what was going to happen to the tax rate.

“Many of them had to be renegotiated entirely, or in some cases the projects fell apart because of the uncertainty of what the value of those tax credits was going to be in the long run.”

At the time, Mathon was working in Austin, Texas, working for Foundation Communities.

“We saw the value of those tax credits go from roughly $1.10 on the dollar to about 90 cents on the dollar. For us, roughly speaking, every penny difference equated to as much as $150,000 of cash value towards the project’s capital stack."

“Projects in general struggled to make the numbers work for a lot of other reasons, in large part because the cost of construction and land continues to rise. So that drop in tax credit value had a big impact across the industry.”

He said the LIHTC program is more than 30 years old and the value of tax credits had dipped in the past, usually when the economy was down. This time it was different, however.

“Generally speaking — because the tax credits were based on supply and demand in the overall market — if you saw a dip in their value, you would usually be in an economic slump. Which nearly always meant the cost of land and construction were also dipping, so it sort of balanced out."

“But this marks the first time in the tax credit program’s history that you have the opposite trend. Now you have the value of the credits going down, while the cost of land and materials and labor are going up — which then creates a very difficult gap for projects across the country.”

Mathon said when he was leaving Austin, Foundation Communities was designing a 120-unit apartment development community and was in the process of applying for tax credits. The change in tax law, he said, had some significant impacts on the achievability of that project.

“The consequences were that in order to make the project work under the same terms, we had to do a heck of a lot more fundraising and search for more money that was already difficult to find."

“In the end, that project came to fruition after I left because they were able to find additional funding. But you can’t do that every time and repeat that over and over. You can only go to the well so often.” Currently in Charlottesville, he said the Piedmont Housing Alliance is applying for tax credits for a new, 106-unit apartment development. Rents will range from $400 to $1,200, depending on the different income levels and size of apartments. He said the market-rate rent for a two-bedroom apartment is $1,300.

“The difference in the value of the tax credits we’re seeking today, vs. what we believed we could have gotten before is $3 million. That has stretched our need for additional subsidy, considerably. The story is the same all over the country."

“You have individual developers in both nonprofit and for-profit realms who are struggling to figure out how to approach their philanthropic sources. Often times the states that administer tax credit programs have had to scramble to figure out how to help projects and local municipalities are having to stretch their own dollars to bring more resources into developments to make them viable, particularly if they want to incentivize affordability.”

Mathon said he’d love to see changes in the tax law, but he has little hope that will happen during the current administration.

“For the most part, everyone I know is working under the assumption that this is the new status quo. Of course, we will advocate for changes in policy. And one great organization that we strongly support is the National Low-Income Housing Coalition, based in D.C. They do extraordinary work around housing issues.

“The president’s budget over the past few years has called for very significant cuts in HUD-related funding and other housing-related programs. But each time the president has made certain proposals outside of the tax cut, Congress has soundly and on a bipartisan basis, rejected his proposals.

“In large part, that’s because housing is one of those things where almost everyone knows someone who needs access to affordable housing. When you can clarify that position, you have people on both sides who generally support the work that the national providers do.”

His only hope, at least in the short term, is that the total number of tax credits offered through LIHTC can be increased.

“That would allow for more affordable housing to be built in general,” said Mathon. “And it could also, depending on how the states administered it, permit them to give more tax credits per project to help close the funding gap."

“Because we certainly know the need for affordable housing is not going down. One statistic that the National Low-Housing Coalition recently published is that there is a need in general for about 7 million homes and apartments to fill the affordable housing gap.”

Andrew Spofford, chief of staff for the nonprofit Preservation of Affordable Housing (POAH), said there were some concerns during the tax overhaul effort that LIHTC might be done away with entirely.

“But there was a big and ultimately successful pushback by housing advocates to retain that tax credit because it is fundamentally the only way we can build affordable housing at any scale in the United States,” said Spofford, whose organization owns more than 10,000 affordable apartment developments ranging in size from 27 units to 745 units in the Midwest, Mid-Atlantic, New England and Florida.

“It was a scary process to watch, though, because LIHTC is fundamental to how we advance our mission to house low-income people. If it had been eliminated, it would have been a disaster for anyone who cares about affordable housing from our residents on up.”

Fortunately, he said, LIHTC remained. But because corporate tax rates were lowered significantly, the tax credits’ value declined.

“The equity that it generates for affordable housing projects is now lower by about 10 percent. So tax reform has had a substantial impact on what we do.”

Spofford said the tax credit equity on POAH developments — depending on the specific kind of project — can be from 30 to 70 percent of the budget.

“A reduction of 10 percent can put a hole of $1 million in a project’s budget. So you have to go out and try to find $1 million in ‘soft money’ from state or local governments — money which is already in short supply — to make a project that would have worked in 2015 go forward."

“That means fewer projects are getting built. And the ones that are getting done take longer because you have to go through competitive funding rounds with state and local sources."

“We had projects that were nearing closing and were far along in the financing process when the tax rates changed. Those projects ultimately did go ahead, but they were frozen while we assembled new sources to fill the gaps that resulted. In some cases, POAH put its own money in so a project could go forward because there were residents waiting for renovation or replacement units.”

At the same time, Spofford said the need for affordable housing is rising rapidly around the country, with no state or county exempt.

“So the more the need expands and the resources stay the same, it takes longer for any individual project to be funded and proceed. It’s nationwide and it’s getting worse.”

Even though the economy is growing and the national unemployment rate was less than 4 percent in March, Spofford said stagnated wages since the 1970s has made finding affordable housing difficult for many.

“Even with the economy ticking now, I’m not sure if that will change things much,” he said. “There is a lot of catching up to do. In some markets, we’ve heard anecdotally that the improved job market has started to help people — especially where higher minimum wage laws have been passed and are lifting up incomes at the lower end of the wage scale. It’s just a start, because wage stagnation is a long-term trend that will take substantial wage gains to offset.”

Government agencies haven’t created new public housing projects since the early 1980s and most housing production has shifted to a public/private partnership model, he said.

“That’s the prevailing model now, where private developers do the development work and public sector agencies to a greater or lesser extent help pay for it,” he said."

“The new model — with low-income housing tax credits and government-backed debt — has worked pretty well. When those projects get built, they are built as efficiently as possible because there are good incentives to do that. The LIHTC rental stock has among the lowest failure rates of any class of real estate."

“But there isn’t enough of it by any measure,” he said. “Nationally there is a vast shortage of affordable housing for people who can’t afford market-rate housing. And the changes in the new tax law only made things more difficult.”

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