The impact of high residential housing prices on the subsidized housing market
Affordable housing is reliant on subsidies which come in many forms. The most important resource for affordable housing in the United States is the Low Income Housing Tax Credit (“LIHTC”) program. The LIHTC program encourages the use of private equity funding for these projects by issuing tax credits as incentives. In addition to tax credits, LIHTC projects also often benefit from state or city level funding under favorable terms. This financing typically breaks down in to two general types. The primary mortgage may be conventional financing, or it may be issued by a state or city agency, or by a corporate entity that specializes in such loans. In addition to the primary loan, there are generally a number of subordinated finance instruments issued by government agencies and not-for-profit entities that loan significant amounts at very beneficial terms.
Low-income tenants in an LIHTC project can be charged a maximum rent of 30% of the maximum eligible income, which is 60% of the area’s median income adjusted for household size (as determined by HUD). The LIHTC program is estimated to cost around $9.5 billion per year. Despite its success, the LIHTC program has not kept pace with the needs of low-income families. It is estimated that there are currently enough low-income units for approximately 30% of the qualified households.
The supply and demand dynamic of the current housing market heavily favors the supply side. There are not enough dwelling units to meet demand and prices reflect this imbalance. Developers are hindered in their efforts to construct new properties by labor shortages, high material costs and escalating land value. The developer faces these increased costs regardless of the type of project.
Subsidized housing is typically a stable and safe investment. There are always more people searching for a subsidized unit than there are units available, so lease up is very rapid and an excess of future vacancies is unlikely to occur, even if the economy turns sour. However, in the current environment, developers have very attractive alternatives to the construction of affordable housing projects.
Since the revenue stream from a subsidized property is below market rate, the developer relies on subsidies to reduce the cost of development and provide low interest loans to sustain it. And, because subsidized housing delivers a lower revenue stream, operating expenses and debt payments must be reduced to offset the limited growth in revenue.
Once a subsidized property is completed and leased, it should produce a modest profit for the developer. Going forward, however, because the rate of rental growth is a function of average income levels rather than being pegged to overall cost of rent, the subsidized rental rates will stay below market rates and, in periods of economic strength, the rental rates in a subsidized property will fall farther behind market rental rates.
Subsidized properties also have a far lower residual value due to the depressed rental rates. So, in addition to having limited marketability, a subsidized property does not offer the long-term gains that a market rate property will.
Finally, during a period of economic strength, a market rate rental property can be converted to a condominium, offering potentially even greater gains. This is not a viable option for most affordable housing projects.
A developer of affordable housing has a limited number of options to improve the financial performance of a subsidized project. Additional federal funding for the LIHTC program would help, but it is unlikely that Congress will support significant increases to this program in the near term.
A developer can take on additional debt to support construction, but lenders will require that the property generate sufficient revenue to support that debt.
Another option to improve rental revenue is increased project density. More units will generate more revenue. However, greater density increases construction costs and operating expenses resulting in a marginal increase in profit.
Despite ongoing efforts to expand the subsidized sector, the number of units available is a small fraction of the number of applicants who qualify for them. A vibrant economy offers opportunities and developers will choose the projects that produce the highest returns commensurate with acceptable risk. Higher construction costs combined with rental rates which are indexed to household income will continue to depress the number of affordable units being developed.
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The information provided here is for general guidance only, and does not constitute the provision of tax advice, accounting services, investment advice, legal advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisers.