As fundamentals remain strong in the U.S. apartment market, developers continue to ramp up construction of conventional properties. But this building spree could be having an inadvertent effect on the affordable housing sector – and not in a way that results in additional affordable units. Instead, the historically high levels of conventional apartment construction have driven up development costs. And that could further squeeze affordable development, as funding for affordable apartments is not rising to offset the higher price tag to build. All the while, demand for affordable supply continues to be high, as wage growth is limited and the number of renting households grows.
There are several programs designed to encourage development of affordable rental housing. By far the biggest, as outlined in a recent blog by MPF Research, is the Low-Income Housing Tax Credit (LIHTC), a U.S. Housing and Urban Development-sponsored program that offers federal tax credits for construction or rehabilitation of affordable rental housing units. Since its inception in 1986, the LIHTC program has financed development or rehabilitation of 2.2 million affordable units. However, the fixed financing structure of the LIHTC program leaves it vulnerable to swings in development costs.
Market conditions strain production of LIHTC units
The clearest obstacle inhibiting LIHTCs are the statutory limits placed on allocation. Simply put, federal housing tax credits are awarded to developers of qualified projects, and are administered by state housing authorities. Developers then sell these credits to raise capital for their projects, thus reducing the debt that the developer would otherwise have to borrow. Since the debt is lower, a tax credit property can offer lower, more affordable rents. However, credits are ultimately capped by federal investment in the program, reducing the number of credits states can issue per year. Most recent data show fewer than 94,000 LIHTC units were produced in 2012, according to the National Council of State Housing Agencies (NCSHA). Meanwhile, more than 234,000 units of all types were started at the end of 2012, according to the Census Bureau.
The chart above shows a general inverse relationship between total volumes of construction of rental units and total construction volumes for affordable units. As total construction increases, construction of affordable units generally decreases. And since 2012, construction of conventional properties has continued to climb aggressively. Increased construction has pushed up prices for land acquisition, construction materials and labor and related costs. For example, the Producer Price Index for materials grew 5.2% in 2012, while the Employment Price Index for construction workers grew 1.6%, according to data from The Associated General Contractors of America and the Bureau of Labor Statistics. Because LIHTCs are not awarded on a per-unit basis, the program’s funding isn’t touching as many affordable units as when units were cheaper to build.
Developers are seeking ways to contain costs, and states are implementing various methods to better partner with developers. A recent article in Housing Finance highlighted these strategies. One strategy being adopted by the Indiana Housing and Community Development Authority is a performance-based developer fee based on the number of LIHTC units produced. “What we use is very simple: it’s how many units you produce,” the housing authority’s director, Jacob Sipe, told Housing Finance. “[Developers] get paid a certain dollar amount for that unit you produce.” Another example came from Cate Racer, associate director of the Massachusetts Department of Housing and Community Development: the state recently increased its recommended cost limits in its LIHTC program. Cost containment is especially important in coastal states where development costs are traditionally high and available land is limited.
Improving the LIHTC program
Recent data from the National Multifamily Housing Council (NMHC) show just over 50% of the existing apartment stock was built prior to 1980. What’s more, around 100,000 to 125,000 aging affordable units are coming offline per year. With more affordable product coming offline, the LIHTC program is the most significant mechanism by the federal government to preserve and expand the supply of affordable rental housing for low-income households. However, the program is not meeting the demand of designated affordable units, especially as incomes remain stagnant and the number of renter households grows. In turn, occupancy rates for LIHTC properties remain tight. Recent research by Fannie Mae indicates occupancy is just above 97.0%, based on recent data through 2013.