A version of this post originally appeared on Redfin.
Financing affordable housing isn't easy.
Our new interactive tool shows that without subsidies, which can be hard to come by, it's virtually impossible for developers to build homes that are affordable to low- or extremely low income families. That’s because lenders loan money for housing development based on the property’s expected income, and when rents are set to affordable levels, there’s a huge gap between the money needed to build and the money lenders and investors provide.
Yet, new affordable apartment buildings—albeit not enough of them—are built. So how do those developers do it?
The primary source of development funding is the Low-Income Housing Tax Credit (LIHTC), a federal tax credit administered by state agencies. Most affordable housing that gets built receives an allocation of tax credits. (You'll see in our simulation that the LIHTC tax credits are the default for 100-unit buildings.)
To receive tax credits, a proposed development must dedicate at least either 20 percent of its apartments to people who earn less than half of the area median income or 40 percent of its apartments to people who earn less than 60 percent of area median income. To be affordable, the rent for those apartments must be no more than 30 percent of the target income level. In practice, most properties dedicate most or all of the units to affordable use.
Yet, even if a proposal meets these conditions, tax credits aren't guaranteed. States allocate tax credits through a competitive process that varies by state and in most places has many more applications than available credits.
And even if you get the tax credit, as our tool shows, it's not enough. This is where developers have to get even more creative.
Most affordable housing financing deals involve a mortgage, tax credits, and two or three other sources of money. It's not uncommon, however, for developers to rely on upward of 20 financing sources as they try to fill the gap between what it costs to build affordable housing and the money they have available.
Some of that money comes from federal block grants like the HOME Investment Partnerships Program or the Community Development Block Grant Program. Some of it comes from foundations, local trust funds, or state housing trust funds. Sometimes states or localities will give developers relief from their property taxes. There are also tax credits for clean energy or for using a historic building. In rural areas, the US Department of Agriculture sometimes subsidizes affordable housing.
And then there's rental assistance; the promise of federal rental assistance can make a big difference in the development stage because developers can confidently tell lenders and investors that they will have renters and those renters will be able to pay (because the government is actually paying much of the rent). Rental assistance allows developers to serve lower-income renters while still ensuring necessary revenue to operate the property and pay debt service. Still, only about one in four people with low enough income to qualify for housing assistance actually receives it.
The problem with this multitude of funding sources—besides the fact that funds are limited—is the lack of standardization. Most of these tax credits and subsidies are awarded through competitive processes, but those processes often run on different timelines and require different applications. And if you need even three or four funding sources beyond the LIHTC to move forward with a proposed apartment building, winning one grant but having to wait six months for another can be fatal to the project. (Some states, such as Massachusetts and Minnesota, coordinate the state-run grant and tax credit programs to mitigate this problem).
Funders also change what they want to fund. For example, Illinois recently prioritized housing in areas of opportunity in awarding grants to affordable housing developers. This year, however, they've added priorities for projects that help with community revitalization. Changing allocation year to year is mostly good from a public policy perspective, because it means public dollars flow to highest need. But shifting priorities can pose a challenge to developers looking to build affordable housing, because acquiring land, planning a development, and applying for funds is a multiyear process.
Given that developers must rely on many sources—sometimes as many as 29—beyond a mortgage loan and the LIHTC tax credit to build affordable housing, it's important for states to consider ways to better coordinate the variety of grants and tax relief opportunities available, and it’s important for all levels of government to ensure there are enough subsidy funds available to meet the need. Developers must overcome many obstacles, such as permitting, land acquisition, and gaining community support. Governments should take steps to make sure closing the financing gap is not the obstacle that dooms development.
The Assisted Housing Initiative is a project of the Urban Institute, made possible by support from Housing Authority Insurance Inc. (HAI, Inc.), to provide fact-based analysis about public and assisted housing. The Urban Institute is a nonprofit, nonpartisan research organization and retains independent and exclusive control over substance and quality of any Assisted Housing Initiative products. The views expressed in this and other Assisted Housing Initiative commentaries are those of the authors and should not be attributed to the Urban Institute or HAI, Inc.
Pamela Blumenthal is a senior research associate in the Urban Institute’s Policy Advisory Group, where she and her colleagues work to provide urban policymakers with evidence-based policy recommendations. She is also part of the Metropolitan Housing and Communities Policy Center, with an emphasis on qualitative research and expertise in affordable housing, land-use regulation, and economic resilience.