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Affordable Housing Debt and Equity Outlook: What Affordable Housing Developers Should Know

Published by Julie Sharp on Friday, June 7, 2024

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According to The Gap: A Shortage of Affordable Homes, a March 2024 report from the National Low Income Housing Coalition, the United States has a deficit of 7.3 million affordable homes for extremely low-income families. The report found that a staggering 74% of renters with incomes below the federal poverty line or with incomes at or below 30% of their respective area median income are severely cost-burdened, meaning that they spend more than half of their income on housing. 

An affordable housing crisis of this scale requires large-scale construction of affordable housing across the United States, as well as preservation and revitalization of aging affordable housing stock. Yet, affordable housing developers are grappling with numerous challenges in financial markets that have sidelined the production of thousands of units of new affordable homes. Limited availability of private-activity bond (PAB) volume required to generate 4% low-income housing tax credits (LIHTCs), sustained higher interest rates, skyrocketing insurance premiums and rising equity yield requirements have contributed to a tumultuous outlook for penciling new affordable housing developments. 

Dozens of states are now reporting oversubscription of PAB volume cap required to generate 4% LIHTCs. Transformative affordable housing projects are sidelined, as legislative measures to address the affordable housing crisis in the United States stalled. As of this writing, the bipartisan Tax Relief for American Families and Workers Act of 2024, which passed in the House of Representatives with overwhelming support, is stalled in the Senate. The bill includes the largest expansion of the LIHTC in decades and includes two key provisions: 1) restoration of the 12.5% allocation increase in the 9% LIHTC that expired at the end of 2021, and 2) a reduction of the PAB threshold requirement from 50% to 30%, which would allow more projects to generate 4% LIHTCs with a lesser allocation of PAB volume cap. 

If signed into law, the proposals will facilitate the creation or preservation of hundreds of thousands of affordable homes. However, the influx of additional tax credits in the market will require meaningful price adjustments as investors find an equilibrium to balance the increased supply. In the near term, the uncertainty surrounding a would-be expansion of the LIHTC has sidelined some economic investors, who prefer a “wait and see” approach to a potential market adjustment–and the opportunity to take advantage of lower tax credit pricing.

Properties that have received LIHTC allocations have seen some relief in construction cost volatility that was the hallmark of 2021 and 2022. However, sustained higher interest rates and inconsistent outlooks on rate cuts have a large impact on penciling construction budgets, as housing developers try to estimate where construction loans will price through the construction period. It’s wise for borrowers with limited financial capacity or tighter deals to purchase caps or swaps for construction loans and early-rate lock to provide certainty of execution while they wait to close their construction loan. For well-capitalized sponsors willing to let construction interest float (betting on future rate cuts), syndicators and investors will look closely at the flow of funds to determine adequate sources and fees in the deals to hedge against higher-than-expected borrowing costs. 

Aside from interest rates, turmoil in the banking sector and worries about commercial real estate valuations trickled into tighter credit boxes across all real estate asset classes, including affordable housing. Lenders and investors have placed a larger scrutiny on borrower credit quality and financial position. Project owners should continue to focus on liquidity and managing their real estate owned portfolios to acceptable performance metrics, specifically with respect to variable-rate loans that are maturing. 

Insurance premiums have also rattled proformas across the sector, particularly in coastal and fire-prone communities. On average, we’ve seen double-digit year-over-year increases in insurance expense. We applaud the leadership of the U.S. Department of Housing and Urban Development and the government-sponsored enterprises who are working with industry stakeholders to help better address this issue over the long term, but in the near term, developers should work with their syndicators and lending partners to understand deductibles and required coverages. We’ve seen an increased willingness to raise deductibles to curb costs for well-capitalized sponsors. 

Looking ahead to the second half of 2024, Merchants anticipates increased demand for government-backed financing options, including Fannie Mae, Freddie Mac and FHA, due to the volatility in the banking sector. Despite some sidelined economic investors, we’ve seen steady demand for LIHTC investments from CRA-motivated bank investors. LIHTC pricing in most markets has remained stable over the last 12 months, but the outlook for the second half of 2024 is that LIHTC prices will fall. Investor yield requirements have been steadily increasing over the last several quarters due to uncertainty in a LIHTC expansion that would increase supply, competition from a growing energy tax credit market, increased focus on bank liquidity that has sidelined some regional banks and attractive yields on alternative investments. However, project owners have been successful layering other tax equity sources into deals, such as solar, IRC Section 45L and state tax credits into capital stacks to balance sources and uses. Other recommended practices include engaging cost segregation studies to generate higher returns for end investors with a corresponding increase in credit pricing and highlighting social impact features when marketing your deals to prospective investors.

The need for sensible solutions in affordable housing finance has never been greater. By staying informed about market trends and regulatory changes, layering additional tax equity sources, leveraging interest rate swaps and caps and optimizing costs, sponsors can navigate these challenges. 

Julie Sharp is executive vice president at Merchants Capital, a national multifamily financing firm that has deployed more than $40 billion in financing to support multifamily properties across the United States. Sharp established the firm’s national tax credit syndication business in 2020 with more than $1 billion in equity under management via Merchants’ multi-investor and proprietary fund offerings. 

Sharp is Secretary and a member of the board executive committee of the Affordable Housing Tax Credit Coalition in Washington, D.C. and a mentor for the Goldie B. Wolfe Miller Women Leaders in Real Estate in Chicago. She is based out of Merchants’ corporate headquarters in Carmel, Indiana. 

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