For over a decade, the supply of affordable rental housing in the United States has been woefully insufficient to keep up with demand. Consider the following data from affordable housing from Harvard University’s Joint Center for Housing Studies State of the Nation’s Housing 2015 report: from 2003 to 2013, the number of households defined as cost burdened—i.e., paying at least 30 percent of their income on rent—increased by 16 percent; among the 40 million households that constitute this group, slightly more than 11 million are considered severely cost burden, paying at least 50 percent of their income on rent.

The ULI Housing Opportunity 2015 Conference, held in Minneapolis July 13–15 and cosponsored by the ULI Terwilliger Center for Housing and Enterprise Community Partners, took a hard look at this multifaceted problem, particularly as it relates to rental housing. Two panels in particular focused on themes that might result in increasing the supply of affordable rentals: cost containment strategies, particularly on subsidized or tax credit–funded projects, and new financial instruments to preserve and upgrade so-called naturally occurring, or unsubsidized, affordable units in the marketplace.

Containing Costs per Unit

The discussion on cost containment began with necessary context for understanding the severity of the affordable housing shortage and the housing insecurity that families feel. Housing insecurity affects people at all income levels, with two-thirds of the severely cost-burdened households being fully employed, according to Michael Spotts, senior analyst and project manager at Enterprise.

Although new multifamily units are in the pipeline, “we are still producing net new rental units at a rate lower than new rental household formation,” Spotts said. “We are falling further behind every single year.” The majority of new multifamily units are considered out of reach for 60 percent of renters, adding pressure to the total number of affordable units, subsidized or not. Compounding the problem are wage stagnation and dwindling political support for federal subsidies like the HOME program.

“We need to make sure we can stretch every subsidy dollar as far as we possibly can,” Spotts said.

In the case of subsidized, income-restricted housing, one of the major chokeholds on new supply is what it costs to produce it. The Low Income Housing Tax Credit (LIHTC) program funds 90 percent of all affordable housing in the United States by leveraging private equity, but the requirements of the program add a financial burden to developers that they cannot recoup through rent increases or fees. Still, the panel agreed that inefficiencies within the affordable housing delivery system have to be fixed to bring down the per-unit cost of affordable housing.

“If we don’t begin to face the cost-per-unit question in affordable housing, we’re going to lose political support and put ourselves in the box of fewer resources over time,” said panelist Eric Muschler, program officer at the McKnight Foundation. The foundation is one of ULI Minnesota’s and Enterprise’s partners in the MN Challenge, an ideas competition for cost reductions inspired by the Terwilliger Center’s Bending the Cost Curve publications.

The state of Minnesota is encouraging private and nonprofit developers of affordable housing to “sharpen their pencils” to trim costs, said panelist John Patterson, director of research and evaluation at the Minnesota Housing Finance Agency.

The agency puts affordable development proposals through a “cost reasonable test,” which compares their proposed TDC, or total development cost, per unit against a predictive cost model based on 17 project characteristics. The agency also gives four extra points to developers that can demonstrate a lower TDC per unit in their applications for tax credits. Applications are scored according to a point system and are awarded credits based on their final scores.

Tax-credit projects are clearly where cost savings in the deal assembly and delivery system are sorely needed. According to Patterson, soft costs—in the form of architectural or engineering fees, permits, taxes—account for 25 percent of TDC per unit in newly constructed, subsidized affordable housing in the Minneapolis metropolitan area; a project with LIHTC financing costs about $242,108 per unit, whereas a non-LIHTC project costs $189,485 per unit to build with only 17 percent going toward soft costs.

Panelist Jack Cann, executive director for the Housing Justice Center, presented strategies intended to ramp up the production and reduce the per-unit cost of affordable housing as part of a proposal that won the MN Challenge. Along with Professor Ed Goetz at the University of Minnesota Center for Urban & Regional Affairs and consultant Stacy Becker, Cann believes that local municipalities already have tools to increase supply, but they are not being fully used or implemented.

Revising zoning to allow for scale and density, fee waivers and reductions, parking requirement reductions, inclusionary zoning, and a greater use of manufacturing housing would all expand housing opportunity for families earning less than 80 percent of area median income, according to their proposal.

A new challenge confronting affordable housing leaders is that construction and land costs are going up at the same time as suburban poverty and housing insecurity. Although the St. Paul suburb of Woodbury met its affordable housing goals through 2010, the chances of meeting future targets is dim, said panelist Karl Batalden, the city’s economic development coordinator. And the housing subsidies that the city receives will be insufficient to leverage the private capital required to keep up with future demand, he said, leading him to conclude his presentation with the following: “Affordable housing is expensive.”

New Financing Tools

Coming at the supply expansion question from a different angle are efforts to preserve and upgrade naturally occurring affordable properties in the marketplace through new financial products.

This was the subject of a panel moderated by Deidre Lal Schmidt, president and CEO of CommonBond Communities and coinvestigator of The Space Between, a study of the unsubsidized affordable rental marketplace sponsored by the Family Housing Fund.

Naturally occurring affordable and workforce housing is vulnerable to market forces that seek to convert it to market-rate or luxury housing or to the neglect that poorly funded properties fall into. These properties are typically Class B or C apartment buildings, older housing stock with few amenities that are often located in low-income census tracts and that are not funded through government loans or tax credits.

“It’s good, safe housing with not a lot of frills with a rent level that is affordable,” said Colleen Schwarz, vice president of affordable housing at the Community Reinvestment Fund (CRF), USA, a community development financial institution based in Minneapolis.

Schwarz and copanelists each presented distinct financial tools that fund the preservation of naturally occurring affordable housing. In the case of the CRF, the product is a fully amortizing loan to fund the acquisition and renovation of affordable properties. Historically, owners or developers who wanted to rehab affordable properties would enter into short-term or “balloon” mortgages where interest rates spike each time the loan comes due. Long-term stewardship of affordable properties is the key to their success, which a fully amortizing loan with a predictable payment schedule supports.

While CRF does not actually fund the loan, it connects borrowers and lenders whose missions align. Finding the right lender—one who is not going to feel pressured to liquidate during tough times—is essential. “If I were a developer or borrower, I’d make sure I was synching myself up to the right group,” she said. “It’s a long-haul relationship, or at least it should be.”

On the equity side, new funds are being invested to support the preservation of affordable rental units, including a conventional equity fund created by Enterprise in 2013.

Enterprise heard from affordable housing industry leaders that they struggled to find equity financing to cover the portion of acquisition costs not covered by loans. Conventional equity, as opposed to tax-credit equity, “isn’t something organizations in our industry are used to bringing to the table,” said panelist and fund manager Chris Herrmann, vice president of syndication at Enterprise Community Investment.

In the case of unsubsidized affordable or workforce housing, conventional equity has to fill the gap. The purpose of the fund is to provide 80 to 90 percent in equity financing to fill that gap for up to seven years on these properties. The partners, with whom Enterprise enters into a joint venture, is responsible for coinvesting the balance of the equity gap.

“We saw a need to provide for and assist responsible stewards of multifamily properties and capitalize on acquisition opportunities that had been identified in that market,” he said.

Leveraging private equity to preserve affordability in the marketplace requires a different mind-set than tax-credit deals, panelists said. “There are basic real estate economic dynamics that LIHTC has shielded us from all these years,” Schmidt said.

A market-driven, clearly articulated business plan is what Herrmann looks for when he receives requests for conventional equity. The plan has to demonstrate value creation in the form of expense reductions, energy retrofits, or increases in net operating income and that “there will be value in excess of what we paid [for the property] when we sell,” he said.

The returns on investment he seeks, up to 10 percent, are higher than what partners may expect “because it’s a much higher-risk proposition,” he said. “These projects need to stand on their own.” Panelists agreed that the physical condition of the property is key to driving investor interest in naturally occurring affordable housing.

“There is a reason that these market-oriented projects do have regular rent increases with an eye towards the bottom line with respect to growth,” he said. “While we insist on those affordability restrictions, we encourage rent growth and identifying improvements the existing tenant base values and is willing to pay a premium for.”

Yet another new financial tool that is being used to preserve market-based affordable housing is the Housing Partnership Equity Trust, a real estate investment trust (REIT) formed two years ago by 12 leading nonprofit affordable housing organizations, including Denver-based Mercy Housing and Enterprise. The REIT is focused on investing in affordable and workforce properties near job centers and creates partnerships between investors and its member organizations. Initial investors included Citigroup, Morgan Stanley, the John D. and Catherine T. MacArthur Foundation, and the Ford Foundation.

So far, the REIT has acquired eight properties, said panelist Cindy Holler, president of the Chicago-based Mercy Housing Lakefront. Holler reminded the audiences that naturally affordable housing is an asset class by itself and needs to be marketed and managed differently than LIHTC properties. “The way you engage with people, the way you market the property is different,” she said. “And your financing partner needs to be on the same page as you.”