A 2013 finalist for ULI’s Global Awards for Excellence, MacArthur Park Apartments in Los Angeles makes homes available to families earning between 20 percent and 60 percent of area median income.

A 2013 finalist for ULI’s Global Awards for Excellence, MacArthur Park Apartments in Los Angeles makes homes available to families earning between 20 percent and 60 percent of area median income.

Whether the location is New York City, San Francisco, Boston, Washington, D.C., or another major metropolitan area, one fact is consistent: the ordinary resident feels crunched by the cost of housing. Average rents in these cities far exceed the purchasing power of median household incomes. Creating housing that is affordable for middle-income households is challenging, especially in big cities where income gaps grow wider each year.

Households should not have to spend more than 30 to 35 percent of their incomes on rent; those that do are classified as housing-cost burdened. A large percentage of residents of most major American cities continually feels that burden, according to data provided by the U.S. Census Bureau, as supplemented by Reis reports (see table 1).

How does one build or rehabilitate housing for these income levels while getting the appropriate returns for a successful development? How does the country provide housing for teachers, firefighters, police officers, health care workers, and first responders who earn no more than the median income?

The solution is not that complicated. Combining a small amount of local government subsidies with developer-led programs can make housing affordable to people with a spectrum of incomes, ranging from half the median income to the median income. And it can be done without use of federal subsidies.

curzan2_800The following examples show how it can be done.

Property A is a luxury building with units averaging 900 square feet (84 sq m), featuring balconies, granite countertops, and hardwood floors. It is located in a high-end neighborhood, which means land costs will be high. Operating expenses will also be higher at this property because of special amenities such as 24-hour concierge service. The building is owned by a private developer seeking a double-digit return on investment.

Property B is a well-constructed basic building—without expensive architectural design, high-end amenities, or finishes—that has slightly smaller units averaging 800 square feet (74 sq m). It is located in a less expensive part of the city on less expensive land, perhaps in a neighborhood that has yet to blossom. It is being built by a nonprofit developer that requires only a modest return for its work—4 to 5 percent rather than the double-digit return sought by the for-profit company developing property A. The property B building is treated wood frame rather than steel frame, which cuts costs per square foot significantly; the lack of elaborate outdoor space or landscaping also reduces expenses.

curzan3_619To calculate the minimum income required by a household to afford to live in either building, one must take into account the expenses that rent must cover for the developer, which encompass the cost of capital (including debt service coverage), property taxes, and operating expenses. All those factors combined, plus a requirement that the rent be no greater than 33 percent of household income, leave property A’s minimum income required at $123,900 (see table 2).

A basic building such as property B has a lower cost of development plus a lower cost of capital because the project is developed by a nonprofit entity, which largely derives its income not as a return on equity but rather from development fees, management fees, and debt-service coverage. The assumption in this example is that the nonprofit received financing at 100 percent of the development costs at 5 percent over 30 years, a lower cost than the 9 percent property A derived from blended debt and equity rates for the developer and commercial lender. This lower financing cost combined with lower operating costs allows the developer to offer basic units requiring a minimum household income of $66,600.

For the purpose of assessing how to provide affordable housing, this analysis takes property B’s structure as a base before stripping off additional costs, including land and infrastructure, and reducing costs through the use of internal subsidies, soft second loans, low-income housing tax credits, and the addition of retail space.


State and local governments have historically used public land for the development of affordable housing. As cities grow, land is dedicated to multiple uses that benefit the public, such as libraries, schools, and affordable housing. City governments determine whether a property no longer in use can be used productively by a government agency. If no agency takes the property, the mayor normally requests that the city council classify it as surplus, thereby opening it up to developers.

Once it is assigned to a developer, a land disposition and development agreement must be prepared specifying the terms of the transaction and how it will benefit the community. The developer provides the city with public benefits—such as affordable housing—and the city gives the developer a discount on the price of the land. It is not uncommon for the land to be leased at $1 per year, with a return of additional dollars to come to the city eventually from increases in net operating income or owner sales or refinancing proceeds. Similar transactions can be entered into by universities, hospitals, and even private employers.


Infrastructure costs can be subsidized by local and state governments through, for example, tax increment financing (TIF), a subsidy provided through the government’s use of new property taxes and sales taxes to repay the bonds used to pay for infrastructure. The government subsidizes a development by committing incremental taxes to finance a portion of the development costs for an affordable housing project that is deemed essential to the community.

Internal Subsidies

After taking out land and infrastructure costs, the household income required for a basic building has gone from $66,600 to $51,000 (see table 3). The model can now be modified in an owner-led approach that in its most basic form allocates units by low-, middle-, and higher-income tiers. The effective rent required to sustain the units allocated to the low-income tier is reduced by allocating the cost of operating those units to the higher-income tier. Furthermore, because no rent is more than 33 percent of the household income and the land and infrastructure costs have already been subsidized, every threshold receives a bargain rent cost.

In its simplest form, this approach means a household making $41,000 per year can live in a building where the income requirement is about $51,000 per year, because one-third of the units are priced for households making $61,000 per year (see table 4).

curzan4_619Soft Second Loans

Some jurisdictions, including the District of Columbia, use soft second loans to subsidize the cost of constructing affordable housing, placing a second mortgage on the development costs equal to the soft loan. While generous, these soft loans are an inefficient subsidy mechanism. For example, a commitment of $30,000 at a 2 percent interest-only rate saves only the differential between 2 percent and the debt-service rate on the development’s cost of capital, i.e., 6 percent. Put another way, the loan reduces the required income of the purchaser by about $40 per $1,000 loan, or by $1,200, assuming a $30,000 loan at 2 percent per unit. This reduces the income required by $3,600.

A far better approach is to use a portion of the soft loan to subsidize operating expenses paid by residents—for example, by paying the property taxes and 30 percent of the operating expenses, for a total of about $3,500 in the first year. The soft second loan is reduced by $500 per year, meaning a total of $14,000 will be expended over six years, or half of a traditional soft second loan. A $3,500 phase-out loan—phasing out at $500 per year—will reduce the resident’s normal income commitment by $10,500 in the first year. This subsidy brings down the income required from $51,000 to about $40,500 (see table 5). And when internal subsidization is applied, it brings 33 percent of the households down to a required income of about $30,500.

Low-Income Housing Tax Credits

If the local government should decide it does not want to make soft loans available or wants to serve still-lower-income households than those earning $30,500, it can add the low-income housing tax credit (LIHTC) to the mix. The federal LIHTC program acts like a current soft loan program and is therefore a somewhat inefficient leveraging program. But it does replace the most expensive capital, which is equity, and it is the only significant federal locally distributed program that can assist the private sector to go deeper and serve households making less than 50 percent of the area median income.

The LIHTC program, which was created to encourage the private sector to invest in the construction and rehabilitation of housing for low- and moderate-income families, comes in 4 percent and 9 percent tax credit versions. Demand for the 9 percent credit is more competitive and therefore that credit is harder to obtain. In addition, the credits can be increased by up to 30 percent for projects located in targeted poverty areas. When used in conjunction with other programs described here, the minimum income needed to afford housing can drop significantly below 50 percent of median income.

Retail Space

The key to creating the most affordable housing product is for the developer to go beyond government subsidies as a means of funding. A first step is application of the internal subsidy model in which a mix of income brackets allows different households to obtain housing, with all the households receiving a bargain price. Owners can further contribute to the model by adding ground-floor retail space or nonprofit or government offices to the housing site. Even though it may seem like an unusual way of subsidizing housing, it is a solution that can further lower rents.

For example, a developer could rent out ground-floor space at a $5 profit triple-net per square foot ($54 per sq m) to a grocer, a clinic, or both. If the building has a 20,000-square-foot (1,900 sq m) floor plate, with 5,000 square feet (465 sq m) dedicated to a lobby area, 15,000 square feet (1,400 sq m) could be rented out for $75,000 in additional net income. Because of new
and improved treated wood-framing systems, the multifamily building could be up to six stories tall, with the residences above the ground floor. At 800 gross square feet (74 sq m) per residence, the building would have about 100 units.

The additional income could be used as a subsidy to further reduce unit prices. In a 100-unit building, this comes out to a reduction of more than $750 per year in rental costs for each unit. That brings down the required income bracket (in a building built on public land with TIFs and a soft second loan) to about $38,500 per year and can make the low-income portion of the project available to households with slightly less than $30,000 in annual income.

An alternative way to allocate the retail income is for the owner to create a “circuit breaker,” which would work as a rent-forgiveness program. Instead of allocating the retail income to subsidizing renters, the project owner could develop a fund to which the income from the retail space is allocated. If a tenant becomes unemployed or faces a life event, such as a significant accident or health issue, the fund would be there to ensure that the resident could pay the rent and deal with a phase-out of the soft second loan allocated to operating costs and not lose that housing. In addition, the assumed cost of capital includes a 1.2 debt-service coverage ratio that is not being expended and can instead be reallocated to the fund or as a subsidy to the operating costs of all units.

By year’s end, the fund theoretically should be able to support multiple minimum-wage households for an entire year’s worth of rent. If the developer wants to structure the circuit breaker in such a way that households in financial distress can have their rents subsidized for a preset period of time, the number of residents who could benefit from the program could be far higher.

The concepts presented here are simple and straightforward. What is required is that local governments, public employers, nonprofit employers, and nonprofit developers see that it is in their best interests to provide housing to first responders and lower-income people who have jobs. The United States can continue to build luxury skyscrapers until the housing bubble bursts again, or it can turn its attention to those who need housing and cannot afford the price of the units now being churned out by the development community. The choice seems clear, but the question is whether it will become apparent to those who must set the nation’s housing policies and then sponsor the development providing affordable housing.

Myron “Mike” Curzan is a senior adviser to the firm of Brailsford and Dunlavey, which specializes in developing facilities for universities and local governments. Marta Lopez is a graduate of Georgetown University’s Masters of Professional Studies in Real Estate Development program, working as an adviser for multifamily developments.