Many of today’s headlines about multifamily housing have focused on the market’s two extremes: homelessness and high-end penthouses. Meanwhile, a crisis has been growing in the “missing middle” the shortage of affordable rental housing for middle-class workers like teachers, firefighters, and police officers.
In recent years, middle-income families have been struggling with flat wages and rising childcare, education, and healthcare costs. Not only are families being priced out of homeownership, but they’re finding fewer rental units in their price range.
Indeed, rents have been rising, particularly in cities with booming economies. Nationwide, only 37 percent of all available units rent out at or below $1,200 per month, according to NLIHC’s Out of Reach report and the Joint Center for Housing Studies. Yet in only 13 states do workers earn an average of at least $22.96 per hour, the amount required to comfortably afford a $1,200/month apartment. Charlotte, for example, is short 34,000 affordable housing units, and Salt Lake City–54,000. In total, there is a need for hundreds of thousands more affordable rental units, as we discussed in our Winter Multifamily Outlook.
The problem is a matter of supply as well as demand. Formidable obstacles currently impede the development of workforce housing. An overview follows of how we reached this point, and how combining Opportunity Zone incentives with new HUD/FHA programs can provide a creative solution going forward.
Many market rate developers are interested in building housing for middle-income renters, so why aren’t more workforce housing properties being developed? In short: low incentives and high execution uncertainty.
Targeted programs – such as subsidies, tax incentives, Community Reinvestment Act tax credits, and attractive debt options - have long been in place to develop properties for renters who earn less than 60 percent of a region’s area median income (AMI). On the other end of the rental housing spectrum is luxury. Home to renters with the income flexibility to accommodate rising construction and labor costs and higher rents, these properties have accounted for up to 80 percent of new supply during some cycles. In fact, some of these units replace the Class B and C stock typically tailored to renters earning between 60 percent and 120 percent of their region’s AMI.
Workforce housing often fails to qualify for the tax credits, subsidies, and other benefits reserved for “traditional” affordable housing projects. The residents, at 60 percent to 120 percent AMI, simply make too much money to qualify for low-income housing. However, the amount they can reasonably afford to spend on housing each month is decidedly lower than the monthly budget of a market-rate or luxury renter. This means that developers of workforce housing have less flexibility to cover rising construction and labor costs with rent growth, as they might with a market-rate property.
These rising costs and uncertainty of execution make financing from private lenders such as banks and private equity funds difficult to obtain. To compound the problem, if workforce housing is part of a program like a mixed-use development, the administrative complexities, environmental and noise restrictions, and timelines for overcoming these obstacles pose further disincentive for financing. In many cases, private lenders limit the loan-to-cost or simply decline to lend the money.
Public sector funding faces similar challenges with construction. Fannie Mae and Freddie Mac have successfully refinanced a significant amount of existing workforce housing stock, and their ability to lend $100 billion per quarter from 4Q 2019 through 4Q 2020 will enable them to continue to do so. However, the GSEs do not have any programs for construction lending.
Created in 2017, Opportunity Zones encourage long-term investments in affordable housing. In all 50 states, the District of Columbia, Puerto Rico, and Guam, there are 8,700 Opportunity Zones located in low-income areas. Investors and developers can benefit from lower or deferred capital gains taxes, full tax abatement on any appreciation after the initial investment (without recapture of depreciation for investments held over 10 years), and credits and incentives that lower lending costs.
With these cost savings, developers have a better chance of constructing properties that members of the middle class can comfortably afford. Unfortunately, thus far the benefits of Opportunity Zones have remained unrealized, in part because there is a time element to Opportunity Zone investments. Developers must declare their projects by a specified date within a calendar year to qualify for tax deferrals.
That’s where the HUD construction lending programs play a role, by streamlining the process and strengthening certainty of execution. Specialized expertise in HUD/FHA lending can also expedite the process.
Programs from HUD have evolved to fill the construction lending gap: new HUD programs combined with Opportunity Zone incentives make workforce housing both feasible and financially attractive.
The HUD 221(d)(4) program addresses this problem by insuring mortgage loans to facilitate the new construction or substantial rehabilitation of multifamily rental properties. Furthermore, a 2012 HUD pilot program to streamline FHA mortgage insurance applications — specifically applications to refinance mortgage debt — has been expanded to include new construction and substantial rehabilitation.
Compared dollar-for-dollar with conventional construction financing, HUD financing can yield twice the number of affordable housing units. Opportunity Zone incentives sweeten the deal for workforce housing even more.
The positive leverage with the HUD financing allows the creation of more workforce housing units than would be feasible under a conventional construction loan. Please consider these two simple capital stacks on projects with equal 100 percent rent restricted, mixed income workforce housing.
In Tennessee, creative application of such programs accelerated over $11.5 million for Lewisburg Summit Apartments. Through HUD’s new Low-Income Housing Tax Credit (LIHTC) pilot program, the development was able to take advantage of four percent tax credits. Moreover, this affordable multifamily community is located within the bounds of an opportunity zone, meaning that the developer saves even more in terms of deferred/decreased capital gains taxes.
Walker & Dunlop used its extensive HUD financing expertise to work with the developer to ensure the financing terms were consistent with opportunity zone guidance. HUD reviewed and approved the application within 36 days and achieved a closing within 72 days of submission.
“HUD has continued their efforts with prioritizing and offering lower fees for both affordable tax credit properties and projects located within opportunity zones, which allowed for this complex, tax-exempt bond transaction to close expeditiously under the strenuously tight timeframes required,” said Walker & Dunlop Senior Vice President Rob Rotach.
As the middle class becomes priced out of rental markets nationwide, serious implications loom for America’s workers, families, economies, and communities. Through the creative application of opportunity zone incentives and FHA financing, multifamily developers can be part of the solution.
For more information on Walker & Dunlop’s role in opportunity zone financing, check out our white paper in collaboration with the City of Miami discussing what steps can be taken within the Department of Housing and Urban Development (HUD) to further address the affordable housing crisis in the United States and increase housing affordability in opportunity zones.
Download the Opportunity Zone white paper
Walker & Dunlop provides all types of HUD/FHA lending to property owners.