Economics of building affordable housing?

Can anyone share some insight as to how these deals pencil out? What sorts of credits/ subsidies are available/ support these deals? Are there specific states in which these deals are more favourable? Any specific reason why it is such a niche asset class/ why more developers don't get involved?

 

My group occasionally operates in the affordable housing space on the east coast. We raise our own capital, develop the asset and stay on as manager. We haven't developed a ton of these deals in recent years but I can speak to what I've heard around the office and what I know of our management of these contracts.

We make most of our nut on the development side of these deals. The tax credits and subsidies are the life blood of making them pencil. There are a variety of credits and subsidies out there and the criteria for receiving them varies widely depending on the program. Some credits are competitive where the agency ranks projects applying on criteria like location, market need, project readiness, etc... Other credits can be awarded through an application process and based on availability of funds. There are also special low interest loans that can be awarded.

All of these credits allow the developer to get into the deal with almost nothing on the table, making their fee all the more attractive. These credits let you into the deal with almost no basis but often put a noose on the income that the property is "allowed" to generate.

I've seen credit/subsidy agreement with language that limits the amount of money the developer can receive on a sale. There are other covenants that force a steep annual contribution to a reserve that stays with the property in perpetuity, require permission from the agency to make capital improvements from said reserve and permission to raise rents (even on the market units), include sweep fee provisions, and the list goes on. All of this to say, the limits that comes with these deals makes it difficult to exit at a price that justifies the development.

Would be curious to hear others experience with these deals.

 

How would tax credits lower a developer's equity basis? Are you referring to grants? If you had a low basis in those deals...you must have taken on a good amount of mezz. debt, no?

I really don't know much about this space. So I could be completely wrong.

From what I understand: special funding comes from three methods: tax credits; bonds; and grants. Each state has a separate process for how tax credits are distributed. Some developers sell off the tax credits to generate cash to be used as equity in a deal. A deed restriction gets filed on the property that lasts for...I believe...a period of 15 years. So...I think...an asset could revert to a standard market rate deal after 15 years.

 

I mean, this question really needs an entire textbook to answer, but to address some of your points:

  • tax credits lower a sponsor's equity basis because they proxy as equity. If my total development cost for a deal is $100mm, and the project generates $10mm of tax credits, then I can plow those credits into my capital stack instead of equity. Due to political concerns (like fulfilling CRA requirements) and financial ones (there is little to no lease up risk on a tax credit deal), lenders are usually willing to give high-leverage loans, especially to developers with whom they have a relationship. And agencies/municipalities are generally willing to give very low interest rate loans to make up the difference. So you end up with 85-90% leveraged properties, with tax credits making up most of the difference, and only a very small investment (if any) by the developer

  • deed restrictions usually last longer than that. You are thinking of the 15 year restriction on resyndicating tax credits. Generally speaking you are looking at a 30 year regulatory agreement, with the ability to re-syndicate your credits in YR 15 (generally to do major capex), which in an of itself often requires an corresponding extension in term for the regulatory agreement

 

On the one hand, this is one of the few spaces that my shop isn't very active in so I'd love to learn more about it.

On the other hand the economics are pretty simple: Developer makes PAC contribution-->Developer receives inside scoop on affordable housing plans-->Developer makes a few more political contributions/makes someone's wife or brother-in-law or whoever a well-paid sinecure employee of a technically separate corporation-->Developer becomes first in line for tax credits and block grants.

 
emceedrive:
On the one hand, this is one of the few spaces that my shop isn't very active in so I'd love to learn more about it.

On the other hand the economics are pretty simple: Developer makes PAC contribution-->Developer receives inside scoop on affordable housing plans-->Developer makes a few more political contributions/makes someone's wife or brother-in-law or whoever a well-paid sinecure employee of a technically separate corporation-->Developer becomes first in line for tax credits and block grants.

Either you are very stupid, or your firm is soon to make headlines in a corruption and bribery scandal. This isn't how the world works. There is corruption, yes, but not in this manner. It's too obvious - this is far more likely to happen in the private sector than with politics. Influence peddling is generally more subtle and therefore pernicious than that. I guess this is the norm in the Trump White House, but generally not the case in most statehouses.

Additionally, politicians generally aren't doling out tax credit subsidies. Agencies do that. And contrary to currently popular beliefs, bureaucrats aren't always lazy liberal lefties. Many of them genuinely care about their jobs and the impacts they create, and are as honest and hardworking as their counterparts in the private sector.

Long story short, lets all hope emceedrive doesn't enter the affordable space. He'll be in jail inside a year with how he seems to think a business should operate

 

I....never claimed thats how it should operate, nor did I mention anything about any of this being how I operate. You'll notice (or in this case, not) that I took pains to mention that I don't do any business in this space.

You're quick with ad-homenims but pretty light on comprehension. It was merely a tongue-in-cheek throwaway comment about the opaque nature of tax credits and how they seem to go to the same batch of well connected political contributors every time. As if there's even a shadow of disagreement on that topic

"There is corruption, yes, but not in this manner." Lol you haven't been watching the news lately buddy. We live in a world where bribery has been legalized thanks to dubious court decisions. We just call it lobbying and pretend like it isn't the same.

" as honest and hardworking as their counterparts in the private sector" Who the hell said there was any morality in the private sector?

Lazy liberal lefty stereotypes? What the hell are you even talking about? Talk about non-sequitur... My personal political opinions aren't something I really delve into, but I guess based on the above expose of superior intellect and moral fabric you just displayed, you'd be surprised by my opinions on politics.

Long story short, lets all hope @ozymandia gets laid and stat.

 

Can't speak to all affordable housing groups, but the core way for the developer to make money is the developer fee and then inputting its own property management firm as the PMC. So they make some dollars in the front end with the developer fee and then they feed their PMC fees. Affordable housing isn't a hugely profitable venture, but those who are experts in the field know how to make a good living.

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Agreed that it is not hugely profitable, but it can be a great way to get started in development form a risk adjusted return perspective. Put up ~100k in predev, get reimbursed for all those costs as closing and then earn a fee 5-10x your predev costs and a bit of residual cf. A few guys I know built up a pretty significant net worth doing this and now have a few PMs on staff to keep their affordable business going while they focus on larger market rate projects.

 
maineiac42:
Agreed that it is not hugely profitable, but it can be a great way to get started in development form a risk adjusted return perspective. Put up ~100k in predev, get reimbursed for all those costs as closing and then earn a fee 5-10x your predev costs and a bit of residual cf. A few guys I know built up a pretty significant net worth doing this and now have a few PMs on staff to keep their affordable business going while they focus on larger market rate projects.

It requires an enormous amount of knowledge to do, though. I agree, a great way to break into this business at a reasonably young age is to work for a LIHTC developer for several years to build those relationships and that kind of institutional knowledge and then do a few of them on your own. If you can execute well even once, you'll be in a position to do more deals, and the fees definitely add up. I know in NY it's like 10% of land basis and 15% of construction basis. Given how high those costs can be, it turns into a lot of money.

That being said, there is a LOT of guarantee risk involved for a very limited upside. Obviously completion risk, but timing risk, in that if you deliver late, you get a downward adjustor on the credits and all of a sudden you are out of pocket real cash. You avoid lease-up and market risk, of course, which is awesome. But still a lot of guarantees, and lots of partners, public and private, will look askance at that.

 

Lots of very bad info here. At the most basic level, there are two different common LIHTC structures including 9% credits (competitive) and 4% credits (non-competitive). The credits are allocated from the feds (HUD), to the state housing agency, to the developer. Developers are selected based on a competitive process with multiple variables that change every year (i.e. pedestrian access to public transit, proximity to downtown, political approval process, etc..). A 9% award normally spans over a 10 year time frame although the developer will syndicate the funds (i.e. $1m * 10 = $10m). The investors who buy credits are normally motivated by CRA demand or economics (think 3.5% IRR) and normally pay a % of par (ie. $1m10 years95% = $9.5m) and the credits are normally released in 3-6 installments based progress (closing, ground breaking, CO, stabilize, etc.). Developers make their money on fees and CF.

There are hundreds of variations of how this works state-by-state, deal-by-deal, and the rules change annually.

https://fas.org/sgp/crs/misc/RS22389.pdf

 
REValuation:
Lots of very bad info here. At the most basic level, there are two different common LIHTC structures including 9% credits (competitive) and 4% credits (non-competitive). The credits are allocated from the feds (HUD), to the state housing agency, to the developer. Developers are selected based on a competitive process with multiple variables that change every year (i.e. pedestrian access to public transit, proximity to downtown, political approval process, etc..). A 9% award normally spans over a 10 year time frame although the developer will syndicate the funds (i.e. $1m * 10 = $10m). The investors who buy credits are normally motivated by CRA demand or economics (think 3.5% IRR) and normally pay a % of par (ie. $1m10 years95% = $9.5m) and the credits are normally released in 3-6 installments based progress (closing, ground breaking, CO, stabilize, etc.). Developers make their money on fees and CF.

There are hundreds of variations of how this works state-by-state, deal-by-deal, and the rules change annually.

https://fas.org/sgp/crs/misc/RS22389.pdf

I'm not sure what bad info you're talking about. maineiac42 and I are just having a much more detailed discussion about the finer points of LIHTC financing than the extremely broad (but accurate) summary you've provided.

 
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