% Affordable Housing Req. For Entitlements


For all the multifamily guys on here, can you share your experience with integrating some percentage of affordable (80% AMI) units into luxury multi product (a tower for example) in cases when you’ve had to to obtain necessary entitlements (height or density variance)? Is it as simple as underwriting the lower rent on the select affordable units and keeping the rest at market rate? On the capital markets side of the equation, have your debt and equity investors expressed concern over the affordable units or are more markets moving to this requirement? How about at exit—do you take a higher cap on exit as a result of the sprinkled affordable units, or does the lower NOI driven by those units naturally reduce the residual value? Sorry if I seem less than concerned with the affordable housing issue in America—I understand it needs to be addressed but also disagree with some of the methods cities are using to implement.

Comments (14)

May 3, 2018 - 9:05am

On the capital markets side, affordable is viewed as a less risky asset from an occupancy perspective. The risk to the investor is the GP's ability to comply with the affordability restriction and make sure the tenants do in fact meet the requirements.

A few affordable units will not have an impact on your exit cap. However, You may also be able to underwrite to a lower vacancy on the affordable units which will help bring the total NOI back up a bit.

May 3, 2018 - 9:32am

Can't speak specifically to the underwriting of some percentage, but I second the compliance aspect of it. I may be way off the mark on what you're looking at, but there are so many HUD and Govt. assistance programs that all have different standards and rules for eligibility of incentives/distributions etc.

I'd just read up on anything applicable related to compliance/local laws that might affect your performance/return metrics. I've asked many GPs to return unauthorized distributions and let's just say they are never happy.

For what its worth, I do a lot with Section 8 within a specific HUD voucher program. PM me if that's at all related to what you're looking at or if you have any ?s

May 3, 2018 - 10:19am

This is important. You may need to underwrite higher management fees or higher payroll number because at a certain point you need someone certified to handle these types of tenants.

Additionally, depending on how many affordable you're putting in the building, at some point it may be worth considering doing a LIHTC execution. Company I'm at did this and had to condo the building into affordable and market rate portions (not contiguous) which shared a common area. The affordable portion was a 100% LIHTC and had separate owners. This also allowed us to get around the whole first unit available issue.

May 3, 2018 - 12:32pm

Probably not worth it for this project. For one, the 80% units are more valuable than the 60% units you'd need in order to qualify for LIHTC. That also comes with a ton of additional expense, both on the financing side and in annual reporting and compliance, as others have noted.

Couple other things - you may have to alter the layout of your building to include ADA compliance in the units. You should also be cognizant that it may put a small drag on your overall sellout/lease-up, as there are lots of intolerant assholes who may want to discount what they pay because they're living next to affordable tenants (hence the "poor door" in NYC). And the operations stuff goes beyond hiring specialists who can do the reporting - your onsite staff now has to handle 25% more units, and the affordable tenants won't be paying a rent that contributes to that.

As far as exit goes, it shouldn't hurt your cap rate too much. It's being built into the NOI as you say, and those tenants tend to be more stable, so not a ton of lease up risk. What is the time period attached to this? Also, at some point in the future you can plead poverty on the opex front and ask for a tax abatement.

Best Response
May 3, 2018 - 12:58pm

Some cities allow you to just pay a fee in lieu. On a project in Charleston, we were given the option of paying $1MM to get out of it, which would give us just under $4 MM in additional value. Kind of a no brainer from a financial perspective, but laughable for the city to pretend like they're supporting workforce housing.

Commercial Real Estate Developer
May 3, 2018 - 12:08pm

In our experience in CA, virtually every new development project requires an affordable component if you want any realistic chance of getting it approved. No impact on residual. Plus, it's typically accretive if you get a density bonus out of it. We usually underwrite the absolute lowest income level (if a jurisidiction gives you the option of 9% extremely low income or 11% very low, etc.) because it reduces the overall number of affordable units in the building, and the difference in building total rents is negligible.

Keep in mind a lot of jurisdictions require you to spread the units out in "like kind" to the rest of the building. In most cases you can't jam all the affordable units to the crap part of the back of the building...they need to be distributed evenly.

May 3, 2018 - 1:00pm

Ricky Rosay:
Plus, it's typically accretive if you get a density bonus out of it.

If there are any city officials reading this, this is exactly how you actually incentivize workforce housing. It's quite literally a win-win.

Commercial Real Estate Developer
May 3, 2018 - 2:26pm

Lower finishing quality (save a little bit of cost) and lower rents. Many new buildings have affordable housing requirements (which are complete bullshit, btw), so I wouldn't expect a cap rate differential. Usually, it doesn't take much more to manage because these aren't HUD programs, nor do they typically have LIHTC equity--they are just agreements with the city/municipality.

May 3, 2018 - 3:56pm

Great answers, thank you to all. This would be 3-8% of total units and not section 8. Product would be luxury high rise, so the comparison to the new stuff in NYC and CA where it has to be done sounds most realistic. For this circumstance, how much would you bump payroll, and is that the only OpEx that would adjust? If anything I would think taxes might be marginally lower but wouldn’t underwrite that way. Agree on the stickiness of the affordable tenant base, and also on the density bonus vein accretive. That’s actually the only way I can get this deal to potentially work—the bonus FAR I would need from council.

May 3, 2018 - 4:22pm

I wouldn't bump payroll or expenses at all (additional costs will be rounding errors). A typical multifamily manager will have (or should have) the basic knowledge/resources to handle this at no material additional cost, which is one of the many reasons why you're paying a management fee to them.

I would underwrite standard market vacancy rate without regard to the AH units. If the market is 7% then underwrite to 7% (or whatever the minimum your lender and/or internal guidelines require). Generally speaking, property taxes will be based on your final NOI (some areas are a bit different than others), so that's where AH units should impact your taxes.

In other words, I wouldn't over think it. AH units will marginally reduce your construction costs per unit and decrease your gross potential rent. Beyond that, I wouldn't mess with the UW that much.

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