Market-rate vs Affordable multifamily development
Is being an affordable apartment developer (lower rents at exit, less promote?) less lucrative than being a market-rate apartment developer? Or do the tax credits and subsidies more than make up for that?
I am thinking about leaving my REPE megafund role for development (you're kind of on the sidelines as a financier), and am wondering if affordable development is "where it's at" in California, where you constantly read and hear about the "affordability crisis". On the other hand, I worry about how scare/competitive LIHTC financing is and how lucrative affordable development really is vs market-rate development (I realize most-market rate developments in California have a small % of low-income units.)
Trying to steer my career path in the right direction...
So I’d say it’s a trade off. Let me preface by saying that in order to do any affordable housing deal, you NEED a government subsidy i.e tax credits. This complicates matters because there is a finite amount of credits and being that it is administered and regulated by the government, we know that’s a recipe for inefficiency. However, if you are able to get an affordable deal done, you virtually have no worries about occupancy and cash flows. You’ll always be 100% occupied with paying tenants, if you’re located in a major metro area. On top of that politicians are always on your side because they love to push the mantra that they are for the working class who need affordable housing. I’m pretty sure affordable housing is less lucrative than market rate but it is more stable and maybe it’ll give you a morale boost.
But realistically, most lenders don’t get involved with someone who has no experience in affordable housing. You should consider partnering up with someone who already has experience or do some deals on the market rate side then transition over to affordable if the opportunity presents itself.
I agree with all the above. I would add affordable housing is fee development. Generally speaking the fee comes during new construction, acquisition rehab, or resyndication of an existing affordable project after compliance period has passed, which is typically 15 years. I had a call with a recruiter over the break and does definitely look like the push for affordable housing development and ultimately roles in that space are on west and northeast where affordability has been issue well before the "pannie". I would say there is good money to made if you can make it on your own but career progression seems to be very slow because of approval process to secure subsidy for government. I can't speak for California, but the state I'm in the can be very competitive and some years will reach their volume cap for funds and put your project in cue 1 to 2 years out to receive funding. I do think Biden administration will make tax credit project more streamlined but under current guidelines it has be very cumbersome to get funding to green light your project.
Very helpful, thanks guys. Seems like market-rate development is the way to go.
Out of curiosity, how did you come up with that conclusion? I didn't read either of those replies as being pro market rate development.
I'd boil it down further. Market rate is more lucrative, but also far far riskier. Market rate requires equity to get started. Affordable housing is fairly well insulated from market swings, doesn't require balance sheet, and provides consistent and relatively risk free returns. So it depends on your personality type and your personal situation.
I can add my two cents here with observations from Canada. The main plus for doing affordable housing is the ability to access government-backed debt financing once you obtain approvals that can cover up to 100% LTC (don't care about LTV) with ridiculously low rates through construction and subsequent refi into a term debt upon completion. Obviously you'd be restricted from raising rates to market for 10 yrs, but the fact that limited equity is needed to fund the whole project could make the return calc very attractive from an IRR perspective (though you'd likely make less dollar wise).
For sure, you won't make any acquisition or development decision just based on IRR. Nevertheless, the way through the gov is aiming to support supply of affordable units has made the option competitive in certain cases.
I do market rate in California and know developers in Affordable housing. One can say it’s less lucrative just because affordable housing has limited upside, but it’s also less risky (limited downside). We make our money in different ways.
My understanding is that AH developers typically have large developer fees (close to 15%) and little equity. MR developers typically have lower dev fees (~3.5%), but earn their money in equity/promote. So it’s a risk/reward debate.
I work for an east coast firm that does both acquisitions and development of market rate and affordable housing. For folks in the middle market space, it can be very hard to be a good competitor for market rate deals, because there is always faster, stronger capital ready to scoop up deals and see value where it just doesn't pencil for anyone else. Affordable housing can often even the playing field, allowing for those with experience in the space (which is very bureaucratic and knowledge driven) to get the edge over institutional capital.
We structure our deals were after we stabilize the property and collect our 15% developer fee, we add a subordinate bond to the capital stack which we then purchase with our investor capital. Creating deals that throw off 12% CoC every month on top of asset management fees and dev fees that go to the house.
Wait, so what is your stabilized cap stack? Normally you'd have public subsidies and the deferred dev. fee, but you're saying you have public subsidies, deferred dev fee, and then a subordinate bond? Or are you saying you are basically taking the leftover cash flow and packaging it into a bond to get the upfront value of the cash flows?
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