The development of affordable rental housing has always been difficult, but the past few years have been especially challenging for developers as the tools—mainly the Low Income Housing Tax Credit—that they’ve relied on the past 25 years or more have begun to show their age and not kept up with market realities. What’s needed is a new way of thinking for additional financing of affordable rental housing that mirrors the private sector development market; one that creates stronger nonprofit developers, while not abandoning the mission focused reason that nonprofit developers exist: to create and sustain affordable rental housing for those most in need.
The LIHTC, the “golden ticket” for financing most of the affordable rental housing stock in the U.S. over the past few decades, has become less valuable and available as the biggest investors in the credit have largely pulled out of the market. While a few market areas are seeing a resurgence of tax credit investors, the problems that started in 2008 with less demand and lower LIHTC prices are expected to continue in 2011 in many markets. This situation forces developers to scramble to fill their project financing gaps either by reducing development fees (which weaken already thinly capitalized developers) and pursuing increasingly complicated, time consuming, and inefficient and more expensive multilayered financing packages or by simply not developing the affordable rental housing that their communities need. The latter is of grave concern as affordable housing remains a present need as economies weaken and more people need housing within their means.
There are few who expect that the major national LIHTC investors of the past—Freddie Mac and Fannie Mae who combined for more than $1 billion in LIHTC investments and as recently as 2006—to return to the stage. The absence of these two mammoth players means that the largest source of equity or risk capital available for the construction of affordable rental housing in markets large and small across the country is largely gone for the foreseeable future.
But they’re out of the picture. Do they need to be replaced and what can replace them?
The answer to the first question is yes, and a key element to the answer to the second question is “another form of equity financing.”
LIHTCs are still around and are useful investments for companies, primarily in the banking sector. But there is no question that LIHTCs have less effect than before. But more importantly, even before the decline in the LIHTC market, the affordable rental housing development model had an important gap in financing this business. That gap is at the enterprise or nonprofit, small-business level.
Nonprofit affordable housing developers are mission-driven organizations—serving the neediest residents, provide the richest service packages for special needs, and often reach locations that are the most underserved—but they are private businesses managing millions of dollars in development activity and they need capital to operate to build and manage these assets.
The existing affordable rental housing model focused on getting capital into the project, often leaving these developers on a shoestring financial budget of its own. Such a model has resulted in most nonprofit developers holding thin amounts of capital on their balance sheets, and while not teetering on the brink of failure, many nonprofit developer balance sheets are not very well equipped to provide the kind of flexibility that a dynamic and unpredictable housing market requires. And, the marketplace relies on these developers to deliver and care for these often irreplaceable properties/community assets. Community assets that could be thought of as living on thin air, rather than being held firmly on the balance sheets of appropriately capitalized entities.
That’s where the idea of enterprise level financing fills a gap. Imagine if every single-family homebuilder in the U.S. had to go out and seek individual, nonportfolio based financing for each and every home that it built. The current housing market malaise notwithstanding, the construction of single-family houses would slow to a crawl.
That’s how affordable rental housing is developed: one project at a time, each with its own unique menu of financing ingredients. Affordable housing developers build layer cakes of financing for each project, and as any baker will explain, if one of the layers isn’t right, the whole thing is wrong.
At a symposium sponsored by NeighborWorks America in August, investors and nonprofit developers zeroed in on the need for a new financing tool for affordable rental housing and how investment directly into the nonprofit developer could be the next big thing for the industry.
For enterprise level financing to move ahead, conference attendees agreed that no single model had an edge on the others. For example, while social investors on the panel with capital to deploy were more likely to suggest that the investment returns be modest, others who saw affordable rental housing as a purer investment talked about a return on investment threshold that was closer to, if not dead on, with other market rate returns.
And through the agreement to disagree on details, a consensus emerged that investment in the nonprofit itself, and not just in the housing project, was the only way to move the sector forward on a sustainable basis. One attendee noted that by not investing in the nonprofit enterprise investors were asking that a company frequently with less than $100,000 of capital be responsible for the long-term management of assets worth millions of dollars.
So how does a nonprofit developer/owner of affordable rental housing shift its model away from project level financing? The first thing that’s required is a standardized way of accounting for and evaluating the owner of a portfolio of affordable rental housing.
Toward that objective, NeighborWorks America, the Housing Partnership Network and Stewards of Affordable Housing for the Future in 2009 launched Strength Matters. Funded with support from the John D. and Catherine T. MacArthur Foundation, one of the goals of Strength Matters is to develop an enterprise-based, transparent and consistent reporting model that will attract capital.
When financial reporting for affordable rental housing enterprises and portfolios is standardized, investors can more easily underwrite and compare investments. The expectation is that additional capital will flow to the sector.
And that capital can take various forms. There are no plans or expectations to transform nonprofit housing developers into publicly traded companies. However, the goal is to increase the amount of permanent capital—similar to equity on the balance sheets of the nation’s for-profit homebuilders—so that nonprofit developers can be stronger in their business and in their service to their communities, even as they continue their missions to serve those communities by housing those most in need.
As mentioned earlier, the cost of capital can be across a range, just as it is in the for-profit sector. Some investors will be satisfied with below-market rates of return, comfortable with the fact that their money has enabled the creation and sustainability of affordable housing and the benefits to its residents and society; other investors will want market based returns. All investors will require an easier way to extract their capital from the nonprofit enterprises, a process that is very difficult now.
But if the development of an enterprise level financing market develops, early investors will be replaced by new investors in much the same way that an IPO investor has its early stake taken out by a subsequent investor. The bottom line: the nonprofit enterprise retains capital to build its affordable housing business and more capital flows into and through the market, just as it does with for-profit builders.
Thomas Deyo is the director of real estate programs and Frances Ferguson is the senior manager of real estate programs at NeighborWorks America.
