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Economy Creates New Barriers for Affordable Housing Development
Challenges Lay Ahead
Economy Creates New Barriers for Affordable Housing Development
By Whitney Parra-Gutiérrez, TAAHP Policy & Regulatory Manager
According to the National Council of Housing Authorities, from its inception in 1986 through 2018, housing tax credits have been responsible for the development and maintenance of 317,510 affordable homes in Texas, generating $21.9 billion in tax revenue and $62.9 billion in wages and business income, and have served 737,390 low-income households. However, recent economic challenges are diminishing the level of impact this valuable tool has long provided for developers to provide desperately needed, quality affordable housing for some of the most vulnerable citizens in the state.
As state and national economies emerge from the global pandemic, new barriers are limiting the development of affordable housing. As a result, demand has skyrocketed beyond crisis levels to “code red.” Despite having one of the strongest economies in the country, Texas is not building enough housing to meet the demand of those seeking to relocate to the Lone Star State. New U.S. Census data shows Texas ranks first among other states as a destination for migrating talent by adding four million new residents between 2010 and 2020. Moreover, Texas’ growth rate of 16 percent is more than double the national rate of 7 percent. But a booming economy may falter if the availability of housing at all levels cannot meet the influx of new people calling Texas home.
Critically Low Supply Pushing Rents & Prices Higher
As a reaction to low housing supply, rents in Texas have increased by 22 percent since April 2021, which is 7 percent higher than the national average, according to a Redfin analysis. The combination of record property tax increases and lack of supply means that rental property owners in highly sought-after destinations like Austin have raised the rent by 46 percent in just the last year – the most significant increase in the nation. These rent hikes will inevitably require families to make tough economic decisions, given that wages have not increased at the same rate, worsening the housing cost burden on Texas families and stifling economic growth.
States across the country are racing to build more housing of all types - particularly affordable homes - to combat a housing crisis that has driven thousands of residents out of their communities, limited housing choices for many, and pushed the most vulnerable into homelessness. According to a recent study conducted by the National Low Income Housing Coalition, extremely low-income renters (ELI), whose incomes are at or below the poverty guideline, or 30 percent of their area median income (AMI), in the U.S. face a shortage of seven million affordable and available rental homes. Texas tied for sixth place among states with the least amount of available rental housing for low-income families with a shortage of 614,487 rental homes for ELI households. Equally alarming, according to the U.S. Census American Community Survey, 1.6 million renters in Texas were cost-burdened (paying more than 30 percent of their incomes towards rent) from 2015 to 2019. With 40 percent of all Texas renters identified as low- or moderate-income, meeting the needs of this large proportion of the state’s households is a multifaceted challenge and should be a top priority.
There is a strong desire to build affordable homes. However, developers are now facing new economic barriers making what was already a difficult task almost impossible without immediate and targeted intervention.
Barrier: Rising Inflation & Interest Rates Increase Borrowing Costs
Artificially depressed during the pandemic to keep the economy moving, interest rates have since increased at an alarming rate and are fueling the low supply of housing options — resulting in higher home prices and rents. Concurrent with these challenges, inflationary pressures have also increased, with the annual inflation rate ticking up to 8.6 percent for the 12 months that ended May 2022, the most significant annual increase since December 1981. This was followed by the prior month's 8.3 percent year-over-year rate, according to U.S. Labor Department data published June 10th. In response, the Federal Reserve has begun to dramatically raise interest rates, which increases lending costs to develop housing. On June 15th, in its most aggressive move to stabilize market pricing, the Fed increased interest rates by three-quarters of a percentage point. But while the latest increase is the most substantial to date, it’s not expected to be the last. According to a recent Washington Post article, the Federal Reserve made clear that in the coming months, officials expect “ongoing increases” of three-quarters of a percentage point “will be appropriate.” However, it is unclear exactly how many or how often as they attempt to avoid an economic recession.
Market conditions heavily influence the affordable housing industry and the effectiveness of vital economic development tools such as the Low-Income Housing Tax Credit (LIHTC) program. When the Texas Department of Housing and Community Affairs (TDHCA) initially awarded tax credit awards before the pandemic, the deals proposed by developers relied upon typical market conditions. However, these conditions have materially changed, and unlike the open market, the cost of inflation is not easily passed on to renters. These overlying market threats have created an unprecedented environment for most, if not all, affordable housing developments either under construction or attempting to close financing. The current market conditions, supply chain distributions, and overall lack of material availability have commoditized just about every building component,” says Justin Bailey, president of Maker Bros, LLC, a privately held real estate development and construction company, based in Dallas, Texas. “Nowadays, it is not uncommon for bids to only be good for a couple of weeks due to current price volatility.”
Barrier: Supply Chain Delays Threaten Development Viability
Texas housing developers also face extraordinary challenges in obtaining building materials and labor. Although developers may address some of these challenges by modifying designs or using alternative materials to minimize cost increases and delays, overall market forces and the supply chain drive the dynamics.
“The multifamily industry continues to see unprecedented cost increases, material shortages, and lengthened delivery schedules. This, coupled with the massive demand for housing in the Texas market, have stressed project budgets and schedules,” says Bailey.
“When it became clear that there would be more supply chain issues happening, we responded by enhancing some of our processes to ensure that material orders are accurate, placed as early as possible, and consistently tracked,” says FTK Constructions’ COO Mark Frazier.
According to the National Association of Home Builders (NAHB), the costs of building materials have increased by 20.3 percent in early 2022 compared to a year ago. Additionally, the shortage of construction workers has decreased the opportunity to gather competitive bids and, by extension, has contributed to higher construction costs. Supply chain delays prevent suppliers from locking in pricing beyond a 30-day time frame in many cases, making it impossible for affordable housing developers to reliably predict the cost to construct their developments 18 or more months out as required.
“The facts are in the numbers,” says Bailey. “The chart below illustrates a brief analysis of two affordable housing developments, both located in the Dallas/ Ft. Worth (DFW) metro, of similar project size, average unit size, and finishes that were bid one year apart. To further emphasize how comparable these projects are, they both have the same design team.”
Many affordable housing developments have become financially infeasible, forcing developers to request deadline flexibility to wait out market fluctuations. Un- like their market-rate counterparts, affordable housing developers cannot increase rents to balance out added costs. Without additional public funding, affordable housing developments will continue to have difficulty, and Texas will find it even harder to build to the scale necessary to ease the shortfall in both supply and affordability.
Besides cost, affordable housing developments also face the added pressure of meeting “placed-in-service” deadlines. The Texas Department of Housing and Community Affairs’ Cody Campbell reminded developers at a recent TDHCA meeting that “Internal Revenue Code 6 Section 42 establishes that tax credit developments must be placed in service no later than the end of the second calendar year following the year of the award. Placing in service means that the building is ready for its intended use, and it’s generally evidenced by a certificate of occupancy.” Campbell went on to say that while the department has no authority to extend these deadlines, the Texas Qualified Allocation Plan does include a force majeure clause for unforeseen circumstances that would allow, with TDHCA Board approval, a developer to return their previously awarded credits and have them reallocated in the current year, which effectively resets the clock for their placed-in-service deadline.
It’s no surprise that in several recent TDHCA board meetings, many developers have asked for force majeure relief. One such developer stated in a June 1st letter to the TDHCA board that due to a 51.8 percent increase in the original projected construction hard costs, they would not be able to meet the department’s 10 percent test and place-in-service requirement deadlines needed to retain housing tax credits awarded to them in 2021. Unfortunately, they are just one of many.
Barrier: Reduced Value of Housing Tax Credits is Creating a Big Financing Gap
Affordable housing developers are getting hit on both sides. While material, labor, and transportation costs have increased, the housing tax credit value is beginning to decline as interest rates rise — creating challenging circumstances for developments based on pushing the margins of financial viability to keep affordable rents. In a 2022 survey, TAAHP members cited the pricing of tax credits as one of the biggest obstacles to constructing fiscally sound deals. One of the few solutions to the diminishing value of tax credits is increasing the allocation per awarded development.
“One of our urban area deals hit a snag earlier this year when we learned that our tax credit investor would only offer $0.87 on the dollar rather than the $0.93 we were expecting,” says Lora Myrick, president of Housing Lab by Betco. “This created a substantial financing gap that led us to look for soft funds from federal, state or city sources at a time when soft funds were running low.”
“There is a greater need for soft funding to cover the gaps in financing,” says Valerie Williams, senior relationship manager with Bank of America. “Access to soft funding can be limited depending on the location. Our team continues to monitor lead times given these current market factors.”
TAAHP recently surveyed 2021 Housing Tax Credit recipients to ask how much their development would need in supplemental tax credit funding to close their deal. A majority of the 48 developers, over 95 percent, who answered the survey said 10 percent or more would be necessary to make their deals financially feasible.
“Equity proceeds from the sale of the LIHTC is one of the largest components to the capital stack in these deals. Strong equity pricing from investors is important to help these deals pencil,” says Dan Kierce, managing director with RBC Community Investments.
Kierce says that while current tax credit pricing is relatively stable, that could change. “As interest rates continue to rise, alternative investments to LIHTC become more attractive. Current LIHTC investors may need to increase their yield thresholds to keep pace with rising rates. This could create lower equity pricing for deals and further increase gaps in financing.”
Threading a Shrinking Needle
Due to the increased need for funding resulting from rising costs in the industry, the number of tax credits requested has increased substantially from previous years. As a result, the current tax credit cycle is more oversubscribed than ever before. The FY 2022 total estimated housing tax credits (HTCs) available is $79.6 million; however, the current log reflects $175.3 million in requests for 127 applications. Last year, TDHCA awarded 71 projects totaling $85.1 million in HTC credits. Further, historically considered “non-competitive,” private activity bonds were also oversubscribed with $2 billion more in requests than the FY 2021 state ceiling allowed.
In addition, the LIHTC developments that TDHCA had already allocated credits for in 2019 and 2020 are also experiencing financing gaps due to inflation, supply chain delays, and steep cost increases. This year, many affordable housing developers petitioned TDHCA for additional funds to help close their financing gaps. The state agency has provided relief through supplemental tax credits and by extending placed-in-service deadlines available through force majeure allowances. If prices continue to rise, TDHCA should expect more requests for financial relief from affordable housing providers.
Working for Solutions
While developers are motivated to build more affordable housing for the overwhelming number of Texans who desperately need it, there is not enough resources to build them, at least not on the scale needed to keep Texas’ economy thriving. No single policy solution can fix the growing housing affordability crisis. Instead, Texas policymakers must pursue multiple policy changes that will collectively help preserveand produce affordable housing. The longer it takes for these solutions to take hold, the deeper the economic toll on our state. Elected officials should be aware of the short- and long-term consequences of insufficient supply and be open to a multifaceted policy approach to respond aggressively to these impending challenges.
Given that the State of Texas has limited ability to tamp down the effects of inflation or resolve national supply chain issues, the most direct and efficient action it can take to address these concerns is to seek increases in funding for affordable housing across its various programs, especially in the housing tax credit and private activity bond programs. Without added resources, many current housing tax credit developments will be at serious risk of failure, and future development feasibility will become more limited.
This upcoming legislative session is a new opportunity for Texas to advance its efforts to develop and protect affordable housing. TAAHP members are working on various solutions (see page 30) to present to lawmakers in Texas’ upcoming 88th Legislative Session. Please make plans to join us to advocate for the viability of affordable housing in Texas.