Financing Solutions for the Missing Middle

Eddie Lorin

For generations of Americans, home ownership is a foundational element of the American Dream. However, in recent years, stagnating incomes and a sharply rising cost of living has pushed the dream further and further out of reach. The United States is in the middle of a historic affordable housing crisis, with working class families increasingly struggling to pay rent—let alone purchase a home.

According to the Pew Research Center, average household income growth slowed to an annual rate of only 0.3 percent between 2000 and 2018. In addition, during approximately the same time period the median net worth for middle-income families fell by 20 percent. Harvard University’s Joint Center for Housing Studies found that in 2019, nearly 50 percent of renters were cost burdened (renters are considered cost burdened if they spend over 30 percent of their incomes on housing). Meanwhile, due to the COVID-19 pandemic, 49 percent of renters reported experiencing employment income loss between March and September of 2020—exacerbating an already precarious financial situation.

For some of those in need, government subsidies are available to alleviate the burden of housing costs. But for working families who earn between 60 percent and 120 percent of their area’s median income and therefore do not qualify for assistance, skyrocketing rents make it increasingly difficult to pay the bills. Particularly in high-density locations such as Los Angeles and New York, expenses like rent, transportation and student loan payments eat up the majority of paychecks, leaving little room to cover an unexpected medical bill or save for the future.

The U.S. currently faces a critical need for housing that serves this “missing middle” class, which includes veterans, healthcare workers, teachers, and other critical workers. While there is a surplus of luxury development, those rents are too high (generally 70 percent of an area’s median income) to be affordable by working families. Whether it’s by purchasing existing housing with the explicit aim of keeping it affordable, or investing in new developments, the middle-income sector is desperately in need of capital to resolve this major societal issue.

Collaborative Efforts

There is no single, one-size-fits all solution to the shortage of affordable housing for working class families. Government funding lacks the capacity to close the gap between developments that qualify for the low-income housing tax credit (LIHTC) and those that cater to the “missing middle.” Investors seek a balance between impact and returns, which tend to be higher for luxury properties; and philanthropy alone is not enough. But when these three interest groups collaborate, the result of their combined efforts can be a solution that works for all parties.

Government Subsidies and Tax Credits

In the government sector, the primary mechanism for funding affordable housing development is the LIHTC. But counterintuitively, the point system for the LIHTC rewards 9 percent credits to those who have the most government financing, so government funded projects can actually be more expensive to build. And the demand for affordable housing far surpasses the amount of housing stock government funding is able to support. In the LIHTC Section 42 world, underwriting often only reaches 85 percent of the capital stack with soft money (cash flow subordinate debt) from government entities being what makes up the remaining 15 percent  of the capital stack. Post-COVID, budget constraints have made it even more challenging to obtain city, county, state or federal funding. Currently, thousands of units nationwide are sitting on hold pending such funding according to our own deals as well as from Novogradac, the premier affordable housing expert accounting firm.

Philanthropic Contributions

Philanthropic donors often play a critical role in raising funds to supplement government-subsidized initiatives. For philanthropic or non-profit organizations, donation-driven investments in affordable housing can generate a positive impact on the communities they serve, while also yielding positive—and evergreen—financial returns.

The Investing Community

For the investing community at large, bond financing offers a risk-adjusted, low-interest investment vehicle with the potential to make a major impact on the affordable housing crisis. The simplest way to make such an investment is through “social impact bonds” that carry an identifier called a CUSIP (Committee on Uniform Securities Identification). This number identifies a financial security for facilitating clearing and settlement of trades, which is generally perceived as a simpler vehicle for investment than private equity.

If 10-year U.S. treasuries are below 1.5 percent and a 15-year CUSIP affordable housing bond offers a 3 percent return, one could argue this is a reasonable risk-adjusted return on developments charging below-market rents that the “missing middle” demographic can afford. Investors should also bear in mind that average occupancy rates for affordable housing are extremely high (98-99 percent), and that since rents are already below-market, there is no market risk associated with the investment.

The present-day affordable housing crisis is the product of economic shifts that took place over decades. It is a complex challenge that cannot be resolved overnight, or by a single capital infusion or policy change. But executed properly, impact investments in the form of CUSIP affordable housing bonds could play a significant role in addressing the current shortage—and in the process, improving the lives of thousands of working families.

Eddie Lorin is the managing member & co-founder of Alliant Strategic Development. With more than 27 years of experience in investment real estate, Lorin has led the acquisition of over 150 properties; 25,000+ units contained in over $2.2 billion in real estate. He is a member of the EIG and the Novogradac coalitions for Opportunity Zones.