Financing Affordable Development: Overcoming the Impossible
NewPoint Real Estate Capital’s Rob Wrzosek on ways to bridge the gap.
Increased labor and construction costs, along with rising interest rates, are making new affordable housing developments even more scarce than they have been in recent years.
According to Rob Wrzosek, president of affordable strategies at NewPoint Real Estate Capital, it is “nearly impossible” to build low-income housing in today’s entangled financing landscape. MHN interviewed Wrzosek about those challenges and about NewPoint Impact, a new lending tool that pairs private capital with government-subsidized products. The platform, led by Wrzosek, is the result of a partnership with multifamily owner Morgan Properties.
What led you to launch this new financing vehicle?
Wrzosek: There is a tremendous demand for affordable rental housing in this country. Nearly half of renter households put 30 percent of their income towards rent, while a quarter of renters put 50 percent or more of income towards housing.
Affordable housing is core to NewPoint’s mission, so creating new tools to help developers build and reposition communities with certainty of cost and execution fits our overarching lending strategy very well. And for our partner in this endeavor—Morgan Properties—the venture is an effective means to provide liquidity to an increasingly supply-constrained affordable housing sector.
READ ALSO: How the Housing Shortage Became a Crisis
NewPoint Impact pairs private capital with government-subsidized products to deliver affordable housing financing solutions. How does this public-private mix work in this case?
Wrzosek: Affordable rental housing has historically been financed through lending programs sponsored by the government-sponsored enterprises/Federal Housing Administration or by commercial banks acting pursuant to their CRA (Community Reinvestment Act) mandate. These legacy programs are useful, but each is constrained by an ever-growing regime of regulatory requirements. These regulatory constraints make it difficult, if not impossible, to nimbly respond to the financing needs of an industry that must navigate the nuances of the Low Income Housing Tax Credit program, municipal finance, the GSE’s/FHA and a variety of state-specific requirements.
NewPoint will combine private, unregulated capital together with capital available pursuant to our GSE/FHA lending licenses to more efficiently navigate the regulatory morass with the ultimate goal of delivering the most efficient and impactful products to developers of affordable housing.
Our platform goal over the next year is to finance up to $1 billion in volume.
How important are government subsidies for the affordable housing financing sector and why?
Wrzosek: Subsidies are incredibly important for affordable financing. While it is still possible to find naturally occurring affordable housing, it is nearly impossible to build it given land, material and labor costs. Inflation, of course, is only making things harder. Developers are prioritizing luxury housing as a result.
This is evident when you look at annual construction levels as a percentage of inventory. For market-rate multifamily, it’s averaging roughly 3.5 percent. For affordable housing, it’s under 2 percent. Further exacerbating this issue is that nearly 700,000 units of housing stock currently subject to affordability restrictions—mostly concentrated in the Midwest and West—are set to expire by 2030. There needs to be a serious, concentrated effort to expand and revitalize the subsidized housing stock in order to curtail the current affordable housing crisis.
What are the most in-demand financing products in the affordable housing sector right now? Why do you think that is?
Wrzosek: There simply isn’t enough subsidy—4 percent bond volume cap is oversubscribed in most states and without additional subsidy, a sufficient amount of affordable housing simply cannot be built. There also appears to be waning demand for LIHTC across the industry, not because existing investors are souring on the asset class but because investing in LIHTC requires extensive and costly internal infrastructure to properly account for it.
What changed over the past two years when it comes to the process of financing affordable housing projects?
Wrzosek: It has been interesting to watch the LIHTC space in recent years because it is in somewhat of a holding pattern in regards to equity investment activity. Part of it has to do with institutions waiting on the sidelines to see what happens with the stalled Build Back Better plan. But the biggest issue is that there is a very limited number of institutions—just a handful of large banks and insurance companies—that have the necessary income tax capacity, investment horizon, knowledge of real estate and sophisticated back office and accounting functions to invest.
The LIHTC industry needs to focus more of its lobbying efforts on expanding the pool of eligible investors for LIHTC. More specifically, the industry should lobby for changes that would allow LIHTC—and the associated losses—to offset investment income as well as traditional “W-2” income.
How has the cost of capital in the affordable housing sector changed over the last few years, and what are your expectations going forward?
Wrzosek: The cost of capital has two components. The first is the risk-free rate—generally the 10-year Treasury is used as reference. The second component is the credit spread, which is how much above the risk-free rate an investor/lender demands to be exposed to the affordable housing sector. Credit spreads have trended up a little bit but not too much. The risk-free rate, of course, is now about 3 percent, whereas it was 0.52 percent in August of 2020. So, in brief, the cost of capital for affordable housing capital is up at least 250 basis points from the lows reached during the pandemic.
What is your outlook for the affordable housing supply shortage going forward?
Wrzosek: The shortage of affordable housing is often attributable to localized phenomena, at least more so than it may appear at first blush. To go back to Econ 101, the supply of housing is inelastic. When supply is inelastic, relatively modest moves in demand can lead to large swings in value. Take the COVID-19 pandemic as an example. More people moved than usual, and they were moving to similar places. That resulted in very dramatic increases in the price of housing in those areas. Is there now a perpetual shortage of affordable housing in these areas? I’m not certain, and it will take a few more years to see where the shortages are temporary and where they are permanent.
The affordable housing crisis in other locations is simply perplexing. For example, San Francisco currently has a population of 840,000 people and 407,000 housing units. That’s one unit of housing for every two people. Across the entire country, there’s one unit of housing for every 2.7 people, meaning San Francisco has an oversupply of housing compared to the country in general. That’s plenty of physical housing, particularly if the city continues to shed residents. But does this mean the supply/demand for housing in San Francisco will finally reach an acceptable equilibrium? Time will tell.