As surprising as it may sound, the single greatest threat to the stock of aging affordable housing today is sponsor weakness, according to David Smith, chairman of Recap Real Estate Advisors. “We have a substantial pent-up need for new sponsors. There is an enormous amount of stress in the industry. Many sponsors have gone quietly moribund.”
The issue of impediments to the preservation of older affordable housing looms large than ever now that there is a huge mountain of such housing—serving specifically the low-income segment–whose government-imposed rent and use restrictions are expiring in great number beginning this year. “A lot of such properties are coming to the point at which the owners and managers have to decide what the future holds,” says industry veteran George Caruso, executive vice president and chief knowledge officer of Edgewood Management Co.
There is an estimated 4.5 million units of existing publicly and privately owned government-assisted affordable housing in the nation. Of the privately owned housing, the stock consists of housing that was produced under various HUD interest-reduction and/or rent subsidy programs at various points from the 1960s and ending in the 1980s. These government housing production programs, serving families earning from 40 percent or less to 80 percent of median incomes, include Section 202, Section 221(d)(3) Below Market Interest Rate (BMIR), Section 236 and Section 221(d)(3), and project-based Section 8 and tenant-based Section 8 voucher programs. In addition, the affordable housing stock includes housing (about one million units-plus) produced beginning in 1988 under the Low Income Housing Tax Credit (LIHTC) program.
Within the older affordable housing inventory produced through 1982, many of these properties had 30- or 40-year HUD-insured mortgages placed on them. This means they began expiring in the 1990s. Beginning this year, for example, it is estimated that more than half of the Section 236 and 221(d)(3) properties will come off of their mortgages (see table). When the mortgages expire, so will all the affordable restrictions on these properties. Furthermore, under some programs, owners were allowed to prepay their mortgages and opt out of the affordability program once a certain number of years have been reached on the mortgages.
To stave off the projected loss to the affordable housing inventory, there have been various government programs introduced and/or modified through legislation in the 1990s and 2000s. Tools introduced include Mark-to-Market, Mark-Up-to-Market, Enhanced Vouchers, and options provided under ELIPHA and LIHPRHA. The programs provided incentives to developers to keep their properties affordable as well as for example, rent vouchers for residents to remain the housing.
Caruso points out that it is critical to preserve this older stock of older affordable housing because there is no housing currently being produced that similarly serves the low-or very-low-income segments of the population. “The assisted housing stock is important to retain for national policy purposes,” says Caruso. “Congress is not presently going to look at funding any new housing targeted at the market below 40 to 50 percent of area median income.” The LIHTC program, he notes, does not for the most part target the low-income market served by the older stock, as LIHTC principally serves the segment of the market whose incomes range from 40 to 60 percent of median.
The good news is that many of the government programs that were introduced to help preserve the affordability of the older housing stock have been utilized by developers. For example, much of the project-based Section 8 properties have already taken advantage of various programs to recapitalize, and virtually all properties that were eligible for Mark-to-Market have been subjected to the program, says Smith. Nevertheless, many of these preservation tools are now defunct. Mark-Up-to-Market is still available, says Smith but ELIHPA and LIHPRHA have been effectively repealed in 1996. Mark-to-Market continues to exist, but nearly all relevant properties have been subjected to the program. And Enhanced Vouchers are available for very old properties, but scarcer than they were a decade ago, says Smith.
“In general the resource environment is more difficult than it was a decade ago, because not only are more properties candidates for preservation, there are fewer tools and less money in inflation adjusted terms,” says Smith.
Properties confront obsolescence
As to the threats to the stock of affordable housing, properties that can opt out of affordable use usually do not do so, says Smith. Often, this is because the markets in which the properties are located are not strong enough, and the properties not in good enough condition, to carry much higher rents. Another reason could be that the government benefits the properties can receive if they do keep their affordability are enough to keep the owner incentivized to keep the properties affordable. Losing the housing through physical obsolescence, default or foreclosure, presents the greater danger to the inventory, says Smith.
Within the inventory of older government assisted housing, the youngest properties are now nearly 40 years old, as 1982 was the last year in which project-based Section 8 was built. “Because the bulk of the existing affordable housing stock was initially constructed between the late 1960s and 1982, the buildings are now between 30 and 40 years old,” says Caruso. Thus just on a purely physical consideration, the properties will need some form of renovation of their physical structure. Additionally, new market conditions may warrant upgrades and design changes, and there may be a need to adopt new technologies or green sustainable features.
Caruso’s company, Edgewood Management, is heavily weighted in its portfolio toward what it categorizes as assisted (eg. Section 8, Section 202) and affordable (eg. LIHTC and Section 236, 221(d)(3)) properties. Many of the company’s assisted properties are just a few years away from paying off their initial mortgages, and many of its new construction-assisted properties are now at or approaching 30 to 40 years old, says Caruso. “In recent years, a significant minority of our owners have refinanced and, with the use of tax credits, partially rehabbed the oldest properties. Each year as we go through the budget cycle we sit with owners and look at how the properties will be preserved and re capitalized.”
If anything, there remains a continuous need to preserve the aging stock of housing on an ongoing basis, says Smith. “Preservation is a misnomer because that implies you do it one time, and you are done. Instead, preservation is less a one-off event than the management of a chronic condition,” says Smith. He says properties may even need to undertake some sort of preservation action once every seven years, and noted that many aging properties are slowly developing chronic conditions.
In Smith’s view, the number issue in affordable housing preservation today are general partners that may no longer be as effective for any number of reasons. Smith says many general partners today may be undercapitalized, or specifically, financially stressed. As a result, they may not be able to respond to the problems of the property in the same way effectively, thereby allowing it to fall into obsolescence, he explains. Additionally, they may have become inattentive over the years. “The general partner may no longer be active in development, or their knowledge may have become stale. They may have changed business model, or they may no longer be focused on affordable housing,” he says.
Capital falls short
The limited availability of capital is of course another major impediment to the preservation of the affordable housing stock today. “The financing markets are not entirely stable. Until the economy improves, capital will remain difficult to obtain,” says Caruso. Debt capital, in the form of Fannie Mae or Freddie Mac financing, is more fussy today, while soft debt has become even less available as state and local governments have become squeezed in the recession. And on the equity side, the amount of equity developers can receive in return for LIHTC has dropped sharply, though this trend may have begun to reverse itself.
As all the older affordable housing production programs have become defunct, owners of the aging housing today are relying on housing rent vouchers, Section 221(d)(3) and 221(d)(4) and LIHTC programs to fund their preservation.
According to Michelle Norris, senior vice president and chief development officer of the non-profit developer National Church Residences, LIHTC equity is the most effective type of capital to use for preservation. Just refinancing the debt alone does not normally generate enough capital to produce a robust rehab, she explains. In addition, LIHTC capital is needed. “To do a really good preservation, you almost always need tax credits. It is a very versatile tool, but everyone is going to the same tool to solve all their housing needs.” Norris points out that even if all LIHTCs were devoted to preservation, there would still not be enough LIHTCs for the preservation of every unit in the affordable housing stock that needs it.
Norris’s company has more than 250 communities in its portfolio, consisting primarily of LIHTC, Section 202 and Section 236 housing developed over the past 30 years. “Suddenly, the volume is approaching critical mass like a wave approaching. Every year, there are more properties hitting the wall,” she says. Because of the capital limitations, says Norris, the owner is forced to keep the capital improvements projects simple, which may not meaningfully extend the life of the property, she notes.
Solutions for preservation
Preservationists have a number of other suggestions, besides obviously increasing the overall capacity of the LIHTC program, for maintaining the nation’s precious stock of older, aging, housing. The government could reassure the financial markets that funding on which these properties depend will continue to be made available, said Caruso. Funding for the Section 8 voucher program, for example, is renewed from year to year, so that in any given year, there is no complete reassurance the money will be there in the following year.
“Having certainty about continued funding is very important because financiers take the strange view that when they loan you money, they want it back,” quipped Caruso. “They want to be comfortable in the belief that the properties they underwrite will be able to [continue receiving the subsidies].”
Smith advocates that the affordable housing industry moves towards having larger companies run the properties on a portfolio basis, not unlike the apartment REIT model. Larger companies present a number of advantages over smaller ones, he suggests. “Successful long-term owners have diverse portfolios. They present a source of liquidity. And their cost of capital is lower,” Smith says. The weaker properties can be cross-collateralized with stronger properties, for example, says Smith. And when any property falls into distress, the deep-pocketed sponsor will be in a better position to shore it up using cash generated from other properties. Having well-capitalized entities as property general partners will be a good strategic way to bring in additional capital and liquidity into the system.