Testing Ground for Innovation

9 min read

Affordable housing uses deep rehabs, rental assistance and tax credits to help close transactions

By Michael Russo, Contributing Editor

No other segment of multifamily housing has strained the creative energies of developers, investors, syndicators and the U.S. government like the affordable housing market. Fortunately, their exertions have not been in vain, with some innovations and best practices applicable to market-rate development as well.

It’s encouraging to hear people like Larry Curtis, president and managing partner at WinnDevelopment, Boston, say that federal affordable housing programs are “almost back to normal.”

During the worst of the downturn, many leaders in the affordable housing arena stood at the precipice. “Some went out of business, others left the marketplace and some recapitalized,” recalls Thom Amdur, executive director of the National Housing & Rehabilitation Association (NH&RA). “Today, there is a growing robustness in the marketplace, with many developers and those in the syndication field back in business and closing transactions.”

Unfortunately, affordable housing is not as geographically diverse as it once was, but the industry is working on that. In the meantime, almost everyone is optimistic about the opportunities in the mixed-housing submarket.

More choices for developers

Two years ago, when financing was all but cut off in the affordable housing segment, developers chased after tax exempt bonds and whatever donated land was available to build on. Today, the Department of Housing and Urban Development’s (HUD’s) Choice Neighborhoods Initiative and the Preservation, Enhancement and Transformation of Rental Assistance Act (TRA) programs are but two promising options.

The TRA bill authorizes HUD to initiate a multi-year effort to transform properties with rental assistance contracts under various programs into properties with long-term, property-based sustainable rental assistance contracts. This will allow the flexibility to address capital requirements, to enhance resident choice, and to streamline and simplify the administration of rental assistance.

“If TRA is passed, it will represent a major paradigm shift in how major HUD programs are funded,” says Amdur. “Converting subsidies to a predictable program like Section 8 will provide a lot of comfort in the development and underwriting communities.”

A pre-notice has already been delivered for the Choice Neighborhoods Initiative. The legislation hasn’t been enacted yet, but has been funded in the 2010 budget. TRA is still in the hands of Congress, but it is a major priority for HUD Secretary Shaun Donovan.

“This legislation [TRA] not only reflects our best thinking at HUD—but perhaps more importantly our best listening,” says Donovan. “TRA incorporates the lessons we’ve learned from Congress and other stakeholders to streamline HUD’s rental assistance programs and allow them to link housing investments to surrounding neighborhoods.”

Meanwhile, the Choice Neighborhoods Initiative is building on the successes and lessons learned from the landmark (and sometimes controversial) HOPE VI program. HOPE VI was launched in the early ‘90s to help revitalize blighted neighborhoods negatively affected by public housing projects. It was a good program, but became consistently under-funded over time and operating capital became sorely lacking.

In contrast, the Choice Neighborhoods Initiative will take an interdisciplinary approach and fund competitive grants to local governments, nonprofits, for-profit developers and public housing authorities.

“We’re looking at some major policy shifts and a lot of things impacting the multi-housing world,” says Amdur.

The association keeps its members abreast of major developments like the Choice Neighborhoods Initiative with its HousingOnline weekly newsletter. (Check it out at http://twitter.com/HousingOnline). Amdur also advises MHN’s readers to take advantage of the National Council of Affordable Housing Market Analysts through NH&RA.

“All developers need to take a second look at their consultants and internal underwriting processes,” says Amdur. “We feel we have defined the market study process for the industry since 2001.”

At the same time, forward-thinking developers are taking advantage of New Markets Tax Credits (NMTCs) and developing nonresidential real estate around their affordable housing communities, as required by law.

“The most momentous changes we’ve seen are federal-level tax credit programs for affordable housing,” says Matthew Greer, CEO of the Carlisle Development Group, Coconut Grove, Fla. “There’s a flurry of new programs, and changes in others, that allow nimble municipalities and developers to form public-private teams to capitalize on the changes.”

Interestingly, the distribution of these federal tax credits has been “dramatically unequal” across the country. Greer says this is because of the varying expertise of developers and public partners to find the best projects and the money to fund them.

“There’s a continuing demand for affordable housing and a tremendous demand for sustainable real estate development,” says Greer. “The politicians keep saying, ‘Bring me affordable housing with a tax base that creates jobs, is environmentally sustainable and positively impacts the surrounding community.’”

The Carlisle Group has been doing just that, with 14 developments commencing construction in 2010. Based on RIMS II calculations developed by the Bureau of Economic Analysis, Carlisle estimates these developments will create more than 6,300 jobs and housing for more than 1,450 workforce and low-income households.

“Markets with the strongest long-term demographic prospects—and the shortest Community Reinvestment Act needs or demands—are the ones seeing a disproportionate flow of investment capital,” says Greer. “New York is a good example. They get the ‘double whammy’ of strong demographic prospects and high demand for tax credit investments.”

While affordable housing development garnered only a small share of the overall market two years ago, it has changed 180 degrees since 2008. “Complex public-private partnerships are a lot more of what’s getting done in multi-housing as a whole right now,” says Greer.

Weatherization and rental assistance programs

Developers like Larry Curtis at WinnDevelopment are working on deep energy retrofits, sustainable rehabs and other weatherization and rental assistance projects with HUD and the Department of Energy (DOE) in various states.

Curtis also expects rental housing rules to be tweaked more to multifamily’s liking, although it may be a bit early yet for any major changes.

“During the downturn, the government’s principal efforts were to save the programs,” says Curtis. “When the Titanic is going down, you’re not out there rearranging the deck chairs.”

However, as things settled down over the last year, Winn crafted an application with DOE on new and innovative financing models to bridge private capital with stimulus and weatherization money. The goal is to keep the program sustainable after the stimulus money runs out. This effort involves establishing a revolving loan fund to leverage private and public investments, and ensure funding levels for energy upgrades can be sustained after ARRA funds are exhausted.

According to HUD, new financing tools are critical to spur investments in energy-efficient affordable housing. Not to mention that HUD weatherization funding increased by a factor of 20—up to $5 billion this year.

“We are looking to invite other developers to take advantage of weatherization grants to work with us and help change these existing grants into tax-exempt loans through DOE,” says Darien Crimmin, vice president of energy and sustainability at WinnDevelopment.

This is important when property owners and developers are faced with strong disincentives like taxable grants, and weatherization savings down the road are hard to predict.

Regardless, Winn has had success demonstrating real examples of green affordable housing, which has helped to build strong relationships with the DOE and HUD.

“DOE is really good at accepting new ideas like our weatherization financing pilot program,” says Crimmin. “But this hasn’t happened without a lot of efforts toward understanding the programs, including cold-calling state agencies for their plans.”

On the weatherization front, Winn has been partnering with dozens of weatherization sub-grantees in more than seven states, helping to facilitate the most effective use of stimulus weatherization funds. Because weatherization funds must be allocated by certain deadlines, Winn is helping to facilitate program spending and meet production goals by targeting multifamily weatherization projects.

“Multifamily properties are often more cost-effective to weatherize than single-family homes, and we’ve been busy conducting energy audits and enrolling properties into weatherization programs,” says Crimmin.

In Laconia, N.H., Winn successfully completed one of the first multifamily weatherization projects in the country at Wingate Apartments, a 100-unit affordable housing community. In April, the project was recognized by DOE Assistant Secretary Cathy Zoi and U.S. Senator Jeanne Shaheen.

In related efforts, Winn is piloting new ‘green financing’ initiatives, in which energy savings are used to repay the capital expense for new equipment and other efficiency upgrades. By partnering with Enterprise Community Partners, Winn has secured a private line of credit to test new financing models that can help ‘green’ privately owned affordable housing.

“The innovations affordable housing developers are bringing forward include buildings that are economical to construct and operate in a fashion that is ‘green’ and healthy for communities,” says Jonathan F. P. Rose of Jonathan Rose Companies, New York. Rose’s company is a leading “green” urban solutions provider that manages more than $1.5 billion of work—much of it in close collaboration with not-for-profits and local towns and cities.

The HUD rental subsidy market

The tax credit-based HUD rental subsidy market effectively expired in 2009, but interest from the multi-housing sector continues. Apart from the Midwest, most major cities still have enough banks and corporate investors to raise hopes that tax credits will sell. The soon-to-be-approved federal “extender” legislation—a follow-up to the Tax Credit Exchange Program and Tax Credit Assistance Program—is also keeping the market alive.

Unfortunately, well-intentioned state housing authorities and corporate investors continue to demand unrealistically high rehab investment requirements on the order of $25,000 per unit. And they continue to be outbid by yield-motivated buyers.

“It may be politically incorrect for state housing authorities to lower their rehab requirements, but they have to adapt to the realities of the market,” says Paul Davis, senior vice president with Marcus & Millichap and president of Affordable Housing Advisors. “The rehab thresholds have crept up, and they are not sustainable in the current tax credit market.”

In 1987, 100 percent of Davis’ sales were based on tax credit executions. By 2005, 50 percent of his customers were yield-motivated buyers. So far this year, he has made 36 transactions in 15 states and only one involved tax credits.

Smart investors are picking up properties that are 95 percent occupied and in good condition—with HUD paying most of the rents. These projects have a good revenue stream, unlike the inner-city Section 8 developments that scare many off.

“The corporate investor really has to walk the property,” says Davis. “HUD requires these developments to stay in good condition, and they have.”

In fact, apartment landlords and other non-traditional buyers have noticed these nearly full housing developments. “These buyers learn quickly and then use legal help to acquire them,” says Davis. “The whole business has completely turned around.”

Nonetheless, affordable housing development remains a challenging, knowledge-intensive and relationship-driven enterprise. It requires a skill set that includes using creative financing techniques, deal structuring, asset management, allocating subsidies, nimbly executing NMTC transactions, and much more.

“Affordable housing has all these additional elements because you’re bringing together multiple stakeholders, some of whom are government entities that have strong ideas about managing their programs,” says Greer.

“No matter how big or small, how simple or complex the construction, it’s still a major public-private partnership. Entitlement gets more difficult, construction and liability become more complex, and you still have to bring all the stakeholders to the table within a feasible time frame.”

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