Are Non-Profit Developers The Answer to L.A.’s Housing Shortage?

Non-profit community development corporations (CDC’s) are coming of age. Community-based organizations often with roots in churches, neighborhood organizations, or social service groups, are developing affordable housing in every neighborhood of Los Angeles. Government housing agencies have discovered the capacity of CDC’s to tackle tough projects, and to deliver product efficiently.

Elected officials have learned that a well-managed community based developed corporation can diffuse neighborhood development hostility and create political support. Market oriented developers, frequently facing obligations to build housing as condition to entitlements for market driven projects, have discovered the CDC’s ability to obtain financing and to deliver a unique product.

CDC’s engage in housing development activities as a result of their long term interest in and commitment to the social welfare of their communities. However, CDC’s are quite diverse, serving very different communities. The Westminster Neighborhood Association, for example, has for more than thirty years been providing child care and social services to a specific geographical community. Westminster is now developing 130 units of low income housing in Watts. The Skid Row Housing Trust, on the other hand, focuses on buying and rehabilitating single room occupancy hotels in the Central City East area, for the benefit of the special community residing in that area. The Los Angeles Community Design Center works throughout the Los Angeles basin with a diverse community of low income people in need of affordable housing or technical expertise for development projects.

Because CDC housing development is relatively new, there is a considerable amount of confusion about the objectives and capacities of CDC’s. Though each CDC is somewhat different, the most obvious CDC objective, in general, is to increase and preserve the stock of low income housing.

Long Term Affordability

As the housing affordability crisis has worsened, CDC’s have as a general rule focused on housing for low and very low income households, rather than moderate income households. This focus is consistent with the trend of federal, state and local housing programs to target resources to the lowest income households.

An equally important objective is to secure the long term affordability of CDC owned housing units, without requiring (if things go as planned) future infusions of capital or ongoing operating subsidies. This requires different strategies than for-profit developers.

For example, where a market-rate apartment project pro forma may establish reserves for capital replacements and repairs with contributions out of rental income equal to 2.5% of gross revenue, a CDC’s project development budget will fund a reserve equal to three times monthly gross income out of the original project financing sources, and will build that reserve with annual contributions equal to 4% of gross revenue.

Similarly, when CDC’s finance their projects through equity contributions from limited partners expecting tax credit benefits, CDC’s carefully develop exit strategies that allow them to redeem the interest of their limited partners at the end of the tax credit holding period.

Context Sensitive Development

CDC’s tend to be more sensitive than market driven developers to community concerns, including those of neighbors, community leaders and local elected officials. Community-based CDC’s share neighborhood concerns about parking, greenspace and compatible design. CDC’s often have a reservoir of political support in their communities, which can help to overcome frequent neighborhood resistance to any type of development in this no-growth era, including resistance to affordable housing.

Equally importantly, since CDC’s are not motivated by profit, CDC’s can afford to advocate a smaller neighborhood-friendly project where a market oriented developer must maximize density. For example, ten to twenty unit projects on infill lots are common for CDC’s.

Responsive to User Needs

In addition to responding to the concerns of neighborhood residents and political leaders, CDC sponsored projects focus more squarely on the needs of the end user.

For example, although project sponsors can charge higher rents for units with more bedrooms, the allowable additional rents cannot justify the loss of density or the marginal costs of the additional bedrooms or increased parking.

Market driven developers would therefore opt for smaller units, to keep the rent stream at the highest possible level. CDC's recognize the need for larger units, particularly in family oriented communities. In Central City West, for example, CDC sponsored projects include many larger units, reflecting the needs of the families that presently and formerly inhabited the Central City West area.

Developer Fees

It is commonly (and incorrectly) assumed that because CDC's are non-profit, they sponsor housing development solely out of a sense of mission, and are able to support their staff and overhead costs by foundation grants, fund raisers, and other typical sources of non-profit finance.

In actual fact, very few CDC’s obtain more than 30% of their annual budget from grant sources, and no CDC in the Los Angeles area is engaged in any significant level of private fundraising. However, to deliver the product efficiently, CDC’s must attract competent staff, and to do so they must pay salaries that are competitive with the salaries at government agencies, a common employment alternative for individuals interested in low income housing development. These salaries have risen steadily over recent years.

As a result, CDC’s earn developer fees which come out of the project budgets, usually paid in two installments, half upon commencement of construction and the balance upon completion of construction. Typically a CDC will expect a developer fee of approximately $2,500 to $10,000 per housing unit depending on the project size.

This fee is usually considerably less than a market driven developer would expect, and given the usual size and complexity of the projects involved, is a bargain. A typical CDC project may have four sources of financing (e.g. conventional loan, CRA loan, Proposition 84 loan, and equity) and require 3,000 hours of staff time to package financing, hold community meetings, work with architects and manage the ordinary development activities.

Often the CDC has invested its own cash, in addition to staff time, to pay for unavoidable up-front development costs such as architecture and engineering, plan check fees, or appraisals. This investment and risk of time and cash is common for both market driven developers and CDC’s, but CDC’s often find themselves in the unusual position of risking $300,000 in investments to maybe earn a fee of $150,000.

Moreover, all or a substantial portion of this developer fee is often at risk, subject to reduction or even elimination if construction costs, lease up experience, or other factors do not match the estimates of the pro formas.

CDC’s face a number of limitations relative to their market oriented competitors. These limitations include the following:

Risk Aversion

CDC’s do not have large capital pools to place at risk to attain development objectives. The strongest and oldest CDC’s at most can afford $10,000 earnest money deposits, and even then must insist that such deposits remain refundable for long periods of time.

With respect to an individual project, a CDC typically cannot afford delays and risk which accompany developer strategies such as seeking project variances. CDC’s will pursue a path of least resistance, resulting in projects that minimize risk and hostility if not costs.

Cost Minimization

The objectives and limitations discussed above may result in higher total project costs for CDC sponsored projects. Though CDC developer fees are usually substantially less than the fees and overhead loads charged by a market based developer, these savings can be overshadowed by the costs of previously discussed lower density, architectural amenities, larger units and other features.

Similarly the CDC’s requirement of long term affordability to very low income households, though socially desirable, results in lower levels of market rate mortgage financing, thereby requiring higher levels of local, state and federal government subsidy.