November 30, 1993 - From the November, 1993 issue

Affordable Housing in the Nineties: An Evolving Private Sector Role

By Bill Witte, served as Deputy Mayor for Housing and Neighborhoods under San Francisco Mayor Art Agnos and is currently a principal with The Related Companies of California. 

Ever since the federal Housing Act of 1968 first established a role for the private sector in developing affordable housing, production has come in fits and starts as various programs were funded and later killed by Congress. 

If the 1970's was the decade of big federal rent subsidy programs (Section 236 and Section 8), and the 1980's was characterized by an explosion in the use of market-oriented subsidies such as tax-exempt mortgage revenue bonds, the 1990's are shaping up as a decade in which local initiatives and the federal low-income tax credit program are the dominant vehicles.

The tax credit program, authorized by the 1986 Tax Reform Act as the only tax shelter (other than investment in historic buildings) for real estate and permanently extended last year by Congress, has mushroomed in direct proportion to the recession-driven decline in production of conventional apartments. It has been responsible for the development of over 6,000 apartments in California in each of the last two years. Like tax-exempt bonds, federal law restricts the program to a specified cap or annual ceiling for each state; in recent years, demand in California has exceeded the cap, so the numbers would be even greater if the law permitted.

Thus, given the expected surge of interest from developers and local governments alike, it is important to understand how the program differs from earlier housing initiatives. 

  1. While allowable rent levels are intended to be affordable to low income households, there are no annual rent subsidies attached to the program, so tenants must be able to come up with the $450- $700 per month in rent typical of tax credit projects in Southern California. While generally below market, there is real estate risk in most of these deals, particularly in areas such as Riverside or San Bernardino Counties where ''affordable" rents and market rents are close, or in inner-city neighborhoods, where many cannot afford even these reduced rents without rent subsidies or doubling up. 
  2. Even with equity from the sale of tax credits generating up to half the cost a typical project, the reduced rents generally support a mortgage which covers no more than 20 to 40 percent of local cost. While this ratio is attractive to lenders, it means that another 20 to 30 percent (or more) of the project cost must be subsidized by another source, typically a local housing or redevelopment agency. Since the size of the first mortgage and the cost of a tax credit project govern the need for additional subsidy, it is safe to assume that an expensive infill project in an area that commands lower rents (e.g. parts of inner-city Los Angeles) will require the largest local subsidies. Conversely, a garden apartment project in Orange County, which has the highest median incomes in the region, might require the least. A general rule of thumb is that a subsidy in excess of tax credit equity will be necessary to pay at least the cost of land acquisition, and often, substantially more.
  3. In the wake of the HUD scandals of the l980's, the program has become very tightly regulated. In California, most project sponsors must agree to maintain their restricted rents for 55 years -- effectively the life of the project-- and developer fees and profits are limited to 10 to 15% of the project’s depreciable basis. Not surprisingly, a majority of today’s project sponsors are nonprofit organizations, especially in and around the larger urban centers. (Contrary to the belief of many, however, there is no preference given to nonprofits in the competition for tax credits.) In addition, the state gives a statutory preference to projects geared to families, in which at least 30 percent of the unit, have three and four bedrooms. 
  4. Difficulties in obtaining entitlements for affordable housing, especially for families, and limits on local resources to help subsidize projects combine to effectively limit the size of most tax credit deals. Projects for families rarely exceed 100 units in dense, urban areas or 150 or more units in suburban settings. 

New Support for Affordable Housing 

Since political support for affordable housing and availability of local funds for housing are critical, it is not surprising that the City of Los Angeles has generated a significant majority of the region's  projects to date, while Orange and San Diego Counties have lagged far behind, particularly in light of their shortage of affordable housing. Interestingly, there are signs that this is changing, at least in degree. The dozens of redevelopment agencies in small communities throughout the area have frequently built up large sums of "set-aside" money that is required to be used for affordable housing, and are under pressure to spend it. In addition, many communities have come to the realization that, with the market having dried up for commercial property and high-end housing, an affordable housing project is literally the "highest and best use" for many sites. In Los Angeles, for example, the Community Redevelopment Agency (CRA) has funded a number of projects to convert obsolete office buildings to affordable housing. 

In a similar vein, there have been several projects in other states in which developers have converted failed condominium properties to tax credit-financed rental housing, and construction recently began m the conversion of a vacant motel in Costa Mesa into studio apartments. In fact, in some instances, properly planned affordable homing projects can be used to actually anchor or upgrade troubled neighborhoods and/or to attract residents to downtowns or nonresidential areas. One proposal, recently given the go-ahead by the Los Angeles Department of Housings, would build 70+ apartments on the site of a swap-meet in South Central L.A. By also including some commercial space, the project promises to provide both affordable housing and jobs. 

Affordable Housing and Community Planning 

Affordable housing financed with tax credits can also be used to satisfy community planning objectives. In particular, the program is an effective means of satisfying inclusionary zoning requirements in master-planned communities, where the ''affordable" housing can be integrated into the larger community. In Sacramento County, Elliott Homes, a large home builder, recently joint ventured with a tax credit developer to build a 300-unit affordable apartment project as part of a master planned community, and the Hillman Co. has just negotiated a similar agreement with San Francisco-based nonprofit developer BRIDGE Housing Corp. in Carlsbad in San Diego County. 

By generating large amounts of private capital, the program is a perfect component for public/private partnerships intended to develop mixed-income housing. The Related Companies of California is currently working with the Los Angeles Housing Authority to redevelop Normont Terrace, a 50-year old, 400 unit public housing project in Harbor City, into 800 condominiums, 400 of which will be leased to the current, low-income residents. Syndication of tax credits will raise nearly 50 percent of the cost of developing the 400 low-income units. Related is also working with the San Francisco Housing Authority, in partnership with McCormick Baron & Associates, to redevelop the notorious Hayes Valley projects in that city in a similar effort. In both cases, the public housing residents’ associations will serve as co­general partners.

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While the multiple layers of financing that characterize many tax credit projects can make them complicated and time consuming, the program's structure does permit a great deal of flexibility. Tax credits have been used to finance Skid Row hotel rehabilitations and the construction of craftsmen-style cottages, farm worker housing, and housing for people with AIDS. Careful underwriting and expert property management, however, are essential in attracting investors for 

any project. 

Affordable Housing - A Growth Industry? 

The history of governmental programs in affordable housing suggests that tax credits, and the local initiatives that have sprung up in conjunction with them, will turn out to be a passing fancy; just when the program becomes truly operational, Congress will pull the plug. Likewise, there are those who believe that local support for affordable housing will evaporate when the economy improves and commercial development becomes feasible again. For several reasons, however, this is not likely to be the case, at least for the remainder of the decade: 

  1. Last year Congress reauthorized the tax credit program on a permanent basis, with strong, bipartisan support, unusual for a program that is just five years old.
  2. For the most part, the financing of affordable housing is now in the hands of state and local governments. This is different from the top-down, all-or-nothing approach characteristic of earlier HUD programs. 
  3. Importantly, there is a growing constituency for affordable housing, especially in and around older urban areas, and demographic trends suggest that this constituency will continue to expand. And the affordable housing developed in recent years, almost all of it privately-owned and -operated and of comparable or higher quality than much market-rate housing, will help to erase the stigma associated with earlier low-income housing projects. 

On the last point, the experience of the Bay Area is instructive. Fueled by a concern over the escalation in housing prices, and abetted by a generally more progressive political climate, affordable housing became a major issue in San Francisco and environs as early as the late 1970's. Task Forces were appointed, innovative local initiatives were implemented, and perhaps the country's strongest group of nonprofit housing developers became active. Making the important connection between jobs and affordable housing, the business community jumped on the bandwagon. That climate remains in place today, even as the economy has cooled and home prices flattened. 

The same dynamics have occurred in Los Angeles and, to a lesser extent, elsewhere in Southern California, during the last five years. This is not to suggest that the aversion of middle and upper-income neighborhoods and communities to affordable housing will dissipate. But, as numerous analyses have documented, the growth in population here for the first time in memory is almost entirely among households with lower incomes. The reality is that the market — effective demand for housing — is and will continue to be for the next several years for affordable housing. In the end, that, more than anything else, should maintain the status of affordable housing as a growth industry.

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