New financial solutions to address the affordable housing crisis

The need for affordable housing has never been greater, with 30% of Americans paying more than 30% of their monthly income for mortgage or rent payments, according to Habitat for Humanity.¹ Unfortunately, financing for affordable housing has always been a challenge — and the high interest rates and inflation of the past two years have made that problem even more acute. The need for creative solutions is urgent.

The fundamental challenge of financing affordable housing is that, in a period of high interest rates and scarce capital, traditional financing formulas do not “pencil.” It is an unavoidable economic reality that, before committing capital to any project, investors need confidence that they will get a good return on their investment. But when it comes to affordable housing, meeting that comfort level is complicated. Rents or mortgages typically will not cover both the total costs of constructing the property and paying down permanent financing. Affordable housing developers need additional capital sources to fill these budget gaps.

What’s more, regulations imposed by all levels of government account for an average of 40.6 percent of multifamily development costs, according to recent research² by the NMHC and the National Association of Home Builders (NAHB). Unfortunately, high regulatory costs translate into housing not being built in many areas where it is so desperately needed and add to the complexity of getting these projects off the ground.

As a result of these and other factors, financing structures for affordable housing projects are highly complex. In a typical project, for instance, KeyBank Real Estate Capital might provide a bridge loan, followed by construction financing, then combined with Low-Income Housing Tax Credits (LIHTC) equity, tax-exempt bond funds and Fannie Mae or Freddie Mac funding.

That’s a lot of complexity — but it’s what’s required to get projects done and begin to address the affordable housing crisis. The reality the industry is facing is that even more is needed; government programs intended to encourage and support investment in affordable housing have not kept pace with the demand for affordable housing or the unprecedented macroeconomic challenges that have emerged over the past two years.
 

The need continues to grow

While the financing environment has become increasingly challenging, affordable housing stakeholders can’t afford to sit on the sidelines. The demand for affordable homes is overwhelming. The nation lacks more than 7 million units of affordable housing, according to the National Low Income Housing Coalition,³ with the greatest supply shortages at low-income price points.

“As the cost of food, transportation, and other essential products and services has risen, rents have gone up, too, increasing the burden on housing budgets.”

How high interest rates affect affordable housing project finance

Higher interest rates make financing affordable housing more expensive. Short-term interest rates have climbed steadily over the past 18 months, contributing to increased construction costs. The 30-day LIBOR was .08% in September 2021; now it is up more than 500 basis points to 5.44%.⁴ Similarly, the 30-day SOFR, which was 0.05% in September 2021, has jumped to 5.3% as of November 2023.⁵ Long-term mortgage rates have risen as well, tracking the rise in the 10-year Treasury Index from 1.30% a year and a half ago to 4.6% in November 2023.⁶

Not surprisingly, residential mortgage rates have rocketed higher, making homeownership unattainable for more consumers. As of November 9, 2023, the rate for a 30-year fixed rate mortgage stood at 7.5%,⁷ more than double the rate at the beginning of 2022. Harvard University’s Joint Center for Housing Studies estimates that,⁸ along with insurance and property tax, this increase in mortgage rates helped price 2.4 million renters out of the homebuying market. Unattainable homeownership creates pressure on rental markets, contributing to the shortage of affordable rental housing.

The significant jumps in short- and long-term rates widen the financing gaps common in affordable housing projects, forcing project sponsors to compete for scarce resources to fill these gaps. Finding capital sources can take weeks or even months, adding to the time needed to bring new affordable housing to market. A related complication is that inflation and supply chain logjams are driving up project costs, which have risen about 30% over the past few years. Every delay in financing or construction increases these costs and further exacerbates the challenge in securing financing and ultimately, delivering the housing units.
 

A growing need meets shrinking support

In 2018, the U.S. Congress increased LIHTC funding by 12.5%, but that increase was allowed to expire in 2021. At a time when inflation and rents were rising and land prices and supply chain issues were making it more costly to build low-income housing, funding for the largest federal program designed to boost affordable housing development was actually reduced substantially.⁹

LIHTCs are allocated to each state by the federal government based on population. States are allowed to carry over unused LIHTC funding for three years. Historically, most states received more funding than they needed. But recently, thanks to rising rates and increasing costs per unit and due in part to this reduction in funding, states and municipalities have rapidly eaten through surpluses and have found themselves running out of funding.¹⁰

In May 2023, the Affordable Housing Credit Improvement Act (AHCIA) was introduced in Congress. The AHCIA would increase the production and preservation of affordable housing by reinstating the 12.5% temporary increase on 9% LIHTCs. It would also increase allocations by 50% over the next two years and reduce the private activity bond (PAB) financed-by test from 50% to 25%. Under current law, if a developer finances 50% or more of a project with tax-exempt PABs, the owner is generally eligible to claim tax credits that don’t impact an agency’s LIHTC volume cap. Reducing the PAB financing requirement to 25% would increase funding for affordable housing by almost $100 billion annually.¹¹

If this legislation passes, these provisions will lead to the development of more than two million more affordable housing units over the next 10 years.

The affordability challenge requires creativity, innovation and partnership

Despite the many challenges that the sector faces – from a dearth of supply to significant headwinds in the current economy – a broad group of affordable housing organizations, developers, policymakers, government agencies and lenders have pledged their unwavering commitment to tackling the affordable housing crisis. Participants in the affordable sector are working tirelessly to preserve the current supply and create new units and affordable options in cities and municipalities across the country.

KeyBank is deeply committed to addressing affordable housing. As a leading affordable housing lender, KeyBank has provided innovative and often complex financing solutions for projects in urban and rural communities across all 50 states. For-profit, nonprofit and government agencies nationwide have leveraged our broad, integrated platform to execute complicated projects with many moving parts.

In today’s environment, helping communities thrive requires a passion for overcoming obstacles and exploring every avenue to bring housing projects to life. Challenges abound—but so do opportunities for innovative approaches to delivering access to affordable housing where it is most needed.

To discuss our affordable housing expertise and more as it relates to your business, connect with Robert Likes or reach out to his team of experts. You will find our latest article and podcast on LIHTC housing units set to transition to market-rate helpful as well. 

Learn more

Visit www.key.com/affordable.