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— Multifamily Properties Quarterly — August 2016
M
ost of us have heard the
statistics that we need
more affordable housing in
Colorado, period. A “hous-
ing cost-burdened house-
hold” is any household that spends
more than 30 percent of its income
on housing. It is estimated that one
in four renters in Colorado pays more
than 50 percent of her income on
housing, and 325,000 are spending
more than 30 percent of their income
on rent, according to Housing Colo-
rado, a statewide association.
By 2025 it is estimated that Colo-
rado’s population will increase by 1
million due to our continued growth.
Many of the jobs created over the
next 10 years will have annual sala-
ries of less than $36,000, according to
a report from the Colorado Depart-
ment of Labor. That is well below the
income required to afford the aver-
age two-bedroom apartment.With
this lack of supply, the gap in current
inventory would take over 100 years
to catch up to the demand, said a
Housing Colorado report.
So, why are we not developing more
affordable housing? Simple: money.
When an affordable housing devel-
oper is asked to explain how he
finances his developments, he may
be apt to respond with the infamous
Facebook relationship status indicator
– “It’s complicated.”
One reason for this is the prime-
equity markets demand market-rate
returns and affordable housing, by
its very design, offers below-market
rents. Prime markets (investors seek-
ing the best economic returns) out-
number the affordable markets (inves-
tors seeking tax credits and other
forms of economic or social benefits).
With fewer equity
options, affordable
developers must
seek alternatives to
their funding sourc-
es, also referred to
as the capital stack.
Available Programs
There are mul-
tiple programs that
provide grants such
as the Community
Development Block
Grant program,
which is allocated
and managed by
the U.S. Department of Housing and
Urban Development to benefit low-
and moderate-income persons, and
HOME funds, which are federal grants
to create affordable housing for low-
income people. But even with these
sources, developers often are stuck
with a financing gap.
Local municipalities are another
potential gap-funding source. The
Office of Economic Development for
Denver hosted an affordable hous-
ing conference in May called Bridg-
ing the Gap with the goal of having
community leaders help solve this
critical funding issue. One innovative
way OED approached the financing
gap was by creating a new Revolv-
ing Affordable Housing Loan Fund
in 2015, which has helped close the
financing gap on several local devel-
opments with a commitment to fund
more.
The largest funding source, outside
of the permanent debt, is federal and
state low-income housing tax credits.
There are 4 percent and 9 percent tax
credits, which contribute roughly 30 to
70 percent, respectively, of the equity
needed for the development. The 9
percent tax credit is very competi-
tive, due to a limited supply. LIHTC
incentivizes private investment in
affordable development by providing
reductions in state and federal tax
liability for the tax credit investor. The
Colorado Housing Finance Author-
ity is the designated state-allocating
agency for Colorado and is responsible
for designing and implementing the
program.
As you already may have surmised,
even with all the federal and state tax
credits and municipal programs, there
still remains a funding gap in many
developments to breaking ground and
delivering these much-needed hous-
ing units to the local community.
An effective approach to decreasing
the financing gap is to increase the
size of the permanent mortgage. A
larger mortgage may completely elim-
inate the gap and remove the need for
an affordable developer to defer his
fees as contributed equity.
The Federal Housing Administration
insured loan, in general, provides the
largest loan amount for an affordable
development. This is the case even
compared to other loans specifically
designed for affordable housing, such
as the Freddie Tax Exempt Loan. Fred-
die TEL and FHA both have the same
debt-service coverage requirement of
1.15 to 1, but FHA provides for a lower
rate, generally by 0.50 basis points,
and a longer amortization, 40 years
versus up to 35 years. The combined
effect creates a lower loan constant.
The lower loan constant results in a
larger qualifying loan. This is due to
the fact that it is common for afford-
able developments to be debt-service
constrained. After loan and lender
fees, the FHA loan provides the lowest
cost of capital for the senior debt.
The 4 percent LIHTC creates the
largest financing gap and is more
readily available, compared to the
competitive 9 percent; however, such
bonds are not unlimited. In fact, the
state is provided with a volume cap
of tax-exempt bonds to be used to
promote certain private activities for
the public good. At least 50 percent
of the development’s aggregate basis
(land plus depreciable assets) must be
financed by volume cap tax-exempt
bonds to claim the 4 percent credits.
Therefore, in the case of a $20 mil-
lion total budget, at least $10 million
would need to be funded by a private-
activity bond through the state to
meet the 50 percent test needed for
the 4 percent tax-exempt bonds. The
term of the private-activity bond typi-
cally will mirror that of the construc-
tion period in the form of a short-
term, cash-collateralized bond.
After receiving the PAB, the proceeds
would then be advanced pari passu,
during construction draws with the
FHA loan and account for half of the
funding source. Once construction is
completed, the investor redeems the
PAB and the borrower is left with the
FHA mortgage and 4 percent LIHTC
credits he started with.
As an analogy, we can think of the
PAB as the red wine in a spaghetti
sauce that is cooked off during the
preparation (construction) process,
leaving the original recipe (permanent
mortgage and tax credits) intact.
With less available capital, more
intellectual capital is required to
develop affordable housing.
s
Michael Thomas
Vice president,
multifamily
and health
care, Gershman
Mortgage, Denver
Affordable Housing
