Overcoming Affordable Housing Financing Challenges
Across the United States, there is a need for 7 million more affordable housing units for extremely low-income families. Renters in all demographics face rising costs, with rents increasing 24% in the last three years. Even Americans who make an average living find that home affordability is the worst it’s been in 17 years. It’s clear that the housing crisis has reached astronomical heights, but with so much red tape surrounding affordable housing projects, what can developers do to ease the burden?
What Is Affordable Housing?
Affordable housing guidelines are determined by the Department of Housing and Urban Development (HUD). For a property to be considered affordable, a family or individual should spend no more than 30% of their income on housing costs, whether paying rent or a mortgage. With rising costs in the last few years, many families are spending well over this 30% mark on rent, which is why housing assistance programs exist. Housing assistance can take the form of rent vouchers, down payment assistance programs, or utility assistance for low-income families. However, when it comes to actually building affordable homes, developers are faced with a mountain of additional challenges.
The Challenges of Affordable Housing Construction Projects
Nearly every city needs additional lower-cost housing options, but as construction costs continue to rise, finding a way to pay for affordable developments isn’t easy.
In most cases, lenders base their loans on a property’s anticipated income. And when rent is adjusted to more affordable prices and a property’s expected income drops, so does the amount of money lenders are willing to provide. This creates a funding gap.
Without sufficient funds to embark on a project, developers who want to build affordable housing are tasked with finding additional sources of funding. Affordable housing is primarily funded by government subsidies, but one or two of these sources are rarely enough for an entire project. In fact, developers report using up to 20 sources of funding for one affordable housing project. It’s easy to see why project owners are hesitant to embark on an affordable housing project and why the shortage of affordably-priced homes exists.
How to Fund an Affordable Housing Project
Developers and project sponsors often feel intimidated by all the regulations surrounding affordable housing projects, but there are many options to fund these opportunities. Most of them are funded by the Department of Housing and Urban Development (HUD) and are determined based on factors like geographic location, community participation, and intended use.
Low-Income Housing Tax Credit (LIHTC)
The Department of Housing and Urban Development (HUD) created the LIHTC program to incentivize affordable housing development. LIHTC provides credits to state housing finance agencies to allocate to developers, who in turn typically sell them to investors to fund the project. There are two types of LIHTC credits—9% credits and 4% credits—and being awarded a 9% credit will help to finance the majority of development. To qualify for a tax credit, proposed affordable housing projects must meet a use restriction. For example, they must dedicate at least 20 percent of apartments to people who earn less than one-half the area’s median income, or 40 percent of apartments to people who make less than 60 percent of the area’s median income.
Community Development Block Grant (CDBG)
The CDBG is an HUD-funded federal program that provides funds to state and local governments to distribute for community development projects. To receive these funds, local governments must elect to participate—as of 2024, 49 states participate in the CDBG program. Developers are required to submit a Consolidated Plan to be eligible to receive funds.
HOME Investment Partnership Program (HOME)
The goal of the HOME program is to expand the availability of affordable homes and provide rental assistance to low-income families, develop communities, and strengthen partnerships between the government and private sector for better affordable housing development. It’s the largest block grant for state and local governments and is awarded annually. Jurisdictions must match 25 cents of every dollar and ensure housing remains affordable for 20 years to qualify for this option.
221(d)(4)
221(d)(4) is HUD’s construction loan program for both affordable and market-rate housing. These loans are sizable—typically more than $10M—and unlike conventional bank financing, the terms won’t change with the market. Developers pay interest-only during construction years, which gives up to three additional years of financing at the same fixed rate. 221(d)(4)s are often more expensive for developers upfront and can take up to a year to secure because the FHA lender and HUD each underwrite the transaction.
How Property Developers Can Contribute to Building More Affordable Housing
Affordable housing is important for maintaining equitable communities, preventing homelessness, increasing job stability, and giving children a stable living environment. Developers who want to contribute to the increase of affordable housing units have the opportunity to make a difference.
Building relationships with government agencies, taking advantage of subsidies, and collaborating with other developers are ways to ease the potential risks associated with affordable housing projects. Proving that a project qualifies for rental assistance can give lenders more confidence and help developers secure loans. Developers curious about the return of an affordable housing project can use the Urban Institute’s interactive affordable housing tool to see if a project is worth penciling.
How Rabbet Helps Developers Embark on Affordable Housing Projects
Managing multiple funding sources can get messy without the right system in place. Government tax credits, grants, and other programs often place strict requirements on how developers can use funds. Developers may be required to only use certain funds to pay for specific hard costs and no soft costs. With various tax credits and subsidies in the mix, there’s often a lack of standardization among funding sources.
Construction finance software can help streamline the process and eliminate much of the administrative legwork. For example, Rabbet supports unlimited funding sources and tracks fund use at a line-item level. It also verifies documents against each lender or source’s standards to ensure you remain compliant. Developers can retain funding, pay vendors, and keep the project moving forward. Because it’s automated, there’s no need to manually update and review complicated spreadsheets. And for lenders, Rabbet streamlines the HUD draw review and approval process by centralizing workflows and managing HUD documents. With Rabbet, you can automate tasks, set alerts, and easily edit, generate, and sign HUD forms, all within one platform.
Despite an ever-growing need for affordable housing, finding funding sources and managing your capital stack has become more complicated than ever. With a reliable construction finance platform, developers can ease the burden and get meaningful projects completed and added to their portfolios.
