The coronavirus pandemic will have many victims. Many lives will be lost, others changed forever. Many businesses may also disappear permanently, and many jobs will be lost temporarily while others may vanish for an extended period as the economy seeks its way in our new environment.
Sadly, another casualty of this crisis will be new affordable housing development.
Before this crisis, a lot of attention had been given to how we increase the supply of affordable housing — which had reached a crisis point long before the coronavirus entered our consciousness. A growing problem, affordable housing is something our local, state and national governments as well as the private sector were all attempting to address in some manner. The coronavirus will override all of these efforts and make financing new affordable housing development all but impossible.
Let me explain:
There have been two primary methods of developing multifamily affordable housing. The first is to develop an entire building of affordable units. A good deal of this development has been led by Minnesota’s talented not-for-profit development organizations. In every case, the costs of developing and building the project are subsidized by as many as 10 unique sources of financing, as the rents cannot possibly cover the costs.
These sources often include multiple grants, usually from government programs, tax increment financing (loans that are paid back from the real estate taxes generated from the project), philanthropic and foundation sources, and the most common source: government granted tax credits.
A tax credit is a powerful financing tool that, if approved by state or federal government, can be used by developers to raise cash for subsidizing the cost of building the project.
So how do these tax credits — often exceeding millions of dollars — materialize into cash for developers of affordable housing? The tax credits are sold, mainly to corporations and banks, often at a discount. These institutions can then turn around and use the tax credits to offset their own state or federal taxes and can also pocket the profit from the purchase discount.
The money from the sale of the tax credits goes directly into subsidizing the development and construction costs of building the project, which in turn enables lower rents.
Of course, this virtuous cycle only works if the corporate and bank organizations have tax obligations to offset. Unfortunately, the coronavirus is likely to greatly reduce or destroy the profitability of many corporations and banks, thus significantly lowering their interest in buying tax credits.
Without tax credit buyers, the funding available for affordable housing development will be significantly reduced, making many 100% affordable projects unfeasible.
The second primary model for developing affordable housing is through mixed affordable and market rate projects. Typically, in this type of building, 80% of the units are market rate and 20% are affordable. Many cities have recently created policies requiring this type of development.
These mixed projects often struggle to get the subsidy financing that the 100% affordable projects can secure. Most cities, therefore, offer some level of funding support to assist in the financing of the project — usually through tax increment financing. But some cities, like Minneapolis, have mandated that the developer cover a significant portion of the cost with no financial assistance.
I have vocally objected to this mandate before the coronavirus pandemic, arguing that it simply won’t work and development will stall, reducing the overall supply of housing across all categories.
And if you didn’t believe me when I said it then, I hope you will now take a second look as we face the worst economic crisis in modern history.
If we continue to lose our collective economic footing as we have in the past month, it will become increasingly difficult to obtain equity and loans to build real estate projects of all kinds over the next several years — if not longer. Why? The coronavirus is likely to mean bank appraisers will reduce the projected value of projects that aren’t yet built, causing the banks to loan less and requiring the developer to provide more equity. Many will be unable to do so and the institutional investors may also be unwilling to increase their invested capital, if they invest at all.
In order to secure investors, everything in a project will have to be perfect. Adding in the requirements or mandates for affordable housing will make the entire project unfeasible.
That means that those communities with affordable housing requirements and mandates will see a significant slowdown in all types of multifamily development projects. It’s worth noting that before the coronavirus struck, Minneapolis had already seen a significant dip in new development applications since they passed their mandate last year. Some may prefer a development slowdown given the pace of the last 10 years, but it won’t help solve the overall housing shortage we have across our state for all categories of housing.
I have been developing, designing and building commercial real estate for over 30 years. I have developed through many challenging economic cycles, including during the aftermaths of the 1986 tax reform, 9/11 and the Great Recession. But nothing compares to this. The rebuilding of our economy will be more arduous than anything we have seen in recent history.
I hope that as we emerge from this pandemic, our elected officials at the local, regional and state levels will re-examine their policies with the goal of assisting rather than restricting, enhancing rather than constraining efforts to build our communities and create the tens of thousands of jobs that will come with it.
I also hope our elected leaders will use this time to learn how our financial markets work so they can correct their past policy mistakes and formulate new policies in cooperation with the development community. By doing so, they can promote the growth we will need to pull ourselves out of this crisis and create the additional affordable housing we so desperately need.
Kelly Doran, of Minneapolis, is a real estate developer.