Navigating Multifamily Affordability

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Offerd Team

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March 30, 2023

Inflation has bitten into everyone’s wallet, but the national trends of rent growth, while a benefit for multifamily investors, comes with concerns. When prices are too high for anything, consumers may start to say they can no longer afford it.

Moody’s Analytics, the financial and economic analytic branch of bond credit rating firm Moody’s Corporation, noted that for the first time in 20 years, the national rent-to-income ratio reached 30% in the fourth quarter of 2022. The typical American renter is now rent-burdened.

“It’s all coupled with the rise in home prices and mortgage rates,” says David Ellis, Offerd’s managing director of acquisitions. “In a lot of segments, the housing costs have gone way beyond the 30% threshold.”

The conditions should provide a market opportunity for the multifamily industry through affordable housing. Nevertheless, development expenses are hugely inflated since pre-pandemic times. Chain together government figures of final demand and construction pricing for private capital investment, from February 2019 to February 2023 and the growth in cost is 45.2%.

“Just hard costs alone for a garden complex is $150,000 per door,” says Ellis, who says not long ago they were closer to $80,000. At this point, developers cannot depend on elevated rents alone to pencil a viable deal, especially when rental growth has apparently plateaued, at least for now.

However, there are federal and state programs that provide financial incentives to aid in making development deals possible. Those development deals, in turn, can eventually become properties that investors can purchase, though with important considerations.

Many multifamily investors are familiar with the Section 8 housing choice voucher program, which requires government approval for the landlord, annual housing quality inspections, and potentially other state requirements. There is a counterpart: Section 42 of the Tax Credit Reform Act of 1986, which enables the Low-Income Housing Tax Credit, or LIHTC.

“We call it supply side affordability,” Ellis says. The program helps developers undertake affordable housing projects. “They are restricted to renting the units out to individuals and families who make no more than 60% of the median income. They can only charge 30% of that income for rent.”

The transfer of a Section 42 property comes with significant requirements. “The rent restrictions on a LIHTC deal run 30 years,” Ellis says. The original developers hold the property for a 15-year compliance period, after which comes a 15-year extended use period. Some will sell the property at that point.

“Buyers can recredit the property for another 30 years,” Ellis says. “But they may have to invest significant amounts for rehab to make sure the asset will last.” That affects deal viability and achievable price.

A thorough analysis of property-specific and local conditions, the type that Offerd regularly performs for clients, is necessary as part of due diligence for a buyer to know if a deal can work and for a seller to know if a price is realistic.

There are also state-level programs to consider. Ellis mentions public facility corporations (PFCs) and housing finance corporations (HFCs) in Texas, a market he knows particularly well. There are equivalents, done differently, in other parts of the country.

PFCs and HFCs regularly undertake partnerships with developers. “The developers capitalize in a conventional fashion with a 60% to 70% loan and find equity investors for the balance,” he says. “Then they do a partnership with an HFC or PFC to avoid real estate taxes. The restrictions are not as heavy as LIHTC.” Half of the units can be at market rate, for example. The elimination of real estate taxes is particularly significant as Texas has no personal income tax, instead using property taxes.

“When you give relief, that is a big deal,” explains Ellis. “Some states like Colorado have agencies that can also utilize tax exempt bonds to buy properties, but real estate taxes are low in Colorado, so there’s less relief and the deals often don’t pencil.”

“Another program that has been approved in Texas and that has taken California by storm is the use of essential function bonds,” Ellis continues. These offer 100% financing for acquisition of property that is owned by a public entity like a PFC or HFC. “The private entity sponsor is a project administrator. You can buy higher quality projects in the nicer areas of town with those programs.” But the approach takes properties off the tax rolls, which can limit a metro’s appetite. Still, such deals do happen in Texas. “They are a little more politically palatable because the city gets the upside of the income and property value growth.”

Any of these or other approaches toward affordable housing require local knowledge, data, and connections. A digital integrated broker like Offerd has the technology tools as well as the experience to identify properties or buyers, giving consideration to the factors that determine whether a deal will make sense. Get in touch today and we can help you explore the possibilities.

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