How local governments are closing the financial gap for affo…

The challenges facing real estate development today are well-known. Construction costs remain 40% higher than pre-COVID levels and increased interest rates have slowed the pace of new projects. A June 2024 survey of the nation’s largest developers found that two-thirds of multifamily projects in the pipeline are delayed because they are no longer economically feasible under current conditions.

Affordable housing developers, particularly those using the Low-Income Housing Tax Credit (LIHTC) to build new low-income rental housing, are also feeling the effects of this challenging development environment. This post examines how local government participation in affordable housing has changed because of rising construction and financing costs and relies on data from nearly 300 new construction projects awarded 9% tax credits by the North Carolina Housing Finance Agency (NCHFA) between 2015 and 2023.[1]

The data shows that rising costs are taking a toll on new affordable housing projects. Last year, the median development cost for LIHTC projects climbed to $250,000 per unit—over 50% higher than in 2020 (Figure 1).

How have developers adapted to rising costs? One key shift is project size. In 2023, the median number of units in awarded projects dropped to 56, down from the historical range of 68-72 units (Figure 2). While 9% tax credits typically funded over 2,000 units annually in past years, only about 1,400 units were funded in both 2022 and 2023.

More projects are relying on state and local government support to cover increases in construction costs. One common way LIHTC developers access gap funding is through low-cost loans distributed by two NCHFA programs: the Rental Production Program (RPP) and the Workforce Housing Loan Program (WHLP).

In 2023, NCHFA allocated over $21 million in RPP loans to 80% of awarded projects (Table 1).  In past years, WHLP was also a significant source of gap funding for 9% tax credit projects until funding for the program lapsed in 2020.[2]

Local governments can also assist housing projects for low-to-moderate income households in several ways, such as offering publicly owned land and other methods described by my colleague Tyler Mulligan in blog posts here and here. In North Carolina, one of the most common forms of local government support for LIHTC projects is through soft loans with favorable terms – like reduced interest rates or deferred payments – that are unlikely to be repaid in full. This funding typically comes from local housing trust funds, HOME program funds, or general funds (when authorized as described here). In 2023, over half of the awarded projects received this type of gap funding from local governments (Table 1).

Consider the funding sources for two similar projects in Wake County (Figure 3). In 2015, a developer could build 88 units of affordable rental housing for approximately $10 million. In 2022, a smaller project cost double that amount and required significantly more gap funding from local government and RPP loans.

In total, local governments contributed nearly $30 million in gap funding for 9% tax credit projects, more than double the amount contributed in any previous year since 2015. Historically, local governments lent around $10,000 per unit for new affordable housing. However, gap funding surged to four times that amount last year (Figure 4).

These numbers don’t capture the full extent of local government gap funding, as many projects receive additional funding from local governments, even after being awarded tax credits, due to unexpected cost increases. For instance, in 2022, the City of Durham was asked to contribute an additional $4.1 million to support a 72-unit development affordable to low-income families. In September 2023, an affordable housing developer in Wilmington requested an extra $1.25 million from the city and county to cover the impact of rising interest rates. While this analysis focuses on 9% projects, local governments are often called upon to fill a much larger funding gap for new units funded with 4% tax credits. Last year, local governments committed $22.3 million in gap funding to more than 1,000 new units under the 4% program. Across both programs, local government gap funding exceeded $50 million in 2023.

Even if interest rates decline in the near future, local governments are likely to play an even larger role in supporting the development of affordable housing as construction costs remain elevated. Securing funding from other sources will also affect developers’ ability to compete for tax credits. Starting this year, NCHFA has begun considering third-party, non-agency funding (such as local government loans) when scoring tax credit applications. Partnerships between local governments, foundations, local businesses, and affordable housing developers will be essential to expanding the production of rental housing across the state.

This blog post was written with analytical support from Ethan Sleeman.

[1] LIHTC consists of two programs, commonly referred to as the 9% program and the 4% program. The 9% program is more competitive but provides greater subsidy to the development, while the 4% program is less competitive but provides less subsidy. Because 4% projects receive less tax credit equity, they typically require more local government gap funding than 9% projects.

[2] Funding for WHLP was recently renewed and will be used to help fund projects awarded 9% tax credits this year.