How Developers Are Clearing the Affordability Hurdle
The ongoing affordability crisis is worse than ever. In a recent issue, the National Low Income Housing Coalition (NLIHC) reported a shortage of over seven million affordable homes for the 10.8 million extremely low-income households in the U.S. An estimated seven in 10 low-income families spend more than half of their household income on rent, while more than half a million people have no housing at all. To make matters worse, while the need for affordable housing increases, multifamily construction has slowed substantially. In October 2023, starts were down 30 percent year-over-year.
Pile on high interest rates, widening rent distribution, outpaced incomes, and construction costs, and the affordability hurdle appears impossible to clear. Here’s what developers in New York City, Los Angeles, and other metropolitan hubs are doing to solve America’s affordable housing puzzle.
New York City Invests In More Affordable Housing
Rather than look away, developers in some cities have started to turn toward affordability. In Q2 2023, approximately 43 percent of New York City’s $3.9 billion in multifamily development was for affordable housing. Most developers responsible for the sizable investment were “mission-driven capital sources,” Forbes wrote. In addition to its main benefits, affordable housing helps investors satisfy a double bottom line (i.e., financial success and social accountability), offers tax incentives, and provides other value-add opportunities like rent vouchers.
Unsurprisingly, New York City’s increased demand for affordability remains somewhat of an outlier. In January 2024, the U.S. average asking rent was $1,710. In contrast, last year, the average monthly rent affordable to a cost-burdened family of four was $694—a near triple gap. State law deems housing “affordable” if the cost is under 30 percent of the household income. What’s more, from 2021 to 2022, the number of rental units priced between $600 and $799 decreased by almost half, while the number of units priced above $2,000 more than doubled. Though construction starts are down, it’s clear that U.S. multifamily development over the last decade has favored more high-end and Class A housing.
DECREASE IN U.S. LOW-COST HOUSING
Source: Harvard Joint Center For Housing Studies
Expiration of 421A
Since the expiration of 421A, New York City’s tax abatement program, filings for multifamily construction dropped substantially last year. The 421A Tax Incentive previously waived property taxes for developers who offered 25 to 30 percent of a project’s units below market value and at affordable rents to low- and middle-income families. Approximately 3,000 properties (or 170,000 units) leveraged the program over the last decade, and more than half of all multifamily units leveraged the program in the last eight years. While the impact of 421A’s expiration continues to unfold, developers can expect a shift away from tax breaks for affordable development.
Los Angeles Speeds Up Affordable Development
Los Angeles historically has been known for its lengthy construction delays, due in part to the city’s exhaustive regulations and code enforcement. Approvals can take a year at least, and in one property’s famously long case, a maximum of a decade. Shortly after taking office in December 2022, Mayor Karen Bass moved to tackle this red tape by signing Executive Directive 1 (ED1).
What is ED1?
Considered an “emergency declaration,” ED1 called for city departments to expedite 100 percent affordable projects. By doing so, Los Angeles city leaders exempted affordable development from various codes and regulations and mandated a 60-day approval window. The directive’s first year added more than 16,000 new affordable units to the city’s pipeline—more than 2020, 2021, and 2022 combined, and without any new funding, public subsidies, or tax credits.
The early success of ED1 offers promise for other cities with a more severe affordability gap. Encouraging developers to pursue 100 percent affordable projects while cutting costs and expediting the process helps make the “math work,” as one Los Angeles developer explained.
The Role of LIHTC
Developers have long relied on affordable housing tax credits issued through the Low-Income Housing Tax Credit (LIHTC) program to develop and preserve affordable housing nationwide. Since 1987, the LITHC has brought 3.5 million affordable housing units online, according to Forbes and Community Preservation Partners. But critics argue that the program is outdated, since its scoring mechanisms to evaluate and fund today’s affordable projects are based on old standards.
Recent efforts to mitigate the program’s market lag include the Build Back Better Act, which increased the LIHTC’s 9 percent allocation cap by 10 percent plus inflation each year from 2022 to 2024. Supporters of the act believe that housing credits are essential to new construction, in addition to support from entities like the Department of Housing and Urban Development (HUD). While it may take several years to clear America’s affordability hurdle, one key to increasing affordable housing development (at a reasonable per-unit cost) may be for developers to more closely monitor the effectiveness of the LIHTC program in the long run.
Construction Costs Are Up, Starts Are Down
Of the main barriers to affordable housing—cost, lack of government support, and “not-in-my-backyard” (NIMBY) sentiments—perhaps most enduring over recent years is cost. Building is expensive, no matter what type. However, developers continue to opt for standard or luxury housing over building affordable units because of a desired cost-revenue ratio.
Still, affordability remains a growing opportunity for developers. According to Yardi, affordable housing in 2023 accounted for 19.2 percent of the U.S. multifamily pipeline, a notable jump from 7.9 percent in 2014. The real estate data provider expects a record supply of multifamily housing in 2024, which means rent appreciation in many markets will slow after a period of post-pandemic growth. Absorption will also remain strong in markets with a larger supply, though it may take a year or longer for the new units to be fully absorbed. Unfortunately, for affordability’s sake, most of the new units coming online this year will compete directly with existing Class A units.
This year will be telling for multifamily construction starts, which declined rapidly last year. After a seasonally adjusted peak annual rate of 571,000 units in May, starts hit a notable low in October, down 30 percent year over year. However, a record number of multifamily units are currently under construction. As interest rates are expected to go down, there may be an uptick in construction starts, increasing developers’ runway to build more affordable housing.
What To Expect
There’s a big opportunity right now for investment in affordable housing due largely to recent legislation, cooling interest rates, and a city-level commitment to preserving affordability. Metropolitan hubs like New York City and Los Angeles are leading the charge with more tactical and tailored approaches to affordability. Returns for investors are expected to persist while demand for more multifamily development, specifically affordable units, remains stronger than ever.
