Affordable-housing gap widens: it's getting harder to build and manage truly affordable rental housing. Lenders are struggling to figure out what deals to approve as market conditions grow more challenging.

The housing boom that swept the country over the last few years has been great news for many people. Existing homeowners saw their property values skyrocket. Millions took advantage of low interest rates and creative financing deals either to enter homeownership for the first time, refinance their homes, or upgrade to bigger houses or better neighborhoods. Where land was at a premium, builders went skyward, and condos saw unprecedented popularity. [??] The apartment industry saw some benefit from the boom as well; as property and for-sale housing doubled in value in many markets, rents went up, too. Condo converters took some existing apartment stock off the rental market, thus diminishing supply and helping rental rates to rise. Suddenly, class-A rental units were leasing at monthly rates equal to or more than comparable mortgage payments, and B- and C-class rents crept upward as those apartments became more attractive options for people shut out of the luxury rental or for-sale markets. [??] While things have cooled on the homeownership side in many areas and whispers of overbuilding are starting to be heard in that crazy condo market, apartments keep on renting. Getting a mortgage isn't quite as simple as it was two or three years ago, and more families find themselves looking for apartments to rent instead of property to buy.

Shut out in all of this, however, have been families--especially large ones--that the Department of Housing and Urban Development (HUD) says have "worst-case housing needs." Defined as households that either pay 50 percent or more of their monthly income on housing or who live in substandard housing, their numbers are increasing exponentially.

HUD says that in 2005, the latest year for which numbers are available, 5.99 million U.S. households fell into the worst-case housing needs category--up 16 percent from two years before. Just about everyone, from HUD to nonprofit housing providers, says there isn't nearly enough truly affordable rental housing to begin to cover the need.

The obvious answer--build or convert more low-income rental housing--isn't as simple as it might seem. For one thing, land prices are far too high in and around most cities for developers to begin to cover the costs of building new apartments and charging federally defined affordable rents for them. And, developers say, federal guidelines that govern subsidy programs are too complicated and restrictive for most to even think about using them.

And then there's the issue of supply vs. demand--and a free market. Simply put, most people would prefer to spend as little on rent as they realistically can. In practice, that means some renters who technically could afford market-rate or work-force-rate rental housing instead hunker down in apartments originally meant for the worst-case rental needs market, taking those units out of the pool.

But experts say there are creative ways for lenders and developers to work together to provide more affordable rental housing for the lowest end of the spectrum. The answers, they say, are creativity and due diligence.

Facing a shortage

According to HUD, in 2005, there were 77 available affordable units for every 100 very low-income renter households (defined as those earning no more than 50 percent of area median income). In contrast, there were 81 units available for every 100 very low-income households in 2003.

But that's not the worst of it. Extremely low-income renter households, defined as those earning not more than 30 percent of area median income, only had 40 units available for every 100 households in 2005.

"Three things are going on," says Peter Coccaro, director of product management at Fannie Mae. "Housing is getting more expensive, there's not as much available at affordable rents and there's a decline in the amount that's being built new," he says.

And with land costs skyrocketing and subsidies declining, he says, even nonprofit groups that have traditionally found creative ways to build affordable rental properties are throwing up their hands in frustration.

"In parts of the country where jobs are being created, there's a need for more housing," says Kim Griffith, vice president of multifamily affordable housing at Freddie Mac. "Where there's a need for more housing, there's definitely a need for more affordable housing. But where jobs are not being created or are being lost, there's [also] a need for some replacement housing. And that housing becomes obsolete and run down, and is ultimately lost."

He points out, however, that in areas with job growth, housing costs go up and construction costs go up, making it more difficult to build or reconfigure housing that's affordable to lower-income households.

And while the federal Low-Income Housing Tax Credit (LIHTC) program provides subsidies to owners of truly affordable housing, many developers shy away from it because of its layers of complication. To use them, tax credit property owners must restrict rent so that either 20 percent of the units are available to households whose income is at or below 50 percent of area median (AMI), or 40 percent of the units are affordable and occupied by households at or below 60 percent of AMI.

To qualify for the LIHTC program, owners must also commit the properties to these restrictions for at least 30 years.

The bottom line, experts say, is that multifamily owners and their lenders must be extremely well-versed in tax credit restrictions and regulations to make their projects work--after all, they still have to cover land, construction and maintenance costs over the life of the property, tax credit rent or not.

"Initially, anyone in this business has a hard time," says Matt Wanderer, principal with Alterra Capital Group, Miami. Alterra specializes in purchasing distressed properties, renovating them and operating them as affordable rental housing.

"There's a lot of paperwork where you're constantly showing your track record," says Wanderer. "All of our properties have some subsidies."

That said, Alterra generally prefers to have 10 percent to 20 percent of a property subsidized, and turn to private financing to work out the rest of the deal.

"We've tried to do fully subsidized deals, and there's too much red tape and too many complications," says Wanderer. "There's a lot of government oversight on expenses and the way you manage and run the property. It gets in the way of a business plan and makes it tough to be successful."

Others say Alterra's preference isn't unusual.

"If you are accustomed to dealing only with conventional multifamily financing, the different aspects of an affordable deal are very complicated and difficult to sort through," says Griffith.

That can spell headaches for lenders that work with housing developers to supplement tax credits with other financing options to boost the number of affordable units in a building or on a property.

"It's not necessarily that it's complicated, but it is layered," says Fannie Mae's Coccaro. "You can't just go out and get one conventional loan. You have to find additional financing. And that's where it's drying up. Federal subsidies are drying up; the funds just aren't available, and it's getting harder and harder to find them."

Joan Carty, chief executive officer of the Housing Development Fund (HDF), Stamford, Connecticut, knows this firsthand. The nonprofit HDF has pulled together 18 lenders and corporations to provide funding for affordable-housing deals.

"On the rental side, [funding for affordable housing] is still a challenge," Carty says. "There are a number of financial assistance tools that have been developed on the homeownership side. But on the rental side, because it's a more transient use of housing, I don't know of any specific programs."

Lending 101

The market for financing affordable rental housing is huge, as more developers embrace mixed-use developments in and around large metro areas to incorporate subsidized affordable housing units into projects that are otherwise market-rate, and sometimes very high-end. By blending in a certain percentage of affordable units into a building with market-rate apartments and, sometimes, retail or offices, developers can qualify for tax credits and breaks that they otherwise wouldn't have. By doing so they also help fill the affordable-housing gap, which also builds corporate goodwill for the project and those involved with it.

But often it can mean more homework for lenders.

"We have to think about land use differently," says Carty. "We have to think about where the economics will make the most sense. Lenders have to be very aware of trends and operating expenses, property taxes, insurance costs, energy costs. Those are all huge drivers on the operating side. And it's good to project those out correctly."

Carty says she and other lenders have had to educate themselves on the ins and outs of including affordable units in larger projects, particularly in neighborhoods that wouldn't have been considered for affordable housing several years ago.

"It's back on the radar screen full-force," she says. "It's become a more middle-class issue. It's harder for kids coming out of college to get a foothold on their own, and the cost of land has impacted the cost of housing itself."

But just tossing a few lower-rent apartments into a larger building won't fully address the problem, she says. And it also likely won't be enough for developers to qualify for tax credits and other state-allocated subsidies that could boost the potential for long-term successful financing on a deal.

"Inclusionary zoning means that affordable housing can be delivered as part of a larger market-rate complex, but there's no magic bullet--there's not one way to do it," Carty says. "There are a variety of creative ways that have been proven."

"It would be great to be able to build a 100 percent affordable-housing project in the middle of New York City or Los Angeles or wherever," says Coccaro. "You can pick any urban area. But the reality is that you can't get it to work. There is not enough income when it comes to buying the land and building the building. So we're seeing more deals where it's 20 percent of the units for 60 percent AMI renters, or some other percentage. I think that's going to be the trend. There's no other way to do it."

That said, Coccaro advises both developers and lenders to take a hard look at neighborhoods before committing to a percentage of units for subsidized renters. And, he says, take a good, hard look at the local government and any restrictions or perceptions about this kind of housing.

"It's harder to build. It's harder to lease. It's harder to permit," Coccaro says. "And for all the mixed-use stuff you see when you come into an urban area, there's a lot of NIMBY [not-in-my-back-yard] stuff."

Coccaro points to a new rental property being built in tony Bethesda, Maryland, one of the country's wealthiest ZIP codes, just a few miles outside of Washington, D.C., that was originally slated to have a percentage of affordable housing. A previous phase of the development had similar plans that flopped, thanks to local outcry.

"That deal took 10 years to build, and they never did do apartments because of all the outcry," he says. "The new part was slated to have a certain percentage be affordable, and now it's just going to be four stories of market-rate rentals."

Even states with their own incentives for builders that include affordable units can be tricky, Coccaro says.

"People just don't want that sort of affordable housing," says Sarah Garland, national director of multifamily affordable housing at Fannie Mae. "They have a vision of old HUD concrete. That's not where we are today, but people still visualize that. The projects we participate with, you can't tell the difference between the affordable units and the market-rate units. In fact, that's against the law--you have to mix them in; you can't congregate them."

Being aware of all these types of regulations and others can make or break the long-term success of a subsidized deal. When considering whether to finance a deal that's partially based on tax credits or other government programs, lenders would do well to completely familiarize themselves with both the regulations and the potential property owner's familiarity with them.

"Compliance [in terms of] affordability is an ongoing thing," says Coccaro. "The risk of not being in compliance--of losing your tax credit--is a big risk. If a property owner doesn't know how to manage that component of it, you could be at risk."

Knowledge of the local market is also important, says Freddie Mac's Griffith. "If a property has restrictions associated with it, like if it's for [those] age 55 and above, you need to be sure that the market to be served has a sufficient market within that group of people to fill up your building and keep filling it up," he says.

"You do all kinds of studies looking at potential tenants and whether they're going to qualify. And you do the same thing with any affordable deal, you want to be sure that there's a demand within that group of tenants. Look at the market rents on comparable properties. Look at it both as a developer and as a lender, and look to see that there's a rent advantage to living in this restricted-income property as compared to a market-rate property in the same area."

Non-subsidized housing

Tax credit properties aren't the only ones hoping to reinvigorate the affordable-housing market. Developers across the country are investing in so-called work-force housing. That is the term being used for rental housing that's technically market-value but is rented for lower amounts so that blue-collar and service workers can afford to live near where they work.

"If affordable housing is at or below 60 percent of AMI, workforce housing, depending on location, can be anywhere from 80 [percent] to 120 percent of AMI," says Griffith. "Work-force housing was a phrase that, at one time, was substituted for affordable housing. It's evolved a notch or two in terms of income [level]."

The advantage to that, he says, is that it helps soften a neighborhood's potential resistance to the apartments. Work-force housing is often associated with teachers, police officers, firefighters and other community servants, and doesn't generally get the same negative reaction as pure subsidized low-income housing, especially in more upper-income areas.

Much of what Alterra rehabs falls into the work-force housing category. "The properties we buy almost always need significant investment to make them safe again," says Wanderer. "In order to do that without raising rents, we have to buy correctly. They're usually about 50 percent occupied, and we're buying them out of foreclosure or from a bank."

Because such properties aren't subject to the same reporting requirements as traditionally subsidized housing, Wanderer finds this kind of housing easier to finance and manage properly.

"The markets are liquid both in debt and equity markets," he says. "We're able to find money pretty easily. The hard part is getting deals--people are used to a crazy bull market where prices are going up by 15 percent a year."

Even here, though, builders and owners struggle to find ways to cut costs and keep maintenance on the lower side so rents don't have to go up. And Coccaro says that challenge may stymie some of the appeal of today's affordable and work-force housing in the long run.

"Developers are cutting costs by building smarter," he says. "They're buying stuff in bulk. They're subcontracting everything instead of having a lot of crews. They're doing all those kinds of things. But part of the thing that suffers becomes the expense of doing affordable housing--the community center is smaller; the pool is smaller, or there isn't a pool. Right now, you'd be hard-pressed to tell the difference between an affordable complex on one side of the street and a market-rate on the other. In the future, you may see more of a distinction. That's definitely not the goal," he adds.

Kim Fernandez is a freelance writer based in Bethesda, Maryland, and is a former managing editor of Units magazine. She can be reached at [e-mail].

RELATED ARTICLE: Defining the Need

The Department of Housing and Urban Development (HUC) defines "worst-case needs" households as those who either pay 50 percent or more of their monthly income for rent, or who live in substandard housing. In 2005, 5.99 million U.S. households had worst-case housing needs.

Of those 5.99 million households:

* 1.29 million were elderly, and 2.23 million had children at home;

* 3.10 million were non-Hispanic white, 134 million were non-Hispanic black and 1.17 million were Hispanic;

* 520,000 lived in severely inadequate housing units;

* 208,000 were located in the Northeast, 143,000 were in the Midwest, 338,000 were in the South and 129,000 were in the West; and

* 2.91 million lived in central cities.