The statistics are no surprise.  The Urban Institute says for every 100 extremely low income households there are only 29 adequate, affordable, and available rental units.  A two parent household with both parents working minimum wage jobs might have to wait years to find a safe and affordable place to raise their two kids.  So why, the Institute asks, with demand so great, are developers not racing to build affordable apartments?

Well, that is no surprise either.  There is too little money in it.  The cost to build and maintain housing is typically too high to be offset by the rents potential tenants can afford to pay.  The gap becomes even greater as the target population of renters drops down the income scale. The rent the poorest families can pay may not be enough to cover the operating expenses even if the building could be built for free.

To demonstrate this gap between cost and return the Urban Institute, in concert with the National Housing Conference, has constructed an interesting hands-on software tool.  The real purpose however is to point out that about the only way affordable housing can be built is with government subsidies.

Titled "Affordable Housing:  Does it Pencil Out?", the on-line tool lays out the costs (also called Uses) to build affordable housing. These include

  • Acquisition costs (land)
  • Construction Costs
  • Developer fee
  • Design Fees
  • Construction loan interest and permanent financing fees
  • Reserves
  • Project management fees

The Institute used data from the Denver metro area to construct its tool.  The area has experienced a recent growth in rental housing demand (and home prices have been rising more than almost any metro in the country) but it is not a traditional high-cost city.  The rental housing conditions in the city, the authors of the tool say, are largely representative of other U.S. cities.

The tool takes the user through these various uses and sources of funding and the decisions (or lack of choices) confronting the developer regarding each.  The first major cost, acquisition of land, is relatively fixed although land is sometimes donated such as tax titled properties from city inventories. While a developer could make some decisions to minimize construction costs, they are largely determined by market forces.  The developer fee is built into development costs because a developer uses it to pay all the costs of doing business: hiring staff, running an office, finding new opportunities, and more.  Developers can choose to defer a portion of the fee, recouping the deferred portion as rents are paid over time. leaving more money to cover development costs.  This assumes, of course, that the gap is eventually closed, that the building is built, and that it operates successfully for years.

Using a model in which 50 apartment units are built, without tax credits (which are difficult to obtain for smaller buildings) to be rented to tenants with incomes 30 percent above the area median (AMI), the Institute estimates there will be a gap or deficit of $12,723,798.  Economies of scale play a surprisingly small role; the gap when building a 100 unit building instead (and using tax credits) shrinks by only about $1.9 million.

The most important source of funds for affordable housing projects is debt and loans are of course based on the project's plans showing enough revenue to pay back loans and pay returns to investors.  Lenders use the net operating income (NOI) to calculate how much debt a developer will reasonably be able to pay off, accounting for interest and recognizing the developer still needs to have some cash flow to cover unexpected expenses.  If the rent is set at rates that a working family can afford, that NOI is going to be quite low. It might even be less than zero if operating costs exceed revenue. The lower the NOI, the lower the size of the loan.

The tool takes into account other variables such as vacancy rates, reserves for maintenance and repairs, use of tax credits (just because a project qualifies for them doesn't mean it will get them), and higher rents. 

After a much more complete description of the process and variables than we have provided, the tool allows the user to play. How much does donated land improve the picture (by about 10 percent for a 50-unit development); can construction costs be lowered without violating building codes?  Switch tax credits on and off; defer the development fee, raise the rents, try to close the gap.

What is most striking is how minor the improvements in the deficit are with each individual change.  There is also a fine balance; lower the amount kept in reserves and other variables are thrown out of whack.  Raise the rents and you not only shut out low income renters, the purpose of the development, but risk losing access to tax credits which require rents not exceed 60 percent of AMI, or rent subsidies which are targeted to families earning less than 30 percent.

The tool, as we said, is designed to show that the only way to close the gap is through subsidies.  These come in different forms. Some, like vouchers or rental assistance, help pay the rent, leaving tenants enough income to pay for other needs and making the property operate sustainably. Others, like tax credits, Community Development Block Grants, and housing trust funds help pay the costs of construction, development, or major repairs.

The Institute says "No one subsidy can solve the affordable housing problem. Rather, a combination of programs including federal tax credits, state housing trust funds, local zoning decisions, and public land contributions can help affordable housing get built. To close the gap for affordable housing, especially for the lowest-income households, there almost always has to be assistance for both development and rental income over time.

You can try your hand at developing affordable housing, on paper at least, at http://apps.urban.org/features/cost-of-affordable-housing/.