Housing USA: Higher Interest Rates and Affordable Housing – A Perilous Mix?
By Scott Beyer
5 min read
Increasing interest rates impact virtually all investments since they present higher borrowing costs, falling prices for existing bonds and possibly lower earnings for publicly traded companies. But they’re of particular concern to the housing market and real estate development community, and affordable projects, including those financed through Low Income Housing Tax Credits, are particularly vulnerable. Amid the highest inflation in decades—standing at 8.3 percent at publication time—the Federal Reserve has been hiking the federal funds rate following years of relatively low rates (and prior to that, lowering rates and “quantitative easing”). This marks the most sudden and aggressive tightening in a generation.
Overall, new construction dropped 9.6 percent in mid-summer. This condition compromises housing affordability enough but rising interest rates make affordable projects, such as those financed through LIHTC particularly vulnerable to investor reluctance, and compounds the burden already being felt by inflation and supply chain challenges. Kelsi Boland writes for Globe Street that the hikes “will make housing deals more expensive, but inflation has triggered rapidly appreciating property values, thereby contributing to the affordable housing crisis.”
In 2016, when an overheating economy prompted its own series of rate hikes, analysts suggested that LIHTC projects particularly could be negatively impacted. “Higher interest rates mean smaller loans, resulting in larger financing gaps for LIHTC deals, and there’s less soft money to fill such gaps,” Cinnaire President Mark McDaniel said then.
Fast forward to now, and the Wall Street Journal’s Rebecca Picciotto reports that affordable housing projects are falling through, and developers are reaching or exceeding their budgeted construction contingencies. A Cleveland-area affordable developer has delayed the construction of 200 units. “I’ve been doing this for 18 years. I’ve never seen this level of uncertainty or this level of complexity to get anything done,” Aaron Pechota with NRP Group told WSJ. Industry watchers point to rate hikes as partially responsible for a staggering 45 percent drop in affordable construction in New York City.
“The rise in interest rates is definitely hurting our industry,” writes Brian Coffee, senior director of Community Investment Capital for Synovus, “as the amounts of debt that a property can support are falling as interest rates rise.”
Jim Spound, president of affordable housing financier R4 Capital, says that the rate increase from 1.50, in late 2021, to 3.40, at present, demonstrates how the environment has changed. “That’s a pretty dramatic increase and reduction in affordable properties’ ability to carry a mortgage,” says Spound. Both he and Coffee also emphasize the continued impact of supply chain and material price increases on the development market.
Boland quotes an analyst who speculates that LIHTC- financed projects will face additional hurdles from the increases because they will widen “funding gaps” combined with increasing construction expenses. Spound concurs, noting that his firm has “reacted by, sort of, tightening our lending spread.”
“Everyone is seemingly trying to ameliorate the debt issue by making some underwriting concessions,” Coffee says, “e.g., lower vacancy assumptions, higher rent growth forecasts and operating efficiencies,” though cautioning that this could be harmful if the predictions prove wrong.
Spound says that the affordable housing industry is “being very creative” to keep projects underway amid the rate hikes.
“Obviously developers are working with thinner markets, equity investors will work with their structure as much as they can to generate more proceeds, and folks like us are asking our capital partners to tighten our belts.”
Picciotto says that user requirements for economic recovery funds have made it possible to use them more broadly for affordable housing and that developers are cutting costs by cutting some project elements. Another option seen is exploring private charitable donations, Picciotto reports.
But many projects now underway are proceeding, with developers looking for additional funding opportunities or delaying parts of project delivery in hopes that prices will come down. “It’s not the nature of folks in our business to give up; they slow down, they look for improvements,” he notes. Coffee, however, says he’s aware of examples of projects being “outright canceled.” He also points out that some states have increased subsidies considering the rate hikes.
Another tool available to investors is Department of Housing and Urban Development loans, which provide rates that aren’t as high and “up to a 35-year amortization, compared to a typical CRE loan, which only offers amortization of 20 to 25 years with terms as short as five years.” However, the loans come with conditions, like inspection conditions and “owner distribution and cash out restrictions.”
Granted, LIHTC investment has been relatively strong of late, with Fannie Mae stating, “LIHTC properties have generally outperformed properties with Class C units, defined by RealPage as units in the bottom 20 percent of rents for a market.” And rates still aren’t as high as they were in the early 2000s, JP Morgan reports in an analysis on multifamily construction, further noting that some conditions are favorable for affordable and workforce-centric construction.
Thus, it’s possible that LIHTC investments will remain attractive even amid rate hikes, and that rate hikes could reach a ceiling in the relatively near term, but any disruption could blunt progress on meeting national and local affordability goals.
Then of course there’s the prospect of rising rents: housing analyst John Burns points out that higher interest rates have led some sellers to rent their homes out, while prospective homebuyers delay any purchase and rent instead. This explains why rental inflation is now at 6.7 percent, its highest in nearly 40 years. However, this windfall is not always available to managers of LIHTC properties, due to laws capping rent increases.
Wherever one’s goals lie, high interest rates are counter to the interests of those who wish to see affordable home projects completed. Rising interest rates are a matter for affordable housing investors and developers to follow, as continued inflation makes further hikes likely.
This article featured additional reporting from Market Urbanism Report content manager Ethan Finlan.
