Key takeaways on the role of HFAs in filling unexpected funding gaps from the Washington Report by the National Council for State Housing Agencies.

The state of the housing market is currently jeopardized, with rising construction and labor costs sharply increasing development costs across the board. This has especially impacted affordable housing development, with a growing number of Low-Income Housing Tax Credit (LIHTC) developments struggling to be completed on time. Owing to these challenges, aggravated by the supply chain disruptions caused by the pandemic, developers are increasingly looking to State Housing Finance Agencies (HFAs) for urgent funding.

As the primary sources of financing for affordable rental housing through the LIHTC, HFAs have a lion’s share of responsibility in ensuring affordable housing development in their jurisdictions. During this time of crisis, HFAs have had to step up and employ strategies to help developers close unexpected funding gaps. On September 20, the National Council for State Housing Agencies released a report titled ‘Filling funding gaps: how state agencies are moving to meet a growing threat to affordable housing’, which documents how HFAs are taking extraordinary actions to tackle unprecedented cost increases across development projects. Below we have summarized the main takeaways from the report. 

Overview of the funding gap problem 

The NCSHA report states that across the board, HFAs reported funding shortfalls for LIHTC projects. Developers requested additional funding from HFAs since most of their projects faced significant unexpected cost increases. These cost increases were fueled by several different factors, a few of which are discussed below:

Increased demand for labor and subsequent rise in labor costs

In the post-pandemic market, there has been a noted rise in construction activity, especially in the residential sector. The low-interest rates, the work-from-home transition, and federal stimulus payments all contributed to an increase in demand for housing construction. Respondents to the study reported witnessing more overbooked general contractors and subcontractors and fewer bids on projects. This caused labor shortages and increased the cost of labor in the construction sector.  

Rising material costs and project delays

According to numbers reported by Fannie Mae, the price of most construction materials rose significantly from 2020 Q3 to 2021 Q3. Notably, besides the highly publicized increase in the price of lumber, steel and aluminum were up 22 percent and electrical and lighting were up 12 percent. Additionally, increases in the cost of fuel have also increased shipping costs. Besides the rising cost of construction materials, project delays were another major cause for concern for the industry. Staffing shortages, supply chain disruptions, slower-than-usual development approval processes, and slower underwriting and approval processes for financing partners all contributed to the project delays.

Rising Construction Costs

Increase in interest rates 

Several stakeholders reported that the increases in interest rates further contributed to increase in project expenses. Interest rates went up for construction loans and any delays in the construction process added direct costs to the project expenses. The rate on permanent loans for some organizations cannot be locked until the loan closes, and this led to higher mortgage costs for those organizations, due to delays in construction processes. There were also concerns around the re-underwriting of project deals due to the reduced value of tax credits to investors, since they would be receiving them at a later time. 

Role of HFAs in closing the funding gap

State HFAs and other state housing agencies have played a crucial role in the efforts to help fill gaps in LIHTC deals. These efforts depend on a plethora of factors, including whether or not States have allocated recovery funds, the number of housing agencies present and their specific roles, and the availability of a state tax credit or state housing trust fund.

The report has categorized the strategies of HFAs in helping developers close unexpected funding gaps. Following are the five different categories identified by the report:

  1. Offering administrative flexibility to developers - Allocating agencies worked with developers to offer various administrative flexibilities such as timeline extensions, waiving penalties for returning unused credits, and allowing changes to some aspects of the project, such as the number of units, amenities, and community space. The capacity of HFAs to offer such concessions is, however, tightly constrained by the State statutes under which they operate.

  2. Allocation of future year LIHTC in advance - Most of the HFAs that participated in the study adopted a process of “forward allocation”. This meant that they were allocating an additional 9 percent LIHTCs for projects that already have 9 percent allocations and were facing funding gaps. This process allows a developer to take an extra year to meet statutory deadlines for placing units in service. It also prevented from project credits being returned to the State agency owing to its failure to meet deadlines. This has been able to close funding gaps in the short term but creates long-term challenges since these future credits would no longer be available for allocation the year after. 
  1. Increasing financing from tax-exempt bonds - Projects which use tax-exempt bonds have to take a ‘50 percent test’. For these projects to qualify for 4 percent credits, they need to finance at least 50 percent of the project costs with tax-exempt bonds. To meet the challenges of unforeseen funding gaps for developers, HFAs took to allocating additional tax-exempt bonds to projects to help them reach the 50 percent level. These additional tax-exempt bonds drive up the 4 percent credits, which allows properties to raise additional equity and close a major portion of their funding gap.
  1. Using federal fiscal recovery funds - Congress authorized a recovery funds program in the American Rescue Plan Act in March 2021. Under this, a total of $350 billion was allocated to government entities to support their response to the COVID-19 pandemic. As of June 30, 29 states had allocated nearly $9 billion in recovery funds to a range of affordable housing purposes, and an additional $5 billion was committed by local governments. 
States devoting fiscal recovery funds to affordable housing

Federal recommendations to increase resources for affordable housing 

The report collected a series of recommendations from all the participating stakeholders about how to improve resources for affordable housing development in the long term. These recommendations are primarily concerned with increasing resources for 4 percent and 9 percent credits and changing rules around recovery funds to facilitate their use in funding LIHTC projects. Below are some of the primary recommendations from the report:

  1. Restore and make permanent the temporary 12.5 percent increase in 9 percent tax credits that expired in 2021.
  2. Increase the volume cap for private activity bonds for each state.
  3. Alternatively, reduce to 25 percent the share of the adjusted basis that needs to be covered by bond costs to qualify for 4 percent credits.
  4. Allow recycled multifamily bonds to be used for single-family housing.

The road ahead: how can HFAs improve their operational efficiency?

During this period of crisis and increased urgency to close funding gaps, some HFAs reported experiencing staff shortages, which caused project delays and further pushed up costs. In the process of closing funding gaps, the capacity to quickly underwrite loans, share documents for due diligence, and being able to streamline conversations with multiple parties proves crucial for HFAs. Here are some of our suggestions on how HFAs can improve their organizational efficiency to shorten loan closing timelines:

  1. Set up a digital developer intake form to centralize your loan application intakes
  2. Standardize and digitize the due diligence collection process and double the speed of underwriting.
  3. Create turbo-tax style investor memos with minimum data entry and utilize your underwriting proforma and asset data for data driven underwriting and insights. 
  4. Streamline your task management systems and centralize task-based communications to help close loans faster.

Due diligence checklists that you can make on the Builders Patch platform

At Builders Patch, we are helping HFAs upgrade their lending processes to achieve all of the above and more. We work with NYCHDC to modernize their affordable housing development pipeline and we can do the same for you.

If you would like to know more, get in touch with us for a free product demo. Check out the full report on HFAs closing funding gaps on the NCSHA website.  

Sumedha Bose
Builders Patch Staff

Sumedha is a seasoned urban policy expert specializing in international housing policy. Armed with dual Master’s degrees from the prestigious Tata Institute of Social Sciences in Mumbai and Institut d’études politiques in Paris, she brings a wealth of knowledge and international perspective to her field.