Housing USA: Does LIHTC Need Retail?

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6 min read

The U.S. market for retail space has been in flux. The industry sees a lot of churn generally, and this has been particularly so in the last decade, as brick-and-mortar stores close. Some commentators—laying heavy on the hyperbole—even talk of a “retail apocalypse” that will leave cities with abundant vacant buildings and diminished tax receipts. This doomsday scenario is unlikely, but there’s still enough uncertainty in the sector to affect affordable housing, since the approval and financing of projects often depends on having a commercial component. Thus, parties who would be interested in retail trends should include not only the developers building these projects, but the state agencies that distribute Low Income Housing Tax Credit (LIHTC) equity.

The headlines that blare out about retail speak to a revolutionary shift in the industry. Amazon and other online providers offer lower prices, more selection and greater convenience than physical locations. Since 2017, retailers have closed more than 15,000 stores, and another 75,000 closures are expected by 2026. Today, 16 percent of overall sales are made online, and that’s expected to be 25 percent by 2026.

“This is a healthy cleansing for the retail industry,” says John Morris, a brand analyst for D.A. Davidson, to the Washington Post. “We’re in the middle of a multiyear retail purge. Companies are finding that when it comes to stores, less is more.”

The New Retail Experience
But the retail industry is too complicated to call this an “apocalypse,” or even a serious decline. Rather, commercial space will likely be readapted for new uses. These could include experiential retail (restaurants, microbreweries, coffeeshops and other “experiences” you can’t get online); co-working spaces and other niche office formats; educational facilities, such as charter schools and community colleges; product display rooms for online retailers; warehouse space for the on-demand delivery economy; and more. Some of the retail infrastructure, such as big box stores and indoor malls, has already been repurposed, while in other cases it gets redeveloped into housing. These trends are coupled with a cooling of retail construction since 2007.

As a result, the retail vacancy rate has hit a 15-year low, down to 4.5 percent, according to the real estate investment services firm Marcus & Millichap. In the fall of 2018, Moody’s reported that the industry’s sales growth would be 4.5 percent to 5.5 percent, and changed its outlook on retail from stable to positive. This reflected, says Senior Credit Officer Mickey Chadha in a statement, “Increasing top-line growth and operating profits as companies’ investments to improve both the online and in-store shopping experience continue to gain traction.”

But it’s still good, because of retail’s evolving nature, for the affordable housing industry to be cautious about adding it to projects. Right now, this caution isn’t forthcoming.

Several states include retail provision as a way for developers to score points during the Qualified Allocation Plan (QAP) for distributing LIHTC equity. In Indiana, to name one example, four points are awarded “if an investment of resources is provided that will result in offsite infrastructure improvements within a ¼ mile of the project site(s), and/or the development of parks, green space and shared amenities, recreational facilities and improvements within a ¼ mile of the proposed project site(s).” It later states that improvements or amenities could include “construction of shopping or retail center adjacent to the property.”

In other cases, the language favoring retail isn’t explicit, but surfaces in other QAP points criteria, says Tim Henkel, senior vice president at Pennrose, a large developer of mixed-use, multi-family housing across the East Coast. The rationale is that LIHTC developments are supposed to do more than just provide affordable housing; they often have a coterie of services to help projects generate a complete neighborhood feel.

“There’s a little bit of a bias,” says Henkel. “A lot of states have more subjective categories where you’re talking about community impact and things like that. If you’re featuring some ground-floor uses that are retail or community service space…that kind of stuff carries weight.”

The Burden of Retail
Such thinking is understandable, but can also be problematic. Including retail is especially difficult for LIHTC projects, says Henkel, because retail-residential mixes are often viable only in dense cities with hot markets. Subsequently, those are some of the hardest places to build affordable housing. In secondary and tertiary markets where affordable housing is easier, the concept of walkable, mixed-use development is often not well-embraced.

Henkel says that two recent Pennrose projects that were mixed-use and leveraged LIHTC equity bear this out. One was Meriden Commons, a 151-unit mixed-use project still under construction in Meriden, CT. Pennrose filled its retail space with a restaurant and a deli, but only after an aggressive recruitment process that involved working with the chamber of commerce and the business improvement district. The other was Montgomery Heights, a project in Newark, NJ that had a failed daycare business, and that Pennrose is now trying to refill.

Dara Kovel, CEO of Beacon Communities, a Boston-based multifamily housing developer, agreed that retail is difficult to incorporate with LIHTC projects. An example of where Beacon is trying it is a 130-unit, mixed-use project in Amherst, MA. However, that commercial space will be “more of a placemaking experience, and less of an economic proposition,” and is viable because Amherst is a wealthy market. But Kovel doesn’t think ground-floor retail is applicable in many markets, nor should it be a QAP criteria.

“Making ground for retail to work, even in the strongest markets, is a challenging proposition at best, and retail obviously is a changing marketplace, and combining it with housing in all but the most sensible locations is likely to be doomed to failure,” says Kovel. “It’s not a great idea for state allocating agencies to give that preference.”

Another argument against retail is that it uses space that could go for housing. This matters, given that zoning and financing barriers often limit the size and density of LIHTC projects anyway. For these reasons, state agencies should be careful about constructing their QAP points systems too heavily around retail provisions. And developers who build the space should remember that, amid all the market changes, filling it could be tough.

Story Contacts:
Dara Kovel, CEO, Beacon Communities
[email protected]

Timothy Henkel, Principal and Senior Vice President, Pennrose
[email protected]