The Guru Is In
The Funding Sieve
By David A. Smith
4 min read
To the list of American things that are growing more expensive in real terms, we must add the standard LIHTC apartment, and the principal reason is our capital sourcing model, the funding sieve.
Pour new money into the LIHTC funding sieve and much of it runs out the other side not in additional affordability but in expanded costs of three main types:
1. Higher build/rehab costs. The quantum of expenditure needed to create livable affordable housing isn’t fixed; instead it depends on hundreds if not thousands of decisions about configuration, layout, building materials, finishes, and so on. In a pure market environment, each such marginal change is value-engineered against a simple standard: Will it pay for itself in higher rents or lower operating costs? That question is moot in most affordable LIHTC properties, where the rents are capped at bargain formulas (lower percentages of Area Median Income), and the occupancy concern isn’t rentability but eligibility qualification. Cost becomes a proposition not of economics but of funder desires, and funders like pretty properties.
2. Higher intermediary costs because each new form of concessionary capital or subsidy comes with its own mandates, limitations, requirements, and compliance obligations. Each capital provider has its own rules, goals, calculations, forms, and reporting requirements. Whose requirements prevail over whose? All of them.
3. Higher acquisition costs of property (for rehab) or land (for new-build) because the value of urban land is a residual. Urban land has no intrinsic value; it’s set by competition among buyers who are each doing their development arithmetic. As the buyers are all competing for the same resources (LIHTC, soft debt, state/ local funding), these tend to be priced in their sources of funds, and via the funding sieve they flow through into increased sales price to the current owner. Further, the market anticipates resource changes, all of which are publicly proposed, debated, revised, and then implemented long before the P&S becomes binding. So when the QAP identifies submarkets or subpopulations that will earn bonus points, land prices selectively jump. Properties that win allocations optimize their QAP points and (a) use every discretionary resource available, (b) have layers of externally imposed rules, all mandatory, and (c) win design/development awards. To these (often unconscious but nonetheless powerful) QAP biases are several more that further sieve the additional funding flowing in:
4. Add more missions. The 1949 goal, decent safe and sanitary housing, has gone the way of the dodo or the Blackberry: a great advance when introduced, now hopelessly awkward and flightless. Today’s LIHTC properties are “housing plus,” with services aimed at a subpopulation that is extremely low income (ELI) due to a life challenge. Rent caps at 30% of AMI yield almost zero Net Operating Income, so the per-apartment soft money must rise to compensate.
5. Capitalize the ongoing unfunded mandates. The life services needed by ELI residents cost money to deliver, money that a zero-NOI operating budget cannot fund – so the natural solution, at least for QAP rulemakers and developers striving to win QAPs, is to capitalize a sinking fund for the service that will cover 5-7 years (beyond equity pay-in and far enough away to make hoping something will turn up a plausible funding strategy).
6. Placate the neighbors. In good markets, neighbors oppose; that’s what they do. Opposing, they are never required to propose or to invest, so they must be outlasted (unlikely) or placated. The result is design-by-reassurance, where the build cost and the intermediary costs rise.
7. Just one more straw, Mr. Camel. Few are so saintly that they give money, even for worthy causes, with no strings whatsoever. Most donors believe that as they are giving you ‘free’ money, you should add just this one little additional element.
In today’s LIHTC market, lots of money is poured in to each property; much of it flows out as increased cost. The resulting developments are lovely, ambitious, soul-stirring – and few.
