Leveling The Playing Field

Small-scale developers have access to fewer affordable housing subsidies than their big cousins. What gives?

Hey. Welcome to the next edition of Small-Scale Sunday from Brick + Mortar where readers get insight into the acquisition, financing, design, construction, and operations of small-scale real estate development projects.

First, a quick soundbite. Then, our main ramble.

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🎙 A Quick Soundbite

Minor observation: quite a few price decreases recently hitting my inbox.

Averaging 5-10%.

‘Tis the season, I suppose. But nonetheless— nice to see the market loosening up a bit.

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More Grants, Please

Market rate rents will always exceed what many people can afford.

If I develop an unsubsidized project for $300/SF, I’d need at least $3/SF/mo in rent to cover costs and eke out a marginal return.

For a 500 SF studio apartment, that’s $1,500/mo.

Not super affordable (in my market).

One way to address this is via subsidies such as grants, below market loan terms, and tax credits.

And, in exchange for—let’s call it—”more favorable” financing, developers agree to artificially reduce rents below market rates.

At least two good state housing programs for small-scale projects exist in Vermont:

1. The Vermont Downtown Historic Tax Credit Program (HTC)

2. The Vermont Housing Improvement Program (VHIP)

Both of which have been awarded twice to projects I’ve worked on.

HTC does not have any affordability requirements. In both instances, the award provided <10% of project costs—not enough to sway the needle much on rents yet still critical to funding the project’s capital stack.

VHIP, on the other hand, caps rents at the HUD Fair Market Rent for 5 years in exchange for $50,000/unit.

This means that a studio that would have rented for $1,200/mo without utilities now rents for $715/mo.

And, in return, my project costs are reduced from $150,000/unit to $100,000/unit.

In other words—I’m accepting a 40% reduction in revenue in exchange for a 30% reduction in cost.

The value in this tradeoff is only realized after 5 years. Starting Year 6, rents can be brought back up to market rate (or some middle ground high enough to pay investor returns).

$50,000 cash upfront traded for $29,000 in lost rent over 5 years. Certainly a long-term play.

And, while VHIP is a great program in some situations, the economics for the small-scale developers are far less favorable when compared to the programs the big guys have access to.

Point blank—larger developers have access to better affordable housing subsidies than the rest of us.

There’s the obvious federal program: Low Income Housing Tax Credits (LIHTCs). These reduce project costs by as much as 70% in exchange for the same 40% reduction in revenue.

A much better tradeoff than the 30/40 I get with VHIP if you ask me.

Vermont also has a few programs:

• Vermont Housing & Conservation Board (VHCB) has a program funded through ARPA for affordable housing projects

• Several organizations in our region came together to create the Upper Valley Loan Fund (UVLF) that provides below market debt financing for affordable projects

Unfortunately, all three—LIHTC, VHCB, UVLF—are geared towards larger developers that tackle big projects and have an administrative staff capable of navigating an extensive application.

But what the hell.

It’s only paperwork, right?

So I decided to apply for both the VHCB and UVLF programs (I submitted UVLF’s, still working through VHCB’s).

I’ll note that each is significantly more rigorous than the more friendly VHIP or HTC.

Funnily enough, both programs made it explicitly clear that my project may not qualify due to its small scale.

For reference, it’s a 6-unit infill housing project in the village core—a walkable setting one minute from Main Street shops, dining, and businesses. It’s hard to imagine a better location for affordable housing units.

And yet, perhaps naively, I’m optimistic one of them will pan out.

If not, there will be little means to deliver any of these units below market rates. Especially given where interest rates are headed (which directly impacts borrowing costs for construction which directly impacts long-term monthly debt payments which directly impacts rents).

For folks thinking: Well, why doesn’t the greedy landlord just take a haircut on the profits he’s reaping and proactively lower rents?

If that’s you thinking there—I invite you to take a look at this article I wrote breaking down how monthly rent payments get distributed on my 501 Main project.

Spoiler alert, there’s no haircut to be had.

In fact, there’s less hair on that deal than Vin Diesel had ten years ago.

RIP Vin’s hair. It was an early and tragic death.

You know what’s also tragic?

The gap in subsidy opportunities between large and small developers.

Don’t get me wrong—VHIP is a great first step.

But why should small-scale projects be capped at $50,000/unit when larger projects are getting $150,000/unit (using VHCB as an example)? Especially given that both programs have the same restrictions on rents.

Ultimately, the small guy ends up having to fund that $100,000 difference with debt or investor capital.

Just think about that for a second.

At today’s interest rates (8%+), $100,000 of debt amounts to $850/mo in added payments. For a single housing unit!

With rents are capped at $715/mo, your project is already in the red.

Forget about all the other operating expenses. You won’t even be able to make the first month’s debt payment.

Those numbers just don’t work.

Note: we were only able to make it work for 501 Main because we stacked multiple grants and will have almost 50% equity in the project by the end.

But to some extent, I get it.

The $50,000/unit VHIP program is meant for less intensive projects where surface level upgrades to kitchens, baths, and bedrooms are needed.

And there seems to be enough low hanging fruit across smaller landlords with vacant units for that to make an impact.

But once you get into electrical, plumbing, and HVAC replacement, the power of that $50,000/unit diminishes.

I’m bending the program a bit to work for my project. But only out of necessity due to lack of other options.

To me, this seems like a massive missed opportunity for our downtowns and village centers. Particularly if vibrant, mixed-income neighborhoods are really the goal.

What we really need are more affordable programs that either 1) cater specifically to small-scale projects or 2) can be flexible enough to work with smaller projects.

If we’re going to be holding small-scale developers to the same affordability standards as the rest (ethically, at least), let’s level the playing field.

Until next time.

— Jonah 🧱

P.S. Want to connect? Find me on LinkedIn and my projects on Instagram.