Rising Construction Costs Stall Affordable Housing Projects

This story was originally posted by Stateline, an initiative of the Pew Charitable Trusts.

To start building an 80-unit affordable housing project in Texas, real estate developer MVAH Partners must find a way to fill a $3 million financing gap due to the rising cost of construction.

MVAH Partners received federal tax credits in February of last year to build the apartments. Since then, however, building material and labor costs have increased by more than 40%, according to Brian McGeady, managing partner at the Ohio-based company.

“We’re scrambling to find ways to redesign the development and find gap financing in order to get it across the finish line,” McGeady said.

McGeady and his team faced a similar problem with another development in the Midwest (he wouldn’t disclose the state) that was more than $1 million in the red. In the 50 days it took MVAH to redesign and rebid the project, costs had gone up even more, forcing them to scale back the number of apartments in the development from 58 to 42.

“This is a moving target that is moving at such a fast pace, that you're just not sure what's going to happen,” McGeady said. “I mean, you've got lumber prices going up and down 40% in a 45-day window right now. It's crazy.”

Developers across the country are facing similar challenges. For developers of market-rate apartments, it means charging higher rents. For those building rent-restricted projects using tax credits or other government aid, the rising costs could quash an entire project. And the construction slowdown is coming at a time when there is a desperate need to increase the nation’s supply of affordable housing.

The stock of low-cost rentals has been shrinking for some time: In 2019, there were 3.9 million fewer units renting for less than $600 than there were in 2011, according to the Joint Center for Housing Studies at Harvard University. The overall rental vacancy rate in the fourth quarter of 2021 was just 5.6%—the lowest figure since the mid-1980s—evidence that there is an extremely tight supply of apartments.

Nationwide, rent prices have increased by more than 17% in the past year, according to Apartment List, which tracks rental properties across the country. Those rising rents have put homes out of reach for many low- and medium-income renters.

Tenants’ incomes have not kept up with the rent increases. Nationwide, about half of renters are paying more than 30% of their income in rent, the standard metric of affordability, according to Ingrid Ellen, director for the Furman Center for Real Estate and Urban Policy at New York University.

Ellen said government housing programs haven’t responded to tenants’ changing needs and broader economic conditions.

“Nominal spending on rental assistance has remained essentially flat for the past two decades, despite large swings in the national economy,” Ellen wrote in an email to Stateline. “These challenges will only compound the longstanding housing challenges faced by low-income renters.”

The pandemic has laid bare the country’s housing needs and the extent of housing inequality, said Carolina Reid, faculty research adviser at the Terner Center for Housing Innovation at the University of California, Berkeley. It also has made clear that the patchwork of state and federal housing programs isn’t effectively addressing those challenges.

“U.S. housing policy and programs are the result of decades of little fixes and little programs adding to each other without actually thinking about the whole system and what the whole system needs,” Reid said.

Expensive Lumber

The largest source of affordable housing financing is the federal Low-Income Housing Tax Credit program, known as LIHTC, which was created in 1986. Since its inception, LIHTC is credited with creating 90% of affordable housing in the U.S., according to the federal Department of Housing and Urban Development.

Under the program, which is jointly administered by the IRS and state housing agencies, private developers compete for federal tax credits, which they generally sell to private investors. The influx of cash makes it profitable for them to build units they can rent at below-market rates, which they are required to do for 15 to 30 years.

But because of rising construction costs, many credit recipients say their LIHTC projects are no longer financially viable, according to J.P. Delmore, assistant vice president of government affairs at the National Home Builders Association.

The cost of lumber is a main contributor, Delmore said. The price per 1,000 board feet of lumber topped $1,500 last year, nearly three times the pre-pandemic record. Delmore said his group’s economics team estimates this added an average of $7,300 to the cost of building every new market-rate apartment, or about $67 more a month in rent per unit.

Lumber is not the only material that’s increased in cost. Ohio-based developer MVAH also has seen increases in most oil-based products, including asphalt and shingles. McGeady, manager at the company, said the costs of these products are “going through the roof,” and fluctuating almost as much as lumber. Rising fuel costs also have increased the cost of manufacturing, delivery and transportation of all materials.

“There's never been a time period that I can recall where things have moved this rapidly,” said McGeady, who’s worked in construction for 23 years. “We really don't have a final number until we’re about ready to sign a construction contract and close.”

Nearly every state has LIHTC projects facing financing gaps due to inflationary pressures, according to Jennifer Schwartz, director of tax and housing advocacy at the National Council of State Housing Agencies, an association representing all state housing finance agencies.

“Unless we can fill those gaps, we face a vicious cycle where cost increases make affordable housing infeasible to build and the lack of affordable housing supply allows market-rate rents to rise even more,” Schwartz said.

A Possible Solution?

Schwartz said it would be possible to use billions in federal coronavirus aid to help fill the gaps, but the U.S. Treasury Department spending rules prevent it from being used for LIHTC projects. The problem is that, under the current rules, recovery funds must be spent by the end of 2026. That means the money can’t be used for long-term loans to help finance LIHTC developments.

Some state housing agencies have found a way around the restriction by mixing federal coronavirus aid and other funds. Mark Shelburne, housing policy consultant with Novogradac, a consulting firm specializing in low-income housing finance, said some agencies have been able to use recovery funds to cover up to 75% of the cost of a loan with these workarounds, but the process is complicated and adds costs to a project.

“Projects that got awards in 2020 and 2021 are facing unprecedented cost increases because of the dramatic strangeness that’s going on all over the world,” Shelburne said. “It’s just something about the way Congress wrote the law, and the way [the U.S.] Treasury interpreted it that created this problem.”

A bipartisan bill in Congress would allow states to use recovery money to lend money to LIHTC developers.

Timothy Henkel, principal and president at Pennrose, a management and development company with affordable housing projects in more than a dozen states, said developers are “all sitting on the edge of their seats,” waiting to see whether Congress will approve the bill.

Pennrose has 10 projects with financing gaps varying from $6 million to $8 million. Five of these projects are in Maryland, where the state housing finance agency approved the initial bids more than a year ago. Pennrose had estimated that construction costs would increase by no more than 3% in the three or so months it would take to secure the deal and begin construction. The actual increase turned out to be closer to 18%.

“When you have this volatility and this explosiveness in the industry, in terms of rises in construction costs, all bets are off,” Henkel said. “So our view of the finish line is very muddy.”