A simple Google search related to the lack of affordable housing in the United States will yield a plethora of scholarly articles, each one seemingly making the case for more concerted efforts to increase future development and availability of affordable housing. And, while there are programs aimed at increasing available housing stock, it is important to keep in mind that, for the builder or developer, a strong economic case must still be made.
For anyone looking to build or manage a multifamily housing community, net operating income and profit is a key factor. Even where there is a strong will to build a particular housing development, it is always contingent upon making the business case. In other words, if the expected rental income does not cover the expected operations and maintenance costs, it is highly unlikely that even the most well-planned development will become a reality.
Since the mid-1990s, the Federal Low-Income Housing Tax Credit (LIHTC) Program has played a key role in promoting the development, acquisition and rehabilitation of affordable housing developments across the United States. This program provides federal tax credits to each state based on total population. Each state then awards available tax credits to developers on a competitive basis. Developers sell these tax credits to investors in order to finance new projects.
In terms of tax credits, the higher the corporate tax rates, the higher the credit. With the passage of the Tax Cuts and Jobs Act of 2017, the corporate tax rate was reduced from 35 percent to 21 percent. While this was good news to many, this act actually had a negative effect in terms of the LIHTC Program. The decline in the corporate income tax rate actually reduced the available tax credits by 14%. This translates to almost a $1.7 billion reduction on an annual basis. Since 2017, this has made it increasingly difficult for developers to make the business case for new affordable housing developments.
In addition to the tax credits, there is also the estimated property value, a key factor in the underwriting process. As an affordable housing development is a for-profit business, the net operating income is a key factor in calculating the value of a property. Using net operating income as the key factor is called the “income approach”. This approach entails using a cap rate as a multiplier to determine additional value to the property. For example, a property earning an additional $200,000 per year with a cap rate of 10% would have a value of $2,000,000 more than a property earning $200,000 less. This figure is calculated by dividing the net operating income by the cap rate. Having a higher property value at underwriting lessens the risk associated with the loan and helps to further the business case.
Finally, the amount of rent that can be charged is what determines the amount of net operating income. The maximum allowable rent that can be charged for any given area is set at 30% of the Area Median Income (AMI).
So, how can a developer make a better business case by essentially increasing the value of the property, increasing net operating income and increasing profit? The answer is Utility Allowance Modeling. As covered in previous blogs, the maximum allowable rent is the sum of the net rent and the utility allowance. The higher the utility allowance, the lower the net rent. If a property is operating under a published utility allowance set by the local housing authority, they have no real opportunity to impact the net rent that can be charged. This is even more critical in areas of high demand, where maximum rents are the norm. In maximum rent scenarios, a brand new highly energy and water efficient property would command no more rent than an older, less efficient property that is located directly across the street. And, when a brand-new property can command no more rent than an existing property, it becomes very difficult to make the business case. Enter the case for Utility Allowance Modeling.
Imagine that a planned property with 200 each three-bedroom/two bath units is being considered. If the maximum rent per unit, based on the AMI, is $1,200 per month and the published utility allowance is $300 per month, the net rent is $900 and would be no more than that charged by any other property within the general area. If the required net operating income at 95% occupancy is $2.3 million, the deal would fall short by $248,000 a year.
Now let’s imagine that same property with a custom utility allowance of $150 per month. The net rent would rise to $1,050 per month. The net operating income at 95% occupancy would increase to $2,394,000 per year and the value of the property, based on the income approach would increase by $2 million.
The tenants in this new property would pay a net rent of $150 more per month than the older property across the street, but would enjoy the amenities of a more modern property and an equal offset provided by significantly lower utility costs. Business case made!
Need help making a better case for your current or planned affordable housing development? Give us a call!
Eddie Wilcut, Plummer’s Water and Energy Efficiency Practice Leader, has 6 years of experience conducting energy consumption modeling for Low Income Housing Tax Credit (LIHTC) properties and HUD regulated properties. Eddie also has 22 years of experience in Program Development, Project Management, Program Management, Contract Administration, Scheduling, Facility Assessment, Programming, Cost Estimating, Energy and Water Conservation and Sustainability. To date, the Plummer team has successfully provided energy consumption models for more than 200 properties across 28 states.
The Plummer team includes a group of highly skilled project managers, engineers and energy modelers. The significant expertise, experience and knowledge base of the team acquired by successfully conducting utility allowance modeling for a large number of properties across the United States will help them quickly determine the best and most cost-effective platform and methods required to achieve the best and most reliable results. A proven and collaborative process involving the modeling team and the developer will result in identification of the most important elements that will lead to decision making that will ultimately provide the greatest and most cost-effective results for both the tenants and the owner.
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