I wanted to do a short post today (sorry, it actually turned into a long one) on what I think is seen by many people interested in public development of housing as a significant hurdle, but that I think is perhaps less of an issue in the grand scheme of things: paying for it. If you’re establishing a public sector developer, the biggest hurdle in most places is going to simply be getting a bill that creates the authority for your new entity to buy land and build lots of apartments on it. People hate new apartments.
In an article this summer for Noema I touched on the question of “paying for it” in much broader strokes, but it’s important to get down to brass tacks when you’re proposing a new government sponsored enterprise or public authority that’s going to have a capital budget and is going to have an accounts receivable division with real people (who have lawyers) on the other end of the line. No matter which way you slice it, building housing is very expensive.
So below is an overview of a few ways I think about these issues.
The capital stack
Whether you’re a small community development corporation or you’re The Related Companies, L.P., when you want to build some apartments, you’ve got to put together a big stack of money to make it happen. Among the many different types of developers, this capital stack is remarkably similar: equity, debt, and if you’re a CDC, hopefully some grants.
In the wake of the housing financial crisis, financing for housing development did get more complex, as this visualization from The Real Deal demonstrates. The share of senior debt (i.e., the one who gets paid first if something goes wrong) has gone down, generally, and more complex arrangements of equity investments and mezzanine debt structures have developed, spreading some of the risk around.
Equity: Equity is when someone hands you a bunch of money in exchange for a stake in the ownership of the building-to-be and typically a claim on some of the rents that will be collected. It is a much riskier investment (if the project falls apart, for example) so it comes with a higher return. On the market side, returns on equity investment can be at or above 15%—quite high, relative to many other sectors of the economy.
Debt: Debt is when someone hands you a bunch of money that you have to hand back to them over a number of years, typically with some interest payments on top of that. Debt is much less risky for the investor. If the development fails, guess what: the developer is still on the hook, since they took out a loan. The debt investor typically does not have a claim on the rents, but will need to know what rents you intend to charge so they can see you’ll be good for the money once the building goes up.
Grants: Grants are easy and great. You just get money from the government who says “build some apartments” and maybe gives you some rules about what you can use the money on, like hard construction costs.
What’s the right mix for a social housing developer?
A big question for advocates of a social housing developer is how ought these projects be funded. This becomes all the thornier as one investigates the budgets and politics of states where such developers are most urgently needed. Looking at the types of funding available, grant funding is clearly pretty ideal in a political vacuum. If the State of New York could just hand the New York Housing Corporation a couple billion dollars a year without any expectation of repayment, that corporation would be in great shape.
With a significant amount of grant funding, a public developer would have quite a bit of freedom to determine the most socially beneficial and financially sustainable income mix of its units. Concretely, with no construction debt payments to make, it could more deeply subsidize the rents of its low-income units, for example.
But in the event that whatever grant funding makes its way through the state legislature is not several billion per year, a public developer could actually make do just fine. Below, I’ll briefly review three public sector developers of housing who build almost entirely with low-cost debt financing.
Housing Opportunities Commission—Montgomery County, MD, USA
The Housing Opportunities Commission in Maryland is a state housing authority in Maryland that was established in 1974. For many years, it laid in relative quiet, preserving affordable housing with loan financing or state grants. But earlier this year, HOC got approval and funding from the county government to take a more aggressive approach to addressing the county’s housing problems.
The approach is relatively simple:
The County gives HOC $3 million per year. This is a grant.
HOC issues a bond on that revenue stream from the county and gets big wad of cash that they put into the Housing Production Fund. This is debt.
HOC combines funds from the HPF with conventional debt and outside equity investment to fully fund and then build the project.
After the project reaches stabilization (at four years) HOC issues another bond on the revenue stream of the rents being collected to buy out the HPF investment. Other investors have the option of being bought out or converting their equity to subordinate debt—meaning that HOC takes 100% ownership of the project, and bought-out funds are invested back into the HPF so HOC can do it all over again.
In this scenario, HOC is basically leveraging a tiny investment from the state to get huge amounts of production relative to the $3 million annual fund. With a setup like this, you don’t need anywhere near the level of funding that an entirely grant-funded operation would need. As a tradeoff, your income mix is somewhat more restricted.
(Relatedly, one of the first projects HOC will be building with this model is 268-units of a new passivhaus certified development adjacent to a bus rapid transit line.)
ARA, ATT and Heka—Helsinki, Finland
Heka or ATT go out and get a loan for their project. They just go to the bank and get a loan like anyone else. Notably, the bank is also owned by the government. A great start.
Then they build the building.
The national government, through ARA, covers the interest payments on the loan. When interest rates are low, as they have long been, this subsidy is very small.
There are two things in Finland that make this model work that would be difficult in the US, though. First, the vast majority of vacant land in Helsinki is publicly owned, so land costs are nearly nil. Second, the rents that Heka collects from its residents are higher than what would be affordable to a low-income renter in the US thanks to the robust social safety net of income supports in Finland.
That said, the way to address the rents problem in the US is to have mixed-income projects with cross-subsidization, and the way to address the disparity in development costs due to high land values in the US is to a) add something else to the capital stack to cover the costs (equity, for example), or b) make use of eminent domain authority.
Housing and Development Board—Singapore
In Singapore, it’s even simpler than Finland. The government loans money to the Housing and Development Board, the HDB builds the apartments, long-term leases them to residents, and pays back the debt.
The HDB of course runs a deficit, but since it’s run at the national level, it’s not really a big deal as the government can, and does, just give it extra money in the form of normal funding grants. Last year, in fact, Fitch Ratings gave the HDB a AAA rating and explained a bit of their reasoning in a release:
Government funding provided to HDB is reflected in the national budget and is approved by the Minister for Finance. HDB implements housing and social policies determined by the government and its deficit is fully financed by government grants. Grants are also provided to HDB to preserve the reserves of the past government. The government provides a housing development loan facility to finance HDB's operation, as well as mortgage and upgrading financing loans to fund the financing schemes provided by HDB to purchasers of flats under public housing schemes and lessees of upgraded flats. The government loans formed 61% of HDB's interest-bearing debt as of March 2020. We regard the strong regulatory support framework as the major driver of this assessment, despite the absence of a guarantee.
If we get to the point where we are ready to establish a social housing developer at the national level, the HDB approach seems to be a good model, but getting a state level government to commit to guaranteeing the operations of a public developer is a very different story. Deficits at the national level are one thing, but are basically a no-go at any state level.
So, grants or debt?
What I hope these cases demonstrate is that development of housing can be financed in a variety of ways, not without their tradeoffs, but which give advocates of social housing development some flexibility in putting together state-level programs. If you can get $5 billion you should take it, of course. But if you can’t, $50 million will go a long way.