Addressing Funding Hurdles for Housing Development
The Filling the Gap Tool helps cities identify various funding sources, policies and strategies to bridge the financial gaps that hinder the feasibility of housing projects in their communities. Included in this tool are solutions for housing production and preservation, both of which are necessary for creating diverse, attainable and equitable housing options.
This video provides an introduction to housing finance, explaining the key components of the capital stack and how multifamily housing projects are typically financed.
Key Components of Housing Development
When developing housing, whether through new construction or the preservation of existing housing, the main project components, including estimated project costs and funding sources, should be considered.
Uses of Funds
These are the estimated costs across all phases of the project, generally broken into three categories:
Land Costs
Expenses incurred to acquire land for housing development.
Hard Costs
Expenses associated with the physical construction or rehabilitation of the project, such as materials, equipment, and labor. It also includes the costs of site improvements, utility installation, and infrastructure improvements such as roadway extension or connection to broadband, water and sewer systems.
Soft Costs
Expenses associated with non-tangible items such as services, fees and insurance. Examples of soft costs include architectural, engineering, legal services, financing costs, permit fees, impact fees, project management fees, developer fees and reserves.
Sources of Funds
The sources of funding for housing projects vary depending on whether the project is a market-rate housing development or an affordable housing development.
Market-Rate Housing
Developers of market-rate housing use two main sources of funding for housing development: debt and equity.
- Debt: Debt comes from borrowed funds, typically in the form of loans, which are repaid with interest. Debt is generally paid off first, followed by equity and any profit repayments.
- Equity: Equity comes from investments made by private equity companies, individual investors and developers themselves, and it is often referred to as sweat equity.
Affordable Housing Development
Affordable rental projects dedicated to low- to moderate-income households, usually face a funding gap because:
- Rents are restricted or lower, which limits project cash flow
- Debt makes up a significantly smaller portion of the capital stack due to reduced revenue projections.
- Operational costs remain the same
How Can I Identify a Funding Gap?
Each phase of development is funded by different types of debt or equity. For a project to be feasible, the total development cost must equal the sources of funds which will finance the project.
If the projected use of funds exceeds the available sources of funds, a funding gap exists. Identifying and addressing this gap is crucial to ensuring the financial viability of housing development projects
Project Costs – Funding Sources = Housing Funding Gap
Closing the Funding Gap
There are three primary strategies to close the gap:
1. Reducing Project Costs
While there are limits to how much project costs can be reduced, due to fixed expenses such as labor, materials, fees and services. There are still opportunities for cost savings. Strategies include:
- Reducing or eliminating land acquisition costs,
- Minimizing soft costs by reducing or waiving permitting fees, and
- Using pre-approved plans to lower design expenses.
2. Utilizing Direct Subsidies
Direct subsidies can play a critical role in closing the funding gap by providing non-repayable sources of capital. These subsidies are categorized into supply-side and demand-side subsidies:
Supply-Side Subsidies
These include non-repayable sources such as grants and tax credits, which can fill the funding gap upfront.
Here are some example subsidy sources on the supply side. Use the arrow to expand each section below and learn more.
Low-Income Housing Tax Credit (LIHTC)
The LIHTC subsidizes the acquisition, rehabilitation, or new construction of rental housing for low-income households. The federal government allocates approximately $10.5 billion to state and local agencies to administer these tax credits, incentivizing investments in affordable housing.
State Housing Tax Credits
States can implement programs mirroring the federal LIHTC to stimulate private investment in affordable housing. This initiative offers nonrefundable state tax credits to investors participating in affordable housing projects.
Federal Grants
- HOME Investment Partnerships (HOME) Program: This federal program provides formula grants to states and localities, often in partnership with local nonprofit organizations. These grants fund a range of housing activities, including construction, acquisition, and/or rehabilitation of affordable housing for rent or homeownership or providing direct rental assistance to low-income individuals.
- Community Development Block Grant (CDBG) Program: This federal program provides annual grants on a formula basis to states, cities and counties to develop viable urban communities by providing decent housing and a suitable living environment, and by expanding economic opportunities, principally for low- and moderate-income people. This grant supports housing-related activities such as residential property rehabilitation, but does not fund the construction of new housing.
*Note: Eligible grantees for HOME and CDBG programs include principal cities of Metropolitan Statistical Areas (MSAs), metropolitan cities with a population of at least 50,000, qualified urban counties with a population of at least 200,000, states and insular areas. Cities or counties that are not entitlement communities may receive funding through their respective state.
Demand-Side Subsidies
These include subsidies that supplement the project’s income and reduce operational costs after the housing is developed.
Here are some example subsidy sources on the demand side. Use the arrow to expand each section below and learn more.
Housing Choice Vouchers Program: Project-Based Vouchers (HCV-PBVs)
Project-based vouchers (PBVs) are a component of a public housing agency’s (PHA’s) Housing Choice Voucher (HCV) program. The HCV program provides rent subsidies to help low-income families, elderly persons, and people with disabilities obtain decent, safe, and affordable housing. PHAs that administer HCVs can use up to 20 percent of their authorized vouchers for units in a specific project.
Tenant-Based Vouchers
Tenant-based vouchers increase affordable housing choices for low-income families by enabling them to choose and lease privately owned rental housing that is safe, decent, and affordable. Public Housing Agencies (PHAs) can apply for funding to administer these vouchers to very low-income families with incomes below 50% of area median income and a few specific categories of families with incomes up to 80% of the area median income.
Property Tax Incentives
Cities may offer property tax incentives to affordable housing developers through property abatements or exemptions. These incentives can reduce the total amount of property tax owed for a specific period or apply a partial exemption to the portion of the property designated for affordable housing.
3. Reducing the Cost of Capital
The cost of capital refers to the expense of borrowing funds, including the interest and terms associated with debt financing. Reducing the cost of capital is critical for making affordable housing developments financially feasible. This can be achieved through flexible financing tools that meet the needs of affordable housing developments.
Examples of strategies that reduce the cost of capital include:
- Loans with below-market interest rates
- Deferred loan repayment schedules
- Forgivable loans tied to affordability or performance requirements
By utilizing the Filling the Gap Tool, local leaders can more effectively identify solutions to bridge their housing funding gap and meet their local housing supply needs. By learning from peer cities through case studies, local leaders can find references for success stories and best practices. The Filling the Gap Tool supports successful housing development.
The Filling the Gap Tool builds on the Housing Supply Accelerator Playbook: Solutions, Systems, Partnerships, a resource designed to help communities navigate housing supply challenges. The Filling the Gap Tool delves deeper into addressing the financial barriers that hinder housing development, expanding on the solutions provided in the playbook. Additional resources to accelerate local housing supply are available in the last section of this tool on the Resources, FAQs and Project Notes page.