SPECIAL FOCUS >> DEVELOPERS TALK BACK

Developers Reveal the Costs of Doing Business

By Donna Kimura

AFFORDABLE HOUSING FINANCE • JULY 2007

Most affordable housing owners and developers expect construction costs to increase between 0 percent and 9 percent, longterm permanent loan rates to remain flat, and low-income housing tax credits (LIHTCs) to fetch an average price of about 94 cents per dollar of credit this year.

Those are some of the findings from AFFORDABLE HOUSING FINANCE magazine’s nationwide poll.

The exclusive survey found that the construction cost for a garden apartment is about $116 per square foot, and developers are averaging about $40,183 on rehabbing a unit.

The costs don’t end there. Affordable housing owners reported spending an average of $4,541 per unit per year in operating costs.

These were some of the key measurements taken in the survey. Conducted in the first quarter, the survey drew responses from about 100 local and national, urban and rural, for-profit and nonprofit affordable housing owners and developers across the country.

Each survey served as a single piece of a puzzle. Together, they create a striking portrait of today’s development climate.

Biggest challenges

The survey revealed that the No. 1 challenge for affordable housing developers today is coping with increasing development costs. About 30 percent of the respondents cited these costs as their toughest issue.

One developer said he obtained a reservation of LIHTCs in 2005. Falling tax credit prices, rising construction costs, and other issues, however, made the project unfeasible. The firm returned the credits and plans to apply for new financing for the project.

Another developer said his firm formed its own construction company and entered into “cost-plus” contracts with local contractors and subcontractors to help deal with construction costs.

The majority of the survey respondents, 53 percent, reported experiencing construction cost increases of between 10 percent and 19 percent from a year ago. Another 25 percent said construction costs rose between 0 percent and 9 percent, while 22 percent reported an increase of between 20 percent and 29 percent.

Developers are hopeful the increases won’t be as severe this year, with the majority, 54 percent, predicting construction costs increases of no more than 9 percent.

Finding land ranked as the next biggest challenge, with nearly 27 percent of the developers citing it as their main issue. This is causing developers to deploy new strategies.

For example, Avesta Housing, a leading affordable housing developer in Maine, is assessing the properties that it owns to see if there are opportunities to build additional phases of development, said Mike Myatt, vice president of development.

He pointed out that the density and zoning laws may have changed since the original project was built to allow for additional development.

Another developer also cited the challenges of acquiring properties at a reasonable price. He said he cannot compete in a national bidding war for a site. Rather than using brokers, his firm relies more on relationships with other property owners and contacts in the industry to get deals.

Some firms that have traditionally been new construction developers are now looking for acquisition and rehabilitation opportunities.

Coping with rising operating costs also ranked high on a list of challenges, with about 11 percent of the respondents calling it their No. 1 problem.

A big majority, 73 percent, predict that these costs will increase between 0 percent and 9 percent this year, while 23 percent think the increases will be higher, between 10 percent and 19 percent. The remaining 4 percent say the increase will be even greater.

On the other side, receiving financing ranked last among a list of challenges.

Growing financing gap

The survey found that the average price received for 9 percent LIHTC deals closed in 2006 was 98 cents per dollar of credit.

With tax credit prices dropping since last year, developers said they think the average price for the same types of deals in mid-2007 will be closer to 94 cents.

The survey confirmed that deals on the East and West coasts receive higher equity prices. A rough look at the prices cited by developers in the coastal states showed that they averaged closer to $1.01 for a dollar’s worth of credit last year.

The recent decline in equity prices means LIHTC projects face a larger financing gap. Several developers said this means additional funds from local sources are needed more than ever to close the gap.

One developer added that the gap has been filled by borrowing more amortizing hard debt and reducing developer fees.

Another pointed out that the dip in equity prices combined with higher construction costs means more soft financing is needed or projects will have to serve higher-income households.

There’s also another consequence of projects becoming harder to pencil out. Deals are taking longer to put together,said a developer.

Developers had several ideas for improving the allocation of tax credits, ranging from not capping the amount of credits that a deal can receive to eliminating preferences for nonprofit and inexperienced developers.

Although putting a ceiling on the amount of credits that a single development can receive helps spread credits to different projects, it limits large projects, according to developers.

A few developers also said they would like to see LIHTC allocating agencies give more consideration to high-cost areas.

New ideas

In addition to measuring the costs of developing affordable housing and gauging some key numbers, the survey looked for the latest innovative ideas and emerging policies.

Several developers cited inclusionary housing programs that are helping to produce more affordable housing. These programs require market-rate housing developments to include some affordable units.

Land trusts and local or state housing trust funds also were praised as important efforts.

“The creation of housing trust funds has had the greatest impact on the development of affordable housing,” said Michael Costa, president of Simpson Housing Solutions, LLC. “The public awareness resulting from the election process to create the trust, as well as the needed funds at the end of the day, have created a tremendously positive impact for affordable housing.”

Developers also noted the trend toward mixed-income and mixed-use developments.

“The redevelopment of public sites into mixed-income housing is one way we’ve both seen and participated in to produce more housing and better housing in our area,” said Chickie Grayson, president and CEO of Enterprise Homes.

Her organization has been involved in redeveloping former public housing sites into mixed-income developments.

Developers Talk Back Survey Highlights

AFFORDABLE HOUSING FINANCE magazine’s survey of owners and developers found that the average construction cost per square foot for a garden apartment is $116.38. The median amount was less at $100.50.

The average construction cost per square foot for a mid-rise development is $147.40 and $122.98 for an attached townhome.

The survey also found that:

• A large number of respondents, 53 percent, reported that construction costs increased between 10 percent and 19 percent from a year ago.

• Most developers and owners, 54 percent, expect construction cost increases to be between 0 percent and 9 percent in the next 12 months. Forty-six percent predict increases to be between 10 percent and 19 percent.

• Developers spend an average of $40,183 on rehabbing a unit. The median amount is $30,000.

• The average operating cost per unit per annum is $4,541. The median is $4,200.

• The vast majority of developers and owners, 73 percent, anticipate operating costs to increase between 0 percent and 9 percent in the next 12 months.

• Sixty-three percent of the respondents expect long-term permanent loan rates to stay flat in 2007, while 27 percent predict an increase and 10 percent think rates will decrease.

• The average price received for 9 percent low-income housing tax credit deals closed in 2006 was 98 cents per dollar of credit. Prices aren’t expected to be as high this year, with developers predicting the average price for the same type of deals to be closer to 94 cents in mid-2007.