Types of Funding
The guiding principle in affordable housing finance is that public and private financing sources must equal uses or the total cost of building the building, also know as development cost. Uses tend to fall into five categories:
- site acquisition (purchasing, leasing, etc.)
- construction or rehabilitation, including a contingency allowance
- soft costs (appraisals, marketing, surveys, taxes, insurance, architectural, engineering, legal, accounting, etc.)
- development fees, developer’s overhead, and profit
- financing fees (construction period interest, loan fees, closing costs)
Other types of financing and funding that are usually not reflected in the development cost but are vital to an affordable housing development are predevelopment funding, and rental assistance to help cover gaps and ensure units are affordable. Both of these are discussed in other sections in this guide.
To gain a greater understanding of what it costs to build affordable housing and how to fill in the cost gaps, check out the Urban Land Institute's interactive model, which allow you to pencil out the cost of an affordable housing development and experiment at filling in costs caps.
There are generally three categories of funds to cover these costs:
- Debt — This is borrowed money, generally paid back with interest. Some debt sources may have more flexible rates and terms than others. Some is soft or deferred debt, meaning that it gets paid back only if the project's cash flow permits or at the time of sale. It may be forgiven entirely if the development continues to serve income-eligible people for an extended period of time.
- Equity — This is cash financing that is not paid back with interest but is viewed as an investment with an expected, though not guaranteed, return. Equity for affordable rental housing generally comes from the developer and the sale of tax credits. In affordable ownership developments equity comes from the developer.
- Grants — These are funds to fill the gap between total development costs and what can be financed with debt or equity. This is usually required because of the limited rents or sale prices that low- and moderate-income households can afford. Grants are usually provided by government entities.
Funding Sources for Construction:
Federal Low Income Housing Tax Credits (LIHTC)
The Low Income Housing Tax Credit program, which can be used only for rental housing, has been the federal government's primary program to produce affordable rental housing since the late 1980s. Rather than providing direct funding, it spurs equity investments in affordable developments by giving investors a dollar-for-dollar credit against their federal tax liability over 10 years. These are generally used for projects of 20 units or more because of the cost of selling the credits.
There are two types of credits: 9 percent and 4 percent. The 9 percent credits are more valuable because they raise more equity but they can't be used with projects that use tax-exempt bonds or certain other federal subsidies. Like all states, Massachusetts publishes an annual Qualified Allocation Plan (QAP) that outlines how much credit will be available, along with planned uses.
The annual availability of 9 percent credits is limited. These are awarded competitively. States receive a new allocation each year based on population and use the competition to award amounts to individual projects. Developers sell the credits to investors and use the proceeds as equity. Because the credits are granted for 10 years, a $100 credit award is worth $1,000. Investors pay 65 to 95 cents per dollar of credit, depending on demand; a $100 credit award raises $650 to $950 in equity.
At least 40 percent of the units in a tax credit development must be reserved for households at or below 60 percent of AMI (or at least 20 percent for households with incomes at or below 50 percent of AMI) for at least 30 years. However, because funds are awarded competitively, most developments using 9 percent credits are close to 100 percent affordable and have restrictions up to 99 years. Most set aside at least 10 percent of the tax credit units for extremely low income households (at or below 30 percent AMI).
Four percent credits are mainly used for projects financed with tax-exempt bonds or for preservation projects (older federally subsidized developments. Some developers use them instead of 9 percent credits to avoid a long wait.
State Low Income Housing Tax Credits
The Massachusetts state tax low income housing credit program is modeled on the federal 9 percent program and supplements the limited supply of federal credits. Unlike the federal 9 percent credit, however, the state credit is only an offset to state tax liability and is taken over five years, rather than 10. A $100 credit award, therefore, is worth $500. State law sets the value of the credits available for allocation each year. EOHLC generally awards state credits in tandem with federal credits. For more information, see EOHLC's Qualified Allocation Plan (QAP).
State Housing Bond Fund Programs
Massachusetts finances many of its affordable housing activities by issuing long-term bonds authorized by state legislation (housing bond bills). This allows DHCD to issue bonds for up to a specific dollar amount over a given number of years for specified housing programs. DHCD currently has seven bond-funded programs for private housing development and/or rehabilitation. Awards for rental housing are generally made through DHCD's twice-a-year rental rounds.
For more information on DHCD’s bond funded affordable housing programs, contact DHCD.
Federal Home Loan Bank Affordable Housing Program
The Federal Home Loan Bank (FHLB) is required by law to make some of its funds available to support affordable housing initiatives. Its best known program is the FHLB Affordable Housing Program, which provides grants, interest subsidies, and advances to rental and ownership projects. This is an important source of gap financing.