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Financing the Early Costs in Affordable Housing Development

Financing for the development of affordable housing can be difficult, particularly for nonprofits. And while larger nonprofit and for-profit organizations may be able to use reserves or lines of credit to pay for the initial development costs of purchasing land, as well as conducting feasibility and impact studies, these costs can be a major obstacle for smaller, community-based nonprofit organizations. Indeed, when competing for larger properties in desirable locations, even larger nonprofits and for-profits interested in building affordable homes may have difficulty marshalling the funds for pre-development and acquisition costs in a timely and cost-competitive manner. By offering loans for these initial expenses, state and local governments can make it easier for affordable housing developers and for smaller developers, in particular, to compete for land and meet local affordable housing needs.  

There are typically three types of financing utilized to cover the initial costs of affordable housing development:

  • Pre-development funds help cover the costs associated with investigating potential leads and conducting the due diligence necessary for determining whether a particular development or preservation transaction is feasible.
  • Acquisition funds help a developer purchase and hold a property until additional financing is available to support redevelopment or rehabilitation activities.
  • Interim financing provides funds to operate the property until permanent financing is put into place, generally around the time that the property is fully leased up and begins to generate rent revenue.

Since pre-development and acquisition costs are incurred before construction begins, traditional lenders often consider pre-development and acquisition loans to be high risk and set the interest rates at levels that make it infeasible for smaller organizations to get projects off the ground. Many states and some local lending programs provide low-cost financing for pre-development and acquisition expenses to help increase the availability of affordable homes. These local sources of funding help affordable housing developers compete with often deeper-pocketed market rate developers to acquire subsidized and unsubsidized properties at risk of becoming unaffordable to low-income households and preserve long-term affordability.

Financing for the Preservation of Existing Affordable Housing

In many cases, the only way to preserve an existing affordable property is through purchase by a nonprofit or mission-driven for-profit corporation, typically with local public financial support. Some communities and organizations have established their own pre-development, acquisition and programs to facilitate these transactions. Some community-provided loans are restricted to the costs related to just pre-development or just acquisition, while other communities have broader programs that can be used to finance all three types of expenses. The loans generally have low or no interest, and repayment may be deferred until the development has received permanent financing.

The Role of Community Development Financial Institutions

In creating affordable housing acquisition funds, communities often build partnerships with community development financial institutions (CDFIs) that offer additional financing capital and services. For example, in addition to working with partners to build or renovate homes in North Carolina, the Durham-based Center for Community Self-Help – one of the country’s largest CDFIs – offers loans to support the purchase of homes to be used for supportive housing for people with disabilities. Similarly, the Florida Community Loan Fund supports nonprofit organizations through acquisition and site control loans for the purchase of affordable homes, including affordable rentals that have expiring federal subsidy contracts.

CDFIs can be an important source of predevelopment and acquisition financing. In general, CDFIs help to make credit and other financial services available to nonprofit organizations, affordable housing developers and other entities and individuals that may not be served by traditional financial institutions. These mission-driven, private-sector institutions focus solely on community development initiatives and may be incorporated as banks, credit unions, community development corporations and in other forms. The U.S. Department of the Treasury certifies CDFIs and provides competitive grants to support their activity through the CDFI Fund. CDFIs such as Enterprise Community Partners, the Low Income Investment Fund and the Local Initiatives Support Corporation partner with local governments and regional bodies to expand the availability of lending capital for the acquisition of rental properties, often with an emphasis on transit-served neighborhoods.

Revenue Sources

The size and structure of a dedicated source of funding for pre-development, acquisition or interim activities, will be determined in part by the scale of development to be targeted by the fund. That in turn is influenced by the size of the community to be served, the availability of additional resources and, where applicable, the reach of existing or proposed transit lines. Initiatives focused on smaller areas or targeting a specific neighborhood, such as the Lower San Antonio Community Development Fund, offered through the Northern California Community Loan Fund in Oakland, Calif., may be able to capitalize a modest fund with investments from only a few sources. Initiatives that operate on a much larger scale, such as Denver’s TOD Fund, will need to secure support from multiple public and private partners.

Potential investors and sources of additional funding include:

  • Public sector contributions from a local and/or state sponsor (e.g., bond proceeds, CDBG allocation budget appropriations)
  • Metropolitan Planning Organizations (MPOs) and regional transit agencies
  • Community Development Financial Institutions (CDFIs)
  • Philanthropic organizations, through a grant or program-related investment
  • Private-sector financial institutions

Especially at inception, pre-development and acquisition funds carry a relatively high level of risk: Will the real estate market suffer a downturn? Can the project win the competition for necessary subsidy? Will the proposed project be able to secure permanent financing? Will there be unexpected issues with the site or local approvals?

Public sources generally provide the initial capitalization and sit in the top loss position, meaning that in the event of a failed project or market reversal all other investors are repaid first. Additional investors tend to be socially motivated, as they must be willing to accept the relatively low rates of return needed to support affordable housing and to wait years before they begin to receive a return on their investment. Investors in existing funds include philanthropic organizations (in the form of grants and program-related investments), CDFIs and banks looking to earn Community Reinvestment Act credit.

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