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A Monopoly game board has two green houses on Mediterranean Avenue, the most affordable square on the board. Also visible: The collect $200 salary as you pass go and a red hotel on Boardwalk, the game board's priciest property.
In LA, Costs Climb For Building 'Affordable Housing.' $600K For A Single Unit Is The Median
The work is complicated and can be tediously slow. Affordable housing developers have to overcome major hurdles that market rate developers do not.
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When nonprofit affordable housing developers from in and around Los Angeles gathered during the pandemic to educate an audience of aspiring developers, one of them brought up an unusual job requirement: You have to be out of your mind.

“No one in their right mind would do what we do,” said Steve PonTell, then president and CEO of the nonprofit development firm National Community Renaissance of California.

“Market-rate development is easy compared to some of the hurdles that [we] have to jump.”

PonTell was talking mainly about the psychic costs of trying to develop new housing that is affordable to low-income households. The work is complicated, bureaucratic and can be tediously slow.

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About this series

But the need to overcome the hurdles he alluded to results in additional financial costs as well that help explain the high cost of low-cost housing.

The high hurdle of arranging financing

Bob Buente, president and CEO of another nonprofit, 1010 Development Corporation based in downtown L.A., described one of the most daunting hurdles — the time-consuming and frustrating process of arranging multiple subsidies from local, state and national government agencies, each with its own set of timetables and rules.

“If you can see the hole in my forehead,” Buente told his audience, “it’s from trying to drive nails into the wall as I’m trying to get the funding together.”

Market-rate developers have a simpler task. They typically rely on a straightforward funding scheme that involves just two sources — an investor and a bank.

Affordable housing developers typically have to cobble together funding from four, six, eight or more sources.

The most valuable of these is the last piece of the funding puzzle and the hardest to get. It comes in the form of federal low-income housing tax credits, which can finance up to 70% of construction costs. The money is distributed through the federal government’s Low Income Housing Tax Credit Program.

The program is the federal government’s largest effort to spur creation of new affordable housing. But Congress has not provided nearly enough tax credits to meet demand across the country, resulting in a need for formal competitions that are held only after developers have assembled all the rest of their funding. Even then, developers in California stand only a 1 in 2 chance of winning them.

The high hurdle of overcoming NIMBYism

Dora Leong Gallo, president and CEO of the L.A. nonprofit A Community of Friends, explained another key hurdle — the frequent and time-consuming need to overcome community resistance to having affordable housing in the neighborhood.

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Gallo is famous in her industry for her tenacity or, as one market-rate developer told her, for being “a glutton for punishment.” She devoted 10 years to defeating opponents of her plan to build 49 apartments in Boyle Heights, largely for people experiencing homelessness. The building is finally under construction.

Resources for renters

Market-rate developers have it easier, she said. They “don’t have to answer questions about who their tenants are [going to be].”

Nor do they have to painstakingly document tenants’ annual earnings.

The hurdles that Buente and Gallo described are keys to understanding why it takes so long to develop affordable housing, and how delays drive up costs as projects remain unbuilt while prices for building materials and labor steadily rise.

Last year, the median cost in Los Angeles County to build a single unit of affordable housing hovered at $600,000, with headline-making outliers that exceeded the then-$800,000 median cost of buying a single-family home.

Market-rate housing can be cheaper

There is little doubt that tax-credit supported affordable housing is more expensive to develop than comparable market-rate housing.

In a 2020 report on costs for UC Berkeley’s Terner Center for Housing Innovation, professor Carolina Reid identified the complexity of financing as one factor that adds “considerable costs and time” to affordable housing projects that market-rate projects don’t face.

She also noted that government agencies require 60% of tax credit-financed projects in California to pay construction workers more costly “prevailing wages” — typically union wages — as a condition of receiving subsidies. In an interview, she also pointed to costs of time-intensive efforts necessary to overcome NIMBYism.

Researchers for the federal Government Accountability Office (GAO), which reports to Congress, found in a 2018 study that tax credit developers also faced higher legal, accounting and other bureaucratic costs.

But when federal researchers tried to go further by comparing overall development costs of tax credit-supported projects with those of market-rate projects, they were stymied. They couldn’t get industry groups representing developers and their lenders to give them data.

A similar roadblock appeared in California when a consulting firm hired by a group of four state housing agencies tried for half a year to pry cost data out of 80 market-rate housing developers. It got cooperation from so few that its report said: “Any conclusion about cost differences between affordable and market rate projects would be anecdotal at best.”

To get some indication of market-rate costs, this firm and other researchers have turned to commercially available estimates of market-rate construction costs. Results have been all over the place. One researcher found construction costs for affordable housing in California were 21% higher than market rate. Others have found they were roughly comparable.

  • Most government housing aid programs are offered through the Department of Housing and Urban Development, which has a simple rent formula. Tenants are required to pay rent equal to the government’s affordability standard, which is 30% of their household income.

  • But the Low-Income Housing Tax Credit program is different. It operates under the jurisdiction of the Internal Revenue Service which has more complicated rules. These requirements don’t link rents to a tenant’s income — at least not directly. Each apartment has a rent level intended to be affordable to a tenant earning a specific percentage of median income in the area. Under IRS rules, developers of buildings that offer these apartments can qualify for tax credits if:

    • They promise to make at least 20% of all units affordable to tenants earning 50% or less of the area median income
    • Or if they promise to make at least 40% of all units affordable to tenants earning 60% or less of the area median income
    • Or if they promise to make their average apartment available to tenants earning 60% or less.
  • Because winning tax credits is highly competitive, developers almost always choose to make 100% of their units available to tenants earning 60% of median income or less. Tenants are then charged rent equal to 30% of their apartment’s assigned median income level. If tenants’ incomes fluctuate, or don’t keep pace with increases in area medians, they can wind up paying more than 30% of their incomes in rent.

  • UC Riverside housing economist Bree Lang explains:

  • “In reality, a household living in a LIHTC [Low-Income Housing Tax Credit program] unit may earn much less than [the percent of area median income assigned to the apartment] but the rent level will not be adjusted to their income.”

Construction costs are the largest share of development costs for tax credit buildings but don’t tell the whole story. Examining construction costs alone omits what is usually the second biggest cost in tax credit projects — money for the developer.

In market-rate developments, developers get their money from rents or from selling their projects.

But this won’t work in tax credit projects. Rents are discounted and not always a reliable source of income, and developers are prohibited from selling for 15 years.

Developers get their money from the tax credits in the form of a fee. California’s rules allow developers to earn fees equal to 15% of construction costs or up to $2.5 million per project. But the arm of the state treasurer’s office that awards tax credits has published illustrations on its website that show how fees for very large projects can surpass $6 million. When LAist asked for examples, a spokesperson for the office said it doesn’t track such projects, and it would require too much work to dig them up.

Whether tax credit project developers make more money than market-rate developers is another debatable question.

Edgar Olsen, a University of Virginia housing economist and professor emeritus who has studied tax credit housing production in California, told a U.S. Senate Budget Committee hearing in 2020 that he believes they do.

In an interview, Olsen said this was largely an inference, drawn from the intense competition for tax credits and the expenses developers incur in trying to win them.

[T]he range of fees for their services are well in line, if not below, those of developers of other types of properties.
— Michael Novogradac, managing partner of an accounting firm specializing in affordable housing

There is little public information that sheds light on this. However, Michael Novogradac, managing partner of a namesake accounting firm that specializes in affordable housing, disputed it. In a 2014 blog post about the release of figures showing average profits for market-rate homebuilders ranging from 14% to 20%, he wrote: This illustrates “what low-income developers already know — the range of fees for their services are well in line, if not below, those of developers of other types of properties.” He declined to be interviewed.

How projects begin

Affordable housing projects start simply — the same way market-rate developments do — with an idea of building housing and finding a place to put it.

After acquiring or reserving land, affordable housing developers typically spend at least two years on “pre-development” — drafting architectural plans, getting them approved by the local building department (a process developers say typically takes eight to 10 months in Los Angeles, and which Mayor Karen Bass has vowed to shorten), wooing neighbors, negotiating variances with zoning authorities and sometimes city councilmembers, and arranging various forms of aid from state and local governments. Some of that aid comes in the form of special government low-interest loans that will require little or no repayments for decades.

All this effort will likely lead to nothing unless developers also win federal low-income housing tax credits that have been the government’s main means of helping finance affordable housing since the Reagan years, when Congress privatized the housing construction.

These credits come in two flavors — those intended to cover as much as 70% of construction costs and those intended to cover only 30%. Awards for both are competitive in California.

The value of tax credits

Congress has allocated $11 billion in tax credits nationally this year — enough to make a dent in the nation’s affordable housing needs, but little more. To put the $11 billion in perspective, the estimated cost of building enough affordable housing just to meet Los Angeles County’s needs is $300 billion.

Tax credits are the most lucrative form of tax benefit the government has to offer. Every dollar’s worth of credit means one dollar less that the government can collect in income taxes from the tax credit holder.

But the developers who win them typically can’t use them themselves. Nonprofit developers, responsible for about one third of tax credit-financed construction in California, according to HUD, have no income tax bills. For-profit developers rarely have tax bills big enough.

The market for tax credits

To raise money, developers sell the tax credits they have won at discounts to corporations that have consistently large tax bills.

There is no fixed price. The tax credits are worth whatever buyers are willing to pay, which varies according to economic conditions and changes in the corporate tax rate. In 2017, when then-President Donald Trump and Congress reduced that rate, tax credits became less valuable and prices took a dive, which meant developers had less money with which to build. Developers lately have been collecting 85 cents to 92 cents on the dollar.

In L.A. and across the country, big banks like J.P. Morgan Chase are the main buyers — they scoop up the tax credits from developers in exchange for providing the money to finance the building projects. The tax credit holders earn returns that the U.S. Treasury Department’s Office of Controller of the Currency says are “comparable to similar alternative investments.” They also earn points with federal banking regulators who evaluate the extent of banks’ community investments when determining whether to approve expansion plans. Big companies like Google are also buyers.

Besides the credits, which are distributed over 10 years, tax credit holders get additional tax benefits — mainly deductions for depreciation intended to account for the assumed loss of value that buildings sustain over time.

Banks and other corporate investors typically walk away from their projects at the first opportunity after using their tax credits, which contractually comes after 15 years, according to a study conducted for the federal Department of Housing and Urban Development.

When they exit, investors turn over their 99.9% ownership stakes to the developer who typically has been running the project for them all along. The developer is then free to keep operating the project as is, apply for a second round of tax credits to physically rehabilitate the project’s buildings, an undertaking that would come with a second developer fee, or sell to a new owner who must agree to continue providing discounted rents to low-income households for 55 years. A vibrant secondary market in buying and selling these properties has developed.

How tax credit competitions are run

In most years, there are only enough federal tax credits in California to go around for half of the developers who apply — excess demand that economists regard as proof that developers find affordable housing developments lucrative enough to be worth a lot of trouble with no guaranteed success.

To win the credits, developers in California enter competitions run by an arm of the state treasurer’s office called the Tax Credit Allocation Committee.

Their applications have to comply with the program’s 99 single-spaced pages of rules. They go into great detail. Developers have to identify their lawyer, tax professional, tax credit consultant or syndicator, tax credit buyer, property appraiser, capital needs consultant, energy consultant, architect, general contractor, market analyst and property management company.

They have to disclose how much income they plan to generate by specifying unit sizes, proposed rents and which tenants — in terms of percentages of area median incomes earned — they plan to house.

They have to detail their planned annual operating expenditures.

They have to disclose private lenders and government subsidies they have lined up and show they already have the necessary zoning variance and building permits in hand.

To stand a chance of winning, developers enter knowing they will likely need perfect scores, which, among other things, means proposing construction close to shopping and public transit and sacrificing rental space to create common areas where they promise to deliver special services. These can range from licensed child care to homework help for school children to the more extensive supportive services needed by people who have experienced chronic homelessness.

Most competitions result in ties and an additional tie-breaking round. Only then can the construction process begin.

Gallo, the developer who once spent 10 years fighting to build a project, summed it up this way: Developing affordable housing is “really a convoluted process,” she said.

But, when successful, there are satisfactions beyond money.

“There’s no greater feeling,” she told the audience of would-be developers in L.A. , “than to see people who need the housing move in … I’ve had employees tell me they’ve never worked in a place where you see people cry when you give them their keys.”

  • Numbers reported in this series about the share of tenants who pay unaffordable rents and the share of tenants who receive supplemental rental subsidies such as Section 8 vouchers should be regarded as estimates.

  • These figures were compiled by economists at the federal Department of Housing and Urban Development, which maintains the Low-Income Housing Tax Credit industry’s largest data set. HUD collects its data from the housing finance agencies in every state, which are tasked with awarding tax credits to developers, and are then responsible for collecting data annually on rents and rental subsidies from operators of each tax credit-financed project. The data is inexact.

  • As Freddie Mac, which buys mortgages from issuing lenders, describes it on its website: “The format and contents of the data sent back by each state varies… While HUD tries to ensure high data quality, there are inevitably shortcomings.”

  • Data imprecision extends to the seemingly simple matter of how many tax credit projects currently operate in each state and locality. In California, for instance, the state agency that issues the credits, a part of the State Treasurer’s Office called the Tax Credit Allocation Committee, has cited numbers that are larger than HUD’s. Numbers of households whose incomes would qualify them for the program are also estimates, drawn from Census data and other government reports.

What questions do you have about housing in Southern California?

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