Affordable Housing Is Getting Squeezed By Construction Cost 'Emergency'
New York City is facing an affordable housing crisis, but amid inflation and interest rate hikes, the developers who are trying to build new apartments to alleviate the crisis are facing an increasingly tough environment in which to do so.
“We have an emergency right now, which is that deals are struggling to completion because prices are out of control,” said Andrea Kretchmer, a founding principal of affordable developer Xenolith Partners.
Balancing costs has always been a challenge for developments in which rents are capped. But as labor costs, rising inflation, interest hikes and two years of pandemic-induced supply chain complications are piled on top of increasing materials costs, developers say calculations are becoming even trickier.
“Construction is getting so unbelievably expensive,” Kretchmer said. “Subsidy levels are not expanding along with the construction pricing, so now you're going to be able to build even fewer units.”
New York City has long been the most expensive city in the U.S. for construction, with land availability, the difficulty of getting construction materials to sites and labor costs all playing a role. But the pandemic has presented complications for market-rate and affordable developers alike, with supply chain issues and inflation pushing up materials costs and eating into margins.
In the affordable housing space, developers, contractors and investors are sharing the weight of increased costs on affordable projects, Joy Construction principal Eli Weiss told Bisnow. Developers and contractors have also resorted to "value engineering," he added, redesigning buildings to cost less or getting creative on the land acquisition front.
“The cost of concrete is agnostic, whether it's going into a high-end development or an affordable company,” Weiss said. “In the market-rate world, that means rents are going up. But in the affordable world, where rents are purposefully kept at bay, margins definitely get eaten away at.”
While the margins on affordable housing have shrunk, the need has grown.
Between 2009 and 2018, NYC’s population grew by half a million, but only 100,000 housing units entered the market, according to a 2018 report from the city comptroller. New York's supply of low-cost units, defined as rented for $1,500 or less in 2021 inflation-adjusted dollars, has dropped from roughly 1.5 million in 2008 to roughly 1 million in 2021, according to the New York City Housing and Vacancy Survey released last month.
While most in the city recognize the acute need for more housing, the problem figures to worsen in the coming years. The city has an immediate need for 227,000 housing units to meet present demand, according to a report commissioned by the Real Estate Board of New York. By 2030, the city needs to build 560,000 units. The known development pipeline covers just 14% of the total projected need, according to the report.
"As much as the mayor is pushing for new housing and the last administration was pushing for new affordable housing, it's just really tough to do," Nuveen Real Estate Senior Portfolio Manager of Impact Investing Pamela West said.
Supply chain issues and materials costs have been an issue for developers since the pandemic, further exacerbated by Russia’s invasion of Ukraine. The Federal Reserve has already introduced multiple interest rate hikes, adding further costs to construction, but results have yet to show up among general economic indicators: In April, the consumer price index showed an 8.3% increase to inflation from a year prior, and this week U.S. Treasury Secretary Janet Yellen said she had underestimated inflation’s risk.
The result is that affordable developers in particular are feeling the pinch, Fairstead Head of Capital Markets Tricia Yarger told Bisnow.
“Typically when you see interest rates rise, you see cap rates coming down and purchase prices coming down to balance that all out,” Yarger said. “We're not seeing that happen yet. And it's unclear when it will happen.”
Construction costs aren't relenting — nationwide costs rose by 7% in Q1 2022 from a year prior, according to Turner Construction Co.’s quarterly cost index, placing it in line with inflation seen broadly across the economy. In the last 10 years, construction costs have increased by 52.9%, according to Turner's data.
The price of steel and other metal products have more than doubled since 2020, according to the Bureau of Labor Statistics, and diesel fuel, used to power much of the equipment on major sites, is at record-high prices, up 76% year-over-year in May.
Contractors in public works, another sector with capped revenues, have lobbied the New York Legislature to pass bills that would allow for increased budgets on capital projects to offset cost increases, Crain's reported.
Mayor Eric Adams added an additional $5B toward affordable housing in his proposed budget's 10-year capital expenditure guidelines, but even with a supportive city hall, developers building below-market-rate housing are in a constant juggling act to line up a complex array of financing sources to make deals work.
Projects with 100% of units designated as affordable can draw on Low-Income Housing Tax Credit financing, and the federal government has increased allocations for projects to offset cost increases, Weiss said.
But mixed-income developments rely on local and state sources and often need participation from lenders at multiple points of the capital stack. President Joe Biden released a Housing Action Plan last month that, among other measures, directed the Treasury Department to finalize regulations that would allow developers to use LIHTC for mixed-income developments.
"There's sort of a love-hate relationship across the country with the tax credit program," West said. "I'm a big supporter and advocate for mixed-income housing. I think that's the way that we should be living as a society."
Calculations to fund those types of affordable projects are complex, NewPoint Real Estate Capital Managing Director and Head of Non-Agency Affordable Strategies Rob Wrzosek said. It can take years to assemble capital stacks, which rely heavily on government subsidies and incentives, have strict timelines and require developers to use unionized — and, therefore, higher-paid — construction labor.
When affordable developers fail to deliver on time, they may receive fines that eat into their fees, Kretchmer told Bisnow. Further complicating the calculations, New York City government provides subsidies to affordable developers on a per-unit basis, while construction pricing is generally calculated on a per-SF basis, Kretchmer said.
“Let’s say there's a fixed budget that says it's gonna cost $100M to build this building. Ten million dollars of that is the fee to the developer,” Kretchmer said. “But guess what, if it costs $101M, $102M, $103M because of unanticipated delays, that's coming out of the developer's fee.”
CORRECTION, JUNE 6, 4 P.M. ET: A previous version of this article didn't include the full name of NewPoint Real Estate Capital. This story has been updated.