The High Cost of the Low Income Housing Tax Credit (LIHTC)

A new study from the UC Berkeley Terner Center for Housing Innovation tackles a thorny question in housing policy: how does the Low Income Housing Tax Credit (LIHTC) program actually work to produce low-income housing? And to what extent is complexity a feature or a bug of the program? Kneebone & Reid (2021) are on the case.

Key takeaways:

  • Tax credits aren’t enough to finance any individual project. 80% of projects surveyed in the past decade used four to eight separate financing sources in their “capital stack”—a trend that has grown with time.
  • Coordinating multiple funding sources across different time constraints makes the development timeline longer and delays the construction of much-needed housing.
  • Statewide housing finance agencies can help coordinate funding sources and lower carrying costs for affordable housing developments.

Launched in 1986, the Low Income Housing Tax Credit (LIHTC) has funded the construction of roughly 3 million homes in the United States, leveraging private capital to reduce the debt burden on developers in order to enable lower rents for poorer households. If that sounds complicated, experts agree. The complexity also has costs that can delay homebuilding and leave lower-income households deeper in the nationwide housing shortage.

Kneebone & Reid (2021) explain how tax credits work to fund affordable housing, and how they can create complex webs of institutional constraints. When a developer plans for affordable housing, they must present a proposed “capital stack” of debt financing and other funding sources, and apply to a state allocation agency. If the developer is successful in receiving an allocation, they market their deal to various investors who bid on purchasing the tax credits with equity that will be used to fund the transaction,” the authors explain. The market largely depends on the tax liability of large financial institutions, meaning that Trump’s 2017 corporate tax cuts reduced the value of the tax credits and increased funding costs for LIHTC developers. From 2016 to 2019, the per-unit cost of LIHTC developments increased by 13%.

The array of funding sources typically needed to fund a project also grew. While varying by project type and region across the country, “developers layered an average of 3.5 permanent sources to finance developments built between 2000 and 2018.” Perversely, projects in California typically needed more funding sources than in lower-cost states like Arizona, in part because of land costs. In other words, building affordable housing costs more and takes longer in states where housing is already less affordable. To make matters worse, the data showed that “each additional source [of funding] was associated with an increase of roughly $6,500 on average, or 1.7 percent, per unit.”

By interviewing developers and other stakeholders, Kneebone & Reid found that the increasing complexity of capital stakes made project timelines longer, costlier, and more unpredictable. Across the country, respondents noted that “the lack of alignment of deadlines among key funding sources as a key contributor to longer timelines and associated cost increases.”

In some states, the various funding sources are coordinated by Housing Finance Agencies. In Illinois, the state’s housing finance agency allocates LIHTC funding as well as other “soft” sources such as the state’s housing trust fund, without requiring developers to choose among these different sources. “I don’t care so much that it’s four different sources,” one respondent told Kneebone & Reid. “What I do care about is the probability of getting those sources and the probability increases if it’s one single agency and I know their rules.”

Thus the authors are led to conclude that “reviewing existing funding streams to identify areas for consolidation would be the most direct way to increase administrative efficiencies and costs savings.” Among other recommendations, such as federal government coordination, Kneebone & Reid recommend that states work to coordinate and streamline disparate funding sources as much as possible, even through Memoranda of Understanding (MOUs) where a singular state agency is not feasible. As the authors note: “Bringing more funding partners to the table increases the ability to effectively layer multiple sources and avoid scenarios where projects receive tax credits but stall in moving forward because other funding sources do not come through or take multiple cycles to secure.”

Whether it’s investments in staff capacity, coordination among funding sources, or consolidating administrative burden, the researchers repeatedly stress the importance of “formalized structures” in cutting red tape so more households can have a safe, affordable place to call home.