Chicago, like other markets around the country, has faced a mounting affordable housing crisis for years. There have been efforts—some stilted, some enthusiastic—to address the problem but the COVID-19 emergency has only exacerbated the situation.
More than 26 million Americans have filed for unemployment since the start of the pandemic. For the multitude of those already operating in the low-income bracket, there is a very real possibility of losing their homes, adding to the nation’s housing instability.
The affordability gap
Every year, millions of Americans spend an outsized portion of their income on housing. Advocates and those in the industry have targeted naturally occurring affordable housing (NOAH) as an option to fill some of the demand that these families face for more achievable housing.
Rather than push for new affordable housing development, NOAH offers pre-existing rental stock within neighborhoods where there is a good mix of market-rate and affordable units as an option for households with low to moderate incomes. The pandemic, however, has destabilized an already tenuous situation.
“Even before the COVID-19 emergency, many of these households were considered ‘rent burdened,’ paying more than 30 percent of their incomes toward rent,” said Lee Oller, executive vice president in the Chicago office of Merchants Capital. “Now that so many of these households are unemployed, this burden is far greater and likely to get worse as the crisis continues.”
While low-income renters face tremendous hurdles during this crisis, there are impacts on property owners as well. Landlords face a troubling dichotomy: diminished rent rolls occurring even as the cost to maintain assets increases.
Stay-at-home orders have meant that landlord-paid utilities have all escalated. Additionally, property owners and managers face ballooning maintenance costs as they clean and sanitize common areas within their apartment buildings to combat the spread of the virus.
“Many of our clients have reported increased operating costs, even as rental income declines,” Oller said. “Of course, these property owners must still pay their mortgages, real estate taxes, utility bills, maintenance and management personnel.”
The federal government has allocated significant funds via the Coronavirus Aid, Relief and Economic Security (CARES) Act to both individuals and small businesses. The United States Department of Housing and Urban Development (HUD) announced several further measures to alleviate financing concerns during the developing COVID-19 situation.
“HUD has tried to clarify the CARES Act forbearance requirements and they have instituted some debt service reserve policy to make sure that our underwriting is sound in this changing environment,” said Oller. “But they haven’t stopped working; we’re still making loans and we’re all figuring things out as we go.”
HUD announced that it will suspend monthly deposits to be placed for replacement reserve through July 31, 2020—or longer, if the authority to grant this benefit is extended. Once the suspension period has ended, the total of these payments will be diverted to the reserves for replacement in equal monthly increments over the next 12 consecutive months.
The department also stated that it will use both operating deficit funds and debt service reserves to make debt service payments. Both of these steps are subject to repayment provisions, if any, contained in subject escrow agreements. Finally, HUD will use replacement reserves to meet debt service payments required, so long as the reserve for replacement reserve account does not fall below $1,000 per unit.
However, the timing and coordination of federal efforts has been problematic. Oller reported concern among her clients that the neediest citizens are realizing insufficient financial aid. There is further apprehension that federal relief meant for small businesses has been poorly administered and difficult to access.
As a result, not enough funds are reaching those people and businesses that were vulnerable before this crisis, and only more so since it began. As cash flow problems surge, Oller believes that a clear byproduct of the COVID-19 emergency is a freezing up of the financial and credit markets.
“Many banks—faced with sudden spikes in delinquent mortgages and tremendous uncertainty about future economic conditions—have responded by increasing interest rates, or simply shutting down lending to the owners of real estate,” said Oller. “Unlike many other banks, Merchants Bank is leaning in and still lending because of our experience already with affordable housing.”
The federal Opportunity Zone program, first introduced in 2017, allows investors to defer federal taxes on capital gains until December 31, 2026 so long as the gain is reinvested in a qualified opportunity fund. There is no cap on the amount of money that can be invested, and no taxes are applied to any appreciation for those that hold the investment for 10 years.
It is unlikely, however, that an underlying Opportunity Zone can help with a mismatched supply of affordable housing. The consensus among most developers is that the Opportunity Zones don’t make a bad deal good—proper fundamentals still have to be in place. Additionally, the program doesn’t seem well suited to multifamily projects, whether market rate or affordable.
“In Illinois we haven’t seen opportunity zones coupled well with the HUD programs,” Oller said. “Some people are doing those deals in other markets, but not in Illinois. I’d certainly like to see more affordable deals done within Opportunity Zones.”
First introduced in 2007, Chicago’s Affordable Requirements Ordinance (ARO) requires some multifamily developments to supply at least 10 percent of units at affordable rates. An amendment in 2015 increased the in-lieu fees that developers must pay into the Affordable Housing Opportunity Fund.
However, the ARO has faced controversy from many who argue that it has a deleterious effect on market-rate rents—and thus dampening the zeal of investors and developers. Many would rather see efforts aimed at the existing stock of NOAH units and are wary of policies that create new affordable units if those come at the expense of market-rate development.
Whether or not the ARO has or will have an impact on development, the fact remains that Chicago still faces an affordability gap of roughly 120,000 units. This puts the efficacy of programs like this one into question.
The Lightfoot administration has floated a number of amendments to the ARO, including a potential legalization of accessory dwelling units. Though not yet codified, the possible legislation would allow for the rental of coach houses or “granny flats,” a viable option for those in need of affordable housing.
Though affordable housing targets a niche corner of the commercial real estate realm, and one with slim margins, it’s no different from other sectors in the face of the COVID-19 pandemic. Like other asset classes, we’ll have to wait and see how the situation progresses.