(This post is Part 3 of a series on evaluating catalytic development projects. Click here to read Part 2)
So far in this series we’ve covered the importance of establishing your own desired outcomes for a project and understanding the goals of the other stakeholders involved. We’ve also discussed the basics of project costs, because when the rubber hits the road, achieving desired outcomes must be balanced with the financial constraints of the project. We talked about a few ways to free up space in the project budget, but what if those strategies aren’t enough? What if additional funds are required to make the project “pencil out,” or be financially feasible? If this is the case it may be necessary to pursue outside subsidy.
In an ideal world, developers would not need to rely on outside subsidies to make projects financially feasible. They can be highly competitive and are never guaranteed – meaning an entire project can fall through in an instant because a critical subsidy was not secured. That’s a crushing blow not only for the developer, but also for the development authority that awarded the developer the RFP contract, all the developers who didn’t win, and the community that fought to have their goals reflected in the winning developer’s plans. That’s why we focus so much on doing everything possible to reduce costs and avoid the need for outside subsidies entirely. But sometimes – oftentimes – that is just not possible – so it’s important to know how to navigate this aspect of development as responsibly as possible.
What is Subsidy?
By this point in the series we’ve mentioned the topic of subsidy a few times, so let’s unpack that term. One of our developer friends likes to use the adage “if you can’t get the rent, you can’t build the building” – basically, if you can’t generate enough revenue through rent to cover your project costs, the project won’t happen. Outside money, whether through grants, tax abatements, freezes, or credits, or similar programs will be necessary to contribute to your available funds or lower your upfront or ongoing costs. Remember that goals and costs must be balanced: for example, to achieve targeted affordability goals, subsidies are often required to help make for up the lost revenue from below market rate rents. Building and infrastructure costs remain high no matter the rent rate or project location. In general, if a developer charges high enough rents, they can likely cover the project costs. To offer lower rents, some form of subsidy is often needed to make up the difference.
While outside subsidies can help cover project costs when trying to provide a more affordable project, there are important questions to ask regarding a developer’s promise of pulling in said subsidies. When subsidies are promised, development authorities and communities should consider the following: how competitive are the subsidies to achieve, and has the developer earned and used these subsidies on past projects? If a developer promises to leverage highly competitive subsidies with no proof of prior experience, it would be wise to view their proposal with a healthy dose of skepticism. In our experience, federal subsidies are as scarce as they are beneficial, and most tend to have entire ecosystems of specialists surrounding them as the process is extremely niche and complex. For newcomers, it can be very difficult to break into that ecosystem and secure a win over the many other experienced players. If subsidies are promised and then not achieved, it typically means that a project will be put on hold until alternate funding sources can be found to close the financial gap.
Inclusionary Zoning
What makes things really interesting is when a jurisdiction requires that a certain percentage of new units in a project be rented at below the local market rate – i.e., for developers to subsidize below market-rate housing. In Atlanta, this occurs for projects that fall under the purview of the city’s Inclusionary Zoning (IZ) policy – one of the city’s efforts to gain more workforce housing. These requirements apply to projects in a few districts throughout the city, most notably the Beltline Overlay District, and are difficult, if not impossible, to meet without some form of subsidy under typical development assumptions. There is a critical deficit of affordable housing in the United States – a true crisis facing our country – and policies like Inclusionary Zoning can be a part of the solution; however; these requirements introduce an inherent challenge by limiting a developer’s ability to cover project costs through revenue generation. Remember the adage: if you can’t get the rents, the project can’t happen. Always ask what rents are proposed (for market-rate and affordable units), what subsidies are being pursued, and what prior experience the developer has in achieving those subsidies.
Common Subsidies
In Atlanta, one popular form of subsidy is a property tax abatement. Many large-scale projects will request this subsidy from the City or County in an effort to offset project costs. A property tax abatement accomplishes what it sounds like – it holds property taxes in place for a certain duration, instead of letting them rise with improvements as should normally occur. While this certainly helps with project budgets, it comes at a cost. Less revenue from increased property taxes means less money for entities like ABI (for their TAD, which should help pay for future transit) and APS (Atlanta Public Schools). Depriving the surrounding community of increased future public revenue can be hard to rationalize for projects that are ultimately intended to support the surrounding community. This is one reason why it is particularly important for community leaders and elected officials to understand the basics of development subsidy. We believe property tax abatements – a form of public investment in private enterprise – should only be awarded to projects that will bring some form of benefit to the community, whether through affordable rents, improved public space, or otherwise.
Another form of subsidy are tax credits, such as historic tax credits (as mentioned in Part 2) or credits for providing affordable housing. Our proposal for Murphy Crossing relied very little on outside subsidy. We based our housing (of which 100% was to be affordable/work-force) on a 4% Low Income Housing Tax Credit (LIHTC) deal. These credits are non-competitive, which means that you do not have to beat out other applicants to guarantee that a project can move forward, which eliminates the risk of project delays. Additionally, our development partners had a tremendous track record in obtaining and applying these credits. Unfortunately, it has been almost 18 months since the RFP was submitted, and the Georgia Department of Community Affairs (DCA), who allocates the 4% LIHTC credits, has recently put a hold on this subsidy. The DCA has seen a recent surge in this type of tax credit request, requiring them to stop issuing credits for the time being. This means that even if a new RFP is issued for the Murphy Crossing project, this tax credit will no longer be an option as a subsidy.
Below is our workforce housing portion of the project if we want to include. Feel this section is lacking in imagery.
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Overall, it’s important to understand the give and take needed between communities and developers to balance goals and costs. Be skeptical of developers or development authorities who promise it all: both affordability and flashy amenities. Ask how costs are being covered, what the timeline for delivery is for the flashy pieces relative to the affordable pieces, and if significant subsidies are being proposed. If subsidies are on the table, evaluate the likelihood of those subsidies being acquired by the developer by asking about their prior experience. Ask them how often they have achieved those subsidies before, what the likelihood of achieving them is for the project in question, and what the fall back plan is if the subsidies don’t pan out.
At this point we’ve set goals and explored some financial strategies to make those goals possible. One of the best tools for achieving goals and reducing costs is good design – the topic of the final post in our series on evaluating large redevelopment projects.