A New Construction Lender in Town

In rental housing markets, a vacancy rate of 5% or lower is typically considered an emergency level — because it means there is so little housing available for new households. New York City’s vacancy rates are now 1.4%, according to the housing census conducted in 2023. Unsurprisingly, market rents here have risen sharply over the last five years, from $3,400 to $4,400 for a Manhattan one-bedroom and from $4,400 to $5,400 for a Manhattan two-bedroom.

Those rents are the main thing that makes the city increasingly unaffordable for many individuals and families, and the only sustainable way to drive them down is to produce more supply so that the city’s vacancy rate is in a reasonable range. Think of this like musical chairs (a common analogy to help explain the importance of housing supply): Say you have 100 homes; when people or families are looking for a new apartment, like when their lease ends or when they move out from an apartment with roommates, there is only one empty chair. It’s no wonder our housing market has such fierce competition and sky-high prices.

Producing more units requires a clear-eyed look at the current development process in New York City to determine which pieces of that process are creating barriers. So let’s do that.

What does a developer need? Three things: land, permission to build and capital. Land is limited and therefore expensive in New York, and that’s unlikely to change anytime soon. But the other two ingredients are within our collective control. We can do something about them, and we should.

The barrier that is permission to build is having a moment these days: Pro-housing groups like Open New York have been advocating for changes to the permitting and zoning processes in the city and successfully advocated for a major reform last year, the City of Yes. Nationally, the pro-housing agenda, driven to prominence by the bestselling book “Abundance,” has taken corners of the Democratic Party by storm. And New York City voters have the chance this November to make significant further progress on this issue with four important ballot measures that would make affordable housing development much easier and faster.

But this piece will discuss a less talked-about ingredient: investment, or how people who want to build housing go about getting the money to build. Let’s start with the basics of understanding how a multifamily construction development is financed.

On the face of it, it seems like the economic math should be simple: There’s a lot of demand for housing. People will pay for it. So there ought to be market forces for people to build it, knowing that they’ll get paid handsomely once it’s built. That’s the way it works with most products.

But housing is different for a few reasons. First, housing is simply capital-intensive to build, costing hundreds of thousands of dollars per home. Second, housing takes a long time to build, even with permissive zoning and building codes: It takes months, and often years, to turn a piece of land into even a small apartment building. These two things combined make investing in building housing more risky than, say, buying stocks and bonds, and as such, investors want to be compensated handsomely, too.

Let’s build an apartment

Say we are a developer who wants to build a 200-unit apartment building in Long Island City that is going to cost $100 million. We’ve got our land, but before we go get our permits and start building, we need to go out and get that $100 million to cover our costs.

There are essentially two ways to go about this: We can get that money from government affordable housing programs, or we can get that money from private investors.

First, let’s explore the conventional, subsidized affordable channel. These subsidies take a few different shapes: “tax-credit equity,” which acts kind of like a grant; low-cost debt; or ongoing operational supports like housing vouchers. When we cover a chunk of the project’s cost with tax-credit equity, the loan covering the rest of the costs can be smaller. Think of the tax-credit equity like a large down payment: With a big down payment, you get a smaller loan, which means smaller monthly mortgage payments, which means the rents needed can be lower — i.e., “affordable.”

This sounds great — and is great — but there’s one challenge: Cities and states only have so many housing tax credits (and tax-exempt bonds, and additional city and state subsidies) to go around each year — and every year, New York spends every last dollar. In fact, New York’s housing subsidies are heavily oversubscribed: At any given point, there are five to 10 projects waiting for each slot in the subsidized pipeline. That means that at any given time, there are scores of projects waiting in the wings, often otherwise “shovel-ready.” But for our project, we don’t want to wait years in line to get started, so let’s see what our other options are.

The second channel is private investment. We’ll try for market-rate apartments instead, because private capital is more expensive and we need higher income potential to make that project work. The first stop is the bank to get a construction mortgage. Just as with affordable projects, banks want to ensure that there’s a “down payment,” and won’t give a loan to cover the entire cost. Depending on interest rates, where we are in the business cycle and our project’s modeling, we could get anywhere from 50% to 65% loan-to-cost. Optimistically, in today’s market, let’s say we get 60%, or $60 million, from the bank as a construction loan.

Finding the other $40 million, the “down payment,” is harder — we have to find investors willing to take a risk. We send out a pitch email to a bunch of limited-partner equity investors explaining to them why our “beautiful project” is projected to generate “20% returns.” They won’t believe us, so we’ll send them our financial models. They’ll say our rent growth model is overly optimistic, and the project will actually only generate 13% returns — so they’re not interested. We’ll do this about 14 or 15 times and often still not get an investment.

Sometimes, neither our affordable nor our market-rate channels for multifamily investment pan out. One might say that if the projects aren’t generating high enough returns, then they aren’t economically efficient and shouldn’t be built. But that’s hard to square with New York City’s 1.4% vacancy rate. With housing in such short supply, shouldn’t more projects be viable? Why wouldn’t they be built?

The U.S. Census Bureau, which, among many other statistics, measures construction activity, keeps track of when buildings get permitted, when they start construction and when they finish. As such, one of their measures looks at the number of units that have received permits but have not yet started construction — often because the project is facing a financial constraint.

In recent years, that number has skyrocketed nationwide, more than doubling, up to 140,000 units per year, above the average last decade of around 60,000. And despite their preeminence, even superstar cities like New York, Boston, San Francisco and Los Angeles are not immune to these challenges.

A third channel

Several states and some cities have put in place solutions to these financial barriers, and New York City could learn from these ideas to boost our own housing production. The gist is simple. If we’ve spent all of our housing tax credits for the year, and sufficient investor equity isn’t forthcoming, New York can offer a third approach to investment: Make revolving construction loans to cover costs during construction, and, when construction is over, use the repaid debt to fund another set of projects. This type of funding is called a “revolving loan fund,” because, like a person walking through a revolving door, the capital cycles into a project, back out to the fund and so on.

Without typical subsidies, buildings financed this way won’t be 100% affordable, because the rents would not cover the costs. But if cities or states offer revolving capital at a cheaper rate than the private markets, the resulting buildings can support a mix of incomes. In many states, projects with publicly supported construction loans like this can support rents for people across the income spectrum.

Several states have recently set up programs to do this, including Massachusetts, Michigan and even New York at the state level, with our new Housing Acceleration Fund. But how do these programs scale up, and how can we really make the most of them here in New York City?

As noted above, on the affordable side, New York City has far more project proposals than projects that actually get built. A revolving credit fund could help push almost-there projects — those that just need a little more funding to fill the gap — into reality.

In Michigan, for example, the state has started with providing revolving fund money to projects that applied for federal or state subsidies but were not selected. The state program targets projects that can generate the revenue to pay back the revolving loan, allowing the funds to be redeployed elsewhere after construction is completed. For an enterprising housing agency with a backlog of applications, a revolving construction fund that can process stalled projects as mixed-income can be a monster tool, churning out units even when interest rates make it challenging.

Here in New York, one could imagine this type of tool being used to finance New York City Housing Authority redevelopment projects, both for its Housing Preservation Trust and its Preserving Affordable Communities Together program.

One could also imagine revolving credit that prioritizes Mandatory Inclusionary Housing projects using the State’s property-tax incentive programs that, by virtue of having a municipal construction fund as a coinvestor, could provide additional affordability above and beyond what is required to qualify for the incentive programs.

The opportunities for the City to support housing abundance through public construction investment are plentiful, and the need for hundreds of thousands — maybe millions — of new units is getting deeper every day. We can implement a uniquely New York City structure for supercharging multifamily investment if we put our minds to it.