Construction costs pinch affordable housing developers

By Mark Anderson, F&C Finance Writer
March 30, 2006

St. Paul-based Common Bond, one of the state’s largest developers of affordable housing, caught the full brunt of one of Hurricane Katrina’s northernmost gales as it was finalizing plans for its most recent project.

The nonprofit was preparing to close on financing for a 25-unit supportive housing project to serve people with multiple sclerosis. The $2.4 million north Minneapolis development was being planned with the MS Society Minnesota.

And then the construction bids came in — between $1 million and $1.4 million above projections.

“We went out for those bids at probably the worst time possible, just a few weeks after Katrina hit,” said Ellen Higgins, vice president for business development at Common Bond.

Higgins and her team quickly recovered from that shock and went back to the drawing board, shaving away enough production costs to bring the low bid down to $2.9 million.

Then they started knocking on doors, eventually persuading the city of Minneapolis, the MS Society and Common Bond’s own administration to increase the combined contributions by $500,000, filling the remaining gap.

Higgins said she now expects construction to begin by the end of April.

The nightmare that Higgins and Common Bond experienced was one of the most glaring examples of a trend in construction costs that’s squeezed profits for all developers, but it poses a genuine threat to the development of affordable housing.

Construction costs are generally estimated to have climbed 15 percent in 2005 — driven by increased global demand for construction materials as well as new Gulf Coast demand — and they will continue rising at close to that pace for several years, many analysts say.

For affordable developers, the rules created by their funding sources prohibit those costs from being transferred to the low-income renters that make up their market. And that creates a dilemma in the complex and changing world of affordable housing finance.

Housing developments aimed at the low-income market are funded primarily with equity that’s raised by selling low-income housing tax credits — to banks and other large institutions — and with the bank debt that the equity contributions leverage.

But a substantial gap always remains between those sources and actual development costs, a gap that’s been filled over the years by federal and state housing program sources and an array of local and charitable contributions.

That gap has been growing, though, following the upward trend of construction costs. In fact, the shortfall has more than doubled in the last 10 years to more than $40,000 per unit today, according to Bob Odman, assistant commissioner for affordable housing at the Minnesota Housing Finance Agency.

“What it boils down to is that additional subsidies are needed from some source,” Odman said. “The alternatives are either increased federal and state funding or decreased production of affordable housing.”

As costs have continued their steep rise, however, public funding sources are moving in the opposite direction.

Funding gaps grow

The federal government has traditionally been the largest contributor to affordable housing, through rent support programs, such as Section 8 and public housing, and indirectly through the Community Development Block Grants it provides to cities.

Section 8 allocations have actually increased recently, but only enough to keep pace with rising costs, not to add new apartments, said Chip Halbach, director at HousingMinnesota, an advocate for the creation of affordable housing.

The block grants have long been the primary source for new housing development, but over the last two years those grants declined by 20 percent in Minnesota, Halbach said. Next year’s Bush administration budget proposal would speed up block grant reductions by cutting another $400 million from the program nationwide.

The picture at the state level is a little brighter. Total allocations to housing efforts have remained steady, although a larger portion of those funds are now directed to Gov. Tim Pawlenty’s initiative to end homelessness. The governor and Legislature agreed to supplement that effort with new expenditures for supportive services and bonding authority to develop housing for homeless families.

While developers and housing advocates welcomed that initiative, they also noted that its net effect will reduce state subsidies for housing that targets Minnesota’s working poor households.

And that community is growing. Last year, 10 percent of Minnesota households — almost 160,000 in all — paid 50 percent or more of their income for housing, and that number is increasing by 3,000 each year, Halbach said.

Local affordable developers are worried about by those diverging trend lines, but they are also busy looking for strategies to maintain production.

And they’re uniformly stoic. “All developers tend to whine about conditions,” said Alan Arthur, executive director at Central Community Housing Trust, a Minneapolis-based developer of affordable homes in the Twin Cities. “But this is the marketplace we work in. We just have to find ways to finance these projects.”

One strategy that all developers will follow is to simply expand the roster of finance partners on each project. Affordable housing developments have always relied on multiple benefactors. In the Twin Cities, the lists of metropolitan, county, city, state and private donors generally run from three to 15 or more, developers say.

Those numbers will now climb. “One of the things we’re trying to do is be more creative at putting these packages [together],” persuading more sources that a particular project meets their program goals, said Chris Wilson, the development manager at Minneapolis-based PPL Inc, a nonprofit developer.

That strategy will add cash, but it also brings a downside. The addition of each new partner prolongs a development process that already reaches three years for many affordable developments, according to CCHT’s Arthur. That expanded donor list also adds another round of attorney fees, as well as increasing holding costs on the development property.

Market plus affordable

Another route many nonprofits are taking is to add market-rate housing to their affordable housing projects.

Common Bond is completing a mixed-income development in Milwaukee, an adaptive reuse of an industrial building with a view of Lake Michigan. The prime location made a market-rate component a valuable part of that project, Higgins said.

PPL is in the midst of its first mixed-income project, a side-by-side development of condominiums and affordable rental apartments in New Hope, and it’s planning a second larger mixed-income project at the Bunge grain elevator site in southeast Minneapolis.

Both projects are proceeding well, Wilson said. The market-rate portions have provided income that subsidizes the affordable side, and the combined projects are also generating savings through shared costs and infrastructure. But he cautions that developers are still learning about the mixed-market products. “It’s an experiment in progress for us.”

There’s also a campaign under way that aims directly at boosting state funding again for affordable housing. HousingMinnesota is leading an effort to increase the residential deed sales tax from 0.33 percent to 0.5 percent, dedicating the additional $69 million in revenue to affordable housing.

Halbach said that although his group kicked off the campaign this year, it has its sights set on the 2007 session.

“Our chances depend in part on the state of Minnesota’s economy next year, and then on how well we’re able to tell this story — whether we’re able to help people, especially legislators, see the impact that the pieces in this complex picture are having on low-income Minnesotans,” he said.

Condos, park compete for site near Guthrie

The Minneapolis/St. Paul Business Journal - March 8, 2006
by Sam Black
Staff Writer

Three competing proposals, including a park and a 30-story condo tower, are vying for a coveted site by the Guthrie Theater in Minneapolis, along the banks of the Mississippi.

The City of Minneapolis received the plans in response to a request for proposals it issued in December regarding a 5.6-acre site adjacent to the newly built Guthrie.

The city was looking for development ideas that could include housing, entertainment or small retail. The site has some significant technical challenges, including a large power-line tower and related easements for Xcel Energy.

The deadline for proposals was March 2. Some or all of the respondents will be invited to present their plans on March 22 to a review committee established by the city's economic development department.

The proposals are:

• Brighton Development Corp. of Minneapolis and a Minneapolis-based nonprofit called Norway House have proposed developing two $20 million condominium buildings that would total about 144 units. The plan also includes a 35,000 square foot American Norwegian business and cultural center plus a park and open space.

Norway House, which was founded 2 years ago by former Consul General of Norway Thor Johansen, is led by president James Erickson and facilities committee chairman Harold Ulvestad. The group is trying to build a $15 million facility with a restaurant, auditorium, art gallery and gift shop and Royal Norwegian Consulate General. The Norway House construction would begin in 2008, according to the proposal, but the housing component wouldn't start until the summer of 2010.

Other members of the Brighton group's development team are Meyer Scherer & Rockcastle as lead architect on the housing component and Thorbeck Architects as lead architect for the Norway House development. The Cunningham Group will be the lead designer for the open space of the development.

• Hunt Associates of Minneapolis and North American Partners Development Co. of Dallas have proposed a 30-story contemporary condo tower with 47,200 square feet of restaurant and commercial space for one corner of the site, with the balance being used as park land. Minneapolis-based Hammel, Green and Abrahamson is the lead architect on the project. The cost of the development would be about $100 million.

The McGuire Family Foundation, a Wayzata nonprofit organized by UnitedHealth Group CEO William McGuire, proposed donating between $2.5 million to $3.5 million for a public park highlighted by a 25-foot tall observation mound.

Under the proposal, the city would retain ownership of the land, but allow development of the park and its ongoing maintenance by the developer for the next 10 years. The city would get $500,000, paid in lease payments of $50,000 over 10 years.

Windsdor Cos. Inc., of Maplewood and Osland and Assoc. of Minneapolis are listed as partners in the McGuire proposal. The Guthrie Theater endorsed McGuire's proposal.

Minneapolis in the middle

By Brian Johnson, F&C Construction Writer
February 28, 2006

When it comes to housing affordability, the Twin Cities has a long way to go before it catches up to Indianapolis. On the other hand, it’s light years ahead of Los Angeles — or just about any other major market in California.

The National Association of Home Builders, in its latest survey of the nation’s most and least affordable housing markets, rated Indianapolis as the most affordable major market and Los Angeles as the least affordable.

Minneapolis-St. Paul was 55th among the 159 U.S. markets included in the current survey, which is based on fourth quarter 2005 data.

The Twin Cities’ middle-of-the-road standing may actually be a positive sign, according to Steve Melman, director of ecocomic services for NAHB. Some markets, he noted, are high on the affordability scale because there are no jobs in those cities.

Indeed, 11 of the 14 most affordable housing markets in the nation are in Ohio or Michigan. Those states happen to rank near the bottom when it comes to creating new jobs, according to a new report from the Milken Institute.

“By being more in the middle range, [the Twin Cities] maybe has a better balance than a place like San Francisco, on one end, or Peoria [Illinois] on the other end,” Melman said.

NAHB’s survey calculates affordability by comparing an area’s median home price (new and existing) with its median family income. It then determines the percentage of median-priced homes that are affordable to median-income families.

The upshot is that 61.5 percent of homes sold in the Twin Cities in the fourth quarter were affordable to a median-income household in the area. That compares with 88.7 percent in Indianapolis, and 2.3 percent in Los Angeles.

Recent trends show that homes are becoming less affordable nationwide. Nationally, 41 percent of the homes sold in the fourth quarter were within reach of U.S. median-income households, down from 52 percent in the fourth quarter of 2004.

The current figure is the lowest level of housing affordability since NAHB began tracking that data in the early 1990s.

Those figures are skewed, in part, by notoriously high-priced homes in California. In the latest NAHB survey, 19 of the 21 least affordable markets were in California. The other two were in New York and New Jersey.

Anti-growth sentiment, a shortage of construction-worthy lots, rising building material prices, and inadequate transportation systems are a few factors that are contributing to the bleak affordability numbers, Melman said.

“Some communities are saying you can’t build until you get the roads out there,” Melman said. “I think that’s what they are saying: Don’t put the cart before the horse.”

Minneapolis-St. Paul has been all over the map when it comes to affordability.

In the second quarter of 1995, the Twin Cities was the nation’s fifth-most affordable market, with a median home price of $95,000, median income of $51,000 and an affordability percentage of 83.6.

But just a few years later, in the third quarter of 2000, the Twin Cities plunged to 121st in affordability, with a median price of $179,000, median income of $68,600 and an affordability percentage of 57.2.

The latest Twin Cities numbers ($235,000 median price, $77,000 median income, 61.5 percent affordability and 55th ranking) show big improvement compared with five years earlier.

Now for more good news: Looking at the nation as a whole, Melman expects home prices to level out soon.

“If the employment situation is good, and as new people come into the job market, households would have more money and would be able to catch up a little with the home price side of it,” he said.

“I think more than interest rates, people’s income will start to catch up with the price of new homes. I think that will be the determining factor.”