One Year of the Pandemic Economy and Counting

11 min read

Developers adjust for the ‘new normal’ and beyond 

After a year living through the COVID-19 pandemic, we’ve heard all the platitudes. This is the new normal. We’re all in the same storm, but not necessarily in the same boat. We’ve developed new vocabulary words, like “quarantini” and “doomscrolling.” We’ve become at-home information technology specialists, setting up mesh wi-fi networks to support parents working from home and kids learning from home.

Dr. Anthony Fauci, director of the National Institute of Allergy and Infectious Diseases, tells us there is light at the end of the tunnel as vaccines begin going into arms. But, we are still in the middle of that tunnel, he warns.

As if 2020 wasn’t bad enough, with the pandemic and ensuing economic crash, 2021 has started off with even more uncertainty. Political unrest and violence desecrated the U.S. Capitol building in Washington, DC. In the days following the January 6 insurrection in the halls of Congress, we learned just how close those who stormed the Capitol came to finding our elected leaders before they were able to escape.

If Charles Dickens were alive today and writing a novel, it very well might start with, “It was the worst of times, and it was the worst of times.”

So, what is the new normal exactly? What kind of boat is everyone sailing in this storm? How long will the storm last?

Tax Credit Advisor took some of these big picture questions and surveyed developers around the nation. The affordable housing industry has weathered difficult storms before, but nothing quite like what we’ve seen in the past year and what still seems to be in the forecast. If there’s one thing in our survey that most CEOs say keeps them awake at night, it’s continued uncertainty in the economy, the pandemic and the unpredictable nature of what might be coming. This all translates to uncertainty in rent collections, construction costs, deal financing and more. However, there also may be some unique opportunities during the darkest days of the current crisis, and developers are hoping to emerge from the other side of the pandemic economy prepared for what surely must be better days ahead.

Construction Concerns
Brian McGeady, managing partner at MVAH Partners, sums up what’s on many developer’s minds these days.

“What does the world look like post COVID, and what does it look like right now in the midst of it,” McGeady asks.

For MVAH, McGeady says they were fortunate construction did not slow much on projects already underway in 2020, but it’s in the back of his mind going into 2021.

“If any states go into a more full-scale shutdown where factories are closed and the supply chain is disrupted, that can cause problems, he says. “Right now we have 11 properties under construction and we should be closing another 12 developments throughout the course of this year. I continue to hope the supply chain doesn’t get disrupted the way it did last spring.” McGeady says his firm is specifically watching Michigan and Pennsylvania, where shutdowns could have a significant impact.

Geoff Brown, president and CEO of USA Properties Fund, also is keeping an eye on construction costs.

“What we’re trying to watch is certain commodities, like lumber, which are very volatile, and how that affects our costs,” Brown says.

Brown says USA Properties saw construction costs almost double between 2010 and 2015. For example, he says a three-story unit in Sacramento would have cost about $85,000 per unit in above-ground costs to build a few years ago, and in 2020 that same per-unit cost is closer to $150,000. He attributes the increased costs to a shortage of labor after the 2008 financial crisis followed by increases in materials prices. He is concerned about near-term increases in costs once again.

“With COVID and with some of these trade wars, I don’t think our supply chain is as healthy as it’s been in the past,” Brown says. “I do think our supply chain in certain areas is something we’ve got to watch. You are seeing a spike in the demand for lumber.”

Brown and other developers attribute the spike in lumber demand to continued robust growth in single-family construction as interest rates continue to be at historic lows.

“Single family demand is very strong and interest rates are still very low, and that is bringing additional demand” for construction materials, says Jeffrey L. Kittle, president and CEO of Kittle Property Group. “Pricing is up and there’s a scarcity and delays in availability.”

Kittle, whose company has its own construction arm, says lumber prices are up dramatically. They expect to use about $30 million worth of lumber this year but predict that cost could fluctuate as much as 30 percent. Lumber is the biggest cost for construction components, he says.

In addition to the higher costs, Kittle also notes material availability issues beyond lumber. Drywall, appliances, windows and more are having lead-times of two to three months.

Upsides of the Four Percent ‘Fix’
The COVID-19 relief bill that passed Congress just before the end of 2020 included the four percent “fix” that affordable housing advocates had long sought. The legislation changed the four percent Low Income Housing Tax Credit (LIHTC) to have a true four percent floor, which was undercut in the current era of rock-bottom interest rates. The change means that more equity will be available to finance four percent deals and likely make some deals feasible.

Dara Kovel, CEO of Beacon Communities, says the program change is allowing Beacon to reopen old deals and get more into the pipeline.

“It has made a tremendous difference in many of our deals that are four percent deals,” Kovel says. “Adding 30 percent to the equity to these deals has changed the economics of what’s in the pipeline.”

“When you get more equity associated with tax credits, it makes it more attractive to do tax-exempt bond projects with the four percent credits,” Kovel notes.

Sharon Wilson Géno, executive vice president, national services, and chief operating officer of Volunteers of America, says her organization is looking at recapitalizations using the four percent fix.

“It’s not a new source of funding, but it’s going to make us relook at our portfolio,” Wilson Géno says. “It’s going to make deals work that didn’t work before.”

About 75 percent of VoA’s portfolio is senior housing, she says. Since senior housing tends to take less wear and tear, they sometimes can be recapitalized for less than a family property, she explains.

“We have things we would like to do to bring properties up to modern standards,” she says. That includes increased access to broadband internet for telemedicine, which is likely to grow in popularity after the pandemic.

Concerns About Capital
On the flip side of the four percent fix, developers also expressed concerns that some states could see oversubscribed bond volume.

“While on paper, fixed four percent is bringing in 25 to 30 percent more equity,” Kittle says. “But, if debt gets cut, there’s not as many investors. It’s concerning going forward on holding deals together.

“What we’re seeing is it’s helping getting deals done, but also watching investors and their appetite for additional credits and how much they’re paying generally,” Kittle says. “We’re seeing some discounts to what they were paying before because there’s not additional depreciation. Pricing is going down. That’s concerning.”

The question Kittle says he is asking now is, “Will deals be able to clear the market, will there be enough investors?”

Kittle and others note that some states are at or near capacity on bond volume, and they are looking to Congress to see if there may be follow-up legislation on the 50 percent test, possibly reducing it to 25 percent.

Kittle also notes that long-term interest rates are starting to curve upward. “Six months ago, we had some deals we closed on the tax-exempt side in the mid threes, and we’re seeing that move up in the low to mid fours,” he says.

“We’re excited we got the four percent fix,” says Brown of USA Properties. “It’s going to make a lot of deals financially feasible that otherwise wouldn’t have been.”

“Like anything else in life,” he adds, “it’s an opportunity that also creates a challenge at the same time. The scarce resource is going to be bond allocation.”

McGeady of MVAH also has some caveats about the four percent fix.

“The evolution the industry needs to make is that we’ve always been able to say there’s such a shortage, that there’s a build it and they will come mentality,”

McGeady says. “With a four percent rate, it’s possible some markets could get built close to capacity. We need to be smarter about evaluating our markets than in the past. We’ll need to think more like market-rate developers do by setting rents at the right spot, and taking on a responsible amount of debt.”

Rental Risks
For many developers, the long-term unknowns remain the biggest concern. Will service-sector and hospitality jobs lost in the pandemic economy come back? And if so, at what pace? Will people still travel for business and stay in hotels? And how will workers in those sectors who lost jobs be able to afford a home?

“My biggest concern is what does the world look like from the perspective of hospitality and service sector jobs,” says McGeady. “How do those get changed and influenced from a long-term standpoint. How many companies are going to significantly reduce travel budgets? How does that impact airlines and hotels long-term? What is the long-term impact of employment for those individuals, and what is the replacement employment? That impacts a significant portion of people with Section 42 housing.”

The pandemic economy is creating some opportunity, however. Developers said the slowdown in commercial property could free up some real estate for development.

Kovel says Beacon Communities was able to get property in a prime Boston location after a hotel acquisition ground to a halt during the COVID crash.

“COVID had negative impacts in real estate for retail, hotels, tourism, entertainment and office space,” Kovel says. “There will be real estate opportunities for developers like ourselves.”

Kovel says Beacon is in the process of acquiring a “Class A property in an A+ neighborhood” at 140 Clarendon St. in Boston’s Back Bay neighborhood. The property—a hotel with housing and commercial space—was slated to be sold for its existing use at top dollar, but the deal fell through in April and Beacon secured the acquisition. The company is working to turn the property into 210 units of housing, half of which will serve homeless individuals, pending project and financing approval.

Developers will be focused in the near-term on navigating COVID and helping ensure residents are able to pay rent with the recently passed $25 billion rental assistance program.

“The stability of the portfolio is on the minds of those of us with large portfolios, in terms of eviction moratoria and rent arrearage programs,” Kovel says.

“Getting through COVID has been an occupying challenge for us and our property management teams,” Kovel continues. “It’s going to be a long time until we’re out of the woods on that. It’s a gloomy picture for a while. The federal stimulus helps, but it’s going to be the tip of the iceberg of what’s necessary.”

Kovel adds that Beacon sees opportunities in the nation’s economic recovery. “We want to make affordable housing development the economic engine to create jobs and affordable housing,” Kovel says.

We want the residents to be protected,” Kittle says, noting that his company’s teams are in constant contact with states about rental assistance disbursements, and meet with each other every morning to stay on top of developments.

For VoA, Wilson Géno says the pandemic has renewed their resolve to marry healthcare with affordable housing and technology for seniors. “No project goes through our system now that we haven’t looked at some health care component.”

Wilson Géno also notes that VoA soon will launch a housing and healthcare justice fund. “We will be focusing our investments in communities that historically have been underserved,” she says.

But first, developers need to finish weathering the current storm.

“COVID is still obviously a challenge for our country, for our communities, our management, our employees and our residents,” Brown says. “Hopefully, as we get through the year, we will get the vaccines distributed and get to the point where we can get past COVID. I don’t anticipate that will happen until fall at the earliest.”