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Kansas City, MO

By Mark Anderson

St. Paul-based Common Bond, one of Minnesota'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 administrationto 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 BobOdman, 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.

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, saidChip Halbach, director at HousingMinnesota, an advocate for the creation of affordable housing.

The block grants have long been the primary source for new housingdevelopment, but over the last two years those grants declined by 20percent 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 theirincome for housing, and that number is increasing by 3,000 each year, Halbach said.

Local affordable developers are worried 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 CommunityHousing 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.

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 partof 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 - whetherwe'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.

This article was originally published in Finance and Commerce, Minneapolis, Minn., another Dolan Media publication.