The U.S. housing market is in the midst of a painful contraction after 2022 brought a volatile end to about two boiling hot years.

It’s tough news — especially for homebuilders — as demand dries up and prices flatline or even begin to drop. It’s also still tough for homebuyers. Home prices remain comparatively higher than they were even just three years ago amid today’s higher interest rates as the Federal Reserve continues to wage its war against record inflation levels.

If today’s market is brutal for homebuilders, it’s an even more challenging environment for affordable housing builders that are already trying to push the envelope when it comes to keeping costs low for renters while also ensuring projects are financially feasible.

‘Perfect storm’

It’s been a “perfect storm,” said Greg Gossard, president of The Hampstead Companies, a San Diego-based affordable housing developer that has also completed four projects in Utah.

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“Then things got really out of control,” in 2022, when mortgage interest rates started shooting up, Gossard said. “Rates kept moving. Construction costs, as everyone knows, continued to inflate, so we were in this perfect storm of lower debt proceeds and higher costs.”

And that was just the beginning. As mortgage rates reversed the market, executing projects the rest of the year all of a sudden became extremely challenging, and since then he and other affordable builders have pulled back.

“We’re definitely being a lot more conservative in what we chase because of what we saw in 2022,” he said.

Jeff Nielson, president and CEO of Wasatch Residential Group, a Salt Lake City-based developer that focuses on affordable and market rate housing, said his company faced similar challenges as the market turned.

“We closed on zero tax credit deals in the state of Utah in 2022, which would definitely be a first for us in the last 10 to 12 years,” Nielson said.

Gossard’s and Nielson’s comments came during a virtual panel last week hosted by the Utah Housing Coalition to discuss the state of Utah’s affordable housing market.

As of early 2022, Utah faced a nearly 41,000-unit shortage of affordable and available units for extremely low-income Utahns, according to the National Low Income Housing Coalition. Utah’s affordability issues have also sharpened as the state continues to face a stubborn housing shortage that impacts market-rate prices.

Plus, even though Utah led the nation in homebuilding in 2021, the state still faces a roughly 31,000-unit shortage to keep up with the state’s population growth and housing demand, according to estimates from the University of Utah’s Kem C. Gardner Policy Institute.

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Faced with rising mortgage interest rates, an estimated 79% of Utah households couldn’t afford the state’s median priced home as of late 2022. Even though Utah’s home prices are starting to tick down, they still have a long way to go before coming close to erasing gains since 2019. Even though housing experts are at odds over just how far prices will fall, they aren’t expecting a major, 2008-like crash due to Utah’s strong economy and steady population growth.

Utah Gov. Spencer Cox has proposed $150 million to help address the state’s critical housing shortage through a variety of housing initiatives, as well as “policy solutions” to help facilitate market solutions by knocking down certain barriers for developers.

Last year, Utah lawmakers set aside a record-breaking $70 million for housing and homelessness — but that was far short of the $128 million Cox proposed. This year, Republican legislative leaders say they’re prioritizing housing initiatives. Legislators will spend the next month sorting out budget requests.

What are affordable housing builders facing?

The 2023 housing market’s “headwinds” are the same for all homebuilders — high construction costs compounded with high interest rates that have lowered borrowing amounts. But those challenges are especially sharp for affordable housing developers.

It’s no secret that “one of the greatest challenges in the country is the affordable housing crisis that just is getting worse every single year,” said Robert Likes, president of community development lending and investment for KeyBank and a member of the Utah Housing Coalition board.

“The gap between supply and demand continues to widen. Every county and every state in our country has an affordable housing need,” Likes said as he moderated the panel. “In Utah, same thing. We’re short tens of thousands of units.”

Those “major headwinds,” he added, are “exacerbating, unfortunately, the existing affordable housing crisis,” not just in Utah but across the country.

Nielson gave an anecdotal example of just how much the market’s shift has impacted which projects pencil and which ones don’t. He pointed to City Lofts, a multifamily income-restricted housing project currently under construction at 230 W. 1700 South in Salt Lake City.

The 236-unit project has cost roughly $188,000 per unit to execute, compared to a similar project executed less than three years ago that cost about $124,000 per unit.

“So if you look in that 2 1/2 year time frame, we’re up about 50% in construction costs, which just is not sustainable,” Nielson said. “That’s a huge challenge right now to affordable housing, is the cost.”

Nielson said he’s hoping construction costs might retreat in coming months as higher interest rates continue to dampen demand and work dries up for contractors. But so far, that hasn’t happened yet.

“We’re hopeful with higher interest rates that we’ll see the market rate side of the multifamily space slow down a little bit, because those deals just don’t pencil as well as they used to,” he said. “In fact they don’t pencil very well at all right now.”

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Nielson said as interest rates have risen, builders aren’t able to obtain financing for dollar amounts they otherwise would have been able to in the past. For example, he said his company could have been eligible for $36.4 million in debt, but today that number has dropped down to about $29 million.

“So a $7.4 million reduction in debt proceeds in 12 months. ... So that’s the challenge we’re seeing right now. Deals that penciled a year ago now have a $7.4 million gap just from a debt perspective,” he said. “And costs are going up as well.”

To try to close those gaps, affordable housing developers have been working with city officials, banks and other partners to help make their projects feasible. But they’re also at times forced to consider lifting their area median income percentages to adjust rent income.

What will 2023 bring?

Looking ahead this year, the challenges persist.

“We haven’t resolved these headwinds,” Nielson said. He noted, however, there has been a “significant slowdown” in single-family homebuilding, and he said he expects a slowdown in multifamily building.

Although prices are so far trending flat, “we are pretty optimistic that we’ll see some cost decreases over time,” he added.

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Gossard said rates are “seemingly starting to stabilize,” so he’s hopeful 2023 will bring more stability to the market. “But that’s yet to be seen.”

Likes said the affordable housing industry “always” faces challenges.

“If it’s not something, there’s another thing. These deals are very, very difficult to put together,” but “right now we’re in the middle of some really major” headwinds.

“But I know that we will work through this,” Likes added. “There’s no doubt about it. The people involved are very committed to adapt and to make things happen. You know, it may take a few months, it may take a year, but we’re in this to build and preserve affordable housing.”

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