Over the past several years, the cost of housing has vaulted atop many Americans’ lists for what is driving our current affordability crisis. Much of the debate around how to lower housing costs has centered around two options: regulatory reforms (e.g., zoning changes, minimum lot sizes, or parking requirements) or financial reforms (e.g., making it cheaper to build housing). While the former has received a lot of needed attention through the abundance movement, the latter deserves an equal amount of focus: irrespective of these regulatory barriers, it has become too expensive to build.
Cities with liberalized zoning codes still face constraints in pooling capital to build. Increased interest rates, labor costs, and cost of construction materials are driving hurdle rates (i.e., minimum ROIs) to levels that prevent deals from penciling out, leaving large swaths of projects that have been permitted for construction unable to break ground due to a lack of financing. In fact, from 2000 to 2020, there was an annual average of 50,000 multi-family homes that had been permitted but never started construction. As highlighted in the Center for Public Enterprise’s new report multifamily starts have flatlined at ~350,000 units per year for the last 40 years, compared to 1970-73 and 1982-86, when we produced 3 million units in just 4 years and 2.6 million units in five years, respectively.
This is bad news for everyone. It’s bad for markets as investors are not injecting needed liquidity to kickstart construction, bad for governments who have been working diligently on regulatory reforms only to see deals stall out, and bad for consumers, who are being faced with higher housing prices as this bottleneck continues to choke supply.
The good news is that state and municipal governments have been developing a creative way to lower these financial barriers in order to ramp up production, all while developing more affordable units, making one-time investments that pay back the principal and generate steady returns over time, and increasing public ownership of assets in an effort to support longer-term affordability goals while still offering competitive returns for investors.
Enter housing revolving loan funds (RLFs).
Housing RLFs are an effective and underutilized tool for policymakers to build more housing. These types of programs represent a growing and promising trend for two reasons: RLFs offer very cheap forms of financing that help cities rapidly accelerate deal flow while generating steady cash flows from mixed income properties that are recycled back to grow the fund over time. Helping this idea reach scale requires new types of partnerships between all levels of government and the private sector and could provide a template across many other areas outside of housing. While there is precedence for mixed-income RLFs, there is no standard support model from the federal government for helping states get started, which has led to a diffuse environment where only certain states are taking advantage of readily available federal resources. An RLF Accelerator Program would help standardize existing offerings at the federal level, not require net-new funding, and scale this powerful model that states are already taking advantage of.
The rise of RLFs
In its simplest form, an RLF is seeded by municipalities or states selling bonds and using the proceeds to capitalize a fund that injects low-cost, public debt or equity into a project’s capital stack to kickstart construction. Governments require a lower rate of return on this financing than private investors, lowering the overall cost of capital needed for a deal to pencil out. Existing RLFs have typically provided construction financing, which is historically higher-risk and difficult to fundraise, specifically mezzanine financing, which means traditional private lenders will still be the first to be paid, helping ensure those investors remain at the table while filling critical gaps of the capital stack that typically result in stalled deals.
RLFs also target multifamily, mixed-income developments, where cash flows from market rate units will cross subsidize the affordable units, allowing the administrator of the RLF to not only recoup their bond principal but grow the fund steadily over time. The mixed-income nature of these funds is the critical revenue generating component and is worth underscoring – without rents from higher income units, these funds would not be able to sustain themselves.
While the revolving loan concept is not necessarily a new one in the housing space, it’s application towards short-term, construction financing for mixed-income developments was catalyzed by Montgomery County’s Housing Production Fund, which launched in 2021. Over the past two years alone, at least five states have established revolving loan funds for construction financing – and that number is growing.
These projects have grown in popularity as they’ve demonstrated a low-cost approach to increasing housing supply in a capital-constrained environment. State and local teams have a high degree of customization when designing an RLF, such as housing it in an Housing Finance Agency (HFA) or Public Housing Authority (PHA), having the fund cover different, typically higher-risk, tranches of the capital stack, or, critically, entering into different partnerships with different federal entities to further de-risk the project and lower costs.
This flexibility has allowed municipalities to leverage their local assets and competitive advantages and enter into unique partnerships with federal agencies or impact investors that meet those needs. At the same time, it has allowed for a diffuse landscape to emerge where cities and states have been required to develop one-off partnerships or enroll in singular federal programs that have benefitted those early movers but rely on a fragmented menu of options at the federal level, limiting uptake and preventing the scaling of this successful model across the country.
State and federal partnerships on RLFs already exist
- Increase adoption of the Federal Financing Bank (FFB) Risk-Share program and dedicate a portion of it to support RLFs. This program lowers the overall cost of capital on two fronts: by utilizing the Federal Housing Administration (FHA) to provide mortgage insurance and having the FFB bear the cost of the mortgage, significantly reducing the need for housing finance agencies to issue bonds to cover those costs. In other words, since the federal government is absorbing the mortgage default risk, which lowers the risk profile of the project, HFAs and developers now have access to better financing terms (i.e., lower interest payments) which lower overall development costs. While this program is not specific to RLFs, Montgomery County incorporated this risk-share into the design of their Housing Production Fund, showing that this could support critical parts of a capital stack for an RLF. 27 states are already enrolled in FFB Risk-Share and, since the program was reinstated during 2021, over $2.7B has been used to finance the construction or rehabilitation of 16,200 units, and projections show over 38,000 more units will come online over the next 10 years, highlighting major capital opportunities for housing finance agencies. Congress made this program permanent in 2024, creating a path of certainty for additional states to enroll. With more promotional efforts, HFAs can learn from Montgomery County and start ramping up enrollment into FFB risk-share to support revolving loan funds.
- Develop standard integrated financing packages between HFAs and GSEs to support RLFs. As part of their RLF, known as Bringing Innovation to Lending and Development (BILD), MassHousing created a FORGE loan, which is an integrated debt package consisting of a permanent Freddie Mac financing structured in partnership with Berkadia and a subordinated second mortgage loan from MassHousing. In essence, MassHousing is putting a small amount of state funding on the line to access much cheaper financing terms (i.e., lower interest rates) from the federal government, greatly lowering overall development costs and stretching state funding much further. In addition, Freddie Mac now allows lenders to make preferred equity investments in a borrower under a mortgage the lender sells to Freddie Mac, a feature MassHousing also took advantage of as part of BILD. Depending on how loss positions are structured in their capital stacks, states can readily access these funds from Freddie and Fannie.
- Carve out a portion of Fannie and Freddie’s overall loan purchase portfolio to support RLFs. The power of Fannie Mae or Freddie Mac lies in their ability to purchase loans and repackage them into securities that trade on a secondary market, providing critical stability and liquidity in the mortgage and financial markets. These purchase programs can significantly lower the cost of capital for HFAs or other state institutions as they are building out their multifamily and single-family portfolios. Freddie and Fannie’s overall portfolio exceeds $100B and recently increased, but no portion is dedicated to supporting RLFs. This is a missed opportunity for the federal government since RLFs can present lower-risk projects by targeting shovel-ready deals that lack financing, shortening overall project timelines and lowering costs. RLFs are also typically backed by highly rated state debt, which can further drive down risk from the federal government’s perspective. By dedicating a portion of their portfolio to purchasing mortgages tied to RLFs, Fannie and Freddie can lower their overall risk exposure while stretching their purchase power further since the purchased mortgages allow states financing that is recycled over time, essentially leading to one investment from GSEs having the power to stretch across multiple housing development cycles. Also, this serves as an important signal to the market: if states and cities see that the federal government is offering better financing terms for RLFs, it greatly encourages them to take action.
States can scale these successes across the country
These examples highlight how states are thinking innovatively of lowering their cost of capital through one-off partnerships with different federal programs. Whether it’s FFB risk-share, integrated financing packages, or loan purchase programs, states have readily available federal resources that can be used strategically as one-time financing that can be recycled over time so they don’t need to be coming back for more. Part of the issue is housing finance teams on the ground are sometimes not aware of these resources and need support in finding the right resources for their needs. At a minimum, it is critical that states and municipalities are made aware of these resources and that they are quickly incorporated into existing pipelines and capital stacks, so states and cities can replicate success and reap the benefits these early movers have seen.
An RLF Accelerator Program
While resources already exist and this work can scale quickly with the proper socialization, there is a major opportunity for the federal government to better organize itself to support states in seeding revolving loan funds. Through executive action, the federal government should launch an RLF Accelerator Program that directs relevant agencies to combine the aforementioned existing federal financing vehicles under Fannie Mae, Freddie Mac, Ginnie Mae, the FFB, HUD, and other agencies into a standardized, targeted program that supports revolving loan funds. For example:
- A portion of the HUD/FFB risk-share program can be dedicated to mortgages linked to revolving loan funds.
- Fannie and Freddie can develop a standardized integrated finance package for HFAs and GSEs that is specific for revolving loan funds.
- A portion of Fannie and Freddie’s portfolio could be dedicated to purchasing mortgages tied to revolving loan funds.
These changes, similarly discussed by the Center for Public Enterprise, would create a bi-directional risk share model by leveraging the highly rated state and municipal debt used to seed RLFs to in order to unlock better payment terms and lower financing through the backing of the federal government. By dedicating certain portions of these existing programs to RLFs, and organizing it under one roof, the federal government can support states scaling longer-horizon, evergreen style funds that reduce the need for federal financing in the future. Reorganizing these programs makes them more accessible to states, helping them unlock federal resources to lower costs, generate steady returns, and increase deal flow which, in turn, lowers federal risk and improves federal balance sheets, creating a virtuous cycle for all levels of government that ultimately addresses local housing needs.
The path forward and the case for federalism
Formalizing interagency programs into a multi-agency accelerator program that utilizes the power of federal government balance sheets to enable and scale state-led innovations is reflective of a new, partnership-driven approach to federalism. Allowing states to enter into different agreements with the federal government that offer better financing terms showcases the power of the federal government in de-risking markets that enables and empowers states and cities to design innovative solutions that meet their specific goals.
Given this new type of operating model, risk-mitigation will be key. It is critical to identify the takeout and permanent finance structure of the RLF upfront so that the fund can frequently and consistently revolve and deals can convert their financing once construction finishes and units are rented. RLFs require thoughtful consideration on geographic location so that market-rate rents will provide the appropriate cash flows to cross subsidize the affordable units and pay down debt obligations. Given the lower expected returns from these projects, states need to carefully consider ownership structures (majority or minority) and their risk profile in the capital stack (e.g., mezzanine debt, preferred equity, etc.). These programs also require upfront investment. While, in theory, these costs are only one time, they still represent expenses on the state balance sheet.
The severity of our housing problem dictates action. This moment calls for more state and federal collaboration underpinned by a focus on affordability and fiscal stewardship. A national RLF accelerator program focuses on leveraging low-risk, low-cost state assets to access low-risk, low-cost, and already available federal financing to lower the cost of capital and scale housing construction. In a capital-constrained environment, we need more solutions that are fiscally sound and make housing cheaper. This is an opportunity for states to take the lead, but not to lead alone, as key federal programs and partners are available to support state innovation across this broader housing affordability agenda.
Bruce Katz is the Founder of New Localism Associates and a Senior Advisor to the National Housing Crisis Task Force. Niall Dammando is a Policy Advisor at the National Housing Crisis Task Force focused on housing finance issues. Paul Williams is the Founder and Executive Director of the Center for Public Enterprise.