Understanding the District’s Housing Production Trust Fund

This is the second in a series of posts about how affordable housing works, by an affordable housing developer. Part 1 can be found here.

In my last column, I showed the math, and funding, required to build an income-restricted, subsidized—”affordable”—three-bedroom apartment for a family earning up to $76,060 annually, equivalent to 50% of Area Median Income (AMI). Doing so requires financing from numerous sources, including federal Low-Income Housing Tax Credits (LIHTC), construction loans, and subordinate debt.

In this column, I’ll take a closer look at the Housing Production Trust Fund (HPTF), the District’s primary local funding source for affordable housing development. Unlike LIHTC, which is provided by the federal government, or private equity and construction loans, which are provided by the private sector, the Housing Production Trust Fund is funded and administered directly by the DC government. To understand how affordable housing gets built in the District, it is crucial to understand the Housing Production Trust Fund.

History and structure of the HPTF

The DC Council originally passed legislation creating the Housing Production Trust Fund in 1988, during the Marion Barry mayoral administration. However, it was not actually funded until 2002, when former mayor Anthony Williams’ administration introduced a law dedicating 15% of the District’s real-estate recordation and transfer tax revenues to the HPTF and directing the Department of Housing and Community Development (DHCD) to administer it. Recordation and transfer taxes are paid when properties are sold (the cost is generally split between buyer and seller), so the logic was that revenues from a hot real estate market should be reinvested in affordable housing, with more investments made the hotter the market became.

After proceeds from the transfer and recordation taxes plummeted following the 2008 financial crisis—illustrating the danger of relying too heavily on a highly variable and cyclical revenue source—the DC Council began to contribute directly to the HPTF via annual appropriations from the District’s operating budget. This culminated in a 2015 commitment from the Bowser administration to provide $100 million in annual funding to the HPTF, creating a stable and significant source of local financing to preserve and build affordable housing. The Housing Production Trust Fund has operated at scale in the District for approximately a decade.

The HPTF is a revolving loan fund that provides low-interest construction loans to subsidize the preservation and construction of affordable housing. This generally takes the form of a second mortgage on the property, subordinate to a conventional first mortgage, which is paid back over time from the operating property’s cash flow or when the property is sold. By structuring HPTF investments as loans, not grants, its funds are ostensibly recycled to expand it over time. Standard terms for a loan from the Housing Production Trust Fund are a 3% interest rate, currently well below market-rate, with 75% of the building’s net cash flow going to loan repayment. So, in practice, most of the income produced by a property built with HPTF dollars is returned to the District, with very little cash flow remaining for the property owner.

All new units must be affordable at the low-income level, for those making 50% AMI ($76,050 for a four-person household) or less. Preservation projects must be affordable at the moderate-income level, for those making 80% AMI ($121,700 for a four-person household) or less. Preservation projects are allowed a higher affordability threshold to avoid displacing existing tenants, who might be means-tested out of their homes if the same requirements of newly produced units were applied. For both new production and preservation projects, affordability requirements are enforced via a covenant recorded on the property simultaneous with the loan closing, which means that they survive any sale of the property or transfer of ownership (except in the event of a foreclosure, when covenants are generally extinguished). The DC government is able to maintain an active role in the construction and ongoing operations of the project as a lender with oversight over the property.

Allocating scarce resources

Projects are selected for Housing Production Trust Fund loans via a competitive request for proposals (RFP) process. The RFP is generally released on an annual cycle, with applications opening in the summer after the District’s budget for the next fiscal year has been finalized, proposals due in the fall, and awards announced the following spring. While the RFP selects projects to receive funds from a variety of federal and local sources (including the competitive 9% LIHTC allocations I explained in my previous column), its primary use is to select recipients for HPTF loans. The RFP is a heavily detailed document that includes minimum requirements for all projects, called “threshold” criteria, as well as scoring criteria via a point system to encourage particular types of projects, such as those with more family-sized units, deeper affordability levels, more rigorous green building standards, longer-term affordability restrictions beyond the minimum 40-year covenant, or more desirable locations. Because the RFP process is highly competitive, affordable housing developers are strongly incentivized to design projects that align with the District’s priorities in order to receive the highest possible score.

Once the winners of the RFP process are announced, the developer works with the District to complete underwriting and close on the loan. This process generally takes a year or two, as the developer often still has to complete architectural construction drawings, secure building permits, finalize the construction contract, and secure the remaining financing sources for the project—in addition to completing the lengthy underwriting and loan finalization process with the District. Thus, from beginning to end, it can take three years or more to go from applying for a HPTF loan to starting construction on an affordable-housing project.

The HPTF as “gap” financing

One crucial aspect of HPTF financing is that it is meant to serve as “gap” financing. As I explained in my last column, the “gap” is the difference between a project’s total development costs and the traditional funding sources available. Local affordable-housing development policy generally involves finding funding tools to help fill that gap. So, rather than serve as the primary funding source for a project, the Housing Production Trust Fund is meant only to fill the gap between the costs of completing a project and the funds that can be raised via traditional mechanisms such as first mortgage debt and LIHTC equity. This enables the District to stretch its resources further and fund more projects by encouraging development teams to leverage federal and private dollars. However, it also means that the amount of HPTF funds needed for a specific project is highly variable and can swing significantly with interest rates or construction costs. For example, let’s take a hypothetical $50 million project that includes a $10 million HPTF loan:

Sources	Uses
First mortgage: $20 million	Acquisition: $8 million
LIHTC equity: $20 million	Hard costs: $30 million
HPTF loan: $10 million	Soft costs: $4.5 million
	Financing costs: $3.5 million
	Developer fee: $2 million
	Reserves: $2 million
TOTAL: $50 MILLION	TOTAL: $50 MILLION

In this example, let’s assume the project incurs a 5% overall cost increase due to inflation. This brings the budget to $52.5 million. We can assume about 30% of this cost increase can be paid by an increase in LIHTC equity since tax credits are based on project costs, so higher costs equal more tax credits; this covers $750,000 of the cost increase. That leaves $1.75 million to be paid by the HPTF, an increase of 17.5%. In this scenario, a 5% cost escalation led to a 17.5% increase in the HPTF commitment, multiplying the effect of the cost increase by a factor of 3.5.

A similar phenomenon occurs with interest rates. Let’s assume interest rates increase from 5.25% to 6%; this causes the size of the project’s first mortgage to drop from $20 million to $18 million. The HPTF loan has to increase $2 million to cover this difference. Thus, a 10% drop in the first mortgage value leads to a 20% increase in the HPTF loan, multiplying the effect of the drop in mortgage value by a factor of 2.

Because of this volatility, managing the Housing Production Trust Fund requires careful budgeting and preparation to guard against inflation and interest-rate risk. Because funding commitments are made via the RFP process well in advance of loan closing and construction beginning, there can be ample time for interest-rate and inflation risk to emerge during the underwriting process, which requires an increase in the loan size. Managing this macroeconomic risk is critical for the overall management of the HPTF.

Criticisms of the HPTF

The prevailing criticisms of the Housing Production Trust Fund in recent years have been the lack of transparency regarding DHCD’s RFP selection process and the inability of HPTF projects to meet statutory requirements to allocate 50% of funds to units that are affordable to households at the extremely low-income threshold (those making 30% AMI, or $45,650 or less for a family of four), rather than the low-income (50% AMI, or $76,050 or less for a family of four) or moderate-income (80% AMI, or $121,700 or less for a family of four) thresholds.

While the RFP process does include a detailed set of scoring criteria, the scores are not made public following the completion of an RFP round. A 2019 report from the DC Auditor found that, of nine projects selected for funding in the 2017 RFP round, five scored in the bottom half of the 20 applications received and two were the lowest-scoring proposals out of all applicants. These five projects had not been recommended by the DHCD agency staff charged with scoring and ranking the applications, and the selection process resulted in a DHCD whistleblower complaint. To address this issue, the Auditor recommended the DC Council enact legislation to increase transparency in the RFP process, including establishing specific parameters specifying when the DHCD director can use their discretion to deviate from the scoring rankings and publicly releasing the project scoring and agency staff recommendations. In response to the audit, then-DHCD Director Polly Donaldson said that higher-scoring projects had requested additional funding for operating subsidies that exceeded the amount of funding available and that the lower-scoring teams had better performance track records than some teams with higher-ranking proposals. That said, developer capacity metrics, which are intended to quantify the capabilities and track record of each development team, had already counted for 50% of the scoring criteria at the time.

In addition to concerns about the selection process, the most common criticism of the Housing Production Trust Fund is that it consistently fails to produce a sufficient number of units affordable to households making 30% AMI or less. When the DC Council established dedicated funding for the Housing Production Trust Fund in 2002, it mandated that 40% of the funds be spent on 30% AMI units. This requirement was later increased to 50%. In FY22, only 14% of the units produced were at the 30% AMI level. While DHCD made substantial progress toward this target in FY23, with approximately 48% of units funded by the HPTF at the 30% AMI level, this remains a major ongoing challenge (see 4:17:20).

However, 30% AMI units are uniquely challenging to build because rents are capped at such low rates that, over time, operating expenses for them exceed the revenue they produce—meaning that the units produce negative cash flow. For example, in 2023 the maximum rent for a 30% AMI one-bedroom unit is $910 per month, yet standard operating expenses on that unit—$11,000 annually, assuming a full tax abatement—equal $916 per month. This unit operates at a deficit. This effect is compounded over time, as rents tend to grow at 2% annually while operating expenses grow 3% annually (because maintenance needs increase as buildings age). As a result, the deficit increases over time.

Due to this negative cash flow position, 30% AMI units cannot support a mortgage and require ongoing operating subsidies in order to stay afloat. As a result, the Housing Production Trust Fund cannot produce 30% AMI units on its own; a revolving loan fund cannot support construction of apartments that produce negative income precisely because such projects cannot support any debt. Rather, producing 30% AMI units requires providing ongoing operating subsidies via local project-based vouchers, known in DC as the “Local Rent Supplement Program” or LRSP. Without either an operating subsidy or heavy cross-subsidization from a very high percentage of high-rent market-rate units that enables the apartment to produce income (rather than operate at a loss), it is not possible to build and maintain a 30% AMI unit. (I’ll explain more about cross-subsidization in future columns.)

With the funding requirement for 30% AMI units, the District has put itself in a trap of its own making. The LRSP program is a separate line item in the District’s budget from the Housing Production Trust Fund. But the DC Council mandates the Housing Production Trust Fund to do something—produce a large quantity of 30% AMI units—that is not possible without significant matching funding from the LRSP program. An inability to meet that mandate even in the absence of sufficient LRSP funding is frequently cited as evidence of the HPTF’s failure. This is a classic example of good intentions undermining good governance. Producing more 30% AMI units in the District is a worthy goal, but one that requires funding operating subsidies such as LRSP, not just capital subsidies such as HPTF. Creating a mandate for one program, the Housing Production Trust Fund, that can only be solved by another separate program, LRSP, is a recipe for agency failure and public frustration. The significant improvement in producing 30% AMI units from FY22 to FY23 was, in fact, largely due to an increase in funding for the LRSP program that will likely be difficult to sustain over the long term.

In future columns, I’ll suggest ways that the District could increase the production of 30% AMI units beyond just funding more LRSP vouchers, which are extremely expensive on a per-unit basis. There is an enormous need in the District to create more housing affordable for those with extremely low incomes, and more can and should be done to achieve that goal. But it’s a mistake to assume that an inability to hit an unrealistic mandate means that the Housing Production Trust Fund does not work.

Planning for the HPTF’s future

The Housing Production Trust Fund is the District’s key tool for building and preserving affordable housing, but it has only existed for 35 years, received funding for 20 years, and been deployed at scale for 10 years. It has gone through growing pains, but is maturing into a stable and effective program that is the envy of jurisdictions across the country.

Since 2015, the HPTF has invested approximately $1 billion in affordable housing in the District, helping to preserve and build 8,200 affordable units. Including projects currently in underwriting, those numbers are projected to grow to $1.7 billion and 11,758 units, respectively, by the end of 2024. As of 2022, there were a total of 361,000 housing units in the District, so roughly 3% of all homes in the District are now covered under the HPTF program. Three percent may not sound significant, but housing is an enormous part of our economy, totaling $146 billion in value in the District as of 2022 (page 218). Biting off a significant chunk of a market this large takes time.

It is quite possible to bite off a larger chunk over time, as long as the District stays the course on utilizing and investing in the HPTF. As a thought experiment, let’s assume the DC Council were to continually invest $100 million annually into the Housing Production Trust Fund for the next 90 years. Next, let’s assume that 2% of the total loan disbursements are repaid and recycled each year, given the set 3% interest rate on loans while factoring in cash flow limitations of affordable housing. Let’s also assume that the “gap” in financing cost per affordable unit is $200,000, per recent trends. Finally, let’s assume that every new project includes a recordation of a perpetual affordability covenant, so affordability is not lost over time. (The vast majority of recent projects have committed to perpetual affordability, though it is not yet mandatory.)

With these baseline assumptions, we can calculate that over 100 years (2015 – 2114) the District would be able to build and preserve 176,000 dedicated affordable units. Assuming the city’s housing stock grows 0.5% per year to 571,000 units over that same time span, then the affordable housing stock would represent 31% of the total housing units in the city. This would be an accomplishment worth celebrating: a true mixed-income city with a vast portfolio of dedicated, quality affordable housing spread across the District. (I’ll say more on geographic distribution in future columns.)

Ninety years is a long time horizon to consider, and while housing preservation projects do make an immediate impact for those facing imminent risk of displacement and the crush of increasing housing costs, most of the District’s affordable housing investments will take time to bear fruit. But this does not mean that these investments are not worth making now. Successful cities endure for hundreds, even thousands, of years. Planning and investing in such extended timescales is necessary to make cities prosperous and inclusive in the long term. By continuing to embrace and strengthen the Housing Production Trust Fund, District policymakers, and citizens can help to build a better future for our city and live up to our shared goal of providing stable, secure, and inclusive housing for everyone who calls DC home.