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Sacramento for All: Housing Education Resource Center

4. Market-Rate and Affordable Housing Development

Sacramento for All: Housing Education Resource Center

4. Market-Rate and Affordable Housing Development

Understanding the difference between market-rate housing and affordable housing is critical in comprehending the dynamics of housing production and the City’s housing goals. These differences shed light on the interplay between economic forces, policy, and social needs.

Market Rate Housing

Housing that is considered ‘market rate’ refers to residential properties that are priced according to current market conditions, without any subsidies or restriction on pricing. The cost for this type of housing is determined by how much people are willing to pay for housing in a specific location at a given time. Market-rate housing is priced according to market demand and can often be out of reach for many individuals.

Affordable Housing

Affordable housing aims to provide a variety of housing options for individuals and families who might otherwise struggle to afford market-rate housing. Affordable housing is designed to be affordable for people with low to moderate incomes and it may involve some form of subsidy or assistance to keep rents or purchase prices below market rates.

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There are two main types of affordable housing:

One type refers to regulated or deed restricted housing, meaning rents or sales prices are legally restricted to be affordable to lower-income residents. This housing is income or rent-restricted to ensure the housing is occupied by households earning a certain income, and rents are set to be affordable to those income levels.
The other type is attainable housing or “naturally occurring affordable housing”. Examples of this include older housing stock, or housing that is lower-cost by design like micro-units, manufactured housing, accessory dwelling units, etc. Although more affordable than market-rate housing, this housing type is still unafforable to the lowest-income residents.

How does housing get developed?

Developers go through many steps to develop housing, which requires coordination with many entities including the City, lenders, architects, contractors, and more. The diagram below depicts the steps a developer must take to ensure a project is completed, while also meeting the City’s planning and building regulations.

There are many steps involved in developing housing, it requires coordination with multiple entities including the City, lenders, architects, contractors and more.

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Determining the financial feasibility of a housing project is a crucial first step of this lengthy process. Moreover, in the last two decades the cost to build housing has significantly increased. Between 2000 and 2016, the cost of building a 100-unit affordable project in California increased by sixty percent according to a study by the Terner Center for Housing Innovation. This study found that affordable housing is impacted by the same trends that increase costs for market-rate housing, in addition to being subject to increased local scrutiny, further inflating costs.

There are three categories of costs that affect the feasibility of building new housing. These include:

Acquisition: The cost of the land and closing costs.

Soft Cost: This refers to legal and professional fees (architecture, etc.), insurance, financing, and development fees.

Hard Cost: This refers to the cost of materials and labor for construction. This cost has the biggest impact on the financial feasibility of a project.

Three categories of cost affect the feasibility of building new housing.

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These categories give a developer an accurate cost estimate to pursue financing to pay for the cost of building a project. Generally, developers will obtain funding in the form of a loan from a bank, and equity from an investor. These forms of financing require certain returns on investements (interest) before lenders or investors are willing to proceed with the financing. Developers are responsible for fully repaying the banks and investors including the agreed upon interest. For market-rate housing, this is all the funding they need to move forward with their project.

Affordable housing projects collect less in rents than market-rate housing, creating a gap in funding for the developer that must be filled through public subsidies. Subsidies generally come from local, state, or federal governments, and can be used to cover construction costs, rents, or operating costs. Affordable housing developers generally pursue multiple subsidies to help fill the financing gap needed to make a project feasible.

Unfortunately, due to current market dynamics and development requirements, hard costs and interest rates have increased significantly since 2019 (12.9 and 8.5 percent respectively). These higher costs have created an environment where the development of many housing projects has become financially infeasible.

For more information on the financial feasibility of building housing, visit the Terner Center’s Interactive Web Application Demystifying Development Math.

Additional Resources

Please see below for additional resources:

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