How Subsidy Layering Shapes What Gets Built | Alpha Deal News

Affordable housing deals are rarely financed by a single source. The more typical structure involves multiple subsidy types stacked together — each with its own eligibility requirements, compliance obligations, and timing constraints — in a capital stack that would look complex to anyone outside the industry.

That complexity isn't arbitrary. It's the direct product of a funding system that requires multiple sources to make deals financially viable. Understanding how subsidy layering works — and why it shapes what actually gets built — is foundational to understanding affordable housing development.

Why single-source financing rarely works

The core challenge in affordable housing finance is a gap: the cost to develop affordable housing, in most markets, exceeds what the rents restricted-income residents can pay. That gap has to be bridged with subsidy — and in most cases, a single subsidy source isn't large enough to bridge it alone.

The 9% LIHTC credit, the primary federal tool for affordable housing production, generates equity equal to roughly 60–75% of total development cost, depending on market conditions and deal structure. The remaining 25–40% needs to come from somewhere else: conventional debt, federal soft loans, state housing trust funds, local housing finance programs, or some combination.

This is why almost every significant affordable housing deal involves layered financing — not because developers prefer complexity, but because the arithmetic demands it.

The primary layers

Tax credit equity (9% or 4% LIHTC)

The foundation of most affordable housing capital stacks. The developer sells tax credits to an investor — typically a bank or corporate investor seeking Community Reinvestment Act credit — in exchange for equity that funds the development. The investor receives tax benefits over a 10-year period; the developer receives upfront capital.

9% credits are allocated competitively through state QAPs and carry higher equity value. 4% credits are used with tax-exempt bond financing, are available without competitive allocation (subject to bond volume cap), and generate lower equity per dollar of eligible basis.

Tax-exempt bonds

4% LIHTC deals are paired with tax-exempt bond financing — typically issued by a state housing finance agency or local authority. The bonds serve as the primary debt instrument, at below-market rates enabled by their tax-exempt status. The combination of 4% credits and bond financing can work well for larger deals in markets where the bond volume cap is accessible.

Federal soft programs

HOME Investment Partnerships Program funds — federal grants to states and localities for affordable housing — are frequently deployed as soft loans in LIHTC deals. HOME funds carry compliance requirements that must be coordinated with LIHTC compliance, which adds complexity but can meaningfully improve deal viability.

Community Development Block Grant (CDBG) funds are another federal soft source, though their use in housing production has become less common as many localities direct CDBG toward other community development priorities.

State and local soft loans

State housing trust funds, local housing finance programs, and city or county housing authorities often provide soft loans — typically deferred or below-market — that fill remaining gaps in the capital stack. These are frequently the most valuable and most difficult-to-access layer of the stack, because they're geographically limited and subject to competitive allocation or program cycles.

Other equity sources

Historic tax credits can layer with LIHTC for adaptive reuse projects involving historic structures. Opportunity Zone equity has been used in some affordable housing deals, though its interaction with LIHTC compliance is complex. Solar and energy efficiency incentives can generate additional capital in the right contexts.

How layering shapes what gets built

The composition of the capital stack isn't just a financing technicality — it has direct implications for deal feasibility, deal type, and ultimately what housing gets built.

Deeper affordability requires more subsidy. Units targeted at 30% AMI produce significantly lower rents than units targeted at 60% AMI. To make a deal work with lower rents, more subsidy has to fill the gap. This means 30% AMI targeting typically requires access to operating subsidy — project-based rental assistance, most commonly — in addition to the development subsidy. Deals without that operating subsidy layer often can't support deep affordability despite developer intentions.

Local soft debt availability creates geographic variation. Markets with robust local housing finance programs — significant housing trust funds, consistent local soft loan availability, engaged housing authorities — tend to produce more affordable housing than markets without them, even controlling for land costs and construction markets. The soft debt layer is often what determines whether a deal closes or stalls in the gap.

Compliance complexity constrains deal flexibility. Each subsidy layer in a capital stack comes with its own regulatory requirements — income targeting rules, rent restrictions, reporting obligations, and affordability period requirements. When multiple layers with different requirements are stacked together, the compliance structure becomes complex and constrains the developer's flexibility on many dimensions. This isn't a reason to avoid layering — it's often unavoidable — but it is a reason that experienced compliance management matters for developers who rely on layered stacks.

The practical implications for deal evaluation

Understanding subsidy layering has direct implications for how deals should be evaluated:

Before assuming a deal is feasible, confirm that all the layers you're assuming in the capital stack are actually accessible — not just in theory but for this deal, on this timeline, with this team.

When evaluating a site, think about which layers it's eligible for and which it isn't. QCT or DDA designation affects eligible basis. Location in a state with strong housing trust funds changes the soft debt picture. Prior environmental use could complicate HOME eligibility.

When stress-testing a deal, test what happens if one layer falls through. What does the capital stack look like without the local soft loan? Without the state housing trust fund award? Deals that are fragile to the removal of any single piece aren't necessarily non-viable, but they carry more execution risk than deals with multiple paths to closing.

Affordable housing finance is genuinely complex. But the complexity has a logic, and teams that understand that logic make better decisions — about which sites to pursue, which deals to advance, and how to structure the capital stack given what's realistically available.

Alpha Deal helps development teams model capital stack scenarios from the earliest stages of site evaluation — so feasibility assessments reflect what's actually achievable, not just what looks good in a spreadsheet.