A few months ago, Matt Bedsole received a call from two real estate developers asking him for help. Their plan to build a four-story apartment complex in Chattanooga, Tennessee, had a financial gap that no backer seemed willing to fill. The developers needed $8 million. Would Mr. Bedsole be interested in stepping in?
Mr. Bedsole is not a normal investor. He is executive director of Invest Chattanooga, a fund set up by the city of 200,000 to invest in local housing projects. Unlike private equity firms — the main backers of new construction — he judges deals not just on their financial return, but also on how much housing they can deliver to the city.
The apartment complex has overcome this hurdle. It called for 170 new units to replace a self-storage center surrounded by barbed wire in a gentrifying area of the city. But Mr. Bedsole had conditions. In return for the $8 million investment, he received a 51 percent interest in the building and an agreement that 30 percent of the units would be offered at below-market rate. The developers said yes. They made the deal over pastrami sandwiches.
“Money is tight and developers don’t have many options for capital right now,” Mr. Bedsole said in an interview. “We have it, but we want affordable units as part of the deal.”
Invest Chattanooga is part of a new class of government-sponsored funds that invest directly in new housing. The aim is to accelerate construction and create permanently affordable and locally controlled housing. In doing so, they are rethinking how local housing programs traditionally work.
Each attempt is a little different, but the guiding principle is to get developers to build more housing at lower rents in exchange for public investment. Instead of demanding a high rate of return, as a private investor would, these funds ask developers for less money back but mandate that a portion of the units command below-market rents.
They come at a time when a mix of higher interest rates and rising costs for insurance and materials like lumber have caused investors to shy away from new construction. Economists estimate the country needs about two million new housing units, but the pace of housing construction has slowed over the past year.
Some states, such as Hawaii, have created funds that lend money to developers on more favorable terms than Wall Street or a bank would, while others, including New York, have created funds to accelerate stalled projects. Atlanta wants to use public land to encourage construction of new homes: The city’s Urban Development Corporation donates city-owned land for private development projects and retains a share after the building is completed.
Then there are public investment funds like the one in Chattanooga.
There are about two dozen of these funds in the United States, said Shaun Donovan, the executive director of Enterprise Community Partners, who recently assembled a team to support them and is trying to set up his own fund to bolster their efforts. The funds provide “capital, but capital at this moment of greatest impact when the building is coming out of the ground,” said Donovan, who served as housing secretary in the Obama administration.
Most of these efforts were inspired by Montgomery County, Maryland, whose Housing Opportunity Commission has been a sort of national laboratory for affordable housing innovation for decades. Mr. Bedsole has been something of a human catalyst in this process: He helped build Atlanta’s system based on the Montgomery County model and then brought those ideas to Chattanooga last year.
“The cavalry isn’t coming, so we have to figure this out ourselves,” Chattanooga Mayor Tim Kelly said.
From social housing to patchwork
How to create low-cost housing for people who cannot afford market rents is a puzzle that has plagued cities throughout the modern era. Governments have spent much of the last century vacillating between public and private sector solutions to the problem. Today, most new affordable housing is delivered through a hybrid system, in which public grants fund private development.
This system is more a product of changing politics than thoughtful policymaking. Beginning in the 1970s, the federal government essentially stopped building public housing as part of a broader move away from welfare. What it replaced was a patchwork of rental vouchers and tax breaks — the largest of which, the Low-Income Housing Tax Credit (LIHTC), established in 1986 — for companies that provide affordable housing. Local governments now rely on this loan to build everything from low-cost housing for teachers to supportive housing for people exiting homeless shelters.
One of the problems with low-income tax credits is that they are complicated to use and expire over time, often after 15 to 30 years. From this point on, the building owner can start charging market rents. This is an annoying turn of events for cities, as they often hand out millions in grants to finance affordable projects. To prevent building owners from evicting low-income tenants after affordability restrictions expire, many governments are buying back buildings.
“So now the state has paid for the building twice — first with grants and then with a wad of cash to the developer,” said Stanley Chang, a Hawaii state senator. “That’s obscene.”
A small mistake in a growing problem
Mr. Kelly, the mayor of Chattanooga, said he founded Invest Chattanooga to prevent this obscenity. A businessman who ran car dealerships and co-founded the local soccer club, he was elected in 2021 on a platform of affordable housing (and re-elected last year).
Initially, Chattanooga responded to the housing crisis by revising its zoning laws to allow for higher density and legalizing backyard units on residential properties. This has been the formula followed by many state and local governments over the last decade as rental and real estate prices have skyrocketed. But as in many other cities, there has been a lot of construction on higher-priced buildings whose rents are too high for large parts of the workforce.
Chattanooga has lost about half of its apartments renting less than $1,000 a month over the past five years, according to a city report. Rents for the new apartments are too high, while federal programs are not producing enough units to meet demand.
But when building, there are two ingredients: land and money. So Chattanooga decided to focus on the second of these and became an investor. He invested $20 million to create Invest Chattanooga and hired Mr. Bedsole of Atlanta to run it.
Invest Chattanooga is run like a business that makes money and then converts the profits into more affordable housing. This is the initial cash, usually a mix of equity and debt financing, that developers need to obtain a bank loan. In exchange for the money, projects built with the fund must reserve at least 30 percent of their housing units for families whose income is below the area median income.
The city does get a return, but it is low — about 8 percent for the recent deal to replace the storage center, compared to private equity firms, which in many cases are asking twice that amount. This difference can mean that a developer can save millions of dollars on an apartment building and thus reduce the rent. And unlike units built with federal tax credits, the building is owned by Invest Chattanooga, allowing it to benefit from higher property values down the road.
Mr. Bedsole said Invest Chattanooga has a relatively modest goal of producing 100 affordable units annually by 2030 and raising an additional $20 million for additional projects. It’s a small stone in a problem that gets bigger every day. Unlike the public housing agencies of the past, his agency does not replace developers in housing construction. Rather, it attempts to replace the financiers who decide what gets built and what doesn’t.
“I don’t compete with developers,” Mr. Bedsole said. “I compete with private equity.”