4. Funding and financing affordable housing through a revolving fund scheme in Latvia

The Housing Affordability Fund has the objective to support the expansion of the affordable housing stock in Latvia’s regions. For this, the Fund will need to mobilise a substantial amount of capital and allocate it efficiently to viable investment projects. The impact, efficiency and sustainability of the Fund operation depends on a variety of factors, including the:

  • Framework conditions of investment projects (e.g. social and technical infrastructure);

  • Availability of capital from external financing sources and the (internal) revolving fund mechanism;

  • Attractiveness of participating in projects financed by the Fund for private stakeholders, in particular real estate developers and commercial creditors;

  • Mitigation of financial risks and the fiscal burden associated with the Fund.

Considering those factors, this chapter outlines three dimensions of the Fund’s funding and financing mechanism to assess the setup and derive Policy Actions for Latvia by drawing on the good practices of four peer countries with longstanding revolving funding mechanisms:

  • the investment environment, meaning the conditions that facilitate investment in affordable housing, such as access to infrastructure and housing tenure considerations;

  • the model of intervention of the funding mechanisms in different countries (funding sources, revolving elements, impact on state budget);

  • and financing instruments used in the scope of the fund (financing incentives, safety mechanisms, and related state aid considerations).

For each of these dimensions, the chapter first provides a comparative snapshot, highlighting where Latvia stands in comparison with peer countries, and then builds on the international practices to point at policy recommendations of relevance for Latvia.

Table 4.1 provides a comparative snapshot of the investment environment in different funding schemes for affordable and social housing according to the following dimensions:

  • While infrastructure represents a key enabler of housing development, the revolving fund schemes in other peer countries) generally do not cover financing for major infrastructure development; they sometimes finance or co-finance smaller-scale infrastructure, including inter alia, parks, amenities for sports and leisure, playgrounds/rooms, common rooms or fitness rooms (e.g. Austria and Slovenia). In the Latvian Regulation, infrastructure investments must be directly attributable to individual construction projects to receive funding (e.g. for necessary utility connections and communication infrastructure). In contrast, Denmark presents an integrated funding approach that comprises investments in technical and social infrastructure in the broader environment of affordable housing. Moreover, the Danish Fund is indirectly involved in the design of social infrastructure by supporting the development of the social master plans.

  • While the Latvian Fund will target the development of the residential rental market in Latvia, the status quo of the residential rental market varies widely across Latvia and the four peer countries. In Austria, Denmark and the Netherlands, the residential rental market accounts for over 40% of housing tenure, compared to around 12% and 10%, respectively, in Latvia and Slovenia. At the same time, all countries have policies or institutional features in place to strengthen the rental market. In Austria, Denmark and the Netherlands, housing associations serve this objective (for instance, in the Netherlands they hold around 70% of all rental dwellings). Latvia and Slovenia have also launched policies in the recent past to promote the expansion of the rental market. In 2021, the Latvian authorities introduced a new law on residential tenancy, aiming to balance protections between landlords and tenants, simplify the long litigation process in cases of landlord-tenant disputes, and promote investment in the rental market. It will be essential for the authorities to monitor the impact of the regulation on the rental market (e.g. size of the private rental market, price levels, eviction rates, etc.) over time.

Sufficient technical and social infrastructure is a precondition for the viability and sustainability of affordable housing projects. However, the survey of Latvian stakeholders conducted by the OECD indicated concerns about essential infrastructure preconditions for construction projects, including, inter alia, insufficient water, electricity, and sewage connections as potential barriers to affordable housing development in the regions. Therefore, the planning process of construction projects financed by the Fund should comprise in-depth assessments of infrastructure preconditions, in close co-ordination with municipalities, as the Fund will not finance this type of infrastructure investments. Moreover, to ensure the viability of affordable housing projects, they should be co-ordinated with ongoing or planned economic developments (e.g. planned industrial sites or economic expansion in some regions where additional dwellings may be needed for employees and their families).

Table 4.3 provides a comparative snapshot of the model of intervention of different funding schemes for affordable and social housing:

  • All countries aim to diversify the external funding sources for their investment activities in affordable housing. This comprises public loans from the state, municipalities and/or development institutions, commercial debt, issued through long-term loans or bonds, and equity contributions. Among all instruments, long-term housing loans, represent the most common funding source which is used in all peer countries. In the Netherlands, also apply credit enhancement through public guarantees or a dedicated guarantee fund to lower the financing costs and lengthen the loan terms. The aim for diversification is also reflected in the Latvian funding mechanism where co-financing may originate from developer equity (at least 5%), Altum development loans, and commercial loans (up to 50%).

  • The funding scheme in all peer countries includes a revolving dimension that contributes funding to investment activity; for example, this amounts to, on average, 3-7% of project financing in Austria and 12.5% in Slovenia. However, different approaches to the revolving dimension exist. The most common approach – which will be applied in Latvia – is the allocation of a share of rent contributions towards the fund. In the case of Denmark and Slovenia, a portion of the rents are re-directed to the housing fund, together with returns on loans, in the case of Slovenia. In Austria and the Netherlands, a share of the rents is re-invested via equity contributions from housing associations. Additional revolving features also exist, including the use of principal loan repayments for new construction or revenues generated from portfolio management activity of housing associations (such as apartment sales).

  • All countries seek to limit the impact of affordable housing funding on public finances, yet their approaches differ. Latvia is initially making use of funds from the Recovery and Resilience Plan (RRP) and will limit the issuance of loans to the national development institution Altum; there will be no provision of state loans and guarantees so as to ensure that the Fund remains fiscally neutral. Denmark and Slovenia established their housing funds as independent institutions that operate outside the state budget. In Austria and the Netherlands, housing associations, which lie at the core of the funding regime, are independent institutions with limited, clearly defined contributions from the public budget. In Austria, while not formally ring-fenced, loans repaid to regional governments are re-invested in housing. Table 4.3 clarifies the impacts on state budgets across the five countries.

Building equity for the Fund should begin early on to facilitate the rapid scaling of the housing stock. The higher the equity ratio of the fund, the higher the share of rent payments that can be reserved for new construction projects, reducing the burden of debt servicing. Additional equity for project financing facilitates the partial reinvestment of rental income into the Fund already during the loan repayment period of private and Altum loans. While the principal and interest repayments of Altum loans are reinvested into the Fund in line with the established practice in Austria (Box 4.1), this is not necessarily the case for the repayment of principal and interest of commercial loans. As commercial credit will likely play an important role for the co-financing of projects to scale up the affordable housing stock, its repayment terms could significantly affect the available cashflow from rental income for reinvestments into the fund during the loan repayment period.

Several sources may contribute to building equity for the Fund as loans are being repaid, including the use of retained earnings and grant reinvestments of municipal housing companies, direct equity investments by institutional investors, and the use of a share of rental income generated through enhanced credit conditions of commercial loans (as the rent would stay the same even if the cost of borrowing could become lower, a share of the rent could be reserved for building the Fund’s equity). Equity contributions from both institutional investors and municipal capital companies can be encouraged through targeted measures. Box 4.2 provides an additional example from the United States on how the auctioning of tax credits to private developers can help attract additional equity investments for affordable housing invest projects from third-party private investors.

Moreover, municipal housing companies often differ in terms of capacity and resources for real estate investments so that building additional capacity for the planning and execution of affordable housing projects can be important. Box 4.3 presents a capacity building approach for Community Housing Providers (CHP) in Australia.

Table 4.5 provides a comparative snapshot of the financing instruments of the different funding schemes:

  • Long-term loans are the key instrument to finance affordable housing investments in Latvia and the peer countries. The loan terms vary in terms of durations, rates, and repayment structures. The durations range between 20 and 50 years. The rates are commonly low but vary depending on the origin of public and private lenders. When public loans are provided, the rates are particularly low, in Austria for instance at 1% per year. Public loans usually become subordinate when commercial capital is employed for financing.

  • Different countries use a variety of tools to provide incentives for affordable housing investments. Peer countries like Austria, Denmark, and the Netherlands tend to rely on ex-ante instruments such as loan guarantees that improve financing conditions. Latvia’s capital rebate can be considered a special incentive structure that rewards developers ex-post. The direct use of subsidies has been decreasing as the funding schemes have become more self-sustained and the affordable housing stock has increased. Some incentives are directly linked to the specific institutional set-up around the funding mechanisms. Austria and Denmark grant corporate (and VAT) tax exemption for housing associations that engage in the construction of affordable housing. Only Slovenia does not set dedicated incentives for projects.

  • EU State Aid rules have affected the funding mechanisms for affordable housing in peer countries to different degrees. While the long-standing funding mechanisms in Austria and Denmark have not been challenged by the EU regulation, State Aid decisions by the European Commission have contributed to the reorganisation of the affordable housing funding system in the Netherlands. The much younger Fund in Slovenia has chosen a cautious approach in light of EU State Aid rules by largely refraining from public support to its fund. Latvia aims to account for the past decisions of the European Commission by targeting the model of intervention of the Fund and limiting public financial support to the scope of “Services of General Economic Interest” (SGEI).

A diversified range of financing instruments will be fundamental to scale the Housing Affordability Fund beyond the funding horizon of the RRP, which ends in 2026. To mobilise capital from public and private sources, the portfolio of selected instruments should comprise, inter alia, development loans (potentially with grant/rebate elements), housing bonds or bond backed loans and direct equity investments (e.g. from institutional investors such as pension funds). To facilitate the co-financing at the project level through commercial loans, the financial risk profile and the lending conditions could be improved through credit enhancement tools, including government guarantees.

Latvia’s peer countries that have established, sometimes long-standing, financing mechanisms present a rich selection of financing instruments to facilitate the mobilisation of capital for affordable housing investment. To improve the lending conditions of the most common financing instrument for investments in new housing units, long-term loans, the Netherlands apply a public loan guarantees scheme that operates in absence of contingent liabilities for the Dutch public sector (Box 4.4). Several countries, including Austria, Denmark, and the Netherlands issue housing bonds or bond backed loans to access capital from (inter-)national capital markets for the financing of affordable housing (Box 4.5). Lastly, a background box (Box 4.6) on the Affordable Housing Bond Aggregator (AHBA) in Australia sheds light on the implementation process of a financial intermediary that facilitates the issuance of bonds for affordable housing project financing.

The Housing Affordability Fund assigns an important role in both project execution and financing to private actors, in particular real estate developers and commercial banks. Accordingly, the Fund’s setup should provide for contingency plans that mitigate financial risks. Those risks comprise project interruption or suspension before completion due to:

  • The financial default of a contracted developer;

  • Funding gaps due to insufficient credit availability; and/or

  • Increasing costs of input factors driving up a project’s gross financing needs.

For financial and fiscal risk mitigation, Denmark’s National Building Fund (NBF) provides a focal point for good practices that serve to protect Denmark’s large-scale investment into affordable housing. To minimise the risk of financing shortfalls, the NBF provides for the scheme of fifth, a collaborative arrangement between stakeholders involved in the funding process, to bridge financing shortfalls (Box 4.7). Foresighted fiscal planning at the national level and the consideration of municipal fiscal constraints are implemented through regular budget planning with parliamentary resolution and fiscal master plans (Box 4.8).


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