Chart 1

What's Behind Our Sector View

We expect the balance-sheet strength of not-for-profit housing entities will continue in 2025.   In 2024, the Federal Reserve implemented its monetary easing strategy and lowered the benchmark interest rate by 100 basis points (bps). However, given the potential for the incoming Trump administration's policy shifts, S&P Global Ratings Economics believes the Federal Reserve will reduce the federal funds rate more gradually and reach an assumed neutral rate of 3.1% by fourth-quarter 2026 (previously, by fourth-quarter 2025) (see "Economic Outlook U.S. Q1 2025: Steady Growth, Significant Policy Uncertainty," published Nov. 26, 2024, on RatingsDirect). We believe this will support ongoing expansion of loan portfolios and likely prevent a significant rush of loan refinancing to keep pre-payment risks low in 2025.

Bond-financed lending by HFAs will likely remain the production strategy of choice and bolster balance sheets and capital adequacy.  In fiscal 2023, balance-sheet growth continued for housing finance agencies (HFAs), fueled by the multiyear trend of adding loans and program mortgage-backed securities to their balance sheets--climbing 13.5% year over year, in aggregate--while expanding their investment portfolios by 2.5%. Consequently, average asset balances rose by 10.4%, which we consider strong.

The ability to subsidize mortgage interest rates and provide various forms of down payment assistance (DPA) through single-family loan programs will likely sustain borrower demand for HFA first-time homebuyer programs. Likewise, as financing gaps persist for multifamily borrowers, particularly if proposed tariffs on imports from Canada, China, and Mexico raise construction costs, S&P Global Ratings believes HFAs will continue using program equity, bond financing, and tax credit programs to maintain transaction financial viability. Although equity positions could continue to contract relative to assets based on a second consecutive year of record debt issuance in 2024, or asset quality could deteriorate and assumed losses increase, we believe that HFAs are likely sufficiently well capitalized to avoid near-term rating pressure.

CDFIs are redeploying earlier vintage loan repayments into higher-rate loans, which will likely improve their profitability.  The rise in interest rates between 2022 and mid-2024 compressed profitability margins for some community development financial institutions (CDFIs), although many remained competitive in their products and terms as mission-driven lenders. The median increase in interest expenses in 2023 outpaced a median increase in interest income from loans following two years of relatively little change (2021 and 2022) for both figures. Despite this trend, the compressed net interest margin (NIM) widened in 2023 for most rated CDFIs--increasing by a median of 70 bps in 2023 compared with a median decrease of 18 bps in 2022. We view this trend as a strength of CDFIs' profitability and expect NIM will increase for most rated CDFIs in 2025. Although we don't anticipate interest rates rising in the coming year, if they occur, we believe CDFIs will pursue their growth strategies regardless of the interest rate environment, and ultimately finance the expansion of their social mission through low-cost grants or loans, entering the capital market, or otherwise diversifying funding sources, although balance-sheet growth might decelerate.

SHPs pursue alternative funding sources as part of growth and preservation strategies to offset rising costs.  Social housing providers (SHPs) continue to balance the social mission of providing affordable housing and keeping rents as low as possible with the need to raise rents where doing so is permissible to offset the rising costs. Some report that they can implement modest rent hikes, whereas others are adding market rate units to their portfolios as part of acquisition and construction strategies. However, these decisions could come at a cost to residents, so management is focused on reducing vacancies across portfolios to maximize revenue collections and controlling operational costs through energy efficiency improvements and outsourcing property management.

Despite SHPs' use of some resources to fund the growth strategy and higher levels of debt service, we expect ratings will remain stable, reflecting strong balance sheets. Our expectation also reflects property-level revenue increases from additional units and lagging U.S. Department of Housing and Urban Development (HUD) funding catching up to needs. Furthermore, where affordable housing funding gaps persist at a national level, many advocates and providers are looking to state and local ballot measures that could alleviate funding dilemmas. Some state and local ballot measures included expanding rent control authority, passing housing bond referendums, and enacting a permanent sales tax to fund affordable housing.

Rental housing owners and operators outside of the military housing subsector might struggle to maintain operating performance.  In 2024, some costs stabilized (payroll and maintenance), or the rate of increase slowed (albeit at higher budgetary levels). However, S&P Global Ratings Economics' forecast incorporates modest inflationary pressures in 2025 from the incoming administration's proposed policies. This could exacerbate the already thin financial margins with which some rental housing projects operate following multiyear absorption of higher utility, payroll, insurance, and maintenance costs. For example, proposed tariffs could inflate the cost of building materials, particularly should supply chain disruptions occur, and could pressure repair and replacement expenses that are necessary for state of good repair. In addition, if tighter border security impedes the looser labor market, rehabilitation projects at rental housing developments could face cost escalation. A return to a rapidly increasing cost environment could hinder already struggling properties, particularly those operating in higher-risk regions exposed to insurance markets with limited coverage options and high premiums, likely resulting in downward rating pressure. However, projects with strong oversight and management, close monitoring of operating metrics, and prudent expense management will fare the best in 2025.

Sector Top Trends

Mortgage rates remain stubbornly high, prolonging affordability struggles.   Although the Federal Reserve's benchmark interest rate is 100 bps lower year over year, mortgage rates have not fallen as quickly (chart 2). However, as evidenced by recent improvement in available months' supply of existing and new homes (chart 3), there could be some modest easing of the lock-in effect (whereby homeowners with low mortgage rates avoid moving to prevent refinancing). Real estate professionals typically indicate between five and seven months of supply is balanced, but existing home inventory remains well below that number, at about 4.2 months according to the Federal Reserve Bank of St. Louis. Furthermore, the difference between the median sales price of a resale home (about $407,000) versus a new home (about $437,000) as of November 2024 could also mean that first-time homebuyers gravitate toward resale home purchases rather than new. Considering the lack of more affordable resale homes on the market and mortgage rates remaining about 6.5%, S&P Global Ratings believes the U.S. could suffer a prolonged housing shortage.

Chart 2

Chart 3

Tight housing inventory and rising home purchase sentiment will likely underpin HFA loan production.   Fiscal 2024 resulted in a new high for HFA loan production evidenced by the nearly 15% increase in total debt issuance, of which the majority was for single-family programs. HFA management teams report that DPA programs are helping to spur robust loan production. Therefore, as home prices remain high and affordable inventory remains low, we expect DPA programs will remain a critical tool HFAs use to support their missions. For example, some HFAs received grants to create a DPA program specifically for recent college graduates or used state subsidies to allow forgivable DPA second loans. We believe as home purchase sentiment rises (chart 4), coupled with robust borrower education and flexible DPA programs, HFA loan production will remain steady or rise in 2025.

Chart 4

With finite resources for a backlog of approximately $115 billion of public housing capital needs, according to HUD, and aging affordable housing stock, SHPs are prioritizing recapitalizing or repositioning their existing properties before exploring growth opportunities. Many, particularly those with greater resources, are repositioning their stock in conjunction with bringing additional units on line. As a result of this growth, many rated SHPs have implemented various financing strategies (chart 5).

Chart 5

Potential tax policy changes could require sector evolution.   Notable among potential federal policy outcomes would be the direct effect of tax code revisions to private activity bonds, or--even more dramatically--the municipal tax exemption. In the case of the former, we believe HFA financings for multifamily development and preservation using federal low-income housing or new market tax credits could be substantially diminished, prompting agencies with fewer alternative funding sources to materially reduce their multifamily financing activity. In addition, changes to the Community Reinvestment Act, which underscores CDFI growth strategies, could temper financing sources and lending activity. Furthermore, any material changes to the administration of Fannie Mae and Freddie Mac--namely privatization--could potentially place upward pressure on mortgage rates and, ultimately, ongoing housing affordability dynamics.

If there were modification to, or elimination of, the municipal tax exemption as part of the expected successor tax legislation to the Tax Cuts and Jobs Act, we believe that HFAs would likely need to consider substantially modifying their financing strategies, and could no longer rely on the NIM between the tax-exempt bonds issued and taxable loans originated to support their missions. In recent years, an increasing number of HFAs have issued taxable bonds to preserve tax-exempt volume cap, support loan programs for buyers ineligible for tax-exempt financing, and access a wider array of investors; nevertheless, we believe that limiting the tax exemption could inherently blunt agencies' ability to offer first mortgages at rates below those of conventional lenders, inevitably slowing loan production while borrowing costs increase.

Demographic trends could shape affordable housing strategies.  Home price appreciation continues evolving and leading to changes where the lack of affordable housing inventory could be most acute. Certain metropolitan statistical areas recorded recent home price depreciation, which in some cases is consistent with regions exposed to climate hazards and likely evolving insurance coverage costs and availability (portions of California, the Pacific Northwest, and coastal areas in Florida, Louisiana, and South Carolina). Other states experienced widespread home price appreciation (such as Georgia, Michigan, Minnesota, Ohio, and Tennessee; see map).

AI could help improve efficiencies and reduce costs.   We believe the real estate sector could benefit from AI functionality and expect such opportunities will expand with development of the technology and as confidence in AI increases. In our view, AI applications and solutions could reduce some pervasive cost pressures throughout the housing sector (see table). Although rated not-for-profit housing entities could be slower to adopt AI technology, some management teams might try to stay on the cutting edge.

• Property management technology: Streamlining asset management could reduce costs associated with oversight of multiple real estate elements, including tenant portfolios, facilities, and finances.

• Optimization of preventative maintenance and capital expenditures: AI-driven models can offer property owners the chance to extend an asset's lifespan, reduce costs through more timely and effective intervention and preventative maintenance, enhance an asset's appeal to tenants, and improve buildings' energy efficiency.

• Management through digital twins: Property developers and managers can experiment with real-life virtual properties to rapidly test alternative space configurations and new systems (including heating, ventilation, and air conditioning, and security). However, developing "twins" could be expensive, given the substantial amounts of real-time data, including from sensors and cameras, necessary for creation.

Ratings Performance

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Chart 7a

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Related Research

• U.S. Housing Finance Agencies 2023 Medians: Fiscal Stability Reigns For Now With Some Uncertainty On The Horizon, Dec. 17, 2024
• Five Takeaways From U.S. Public Finance In 2024: Uneven Credit Trends Emerge Amid Rising Uncertainty, Dec. 9, 2024
• Economic Outlook U.S. Q1 2025: Steady Growth, Significant Policy Uncertainty, Nov. 26, 2024
• U.S. CDFIs Take On More Debt To Grow Their Lending Capacity: Ratings Will Likely Remain Stable, Nov. 19, 2024
• U.S. Social Housing Providers: Laying The Groundwork To Address Affordable Housing Needs, Nov. 14, 2024
• The U.S. Rental Housing Sector Remains Largely Stable While Expense Pressures Loom, July 9, 2024
• Military Rental Housing 2024 Outlook: Bond Sector Stable Amid Slow Recruitment And Higher Expenses, March 7, 2024