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In the complex world of affordable housing finance, few details have a more subtle yet powerful effect on project economics than utility allowances. The recent Tax Credit Tuesday discussion between Michael Novogradac and Thomas Stagg, CPAs at Novogradac & Company, highlighted this often-overlooked dynamic, showing how changes in utility costs can erode net rental income even when rent floors appear to provide stability.
Understanding the Basics: Gross vs. Net Rent
For projects financed through programs like the Low-Income Housing Tax Credit (LIHTC), rents are determined not by the market but by income limits set annually by HUD. Each household income band, typically pegged to a percentage of Area Median Income (AMI), dictates the maximum gross rent that can be charged.
That gross rent includes both:
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The tenant’s rent payment, and
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The estimated cost of utilities such as gas, electric, and water that the tenant is responsible for.
The utility allowance represents that second component. It’s an estimate based on local utility rates, building efficiency, and typical usage, of what tenants are expected to pay out of pocket. The property’s net rent (what the owner actually collects) equals:
Net Rent = Gross Rent – Utility Allowance
This means that when utility costs rise, even if HUD’s income limits and rent ceilings go up, the net revenue for owners can decline.
The Rent Floor Illusion
Developers are often reassured by the concept of a rent floor, which HUD allows to protect projects from future income-limit decreases. Once a project locks in its rent limits, they generally won’t fall, even if AMI drops in later years. But as Stagg explained, that protection applies only to gross rents, not to the net rents that pay the bills.“Your gross rents are held harmless,” he said, “but your net rents can erode over time due to increasing utility costs.” This nuance matters. For projects in operation, especially those financed with tight margins or layered funding, rising utility allowances can effectively erase revenue growth. A project may appear stable on paper, but if tenants’ estimated utility costs increase faster than HUD income limits, property income declines despite “stable” rents.
Why Utility Allowances Fluctuate
Utility allowances are reviewed regularly by public housing authorities or by project owners themselves if they commission an independent energy study. They can fluctuate due to:
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Rising energy prices for electricity, gas, and water,
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Inefficient building systems or outdated appliances,
- Climate shifts increasing cooling and heating needs, or
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Changes in HUD methodology or local data sources.
In recent years, inflation and volatile energy markets have caused spikes in allowances, sometimes outpacing rent-limit growth.
Impact on Financial Performance
Even modest changes can have major effects. For a 100-unit LIHTC property, a $25 per month increase in utility allowance equates to:
100 units × $25 × 12 months = $30,000 less annual rent revenue.
That loss can translate directly into reduced cash flow, debt coverage ratios, or investor yield. Over multiple years, the cumulative effect can threaten a project’s ability to fund reserves, maintenance, or refinancing.
Managing the Risk
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Track Allowance Changes Annually: Review your PHA’s published allowances or commission Hedgerow to perform a project-specific study each year. Don’t assume the previous schedule remains valid.
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Optimize Timing: As we discussed in our last newsletter, in markets like Texas, reviewing allowances after peak-price months can better reflect average costs.
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Model Utility Sensitivity: During underwriting, stress-test your pro forma with scenarios for rising allowances. Include both base and “high-utility” cases in your long-term cash flow.
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Invest in Efficiency Upgrades: Energy-efficient HVAC, insulation, and appliances can justify lower utility allowances, improving both tenant affordability and owner revenue. Consult Hedgerow to see which improvements will be the most impactful when it comes to your allowances.
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Engage Your Tax Advisor Early: Early coordination can ensure developers lock in rent floors and plan for the interplay between income limits and utility assumptions before lease-up
Looking Ahead
HUD’s next income limit update, expected in April 2026, will likely reflect moderate national growth, around 4% on average, according to Stagg’s projections. That’s slower than recent years, meaning projects will have less headroom to absorb rising utility costs.
For existing properties, especially those where post-COVID rent caps or local ordinances restrict annual increases, this creates additional tension: operating expenses may rise faster than allowable net rents.
Conclusion
Utility allowances may seem like a technical footnote in the broader affordable housing framework, but their impact is profound. As energy costs fluctuate and HUD continues refining its data and methodologies, owners and managers must monitor how these adjustments flow through to rent collections and long-term viability.
As Stagg summed up, “Your gross rents are protected, but it’s your net rents that pay the bills.” Keeping a close eye on utility allowances may be one of the smartest forms of risk management in today’s affordable housing environment.
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