The math on tax-exempt debt has shifted. In a near-zero-rate environment, given transaction costs, the spread between taxable and tax-exempt yields was often marginal. But at today’s rates, that calculus has reversed. A tax-exempt coupon often delivers 100 to 150 basis points of real savings over comparable taxable debt, and that spread changes the feasibility of deals that would otherwise fail to pencil. For affordable housing, municipal bonds have moved from a useful option to a critical tool.
In a new Housing Huddle, I sat down with Sam Adams, Group Head and Managing Director of Affordable Housing and Public Housing Authorities at KeyBanc Capital Markets, to discuss how the municipal bond market is evolving—and why developers, investors, and housing authorities are finding new ways to use tax-exempt debt as both a financing instrument and a strategic lever for affordable housing preservation and production.
How do municipal bonds work in affordable housing?
At their core, tax-exempt municipal bonds are debt instruments. The distinguishing feature is the federal tax exemption on interest income—investors don’t pay federal income tax on the coupon, which means they’ll accept a lower yield/interest rate than on comparable taxable debt. That yield differential is the mechanism through which tax-exempt bonds reduce borrowing costs for affordable housing.
Municipal bonds also remain central to 4% low-income housing tax credit (LIHTC) transactions. The recent permanent reduction of the bond financing threshold from 50% to 25%—enacted in the One Big Beautiful Bill for projects placed in service after December 31, 2025—has changed how bonds are sized in those deals, freeing up private activity bond capacity that can be redeployed to additional projects. But even beyond the LIHTC context, the higher-rate environment has made the economics of tax-exempt debt materially more compelling than three or four years ago.
What has also shifted is market perception. Short-term 4% collateralized bond structures—which were once viewed as inconvenient necessities—have become normalized and often advantageous. The market has matured around these products, and that familiarity translates into tighter pricing and broader investor appetite.
How does the value of tax-exempt debt increase when interest rates are higher?
The value of the tax exemption scales with the rate environment—it’s multiplicative, not additive. When base rates are at 1%, the tax-exempt benefit might save you thirty basis points. That’s real, but not transformative when accounting for added transactional costs and reduced liquidity for bond investors (relative to taxable debt). At a 5% base rate, the same tax exemption can deliver 100 to 150 basis points of rate improvement, depending on the investor’s marginal tax rate and the specific structure. The bond is otherwise identical—same credit, same collateral, same maturity—but the economic advantage of the tax exemption has multiplied three- to fivefold.
In practical terms, on a $50 million bond issue, the difference between a 5% taxable rate and a 3.75% tax-exempt rate is $625,000 per year in debt service savings. Over a 15-year term, that compounds into meaningful additional capacity—either more units, deeper affordability, or less reliance on gap subsidy. That’s why in today’s market, the muni structure is often the difference between a deal that works and one that doesn’t.
In what new ways are developers and investors engaging with the municipal bond market?
Developers are becoming more sophisticated about how they access and deploy tax-exempt debt—it’s no longer just a passive component of the capital stack, but a resource to be optimized.
In the 4% LIHTC space, developers are being more strategic about how they use private activity bonds, particularly given the scarcity of volume cap allocations in many states. Where available, recycled bonds offer a way to maximize the use of existing allocations without consuming new cap. The 25% threshold change has also created more flexibility in how bonds are sized relative to total development costs, which opens design options that weren’t previously available.
Outside the LIHTC context, we’re seeing growing interest in structures that access tax-exempt debt through public purpose or affordability covenants. Government bonds and 501(c)(3) bonds are not subject to the same volume cap constraints as private activity bonds, which makes them available for projects that meet affordability requirements but don’t neatly fit into the tax credit framework. The muni market opens a different set of options and leverage points that weren’t always available through traditional financing channels.
The underlying objective is straightforward: reduce the cost of capital so that more deals clear their feasibility threshold. But the sophistication lies in how that objective is executed across different bond structures, credit profiles, and regulatory frameworks.
How are housing authorities using the municipal bond market to diversify their financing strategies?
This is where the market has evolved most dramatically. Housing authorities are engaging with municipal bonds on two distinct levels, and the second is potentially more strategically significant.
The first is straightforward conduit issuance—working with developers to issue bonds for developer-led transactions. That’s a well-established role. The more consequential development is housing authorities leveraging their own balance sheet strength to access capital markets directly. In effect, they are operating as credit platforms—using their financial position and recurring revenue streams to secure pricing that individual project-level credits could not achieve alone.
Municipal bond investors understand housing authorities as essential-service credits—analogous to water or sewer systems. Housing authorities may lack taxing power, but they provide a necessary public service backed by recurring, predictable revenue. That credit profile allows them to borrow at rates that reflect their institutional stability, not just the project-level economics of any single development.
The flexibility this gives housing authorities is powerful. They can move more quickly than waiting for years for a tax credit allocation, and they can structure deals in ways that better serve their communities, including middle-income housing in high-cost markets, where the private sector has struggled to deliver supply at rents working families can afford. Additionally, they can complete financing with limited or no equity, consistent with how most governments finance infrastructure in this country.
How does a housing authority’s guarantee translate into better financing outcomes?
This is an important structural point. Many housing authorities are already effectively exposed to the success of their projects—politically, reputationally, and operationally. Even absent a formal guarantee, the market assumes they would step in if a project experienced distress regardless of ownership. The question is whether to formalize that implicit support and capture the pricing benefit it generates.
By formalizing its project guarantee, a housing authority can unlock material financing improvements. A formal guarantee can tighten the credit spread substantially, which translates directly into lower debt service. That lower-cost debt reduces the need for equity, seller notes, or direct subsidies—allowing housing authorities to preserve scarce resources for other projects or to fill gaps elsewhere in their portfolios. The lower-cost debt might also free up cash flow, reducing the risk of the project running into trouble.
In many cases, this is not a marginal improvement—it creates a categorically different financing structure. The housing authority is not just backstopping a deal; it is using its credit to unlock pricing that makes projects feasible that would otherwise require subsidy layers the authority may not have. It is, of course, critical for a housing authority to be aware of the nature of its guarantee as well as ensuring it has the required financial strength to make its guarantee valuable to municipal investors; many smaller housing authorities would not benefit from a credit rating when going to market.
What are the key takeaways from this conversation?
Tax-exempt debt is not a universal solution. It can involve higher transaction costs and added complexity. Smaller projects and some rehabilitation deals may not always benefit enough to justify the use of the structure. The analysis is deal-specific.
But in today’s rate environment, the value proposition of tax-exempt financing is as strong as it has been in years—particularly for new construction, larger acquisitions, and housing authority-led portfolio strategies. The intersection of municipal finance, HUD regulations, and real estate development is complex, and getting it right requires coordination between legal, financing, and development teams. But when the structure is properly designed, it can unlock projects that would not otherwise be feasible—and that is ultimately what this market is for.
