This article first appeared in the March 2015 issue of Units, the Magazine of the National Apartment Association. It is reprinted here with permission.
Real estate developers looking to enter the affordable housing marketplace are familiar with the acronym “LIHTC” (low-income housing tax credit), but may be wondering how one works with a public housing agency (PHA) to obtain operating subsidy or project-based vouchers (PBVs).
When dealing with a public housing agency’s aging housing stock in need of revitalization, or getting into the market for additional rental units, another question could be whether an apartment home may be both a public housing and LIHTC unit.
In either case, concerns with gap financing (CDBG, HOME, AHP, CFFP) could arise and the developer may have seen headlines regarding “Choice” and “RAD.”
This article endeavors to cut through the acronyms and provide a brief outline of how both developers and public housing agencies frequently pursue affordable housing development.
For Developers
Traditional real estate developers may wonder about the “government money” available for the development of affordable housing and how to enter this market.
Low-Income Housing Tax Credits. The development of affordable rental housing is frequently funded in large part with an allocation of LIHTCs. The 9 percent LIHTC (also known as the 70 percent present value credit) supports new construction.
The 4 percent LIHTC (also known as the 30 percent present value credit) (a) supports a project financed by tax-exempt bonds or (b) may be applied to building acquisition costs with a rehabilitation project under certain circumstances.
Obtaining LIHTCs is highly competitive (with perhaps the exception of the “automatic” 4 percent LIHTC for a project financed by tax-exempt bonds). Developers must apply for an allocation of LIHTCs from the state allocating agency (thus each state will have its own acronym or shorthand—e.g., PHFA (Pa.), IHDA (Ill.), Florida Housing (Fla.). Each state allocating agency has its own unique process and deadlines set forth in its Qualified Allocation Plan (QAP). The application is not something that may be quickly “thrown together.” It typically takes months to assemble an application.
LIHTCs are a dollar-for-dollar reduction in federal tax liability in exchange for providing financing to develop affordable rental housing; it is claimed pro rata over 10 years. To use LIHTCs, a partnership structure is typically utilized. A single-purpose owner entity limited partnership is organized with a developer-controlled entity serving as the managing general partner, an investment fund serving as the limited partner and the syndicator serving as a special limited partner. The developer will negotiate with the syndicator with respect to the terms of the equity contribution to the owner entity in exchange for the LIHTCs and depreciation on the affordable housing development.
LIHTCs are particularly desirable because it is not a funding source that needs to be repaid. Of course, such funds do not come without conditions. The development will be subject to a 15-year compliance period and a 15-year extended-use period, during which the development must be operated in accordance with LIHTC requirements, such as (a) 20 percent or more of the residential units in such project are both rent-restricted and occupied by individuals whose income is 50 percent or less of area median gross income (AMI) or (b) 40 percent or more of the residential units in such project are both rent-restricted and occupied by individuals whose income is 60 percent or less of AMI (whichever is elected at the time of application).
Other considerations are the timeframe for completing the development and placing it in service, as well as restrictions on the fee the developer may earn. LIHTC investors will also have requirements such as guaranties to be given by the developer.
Gap Financing. While an allocation of LIHTCs will likely be the primary funding source for an affordable housing rental development, an allocation alone may not be sufficient. Thus, gap financing may also be required. Often, a project will not support a traditional construction/permanent loan, so other options must be explored.
Local government, including a redevelopment authority, may be willing to provide financing on more favorable terms (e.g., cash flow only repayment requirements). Additionally, there may be programs on a state level.
Programs to Consider
CDBG (Community Development Block Grants). Larger cities and counties receive formula funding (the entitlement component) and states funnel funding to smaller communities (the state and small cities component). Activities in support of the development of low- or moderate-income housing, including clearance, site assemblage, provision of site improvements and provision of public improvements and certain housing pre-construction costs (e.g., conducting preliminary surveys and analysis of market needs) are eligible uses of CDBG funds. With a few exceptions, CDBG funds may not be used for the construction of new permanent residential structures or for any program to subsidize or assist such new construction.
HOME (HOME Investment Partnership Program). State and local governments (participating jurisdictions) provide HOME assistance. For rental housing, at least 90 percent of benefiting families must have incomes that are no more than 60 percent of the U.S. Department of Housing and Urban Development (HUD)-adjusted AMI. In rental projects with five or more assisted units, at least 20 percent of the units must be occupied by families with incomes that do not exceed 50 percent of the HUD-adjusted AMI. Participating jurisdictions must ensure that HOME-funded housing units remain affordable in the long term (20 years for new construction of rental housing; 5 to 15 years for construction of homeownership housing and housing rehabilitation, depending on the amount of HOME subsidy).
Finally, participating jurisdictions must match every dollar of HOME funds used (except for administrative costs and Community Housing Development Organization (CHDO) predevelopment loans for projects that do not move forward) with 25 cents from nonfederal sources, which may include donated materials or labor, the value of donated property, proceeds from bond financing and other resources.
AHP (Affordable Housing Program). This is a competitive grant program offered by Federal Home Loan Banks for housing and community development.
Because LIHTC-eligible basis (i.e., depreciable development costs that may be included in the calculation of LIHTCs) will be reduced by the amount of federal grants (i.e., funds which originate from a federal source and which do not require repayment) made to fund the cost of a building, great care must be used in structuring a transaction that involves grant funds.
Finally, if you are working with a PHA on a development, the PHA may be able to provide a loan on favorable terms using financing sources available to it.
Subsidies from Public Housing Agencies
There are two sources of ongoing subsidy that a PHA may provide, (1) operating subsidy for public housing units, and (2) project-based vouchers.
If the affordable housing development includes public housing units, a PHA may provide operating subsidy for those units. Typically, a PHA will pass on (pursuant to an agreement governing the operation of such public housing units in accordance with all applicable public housing requirements) a percentage of the operating subsidy that it receives. Historically, operating subsidy has been funded at a prorated percentage of the formula need.
Additionally, any public-housing project developed that receives operating fund assistance will be required to have a covenant to operate under requirements applicable to public housing for a 10-year period beginning upon the conclusion of the fiscal year for which such amounts were provided (and if Capital Funds were used for the development, there will be a restricted use covenant to operate under the terms and conditions applicable to public housing for a 40-year period that begins on the date on which the project becomes available for occupancy).
Project-based vouchers (PBVs) are assistance attached to specific housing units. No more than 25 percent of the units in a building may receive PBV assistance, unless an exception applies. All units must meet HUD housing quality standards, and all rent must be considered reasonable. The PHA must select PBV proposals by either (a) a public notice of the PHA request for PBV proposals or (b) selection, without competition, of a proposal for housing assisted under a federal, state or local government housing assistance, community development or supportive services program (e.g., 9 percent LIHTCs) that required competitive selection of proposals, the proposal was selected within three years of the PBV proposal selection date and the earlier competitively selected housing assistance proposal did not involve any consideration that the project would receive PBV assistance.
The PHA may enter into a Housing Assistance Payment (HAP) contract with an owner for an initial term of up to 15 years for each contract unit. The PHA may select families who are participants in the PHA’s tenant-based voucher program and families who have applied for admission to the voucher program.
PBV assisted units must meet housing quality standards (HQS). Except for certain LIHTC units, the rent to owner must not exceed the lowest of (1) an amount determined by the PHA, not to exceed 110 percent of the applicable fair market rent (FMR) minus any utility allowance, (2) the reasonable rent or (3) the rent requested by the owner.
For Public Housing Agencies
Traditional Development. For PHAs that do not have in-house experience with constructing new housing stock or revitalizing (rehabilitation or demolition/new construction) existing housing stock, the use of a third-party developer is generally the path chosen.
Typically, a PHA will competitively procure a developer and enter into a Master Development Agreement (MDA) that governs the rights and obligations of the parties (including such things as the PHA earning a portion of the developer fee for its services in the endeavor and the PHA’s participation, if any, in the owner entity created).
The selected developer usually develops a financing plan for the development or revitalization of the affordable housing. The development plan will likely include LIHTCs (with guaranties normally being provided by the developer), gap financing and PHA subsidy as discussed above.
PHAs may also pursue a Capital Fund Financing Program (CFFP) where a PHA borrows private capital to make improvements and pledges, subject to the availability of appropriations, financing a portion of its future year annual Capital Funds to make debt service payments for either a bond or conventional bank loan transaction.
HUD does not guarantee or insure these loans or bonds. HUD approval is required for all Capital Fund financing transactions which pledge, encumber or otherwise provide a security interest in public housing assets or other property and use Capital Funds for the payment of debt service or other financing costs. Generally speaking, these financings are limited to no more than 33 percent of the PHA’s current annual Capital Fund grant adjusted for any activity that would reduce Capital
Funds appropriated or available to the PHA. To apply, a PHA must submit a CFFP Proposal to HUD.
If the real property for the development is being provided by the PHA and is subject to the Annual Contributions Contract (ACC) with HUD, HUD approval is required for demolition and/or disposition (including leases longer than one year). This is handled by the Special Applications Center (SAC).
If the PHA is undertaking mixed-finance development, the development or modernization of public housing, where the public-housing units are owned in whole or in part by an entity other than a PHA (e.g., an owner entity where LIHTC financing is used), the PHA also needs to submit a mixed-finance proposal (this includes a Mixed-Finance Rental Term Sheet (RTS), a Term Sheet Calculator and additional documents) and receive HUD’s approval to (a) proceed with financial closing of the development transaction (following HUD’s review of an initial evidentiary submission) and (b) expend HUD public housing funds approved for the project (following HUD’s review of a final evidentiary submission).
The Latest: Choice Neighborhoods and Rental Assistance Demonstration
Choice Neighborhoods (Choice) has existed since 2010 and is intended to support a locally driven neighborhood revitalization strategy rather than simply a housing strategy. This approach involves many partners such as local leaders, residents, the PHA, local government, schools, police, business owners, nonprofits and private developers.
Given the magnitude of this challenge, there are two funding components: (1) Planning grants and (2) implementation grants. Choice Planning Grants support the development of a comprehensive neighborhood revitalization strategy (Transformation Plan) that will guide the revitalization of the public and/or assisted housing units as well as the transformation of the surrounding neighborhood with the goal of positive outcomes for families.
Choice Implementation Grants support those communities that are ready to implement their Transformation Plan. Notices of Funding Availability (NOFAs) are issued annually and announce the availability of Choice grant funds and provide application instruction.
The Rental Assistance Demonstration (RAD) was authorized in 2011 and has two components. The goals of RAD are to test if the conversion of public housing and other HUD-assisted properties to long-term, project-based Section 8 rental assistance (1) helps to preserve and improve the properties by enabling access to private debt and equity for addressing capital needs and (2) provides residents with increased housing choices.
The first component of RAD allows public-housing properties to convert to project-based Section 8 programs, either (a) Project-Based Rental Assistance (PBRA), rental assistance administered and provided by HUD to owners according to the terms of a HAP contract for the provision of housing to eligible tenants or (b) PBVs. No incremental funds were authorized for this component; this is a conversion of assistance. The competition was limited to 60,000 units, and by Dec. 31, 2013,
HUD had received applications for nearly three times as many units as are authorized. HUD created a queue of projects above the 60,000-unit cap, in the order in which applications were received, that serves as the RAD waiting list. The 2015 HUD Appropriations Act increased the conversion limit to 185,000 units. Note that owners of converted properties are required to renew their HAP contracts and cannot opt out when contracts expire.
While no article of this length can provide all the guidance needed to undertake an affordable housing development transaction, it endeavors to provide a basic outline of the affordable housing development process and an introduction to the lingo that accompanies it.
