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April 2015 — Multifamily Properties Quarterly — Page 17
O ver the past several years,
market-based rental rates
have crept up with con-
struction costs. Not so for
affordable rental units
though, because they are capped
based on low and moderate
incomes that have not risen com-
mensurately. This mismatch result-
ed in an increasing gap between the
cost of developing a new affordable
apartment project and the ability to
finance its development.
Fortunately, there are a couple of
new tools available to affordable
housing developers to close the
funding gap. They are not perfect
but they can be viable solutions to
help develop or preserve affordable
properties – so long as you know
how to navigate their complexities.
The first tool is a new state tax
credit put into practice Jan. 1 by the
Colorado Legislature. It authorized
the Colorado Housing and Finance
Authority to administer a $60 mil-
lion, two-year demonstration of
a state tax credit for the develop-
ment of new affordable housing.
There are two components to the
program: a one-time allocation for
post-disaster relief and the other for
ongoing general affordable housing
development. The second compo-
nent is a competitive program that
CHFA hopes to leverage the limited
resources available to develop as
much new affordable housing as
possible.
If this demonstration is successful,
the hope is that the Colorado Legis-
lature will extend the program on a
more permanent basis. Early returns
suggest that it is already popular
with developers.
In the first round
of competitive
applications, the
program was over-
subscribed two to
one, meaning that
half of the applied-
for demand will be
met. Developers
sell the tax credits
at a discount in
order to raise funds
for development.
State tax credits
are expected to sell for approxi-
mately 60 cents on the dollar, so the
actual amount of money available
for affordable housing development
is $36 million, or $18 million each in
award years 2015 and 2016.
One has to wonder how many
other developers with proposed
projects held back because they
knew they would have about a 50
percent chance of receiving an
award. Assuming six applicants
receive an award of state tax cred-
its in 2015 and another six in 2016,
each applicant would receive an
average of $5 million in credits,
which could be sold to a tax credit
investor at a discount for approxi-
mately $3 million to fund project
costs.
One hitch with the program is
its inefficient financing structure.
A state tax credit is essentially the
same as an expenditure. Unfortu-
nately, since state income taxes are
deductible by corporations against
federal income, the value of the
state tax credit to a corporate inves-
tor is diluted by the loss of federal
deduction. This results in a pricing
of approximately 60 cents for every
dollar of state tax credits, versus
the pricing of approximately $1 for
every dollar of federal tax credit
under the Low Income Housing Tax
Credit program. Therefore, the state
of Colorado is spending $60 million
in forfeited tax revenue for the ben-
efit of $36 million that is actually
applied toward affordable housing
development.
This begs the question whether
there might be a more efficient
way of funding the same amount
of affordable housing develop-
ment with state resources for less
cost, or more development for the
same cost. Advocates for affordable
housing development might want
to keep this in mind during future
efforts to extend the initial two-year
demonstration.
A second tool available to afford-
able housing developers is the use
of short-term, cash-collateralized,
tax-exempt bonds to qualify an
affordable housing development
for federal tax credits under the 4
percent LIHTC program. It is easy
to see why such bonds have grown
in favor over the past few years. It
is because noncompetitive federal
tax credits are almost automati-
cally available to affordable housing
developers, provided they use tax-
exempt financing for development.
Historically, developers obtained
long-term tax-exempt bond financ-
ing as the source of debt for afford-
able housing development. But
after the credit meltdown in 2008,
long-term tax-exempt interest rates
shot up to higher levels than taxable
rates. Applying traditional debt ser-
vice coverage underwriting resulted
in a lower maximum loan amount
and a larger funding gap.
The current solution combines
short-term tax-exempt bond financ-
ing with long-term debt, such as
the FHA 221(d)(4) unitary construc-
tion and permanent loan. Due to
the lower interest rate and longer
amortization, the FHA-insured loan
underwrites to a higher level of
debt, thereby narrowing the afford-
able housing funding gap. Even as
the disparity between long-term
taxable and tax-exempt rates nar-
rows, this strategy still will make
sense due to lower transaction costs
and negative arbitrage cost when
compared to the traditional long-
term bond structure.
In a perfect world where politi-
cians actively seek constructive
solutions and cooperate with each
other, the federal LIHTC program
would be amended to not require
tax-exempt bond financing as a
condition to receive 4 percent fed-
eral tax credits. The tax-exempt
bond-financing requirement only
increases unnecessary cost, adding
hundreds of thousands of dollars
to an affordable housing develop-
ment, thereby diluting the tax credit
benefit. In addition to adding to the
cost of developing affordable hous-
ing, this outdated requirement of
requiring tax-exempt financing also
deprives the U.S. Treasury of tax rev-
enue on interest earnings.
Lenders committed to affordable
housing development have to work
Market Drivers
Peter Wessel
Senior director,
Love Funding,
Denver