CREJ - Multifamily Properties Quarterly - April 2015
Over the past several years, market-based rental rates have crept up with construction costs. Not so for affordable rental units though, because they are capped based on low and moderate incomes that have not risen commensurately. This mismatch resulted 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 million, two-year demonstration of a state tax credit for the development 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 component 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 Legislature 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 oversubscribed two to one, meaning that half of the appliedfor 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 approximately 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 credits 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 approximately $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. Unfortunately, since state income taxes are deductible by corporations against federal income, the value of the state tax credit to a corporate investor 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 benefit 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 development 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 affordable 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 automatically available to affordable housing developers, provided they use taxexempt financing for development. Historically, developers obtained long-term tax-exempt bond financing as the source of debt for affordable 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 service coverage underwriting resulted in a lower maximum loan amount and a larger funding gap. The current solution combines short-term tax-exempt bond financing with long-term debt, such as the FHA 221(d)(4) unitary construction 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 affordable housing funding gap. Even as the disparity between long-term taxable and tax-exempt rates narrows, this strategy still will make sense due to lower transaction costs and negative arbitrage cost when compared to the traditional longterm bond structure. In a perfect world where politicians 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 federal tax credits. The tax-exempt bond-financing requirement only increases unnecessary cost, adding hundreds of thousands of dollars to an affordable housing development, thereby diluting the tax credit benefit. In addition to adding to the cost of developing affordable housing, this outdated requirement of requiring tax-exempt financing also deprives the U.S. Treasury of tax revenue on interest earnings. Lenders committed to affordable housing development have to work within the constraints of existing laws using the tools available. Over the years, lenders have learned to weigh these inefficiencies when analyzing the benefits of pursuing one financing tool over another. But recognize that there is plenty of room for improvement. Programs designed to help fund affordable housing development actually result in a higher cost to develop a new affordable unit than a market rate unit as they are currently structured. If affordable housing is a priority for our state and federal legislators, then perhaps it is time for some new perspectives.