Developers looking to capitalize on the growing market for workforce housing can get one step closer to making their projects pencil out by tapping a government program designed to funnel investment into disadvantaged areas.
The New Markets Tax Credit (NMTC) program, while it can’t be used exclusively for rental housing, can nevertheless fill a financing gap that makes middle-income housing harder to produce.
Developers building or renovating apartments for those earning 60 percent of the area median income (AMI) or below have access to low-income housing tax credits, while those serving wealthier tenants can charge higher rents. Now some developers are using NMTCs to help produce housing for those in between.
“Way too often when people look at workforce housing, they automatically drop themselves down to 60 percent [of AMI] and top out at 80 percent,” said Terri Preston-Koenig, executive director of the Valued Advisor Fund and a partner at Virchow, Krause & Co., LLP. They should instead be targeting those earning between 80 and 120 percent of the AMI, she said. “That gives you access to a much broader section of the market, and makes it much more likely you’ll meet the needs of the prospective employers.”
Sherman Associates, for instance, is using the equity from an allocation of about $20 million in NMTCs to fund 42 of the 70 apartments in The Syndicate, an $85 million mixed-use development in the Old Post Office district of downtown St. Louis. Those units will be affordable to residents earning about 100 percent of AMI, said Brian Gorecki, a vice president with the Minneapolis-based firm, which is developing the building in partnership with Loftworks, LLC, a St. Louis developer.
And the NMTC allocation, which attracted about $5 million in investor equity, was critical to making the project pencil out, he said. “We had exhausted pretty much every source at that point and were looking for additional sources of gap financing, and NMTCs helped us achieve that and give us a leg up on the retail side,” said Gorecki.
Slicing and dicing ownership
The 17-story historic building—which will include 21,000 square feet of retail space, 102 condos, and three floors of parking, in addition to the 70 rental units, when its renovation is completed—drew on half a dozen other major financing sources. They include brownfields tax credits, tax increment financing, federal low-income housing tax credits, state housing tax credits, tax-exempt bonds, and historic tax credits.
Further complicating the deal, the various programs all have different requirements, so the ownership structure had to be sliced into three pieces. One of the limited liability companies (LLCs) owns the 28 units of affordable housing and another owns the condos and the parking. The last LLC holds the Syndicate’s three floors of workforce apartments and the ground floor retail space, a linkage necessitated by the NMTC rules.
“This is a pretty good tool if you structure it correctly and can make it work in your transaction,” said Preston-Koenig. “Because it wasn’t designed for rental housing, you have to be careful how you structure it, and you need to be aware that your transaction will not be made up entirely of rental housing. It needs to include a commercial component.”
Because NMTCs are aimed at spurring economic development, they can’t be used to finance projects consisting exclusively of rental housing. They can, however, help fund mixed-use projects in which less than 80 percent of the income is derived from rental housing.
Doing such deals “may require a developer that’s used to doing 100 percent rental to gain some new skill sets or partner with someone who has them,” said Preston-Koenig.
In the case of The Syndicate, both partners have experience with mixed-use developments, and Loftworks has been involved in the revitalization of downtown St. Louis for more than seven years. “Downtown has seen, in the last six years, $4 billion invested into it,” said Craig Heller, owner of Loftworks. “Over $1 billion of that has been housing. The Old Post Office District is becoming more mixed-use, a more vibrant 24/7 environment than before.”
NMTCs can also be used to develop for-sale housing in low-income areas, but this requires some creativity, as the credits must remain invested in qualified uses over a seven-year period. With homes and condos typically built and sold in less than seven years, that leaves developers with equity from the home sales that must then be reinvested in other qualifying projects.
In California, Heritage Housing Partners (HHP) cleared this hurdle by coming up with a plan to build three projects consecutively and then roll over the repaid equity from each one into the next. The deal called for good negotiating skills, though. The nonprofit developer had targeted projects in two different cities and needed agreements and loan commitments from both, even though groundbreaking would be two years away for the projects in Glendale, the second city.
Charles Loveman, executive director of HHP, called Glendale “a big hero” for committing funds and arranging financing quickly. Another challenge was finding investors willing to take on what he called “redeployment risk.” “You have to have the investors’ trust that you’re going to be able to redeploy [the equity] successfully,” he said. “In our case we had to prove it by showing that we had a second project lined up.”
The first development, Fair Oaks Court in Pasadena, started construction in October 2006 and is scheduled for completion in January 2008. HHP is relocating and restoring nine historic houses and building 35 condominiums in a similar, Craftsman style.
Three of the units are categorized as workforce housing, a term applied in this development to households earning between 120 percent and 180 percent of AMI; four will be sold at market rates; and 37 are slated for low- and moderate-income households, defined as those with incomes between 80 percent and 120 percent of AMI. The total development cost is estimated at $21.2 million.
The NMTCs raised $6.27 in an equity investment from Commercial Capital Bank, which was purchased last year by Washington Mutual. But HHP made the deal slightly more complicated by devising a financing structure that essentially involved treating city subsidies already slated for the project as equity investments. That allowed the NMTC allocation, which totaled $13.7 million, to generate additional tax credit benefits that WaMu can claim. The result: WaMu got an increased return on its investment, allowing the nonprofit to keep more funds in the project.
Once the homes in Fair Oaks Court are sold, about $2.3 million in equity will move on to Doran Gardens, the first Glendale project, and will eventually be used to help fund a total of 55 units. Of those, 18 will be market-rate units and the rest will be affordable.
Even with more than $6 million in funding from city, county, and state sources, HHP needed additional funding to make the project work, said Loveman. That’s where NMTCs proved crucial, he said. “It’s just a very powerful subsidy source.”