In 1989, when Mercy Housing Midwest converted the 100-year-old Mason School in Omaha, Neb., to 32 units of low-income housing, the staff was too happy with a job well done to fret about the future. But more than a decade later, worry began to surface as the Chicago-based nonprofit became increasingly aware of an upcoming deadline that could end the project's affordability.
In 2004, the federal Low-Income Housing Tax Credits used to fund the project would expire, and the investors, no longer benefiting from the program, would almost certainly want out. If Mercy, a division of the larger Mercy Housing Corp. in Denver, wanted to save the building for lower-income households, it would have to find a way for itself or another entity committed to affordable housing to acquire the property from the investors.
Fortunately, says Chuck Wehrwein, senior vice president for real estate investment for Mercy's national operation, the organization was able to pull together funds from a variety of local, state, and federal sources and take title to the property. But not every affordable housing developer is likely to be as adept or as successful at lining up financing.
Since its implementation in 1987, the federal Low-Income Housing Tax Credit (LIHTC) program has contributed to the development of approximately 1.3 million units of affordable housing throughout the nation. Each year another 90,000 units are placed in service with the help of tax credits. Of those, roughly 20 percent are developed by nonprofit organizations; the other 80 percent are developed by for-profit firms, often in partnership with a nonprofit sponsor.
But the future of many of these affordable housing units hangs in the balance: A provision of the program enabling investors to sell the properties after 15 years opens the possibility that a significant number of projects constructed under the program could convert to market-rate status.
The Road Ahead Exactly how many affordable units are at risk is uncertain. The most pessimistic estimates suggest it may reach as high as 20 percent of the total. Most observers, however, expect that fewer than 15 percent of units created under the program will cease to be affordable after the 15-year expiration date.
Still others believe it could be as low as 5 percent to 10 percent. "I don't believe it's actually that big an issue," says Howard Menell, a tax advisor for the National Multi Housing Council in Washington, D.C. "There are additional restrictions on a lot of these properties, which is going to prevent their being taken out of the affordable housing inventory."
Jenny Netzer, executive vice president of MMA Financial LLC in Boston, concurs with Menell's assessment. MMA is the principal operating subsidy of MuniMae, a financial services company specializing in tax exempt investment. "In the vast majority of cases, the properties are staying as affordable," she asserts. "That's what they are best suited and positioned for."
Netzer adds that because many project sponsors have an affordable-housing mission, they will do whatever they can to ensure properties remain affordable. In addition, she says, the individual housing finance agencies that run the program at the state level, as well as the communities in which the projects are located, will fight to prevent the loss of affordable housing.
The projects most at risk of converting to market rates are those approved from 1987 to 1989, when the program mandated only 15 years of affordability. Beginning in 1990, the compliance period for projects built with tax credits was extended to 30 years–but the period of tax credit is still 15 years.
Navigate the Terrain These areas of ambiguity in program guidelines make many developments from 1990 on less secure from market conversion than they seem. Investors are likely to sell after 15 years rather than waiting the full 30, because there is no advantage to hanging onto the property once tax credits are exhausted since few properties turn a profit.
"Generally you have to assume that the investors will be looking to sell their interest once they no longer receive the benefit of the tax recapture," says Netzer. "It would be rare to have reason to hang on."
The investors' decision to exit forces the sale of properties to new owners, explains Jeffery Faile, a principal in the Atlanta office of San Francisco-based Novogradac & Co. LLP, a consulting and accounting firm that focuses on affordable housing. It is here that problems can arise.
For pre-1990 projects, nonprofit organizations that participate in sponsoring or developing the project have the right of first refusal to buy the property at fair market value. If no nonprofit was involved, the property can be placed on the open market, presuming the development contract has no other restrictions limiting sale.
For later projects, owners that do not wish to continue owning and operating them as affordable housing enter into a one-year contract with the state housing tax credit agency granting either the agency or a community-based nonprofit the right to purchase the property, again at fair market value.
If after a year neither the developer nor another entity steps in to make the purchase, the owners can prepare for open sale by giving tenants a three-year notice of intent to convert to market rate. When the three years have passed, they can sell to any buyer.
According to Garth Rieman, director of policy and government affairs for the National Council of State Housing Agencies in Washington, D.C., the properties least likely to attract buyers willing to keep them affordable would be projects that are not meeting debt payments; in need of a substantial infusion of new capital for repair and upgrades; and worth more in the market than nonprofits or state agencies are willing or able to pay. The last group consists primarily of projects in neighborhoods that have gone through gentrification.
At the moment, says Christine Hobbs, director of the Community Development Investment Group for Freddie Mac in McLean, Va., few LIHTC properties have reached their expiration dates despite passage of 17 years since program inception. As she points out, projects usually do not begin to use their credits till they are ready for occupancy. Most projects that received credits in 1987 did not begin using them until 1989 or later, so many tax credit housing projects should have at least a few years of affordability left.
Hobbs says only a handful properties from Freddie Mac's portfolio of about 3,000 affordable projects have reached the end of their compliance period. While most of these were acquired by nonprofits, at least one converted to market status.
At a Crossroads Mercy Housing's Wehrwein says the Mason School Apartments is the only one of Mercy's 160 affordable properties to reach expiration. Mercy is working on a retention plan for a second, the Peter Claver Community in San Francisco, whose compliance period ends in December.
Judy Schneider, vice president and CCO for National Equity Fund, a Chicago-based nonprofit syndicator, says NEF has sold all 15 of the expired properties in its portfolio to their original developers for continued low-income rental. Nonetheless, she fully expects some NEF properties will ultimately convert to market.
According to Joseph Purcell, vice president of finance for Michaels Development Co., a Marlton, N.J.-based for-profit firm specializing in low-cost housing, the major problem preserving affordable housing is finding funds. He says the primary preservation strategy of his company, which owns some 29,000 affordable units in 22 states, will be to resyndicate properties by using new tax credits. About 30 states have set aside a portion of money from low-cost housing bonds to preserve existing projects, Purcell says.
None of these sources, however, is likely to be sufficient to save all at-risk properties. Fortunately, Schneider says, the situation is helped enormously by the limited market value of many affordable projects. "Our properties primarily are not located in the highest value markets. There aren't that many markets where you're going to be hitting home runs in terms of income, so private buyers generally will not want them," she says.
According to Schneider, the lowest price at which a project can sell is the cost of the outstanding debt plus the amount of exit taxes levied on investors. Exit taxes accrue when losses exceed the value of the capital invested, resulting in so-called phantom income. The taxes can sometimes be quite hefty, she notes, and that can drive up the cost of purchase. Properties with high exit taxes tend to be problem projects that will require a significant infusion of new capital to make them viable. Consequently, they are the least likely candidates for acquisition, and some may face foreclosure.
But by and large, those involved in affordable housing seem relatively philosophical about losing some properties because of poor performance or market forces. They can be equally philosophical about losing some to market forces.
"I don't think the loss of the 15 percent of existing units is unhealthy," says Netzer. "There are a lot of nonprofit developers out there, as well as for-profit developers dedicated to building affordable housing. They're all very committed to the affordable housing mission, and I think they'll be able to replace whatever we lose and replace them with much better projects."
Though some affordable-housing advocates panicked initially, at the approach of this milestone year, most have concluded the situation is far short of catastrophic. "Because we pass year 15, it doesn't mean something dire happens," says Janet Falk, vice president of real estate development for Mercy Housing California. "Acquisition money is there if people know how to use it."
The training pays off. About two years ago, a 3-year-old boy was drowning, and his mother couldn't help him because she didn't know how to swim, says Michael Martin, executive director of human resource development at Calex. "One of our employees rescued him, giving him the gift of life," he says.
Purcell agrees there's no need for alarm. "There's a big push for preservation," he asserts. "The existing stock of affordable housing isn't enough to meet our needs, so state and local governments know they can't afford to lose any of it. They're going to make sure that doesn't happen."
–John McCloud is a freelance writer in San Francisco.
Need Directions? If you have a tax credit property that is reaching the end of its 15-year period, here are five things to do as you decide the property's future:
- Check for use and sale restrictions.
- Calculate exit taxes.
- Assess the physical condition of the property and determine need for capital improvements.
- Compare the economic viability of the property as affordable housing and as market-rate housing.
- Explore the financial viability of purchase by a nonprofit developer.
Getting Credit
Key Details on the LIHTC Program History: Operated by the Internal Revenue Service, the Low-Income Housing Tax Credit program was created by the Tax Reform Act of 1986 as part of an effort to shift responsibility for construction of affordable housing from the public to the private sector. It works by enabling investors to purchase credits they can apply as direct deductions from their total tax responsibility.
Purpose: The money is used to provide equity funding for development of apartments that will be rented at less-than-market rates to households earning below median income. The investors buy into limited partnerships that own 99 percent of the projects developed. The remaining 1 percent is owned by the project developer, who is also the general partner.
Money: The credits are taken over 10 years, though investors must hold ownership for 15 years. At that point they can sell their ownership interest. Initially credits sold for as low as 50 cents on the dollar, but once the program became more competitive, the figure was raised to about 80 cents. That is, for every 80 cents investors put in, they receive a tax credit of $1.
Getting Funded: Early on, there were more tax credits than applicants, but in recent years the program has become highly competitive. Today only about one project in three that applies for credits receives them, and some of the winners receive fewer credits than they request.
Nonprofits v. For-profits: About 20 percent of tax credit properties are developed by nonprofit firms, and 80 percent are done by for-profit companies.
Timing: Projects initiated during the program's first three years, from 1987-89, were required to remain affordable for 15 years. From 1990 forward, the compliance period was extended to 30 years. Some states have imposed longer periods. California, for example, requires a project remain affordable for at least 55 years.
Key Agencies: The program is administered through individual state housing finance agencies, which have considerable leeway in determining which projects qualify for tax credit funding. Within limits, states can impose various project requirements, as well as establish quotas for particular project categories. Typical categories include senior housing, new construction, rehab of existing low-income projects, and projects targeted to particular income levels.
Who Gets What: States use somewhat different methods to determine the amount of tax credit an individual project receives. Usually the eligible basis is determined by subtracting non-depreciable costs from total project costs. If the development is located in a HUD-designated high-cost area, the figure is multiplied by 130 percent.
This figure is then multiplied by the percentage of units designated for low-income households or percentage of total square footage given to low-income units. This in turn is multiplied by the federal tax credit rate.
For projects not financed with a federal subsidy, the rate is approximately 9 percent. For projects receiving a federal subsidy, including tax exempt bonds, the rate is approximately 4 percent.
The Formula: The amount of money available for credits is determined by a formula, which currently allocates approximately $1.75 per resident per tax credit year for each state. In essence, a total of $17.50 per resident is allocated to cover each of the 10 years investors receive tax credits for a particular project. A floor level has been set to ensure that states with low populations receive enough funding to make the program feasible.