The impact of the Housing and Economic Recovery Act of 2008 (HERA), as reflected in the 2009 median family incomes (MFI), has brought a welcome reversal to the problem of no rent growth at Sec. 42 low-income housing tax credit (LIHTC) properties, along with a few other benefits for underwriting rents.

HERA included rules specifically designed to address the negative impact previous years' declining median incomes had on rent growth at LIHTC properties. As a result, in 2009, many existing tax credit properties may experience rent growth for the first time in several years. While the program's goal is to maintain affordable rents for low-income families, the ongoing feasibility of LIHTC properties in many markets has surfaced as a significant issue. In some markets, rents have been flat since 2003, and in some instances, net rents have declined due to increasing utility allowances. Striking a balance between affordability for tenants and feasibility for owners was central to the new provisions in HERA relating to median incomes and rent growth.

Underwriting no growth or below maximum pro forma rents, as well as controlling operating expenses, were the few tools available to maintain stable debt-service coverage levels in markets with declining MFIs. However, with the release of the 2009 data, real relief can be anticipated for properties that have been experiencing flat rents and increasing expenses.

While the HERA changes will be welcome, an intensified focus by asset managers and property managers will be required to take full advantage of these opportunities and maintain full compliance at the property level. Specifically, HERA creates a situation where older properties in some markets will have higher maximum rents and income limits than new properties in the same market. This article explains the issues and highlights the relief many markets and properties may experience in 2009.

The good news

The 2008 HERA legislation has provided three key opportunities for LIHTC properties as it relates to underwriting rents. The first and most substantial item relates to the Department of Housing and Urban Development (HUD) Hold Harmless provision for MFI and the associated very low-income limits that are used to determine maximum LIHTC rents.

Let us start with some background to create a basic understanding of the issues. The basis for calculating maximum LIHTC rents is HUD's four-person very low-income limits, which are typically set at 50 percent of the area's MFI. (The four-person MFI is then used as the basis for calculating larger and smaller family income limits.) Because very low-income limits are a function of the area's MFI, maximum allowable Sec. 42 rents do not increase unless MFI increases. Additionally, HUD's Hold Harmless provision says, decreases in MFI will not result in decreases in very low-income limits and therefore will not result in decreases in maximum Sec. 42 rents. However, this provision also went on to state, prior to the 2008 HERA, that very low-income limits and therefore maximum LIHTC rents would not increase until the median income surpassed its previous highest level, prior to any declines.

While rents did not decrease, extended periods of no rent growth would occur under the old rules. As a result, pressure on cash flow and operations in areas where income limits had not increased in several years forced owners and the industry to seek regulatory relief. This relief was granted and implemented as part of HERA 2008.

The 2008 HERA legislation does not fully relieve all geographies and LIHTC properties of situations when there may be no increases in maximum rents; however, it goes a long way in addressing the issue. In fact, in 2009, 98 percent of all geographies (both non-metro counties and metropolitan areas) in the country experienced increases in very low-income limits. As a result, most of the country's LIHTC properties may increase maximum allowable LIHTC rents should the market support the increase. The average increase in very low-income limits was 4.6 percent. The map below shows the percentage increase in very low-income limits by geography.

The 2009 results are in stark contrast to previous years' results, which were impacted by the decennial benchmark census data in 2003; the new OMB Metropolitan Statistical Area definitions HUD used in 2006; and the new American Community Survey data used in 2007. The negative impact of these three methodological changes to determining MFIs and resulting very low-income limits created significant limitations to rent growth at some LIHTC properties for several years. The table below provides historical data that summarizes the total geographies where very low-income limits were held harmless and maximum LIHTC rents were not allowed to increase. A pattern can be observed where the increases in areas that were held harmless coincide with changes in methodology.

HERA details and examples

When determining very low-income limits for a defined HUD geography, there are several steps that need to be considered before a final determination can be made.

  1. The first step HUD uses is to calculate the preliminary four-person very low-income limit, which is equal to 50 percent of the HUD published MFI.
  2. The second step HUD uses is to compare the preliminary four-person very low-income limit to 50 percent of the state MFI.

    HUD then uses the greater of the two income limits to calculate the remaining income limits and maximum rents, unless one of the following two conditions is met.

  3. These conditions relate to the High Housing Cost formula (Fair Market Rent Rule) and the Low Housing Cost formula. Both tests examine the relationship between local rents, using the HUD published two-bedroom fair market rent (FMR) as a proxy, and the area's MFI. Should the relationship be such that the local FMR is either very high or very low in relation to the area's MFI, then the four-person very low-income limit is determined by the result of the High or Low Housing Cost formula, not the previously calculated preliminary four-person very low-income limit.
  4. The final step in this process is the previously discussed Hold Harmless provision and compares the results of the aforementioned tests to the previous year's HUD published four-person very low-income limit. Should the result of the aforementioned tests be lower than the previous year's published four-person very low-income limit, then the Hold Harmless policy goes into effect, and income limits remain the same as the preceding year.

Complicating matters further, as a result of 2008 HERA, a second set of income limits referred to as “HERA Special” have been published in addition to the regular HUD Sec. 8 income limits for 2009. This second set of income limits reflect the 2009 percentage increases in MFI, despite any deficits that may continue to exist from previous year's declines; and regardless of which of the aforementioned tests is dictating the very low-income limits. As a result, many geographies with increases in MFI that otherwise would not have experienced increases in the very low-income limits under the old rules, in fact, did experience increases in 2009 because of 2008 HERA. The HERA Special income limits are to be used with impacted properties in impacted markets (to be explained later). Furthermore, these special income limits only apply to properties that are financed with proceeds from tax-exempt housing bonds and low-income properties funded with tax credits under Sec. 42 of the IRS Code.
The HERA Special income limits are reserved for a special class of properties referred to as impacted properties, which by default, reside in impacted markets.

Impacted markets are defined as any geography whose area MFI for 2007 or 2008 was lower than a preceding year (HUD's actual language says “the preceding year.” However, a review of the published data reveals many geographies fall into the impacted markets classification because of MFIs that were higher in years prior to 2006.) For example, in the case of Chicago, the area's MFI in 2009 was higher than 2007 and 2008, but was still lower than its peak in 2002. As a result, Chicago is included in the defined group of impacted markets that will all use the HERA Special income limits.

Impacted properties in these impacted markets are defined as any existing or proposed property whose rents were determined prior to Dec. 31, 2008. Some questions regarding the specifics of this definition and the word “determined” are pending.

HUD has stated that LIHTC properties that use the HERA Special income limits are now referred to as Multifamily Tax Subsidy Projects (MTSPs). The following map identifies all the impacted markets by county throughout the United States.

Serving as examples as to how this all works, the San Francisco and Chicago metro areas will be discussed. Both areas had not experienced rent growth for several years because of large deficits in the local FMR and the area's MFI, respectively. However, as a result of 2008 HERA, both San Francisco and Chicago experienced increases in their very low-income limits in 2009; thus allowing for increases in their maximum Sec. 42 LIHTC rents. A closer look illustrates how the aforementioned tests and HERA apply to each location.

In San Francisco, the very low-income limits and maximum rents have been flat, or held harmless, since 2003 when the FMR spiked to $1,940 for a two-bedroom unit. Due to that spike, the High Cost Housing Rule (FMR Rule), rather than MFI, became the basis for determining very low-income limits. Prior to HERA 2008, the current FMR in San Francisco of $1,658 would have had to increase 17 percent and surpass the 2003 FMR of $1,940 before income limits would have been allowed to increase (MFI in the San Francisco metro area would have had to increase 20 percent in 2009 in order for the FMR rule to no longer be valid and have MFI drive income limits.) However, because the area's MFI increased 2.7 percent from $94,300 in 2008 to $96,800 in 2009, this increase has been reflected in the HERA Special very low-income limits. This increase comes despite the fact that the area is still subject to the High Cost Housing, or FMR, Rule which otherwise would dictate that increases in the very low-income limits are a function of increases in the FMR, not the MFI. Furthermore, existing properties in this market can now raise maximum LIHTC rents by 2.7 percent in 2009.

Similarly, in Chicago, income limits and maximum rents have been flat, or held harmless, since 2002. However, unlike San Francisco, Chicago was victim to a falling MFI, whereas San Francisco was subject to a declining FMR. Chicago's very low-income limits remain a function of the MFI, which declined 8.9 percent to $68,700 in 2003. Under the old rules, Chicago would not be eligible for increases in maximum rents until the MFI surpassed the 2002 MFI of $75,400. However, because of 2008 HERA, the 4.6 percent increase in MFI from $71,600 in 2008 to $74,900 in 2009 has been reflected in the HERA Special income limits. This increase in income limits has occurred in 2009 despite the fact that the MFI has yet to surpass the 2002 level; thus allowing for maximum LIHTC rents to increase by the same 4.6 percent.

If not for 2008 HERA, both San Francisco and Chicago would have had their income limits held harmless in 2009, and neither would have experienced any increases in their maximum allowable LIHTC rents once again.

The mechanics of how the HERA Special very low-income limits are calculated was touched upon in our San Francisco and Chicago examples. However, it is explained in full detail in HUD's fiscal 2009 Multifamily Tax Subsidy Project Income Limits briefing material, mtsp09/MTSP_Briefing.pdf  and Material_FY09.pdf.

While HUD does a fine job explaining this information and the new process, there are still outstanding issues that require clarification and attention. Furthermore, the ramifications of having two sets of income limits for two sets of properties in one geography may be extensive. For instance, in staying with our San Francisco and Chicago examples, older properties (impacted properties) in San Francisco will have maximum allowable two-bedroom rents that are $41 higher than new properties, prior to any utility allowance adjustment. The difference in Chicago will be $47, prior to any utility allowance adjustment, and the largest variance will be $108 in the New Bedford, Mass., HUD metro area.  These rent variances at properties in the same submarkets may put older properties at a competitive disadvantage. This situation will arise as the direct result of having two sets of income limits from which LIHTC properties will use to calculate maximum allowable rents; i.e., impacted properties (existing) using HERA Special income limits and new properties using HUD Sec. 8 very low-income limits.

The good news, however, is that as a result of new rules regarding the calculating of property specific utility allowances, these variances may be smaller. In some instances, newer properties may deduct lower utility allowances than the less efficient older properties (impacted properties) resulting in net rents that may actually have smaller variances than the gross rents. Furthermore, the older properties (impacted properties) will have higher qualifying income limits, thus increasing the income eligible pool of demand relative to the newer property with lower income limits and somewhat offsetting the competitive disadvantage of higher rents.

Compliance will also be a challenge. Property managers and asset managers need to be aware of these rules and the ramifications in 2009, as well as any changes HUD makes when it publishes the 2010 MFIs and very low-income limits. The map below illustrates the extent of the maximum rent variances by county between new and impacted properties.

Other benefits of 2008 HERA

Finally, before concluding our discussion about the positive news for underwriting rents at multifamily tax subsidy projects (MTSPs) as a result of 2008 HERA, there are two other benefits worth mentioning. The first is that all 9 percent LIHTC properties in rural locations may now use the greater of the national, the state, or the area MFI when determining maximum rents and income limits.

While not all 9 percent rural properties may be able to achieve the higher maximum allowable rents due to demand and market conditions, it will allow these properties to increase the upper end of their income band when qualifying new tenants. The impact of this change will, at the very least, increase the income eligible pool of demand for rural properties, and quite possibly allow for increased rents.

The following link will assist property managers and asset managers in determining what geographies are considered rural.

Additionally, Novogradac's Rent and Income Limit Calculator© is an excellent resource to assist in determining rents and income limits for these affected geographies.

Finally, the last item included in 2008 HERA that impacts the underwriting of LIHTC properties is the exclusion of the basic housing allowances in the calculation of qualifying incomes for military personnel and their families. Historically, it has been difficult to income-qualify military families due to the basic housing allowance effectively increasing their incomes above maximum qualifying incomes. This new rule will benefit applicants that receive a military housing allowance at properties that are located in counties that host a military base or at properties that are in adjacent counties.

While HERA is not a silver bullet and does not eliminate all the issues relating to rent growth at MTSPs, and in fact creates some new issues to be aware of, it goes a long way to provide much needed relief to cash flow, debt-service coverage, and operations at properties in areas like San Francisco and Chicago, where income limits and maximum rents had been held flat for several years.

A.H. (Bud) Clarke III joined MMA Financial in 1998, and he is currently managing director of the Investment Valuation Group and principal of MMA REVAC, a wholly owned subsidiary that provides third-party real estate valuation and consulting services. Clarke is also a founding member and the 2009-2010 chairman of the National Council of Affordable Housing Market Analysts. In 1995, he was awarded the MAI designation from the Appraisal Institute and possesses a Massachusetts general certified appraiser's license.