Development of affordable multifamily housing is a complex proposition in the best of circumstances. It is becoming even more difficult as some agencies require units to be targeted to those earning lower incomes, rents to be reduced, and funding to be leveraged from multiple sources. As more agencies follow suit, the ability to combine various programs with the low-income housing tax credit (LIHTC) program – the primary financing tool used to develop affordable housing – is likely to become a necessity for success.
But mixing programs can get complicated enough to trip up even experienced developers. The following tips can help you overcome the challenges of combining LIHTCs with three of the programs most often used with the credits: tax-exempt bond financing, the HOME program and the Department of Housing and Urban Development’s (HUD) Sec. 8 program.
Tax credits and tax-exempt bonds
As LIHTC demand – which often exceeds allocable supply by 3-to-1 or more – intensifies, more developers are using the credits with tax-exempt bonds. In 2006, states are being allocated $1.90 per capita in tax credits.
However, developers who receive a commitment for the issuance of federal tax-exempt bonds do not have to compete for tax credits under the state allocation. Although state Housing Credit Agencies (HCAs) may place some requirements on the allocation of credits for properties with tax-exempt bonds, they are generally very minimal.
Developers of such properties must be aware that this easier path to credits comes with some strings. Perhaps most important, properties with tax-exempt bonds are only entitled to use 4% credits as opposed to the 9% credits available to properties without tax-exempt bonds or other federal financing. This reduces the credit available to the “conventional” credit properties by more than half, and significantly reduces investor equity.
Other issues involved with combining these two programs have less financial impact but do create issues for property management. They include:
- Set-asides: The minimum set-aside for bonds may differ from that for the credits. While property owners choose the set-aside for tax-credit properties, the bond-issuing agency will designate the set-aside for bond purposes. It is possible for a property to have a “20/50” designation (i.e., 20% of units rented to persons at or below 50% of median income) for bond purposes and a “40/60” minimum set-aside for tax credit purposes (40% of units rented to persons at or below 60% of median income). In this case, management must comply with both set-asides, keeping in mind that units qualifying under the more restrictive 20/50 test will also meet the 40/60 requirement.
- Rents: Unless the owner has selected to “deep rent skew” the property – that is, rent at least 15% of units to tenants at or below 40% of median income – there is no federally mandated rent restriction for the bond units. However, there are very specific rent restrictions for all units claiming the LIHTC.
- “Next-available unit” rule: For bond properties the available unit rule, which requires managers to rent market-rate units to low-income households in certain circumstances, is a projectwide rule; it is a building-by-building rule for tax credit properties. This can create significant management issues for mixed-income properties since it may mean renting two market units to low-income residents when another low-income resident’s income rises above 140% of the maximum qualifying income. This is a particularly high-risk issue and requires careful on-site tracking.
- Students: The LIHTC program has four exceptions that allow for student occupancy; the bond program only has one exception. For this reason, bond/credit properties will often restrict student occupancy to households where all adults are married and file a joint tax return; this rule meets the requirements of both programs.
- Verification of assets: LIHTC properties may accept an affidavit from households with $5,000 or less in total assets, while the bond program may require verification of all assets, regardless of the amount.
Tax credits and HOME
HOME funds are federal grants provided by HUD to states and localities that can be used in a variety of ways to address housing needs. They are often used in tax credit properties as a “gap-closing” second mortgage, usually in the form of a loan that is included in eligible basis in order to maximize credits.
While most federal financing requires that properties utilize the 4% credit mentioned above, a special provision of the tax credit law allows for the use of 9% credits with HOME funds in certain circumstances, making the program particularly attractive to tax credit developers. Here are some potential pitfalls in combining these programs:
- Rents: While a tax credit property may charge rents as high as 30% to 60% of the area median income (depending on the minimum set-aside elected by the owner), at least 20% of HOME units will have to restrict rents to the “low-HOME rent” level, which cannot exceed 30% of the 50% income level. Remaining HOME units may charge “high HOME rents,” which may or may not be more than allowable tax credit rents, depending on the area in which the property is located. Rent determination for HOME/tax credit projects can be particularly vexing.
- Unit designation: HOME units may be either “fixed,” in which case specific units are designated as HOME units, or “floating,” which means HOME funds aren’t attached to specific units. Management must be able to track the designated HOME units.
- Resident certification: Though the HOME program may allow the recertification of existing residents as infrequently as once every six years, the tax credit program requires annual recertifications, even for HOME units.
- Verification of assets: Typically, LIHTC properties may accept an affidavit from households with $5,000 or less in total assets, while the HOME program requires verification of all assets, regardless of the amount.
- Over-income residents: Both programs allow over-income tenants to remain, but LIHTC properties must keep rents restricted until the unit is replaced with another low-income unit. Although over-income HOME units may be charged additional rent, this is not required; managers can instead follow tax-credit rules and remain in compliance.
- 40/50 rule for 9% properties: As stated above, tax credit properties may use 9% credits for properties with HOME funds, but to do so they must generally follow a tax credit rule that requires them to restrict occupancy in each building to ensure that at least 40% of households have incomes at or below the 50% median income level.
Tax credits and project-based Sec. 8
Due to the increasing priority being given to preservation of the aging Sec. 8 housing stock, combining existing Sec. 8 properties with the LIHTC is a rapidly expanding trend. Many of these properties are being rehabilitated with tax credits being used to provide much-needed equity. A number of serious issues face developers of these properties, however. Some challenges:
- Sec. 8 residents already in place may not be involuntarily displaced, even if they are not tax-credit qualified (for example, if they fall above LIHTC income limits or are student households). Developers who don’t want to forego the credits may have to offer incentives to these residents to encourage them to vacate.
- Sec. 8 rent is based on adjusted income, and if a subsidy is being paid on behalf of a resident, that resident must pay at least 30% of adjusted income, even if that rent exceeds the maximum allowable tax credit rent. However, once there is no subsidy, residents may pay no more than the allowable LIHTC rent;
- Sec. 8 tenant income certifications have “effective dates” that may conflict with the certification dates required by a State HCA;
- The Sec. 8 program requires “interim” certifications when household circumstances change; the tax credit program requires only an annual certification.
As you can see, there are many conflicts between the requirements of programs that may be used in combination. All of these programs can be quite complex. Any developer or management company contemplating involvement in the “mixing” of programs should seek the guidance of professionals well versed in the requirements of each program.
A.J. Johnson, Housing Credit Certified Professional (HCCP), is president of A.J. Johnson Consulting Services, Inc., a full-service real estate consulting firm specializing in due diligence and asset management issues, with a particular emphasis on properties utilizing the low-income housing tax credit. Johnson has been involved in the development and management of affordable housing for nearly 30 years.