• Reaching the political crossroads
  • Issues with expiration restrictions
  • Other possible changes in the program
  • How to better serve low-income households

When the Millennial Housing Commission began its research for a report to Congress on the nation’s housing needs and how to meet them, advocates from all sectors of the housing industry started circulating ideas for improving the federal housing tax credit program. A study that was initiated by the commission itself called the 1986-vintage program, “the most successful federal multifamily affordable housing production program of the last 30 years.” The report provides extensive documentation of the program’s strengths and outlines a number of ways that it could be improved. It notes that the Bush administration’s proposal for a tax credit to encourage homeownership could provide a good opportunity for Congress to consider changes to the rental housing tax credit as well.
The report was prepared by Recapitalization Advisors, Inc., in Boston and is titled “The Low-Income Housing Tax Credit Effectiveness and Efficiency: A presentation of the issues.” The report, as well as a large amount of testimony on various housing topics before the commission, is available on the commission’s Web

.With a federal tax expenditure of about $4.1 billion (net present value) annually, the tax credit represents roughly 40% to 50% of federal multifamily housing production expenditures (including both authorized/appropriated and tax programs), the report said. The credit supports or facilitates production of about 60,000 to 80,000 apartments annually, which is 50% to 70% of all new affordable housing, according to the report. Since its enactment nearly 15 years ago, it has stimulated production of more than one million apartments.

The credit has shown “rising effectiveness and efficiency using many relevant metrics,” according to the report. These measures include utilization rates, demand-supply imbalance, equity raised per dollar of federal expenditure, intermediary costs, range of property types financed, programmatic evolution toward effectiveness or efficiency, and operating/compliance performance.

However, the report said, the program now is entering a new phase in its evolution as properties approach full-cycle completion of their affordability covenants and equity investment per dollar of credit appears to be declining.

Reaching the political crossroads

The credit also may be coming to a political crossroads of sorts. The Bush administration’s proposed single-family housing tax credit provides an opportunity to propose legislation to improve the program. It also poses a threat, since the credits it would create could be marketed to the same investors as the current rental housing tax credit, and some of them might find it more appealing.

“Although it is far too early to predict specifics, enactment of a single-family credit would be a major event for the equity market. Its consequences should be thoughtfully considered,” the report said.

For the entire last decade, the credit has benefited from a growing economy, rising market rents and low interest rates. “This coupled with the industry’s fairly steady maturation has yielded curves that have gone only upward, especially the pricing curve,” the report said.

Starting at the end of 2000 and continuing for several months, the pricing trend has reversed, the report continued. Market evidence suggests that credit prices, which earlier peaked at 83 cents to 84 cents on the dollar, have fallen, to perhaps 76 cents to 79 cents and still may fall. The causes of a pricing decline include the 40% increase in credit authority that will take effect this year and next, the departure of some investors from the marketplace and an increase in the volume of secondary-market resales of old credits.

“No one can say for certain whether the credit price decline is a blip or the start of a longer-term phenomenon,” the report said. But it added, while it exists, it could result in a need to re-underwrite previous transactions. It also could create “possible workout exposure,” the report said. “Should the rumored economic downturn arrive, credit properties will not be immune – poor people lose their jobs in recessions – necessitating workouts and recapitalizations. Further, properties underwritten with rents close either to credit cap or market rent may be ill-equipped to handle rapid, unexpected price spikes in operating costs.”

Issues with expiration restrictions

The other major unknown in the evolution of the program is how the expiration of low-income use restrictions will affect the inventory of tax credit projects. The report estimates that one in five of the apartments developed from 1987 to 1993 is at risk of conversion to market-rate use.

The report sets forth a number of possible changes in the program for the commission’s consideration. Among the most interesting is a proposal to establish “credit basis” independent of depreciable basis and let states certify it.

The report said determining credit basis, both at allocation and at completion, is a critical proposition. “For the sponsor, it has some no-win elements: If the basis is lower than the credit allocation, the sponsor must refund credits to the allocator, and if it proves to be higher, no additional credits are available. Moreover, between allocation and completion, external events may intrude (issuance of an IRS Technical Advisory Memorandum) that effectively change the rules for participants halfway through their process.”

“… With credits capped at the state level and with states making allocations of what they rightly view as an enormously precious resource, there seems little purpose in perpetuating this element of uncertainty,” the report concludes. It also suggests the more radical option of decoupling credit allocations entirely from basis and treating them like other forms of federal assistance that do not rely on basis calculations.

Other possible changes in the program

Other possible changes in the program include the following:

  • Conform common definitions among programs, especially income eligibility and rent caps.
  • Eliminate the requirement that projects with other federal funds only can receive a maximum 4% tax credit.
  • Repeal the 10-year rule that precludes an existing property from receiving an allocation of acquisition (4%) credits if it has changed hands within the preceding 10 years.
  • Eliminate “10% expenditure test.” As a stimulus to assure that credits are spent timely, the original credit provided that if a property received an allocation, it must spend at least 10% of the projected basis in the year of award.
  • Allow properties in low-income rural areas to establish rent caps based on statewide rather than county median income. This provision would raise credit caps in very low-income rural areas where credit cap rents are so low, relative to construction costs, which makes development particularly difficult.
  • Waive Cancellation of Debt Income (CODI) of old soft debt for properties that extend affordability. Allowing a CODI waiver for cancellation of soft debt under limited circumstances – such as if new capital above a threshold is contributed or if the property’s use restriction is extended from 15 to 30 or more years –-would give properties a preservation tool coupled with a potential investor exit.
  • Eliminate HUD subsidy layering reviews when FHA or HUD resources are combined with a credit property. The report said the reviews have proven “time-consuming, slow and extremely hard to coordinate with funding cycles.” It added that “ the net effect has been to discourage credit developers from using HUD resources such as FHA mortgage insurance.”

How to better serve low-income households

Trudy Parisa McFall, chairman of Homes for America in Annapolis, Md., would like to see focus on how the tax credit program can better serve lower-income people.

The market for tax credit projects should be broadened not by serving higher-income residents but by increasing the ability of the program to serve households at less than 60% of median income, she said.

There are three actions at the federal level, which could provide tremendous new potential for tax credits to serve these households substantially below 60% of median income, McFall said. These changes are as follows:

  1. Make the amount of tax credits that can be awarded to a project flexible and not limited to the current 9% and 4% of present value basis. Allow states to have discretion in the amount of the tax credit awarded so long as the additional credit amounts are used to provide lower rents. While total state flexibility would be ideal, Congress might feel the need to set some limits on the amount of tax credits awarded to a project. Limits for projects receiving credits at more than 9% present value basis could include a capped total basis amount and/or lower rent requirements.
  2. Remove the legislative prohibitions and complexities on the use of other federal resources with tax credits. Permit all federal housing programs to be used together efficiently. Congress needs to understand that it is not a bad thing to couple and leverage tax credits with other federal resources, even grants and deep subsidies. The tax credit program by itself provides only a shallow subsidy, and leveraging of resources is essential if the program is to serve the lowest income renters.
  3. Create new or expand existing housing subsidy programs that would be used with the tax credit program to reduce rents. Even if the existing federal resources were allowed to be more easily combined with tax credits, additional subsidy funds are needed. Various options are actively under discussion: a rental housing production program, a federal housing trust fund and expanded funding for the HOME program. Any of these approaches could work well with tax credits to enable households at 40% and 30% of income to be served.