Cohen-Esrey used both federal low-income housing tax credits and historic tax credits to complete a historic rehab on Woodson Senior Residences in Yates Center, Kan.
Cohen-Esrey used both federal low-income housing tax credits and historic tax credits to complete a historic rehab on Woodson Senior Residences in Yates Center, Kan.

Yates Center, Kan., population, 1,417.

Welsh, La., population 3,226.

South Pittsburg, Tenn., population 2,992.

These are just a few of the small rural communities where affordable housing developments have recently opened.

“Small towns are still small towns. The thing that has become more challenging are the resources that are available to make these deals work in small towns,” says R. Lee Harris, president and CEO of Kansas City-based Cohen-Esrey Real Estate Services, LLC.

Rural housing projects are often smaller than developments built in other markets. Although it may seem like a small deal would be easier to put together and finance, it's usually the opposite. They're harder to do.

There are funding programs aimed specifically at building or renovating affordable housing in the rural areas. However, just like everything else, these funds have become fewer and harder for developers to obtain.

According to Colleen Fisher, executive director of the Council for Affordable and Rural Housing (CARH), challenges in the rural development arena started back in the mid-1990s, when some negative perception surrounding the U.S. Department of Agriculture's (USDA's) Sec. 515 program surfaced. Negative articles came out in the press, and there were some obvious budget issues at the time. As a result, Sec. 515 was looked at as a program that could be substantially cut to fund other USDA programs.

“The program itself never really recovered from some of those articles and the decisions that were made at that point," she says.

At that point, the low-income housing tax credit (LIHTC) became a more important tool for developers working in these rural areas. There was also a need for a lot more subsidy layering—rural developers worked to get other sources of financing, such as HOME funds, Federal Home Loan Bank Affordable Housing Program funds, and state housing trust funds to make their deals work.

Harris says initially tax credit syndicators had interest in the smaller towns, but that interest has become less intense over the years. The fund sizes are much larger today than they were in the mid-1990s, and those larger fund sizes make smaller projects less attractive. It costs them as much money to underwrite smaller deals as it does larger deals, so the small deals don't get quite the same attention.

And when the financial markets imploded about three years ago, the rest of the country now had to operate the same way and layer even more different sources of funding. “Welcome to the world of rural,” says Fisher.

The LIHTC market meltdown had a big impact on rural deals. There had been a limited number of investors who would invest in the rural deals. But after Fannie Mae and Freddie Mac imploded, a void was left. The larger banks didn't get involved with smaller deals, unless they needed to meet their Community Reinvestment Act (CRA) obligations. Some of those banks would invest, but it was strictly on a regional basis.

“Getting investors to invest has always required a lot more work on the part of the rural builders, developers, and owners," says Fisher. “The ability to attract investors continues to remain an issue."

Banks, which are the major LIHTC investors, like to focus their activities in regions that help them meet their CRA requirements. For large national banks, that's the country's urban centers on the East and West coasts, not rural regions.

Another issue for rural developers has been the financing from USDA Rural Development. “The support within the administration on rural housing has been minimal at best,” Fisher says.

The multifamily side of the equation has been a real issue for CARH, and the organization was able to save a program that was on the chopping block—the Sec. 538 loan guarantee—for fiscal 2012. The program, which has evolved and become popular in the preservation arena, will now be fee-based. “We had to fight tooth and nail,” Fisher says, adding that it's now a no-cost program in 2012.

“We are constantly in the battle within USDA fighting for scarce resources," she says. Fisher says within the USDA, there's a lot of emphasis on the singlefamily side, and resources for multifamily housing programs are being weighed against other major priorities for the agency, such as rural business loans and broadband development.

Financing may be the biggest hurdle for developers, but it's not the only one.

The availability of skilled labor to build projects in the rural areas is also a challenge. “Contractors during the downturn have fallen by the wayside since they couldn't make it,” Harris says. “What we're left with are larger established contractors, which are more expensive and not as easy to get into small towns.” He adds that it's also been hard to find multiple subs who are qualified to bid on the projects.

However, developers are overcoming these challenges with some creative models.

Serving seniors in small towns

Cohen-Esrey has a long history in the rural housing business, starting with managing projects in the 1970s and then developing in rural areas under the LIHTC program starting in the 1990s.

As times have changed, Harris says the company has created a model for developing in these rural small towns.

“We've been successful going into the market and looking at the seniors demographic," he says. “There are hundreds and thousands of small towns around the country where the population is stagnant or declining, but the number of seniors is increasing. Safe, decent affordable housing for seniors in small towns in decline is very difficult, but [these towns] are their homes."

To address the affordability issues in these areas, the company strives to eliminate debt from its projects so it can drive the rents even lower. “If you're going to accommodate seniors in a small town, the rental rate needs to be in the $400 to $450 range,” Harris says, “and you can't do that if you have debt."

Since the traditional LIHTC debt doesn't work in these communities, he says it's hard to build new developments so the company has turned to historic renovations to utilize both historic tax credits and federal LIHTCs.

One example of this model is the Woodson Senior Residences in Yates Center, Kan.

The building was originally built in 1886 as a hotel, where Jesse James, Teddy Roosevelt, and Wild Bill Hickok all once stayed, and Cohen-Esrey turned it into 10 seniors units financed with 9 percent LIHTCs as well as federal and state historic tax credits.

However, the project, which was completed in April 2011, did run into some trouble. Although there was huge interest in the project and the market study showed a capture rate of 4 percent, leaseup was slow because many prospective residents were overqualified.

“This is part of the challenge of working in small towns,” Harris says. He adds that when you have a county where the area median income is so low, there are even seniors on Social Security whose income sources are too high to qualify.

Cohen-Esrey worked with the state to open the project up to all ages and, since the community has a long waiting list for Sec. 8 vouchers, instituted its own interim voucher program through funds available from the capital stack to help the lease-up.

The company's vertical integration has also made it easier to work in these communities.

Developing with Sec. 538

Madison, Miss.-based Arrington Developers has developed 35 affordable housing developments in rural areas, of which 28 are single-family home properties and six are elderly properties.

The firm recently completed 32 single-family rental homes in Welsh, La., using 9 percent LIHTCs, Tax Credit Assistance Program (TCAP) funds, and USDA's Sec. 538 permanent financing. The equity provider is Alliant Capital. Arrington Developers also completed a 40-unit single-family development in South Pittsburg, Tenn., using Sec. 1602 funds and Sec. 538 permanent financing.

Sec. 538 loans have been used on 19 of the firm's rural deals in Arkansas, Louisiana, Mississippi, and Tennessee. The program is critical because it provides rural multifamily developments with 40- year loans at below-market interest rates. USDA provides a loan note guarantee for 90 percent of the permanent loan amount, which coupled with equity from the sale of LIHTCs creates a sound financial transaction. “It makes a lot of deals hum,” says President Dale Lancaster.

Every project, whether it is rural or urban, has its own challenges. “Most of the time rents will be lower, reserves will be higher, and LIHTC pricing will be lower for a rural deal vis- -vis an urban deal,” Lancaster says.

It's not uncommon for rural developments to require $100,000 to $120,000 in replacement and operating deficit reserves. Consequently, there is more often than not a need for some “soft money." “In Welsh, we were able to obtain TCAP funds. In South Pittsburg, we used 1602 funds. Several of our developments have HOME funds,” Lancaster says.

The small size of rural deals presents another big challenge—managing the property. The developments are often not large enough to have a full-time manager or maintenance staff. Project sizes are routinely 24 to 48 units. Ideally, a property can share a manager with another in the area.

“It's been a lot of fun developing rural projects,” Lancaster says. “All of the USDA agencies in the states we work have bent over backward to cooperate, and the mayors of the towns seem to really appreciate what we do."

What's ahead

In 2012, CARH's Fisher says she is hoping that the Sec. 538 program will be looked at a lot more by developers since it's a valuable tool. The organization is also still trying to push to get the House Financial Services Committee and the Senate Banking Committee to pass some preservation legislation that will provide more tools for rural developers.

And it is looking at continuing to promote and lobby for the LIHTC, its role in rural transactions, and the need for the program to continue.

“There's no question of the fact of what further deficit reduction would mean in terms of tax reform,” she says.