Developers, owners, and lenders of multifamily projects financed with low-income housing tax credits (LIHTCs) recently received a major lift from the Department of Housing and Urban Development (HUD). The agency unveiled big changes to its LIHTC Pilot Program that are sure to allow more multifamily borrowers to avail themselves of HUD’s low rates and attractive terms.
A year and a half ago, HUD unveiled the program to test an accelerated approval process for the purchase or refinance of multifamily rental properties financed with LIHTCs. There was no mystery as to what motivated the agency: Part of HUD’s mission is to help preserve affordable housing solutions around the country, and it was facing the very real threat of more than 1 million LIHTC apartment projects leaving the affordable housing stock over the next decade as they come to the end of their compliance periods.
The program was an elegant solution to maintaining at least part of this affordable housing supply. In addition to addressing the lengthy processing delays that had kept many developers and owners from tapping Federal Housing Administration (FHA)-financing, the program increased allowable repairs tied to hard construction costs—a significant inducement for property owners once constrained by a lower repair allowance.
After introducing the program in a number of major cities, HUD expanded the program nationwide. To date, 20 projects have secured financing under the LIHTC Pilot Program. In many cases, including transactions secured by Love Funding, applicants received HUD commitments in less than 30 days.
Even so, HUD officials would be the first to admit that demand was expected to be stronger. Over the past 18 months, HUD has heard from plenty of developers, owners, and lenders that some of the agency’s regulations governing the presiding 223(f) LIHTC Pilot Program did not sit well in the tax credit community because they added unnecessary costs and other burdens to the process.
HUD, led on the multifamily side by Deputy Assistant Secretary Ben Metcalf, deserves a lot of credit for not only soliciting feedback on the LIHTC Pilot Program from its stakeholders, but also acting on it. HUD recently announced it was streamlining the LIHTC Pilot Program in three major ways that are likely to win over many LIHTC developers and owners, and boost demand for this important financing program.
Here’s a quick snapshot of the three major changes:
The problem: The LIHTC Pilot Program allows for more rehabilitation work than normally permitted under the normal 223(f) program, but all repairs still needed to be funded at closing. This ran counter to the way normal construction or rehab deals handle repairs, which are typically funded over time as the work is completed. This conflict resulted in one of two outcomes: 1) tax credit investors were forced to fund all the repairs at once, reducing the price of the tax credits and lowering the amount of tax credit equity available; or 2) the developer would have to find bridge financing to fund the difference.
The fix: HUD now allows applicants to propose a disbursement schedule in line with the tax credit investor, and promises to accept it so long as the schedule is reasonable and at least 20 percent of the tax credit equity is funded at the closing of the FHA-insured loan.
The 92½ Percent Rule
The problem: One nuance of the 223(f) program is that the combination of the insured first mortgage with any secondary debt can’t exceed 92½ percent of the appraised value. The problem is that seller take-back notes and deferred developer fees, which are fairly standard “soft debt” in the tax credit world, were being counted by HUD against that threshold. As a result, a majority of the proposed transactions simply would not work under the program.
The fix: HUD is changing the rule for all LIHTC transactions, providing certain requirements are met. This means that deferred developer fees and seller take-back notes, both standard on LIHTC transactions, will be permitted without limitation. Love Funding has already had one transaction approved under this waiver that probably would not have been approved before the change.
The problem: Another requirement governing the 223(f) program mandates an assurance of completion escrow equal to 20 percent of the financed repairs. This set-aside is designed to ensure that the financed repairs actually get done. But these tax credit deals typically involve much more extensive repairs than a traditional 223(f) transaction. As such, a general contractor is often involved, and most provide a 100 percent performance and payment bond as part of the construction contract. In these situations, the completion escrow is superfluous. The fact that the 20 percent escrow still applied was viewed as another unnecessary equity infusion and therefore was another strike against the program.
The fix: HUD has dropped the standard to 10 percent of the cost of repairs, and the industry is hopeful that waivers down to 0 percent will be permitted if properly supported.
HUD also unveiled a handful of other smaller tweaks that affect inconsistencies in the treatment of tax abatements, the timing of tax credit and bond allocations, and the treatment of identity of interest buyers. In addition, HUD issued a reminder to the field offices regarding which principals in a tax credit transaction are to be underwritten. Finally, HUD announced significant grandfathering for LIHTC deals requiring three-year waivers.
Added up, these changes are likely to stoke significant renewed interest in the LIHTC Pilot Program, given the many conversations we have had with borrowers before this news was formally released.
Anand Kannan, president of WNC Community Preservation Partners in Irvine, Calif., welcomes the changes to the program. WNC worked with Love Funding’s James Vanar to secure funding through the program for two of the first LIHTC-funded projects in California last year.
“These new changes certainly make the program more attractive,” Kannan says. “They address the main concerns we had about using it again in the future.”
Combined with the many advantages of the LIHTC Pilot Program—including industry low interest rates, fully amortizing terms up to 35 years, and up to 85 percent leverage on a straight affordable housing project (87 percent for Sec. 8 HAP contracts)—these changes stand to make the LIHTC Pilot Program a preferred financing option in the affordable multifamily sector.
In fact, don’t be surprised come this time next year if the application figures show a noticeable uptick now that HUD has shown tax credit developers and owners it not only listens to their concerns, but it is willing to change to accommodate them.
Jonathan Camps is managing director of production at Love Funding.