POAH acquired the 115-unit Billings Forge property (above photos) in the Frog Hollow neighborhood of Hartford, Conn., last year from the Melville Charitable Trust. PHOTOS: Courtesy POAH

The low-income housing tax credit (LIHTC) program helps finance approximately 100,000 affordable apartments each year, with a good portion of those units in brand-new developments. That’s the positive news. Yet, at the same time, a huge number of other, old apartments leave the affordable housing stock either through demolition or conversion to market-rate units. Nearly one out of three homes with a monthly rent of less than $400 in 1999 had left the affordable stock by 2009.

The net result is that no matter how many new units are being built, a sizable number is disappearing. No matter how many new apartments are added, it’s not enough to close the gap between the number of available affordable units and the need.

In 2011, 11.8 million renters with extremely low incomes (less than 30 percent of the area median income, or about $19,000 nationally) competed for just 6.9 million rentals affordable at that income cutoff—a shortfall of 4.9 million units, according to the Joint Center for Housing Studies of Harvard University in its 2013 report America’s Rental Housing: Evolving Markets and Needs.

Making matters worse, 2.6 million of these affordable units were occupied by higher-income households.

Looking just at LIHTC developments, thousands of properties have become eligible to leave the program in the past few years, ending their affordability restrictions.

In the worst-case scenario, more than 1 million LIHTC units could leave the affordable housing stock by 2020, according to HUD. Although it would be unlikely that all, or even most, of those units would cease being affordable, it’s still cause for alarm. In any case, many of these properties will require renovation and recapitalization.

With each passing year, preservation takes on greater importance as more properties age. But new strategies are emerging, and developers are pushing new ways to maintain LIHTC and other affordable properties.

Fast-Paced Acquisitions

Competition continues to heat up in the preservation market, developers say. Patricia Belden, managing director and COO of Preservation of Affordable Housing (POAH), says the nonprofit has had to move much more quickly than it used to to compete for deals in a market-driven seller environment.

POAH has moved to a two-part process: buying a property as quickly as it can and then applying for LIHTCs to recapitalize it. The organization’s strong balance sheet supports the property in between the purchase and the recapitalization.

One recent example is the purchase of Billings Forge, a 115-unit property in Hartford, Conn. POAH acquired the property from the Melville Charitable Trust as part of a competitive bid process after the trust divested of the asset last year. POAH worked with Massachusetts Housing Investment Corp. to create a “quick strike” first mortgage, which allowed POAH to close within 90 days of commitment. The loan will be outstanding until the nonprofit is able to complete a LIHTC transaction.

To meet the trust’s financial requirements, POAH structured a two-part payment, with cash at the initial closing and a seller note, which will be paid at the LIHTC closing. “We’re taking more risk than we used to,” says Belden. She adds that it’s too important for these properties not to be re­invested in as they age.

Creative Bond Structure

During the past five years, a new bond structure has also emerged to help developers finance affordable housing, including preservation deals. A combination of short-term, “cash-backed,” tax-­exempt bonds and taxable, long-term loan sales can help projects using Federal Housing Administration (FHA) financing, or certain Fannie Mae and Freddie Mac moderate-rehab loans, reduce their all-in borrowing costs. In the case of FHA-backed Sec. 221(d)(4) projects, this approach can potentially eliminate devastating construction-period negative arbitrage, says Wade Norris, a partner at Eichner Norris & Neumann (ENN), a Washington, D.C.–based law firm specializing in bond financings.

The firm explored the structure during the financial crisis in 2008, and it has been used on approximately 75 to 100 deals since then, according to Norris, who estimates that a strong majority have been preservation projects. The use of the structure has been increasing, with roughly 40 deals using the formula last year alone.

In addition, the projects are being financed with 4 percent LIHTCs. To qualify for such credits, at least 50 percent of the project’s eligible basis plus land must be financed with tax-exempt private-activity bonds, and those bonds must be kept outstanding until the project’s placed-in-service date. This is known as the “50 percent rule.” This rule ensures the project’s public purpose, and it prevents borrowers from simply pursuing lower-rate taxable ­financing alternatives.

The ENN solution is to issue short-term tax-exempt bonds equal to 50 percent of a project’s eligible basis plus land. If the project has a scheduled two-year construction period, the team will structure the bonds with a three-year maturity date to allow for possible delays. Two funds are then established under the bond trust indenture—a “project fund,” in which all the tax-exempt bond proceeds are deposited, and a “collateral fund,” in which FHA loan advances or proceeds from a taxable loan sale to Fannie or Freddie are deposited.

“As the taxable FHA mortgage loan or the taxable Fannie or Freddie loan proceeds, and possibly other funds, are paid in, instead of spending those monies directly to cover project costs, the monies are deposited into a collateral fund under our short-term bond indenture, and the trustee simultaneously disburses an equal amount of tax-exempt bond proceeds out of the project fund, which are used by the borrower to pay qualified project costs,” Norris says.

The monies taken out to pay the costs are tax-exempt bond proceeds, so they qualify toward meeting the 50 percent rule.

“As we draw down the bond proceeds, we’re filling up the collateral fund,” Norris says. That allows the team to obtain a AA+ rating on the short-term bonds from Standard & Poor’s.

Eventually, the project fund is emptied as the bond proceeds are spent, and the collateral fund becomes full. Once the construction or rehab is completed and a project is placed in service, money from the collateral fund is used to redeem the bonds. The taxable debt, including possible subordinate loans that are often used in affordable housing deals, remains the only debt outstanding.

The structure doesn’t add any net proceeds to the deal, but it results in the money being spent in a way that satisfies LIHTC program and tax-exempt bond rules. It also obtains a lower all-in borrowing rate and, on new-construction FHA deals, dramatically reduces negative arbitrage, says Norris.