Across affordable housing, newer financing structures are increasingly used to improve deal feasibility and bridge funding gaps. Two of the most common are ground leases provided by profit-motivated capital providers and accruing subordinate debt structures, often referred to as B-bonds.
These arrangements can enhance early underwriting metrics and enable transactions that might not otherwise close, which can be viewed as a positive outcome in light of the current affordable housing crisis. However, both share a core structural feature: deferral and accumulation of obligations when a project does not generate sufficient cash flow, rather than immediate resolution.
This shift from resolution to deferral changes the way risk manifests over time. While the impact may not be obvious in “base-case” underwriting, it becomes highly consequential in stressed scenarios, particularly when an investor is required to stabilize or restructure a transaction.
1. The Core Issue: Deferral Versus Resolution
Traditional low-income housing tax credit (LIHTC) structures are built around a simple principle: When a property cannot meet its obligations, stakeholders are forced to act. This could involve restructuring debt, injecting capital, or replacing the general partner. These interventions occur in real time, preventing problems from compounding. In contrast, accrual-based structures allow the transaction to continue without resolving the underlying issue. Missed payments do not trigger immediate consequences; instead, they are deferred and added to a growing balance. Over time, this accumulated obligation can become large enough to influence or limit available solutions.
| Traditional Structure | Accrual-Based Structure |
| Cash Flow → Pay Obligations → Address Issues → Stabilize | Cash Shortfall → Defer Payment → Accrue Balance → Larger Future Constraint |
2. Not All Ground Leases Are the Same
Ground leases are widely used in affordable housing, but their purpose can differ significantly. In many cases, public entities such as housing authorities provide land at little or no cost to support project feasibility. These leases are mission-driven and are not intended to generate investment returns. By contrast, profit-motivated ground lessors provide capital in exchange for long-term lease payments calibrated to deliver a return. In these arrangements, ground rent functions economically like a financing obligation. When cash flow is insufficient, unpaid rent does not go away, it accrues. Important, this accrual typically does not trigger a traditional payment default during the compliance period, allowing the obligation to grow in the background.
3. Underwriting Discipline and Hidden Leverage
Most institutional LIHTC transactions are underwritten to a minimum debt-service coverage ratio (DSCR) of 1.15x. This standard reflects long-standing industry discipline and provides a cushion to absorb normal operating variability, including lease-up timing, expense pressure, and market fluctuations. Accrual-based structures often erode this discipline. By deferring a portion of required payments, these structures effectively operate closer to 1.00x DSCR. While underwriting may still show adequate coverage against current obligations, the economic reality is different: The full obligation exists, but a portion is deferred. This dynamic creates what can best be described as hidden leverage. Rather than absorbing volatility, the project carries forward shortfalls as future liabilities. At 1.15x DSCR, a property can withstand moderate stress without disruption. At 1.00x, even minor underperformance results in accumulating obligations that grow over time.
| 1.15x DSCR Structure | ~1.00x DSCR with Accrual |
| Built-in cushion absorbs volatility | No cushion → shortfalls accrue into future obligations |
4. GP Replacement and Workout Dynamics
The most important test of any LIHTC structure is how it performs when a project underperforms. In these situations, investors typically rely on a well-established approach as a last resort to address underperformance of a project: remove and replace the general partner, stabilize operations, and reposition the asset. Accrual-based structures complicate this process. By the time a general partner replacement is needed, the project may already carry a significant accumulated obligation. Any incoming sponsor must evaluate not only the path forward but also the burden of these existing liabilities. This often reduces the pool of potential replacement sponsors or changes the economics required for participation. In some cases, it can delay stabilization or require additional concessions, ultimately limiting investor flexibility.
5. Investor Outcomes: Yield Versus Experience
LIHTC investors typically derive value from two primary sources: tax credits and predictable tax losses, primarily driven by depreciation. These outcomes are generally well understood and incorporated into underwriting. Accrual-based structures can alter this experience. When projects operate with minimal coverage and defer obligations, operating stress can manifest as additional losses during the compliance period. While these losses may increase modeled yield in certain scenarios, they represent a form of return that investors are not seeking: unplanned volatility and economic losses driven by performance challenges rather than structured tax benefits.
6. Relative Risk: Breadth Versus Concentration
Both profit-motivated ground leases and accruing subordinate debt introduce similar economic dynamics, but their impact can differ in scope. Accruing debt primarily affects the capital structure and becomes a focal point in restructuring scenarios. Profit-motivated ground leases often have a broader reach. Because ground rent is treated as an operating expense, it directly reduces net operating income and influences loan sizing from the outset. At the same time, deferred rent continues to accumulate when unpaid. This combination of operating impact and accrual-based liability creates a structure that influences both ongoing performance and long-term outcomes.
Investor Safeguards and Alignment of Interests
While these financing structures can play a role in facilitating transactions, their risk profile can be materially improved through thoughtful structural guardrails that restore underwriting discipline, limit the accumulation of deferred obligations, and preserve investor flexibility in downside scenarios. The most effective mitigants focus on ensuring that obligations are either paid as incurred or, where deferral is permitted, remain bounded, transparent, and ultimately manageable in a restructuring. For profit-motivated ground lease structures, the presence of a hard-pay and contingent-pay framework is a constructive starting point, as it introduces partial subordination of rent to debt service and cash flow. However, this alone may not fully address the underlying risk if the contingent portion continues to accrue without constraint. Additional safeguards may include limiting or capping the amount of accrued rent, restricting or eliminating compounding interest on deferred amounts, and establishing clear, predefined mechanisms for restructuring or reducing accrued obligations in a workout scenario. Similar principles apply to accruing debt structures, where investor protections can include caps on outstanding balances, simple interest rather than compounding accrual, and provisions that ensure claims remain truly subordinate in both form and function, particularly in distressed situations.
Equally important is the preservation of core underwriting discipline. Requiring that transactions meet a minimum coverage threshold—such as a fully loaded 1.15x DSCR inclusive of all economic obligations—helps maintain the intended cash flow cushion and avoids introducing hidden leverage through deferral mechanics. In parallel, structural protections should ensure that investors retain full control over key downside remedies, including the ability to replace the general partner, restructure obligations, or recapitalize the transaction without being impeded by accumulated claims. These provisions are critical to maintaining flexibility in the event of underperformance.
A related and often underappreciated consideration is how these structures influence the overall allocation of value within a transaction. In many cases, the introduction of ground lease capital or accruing subordinate debt serves to increase available proceeds, which are frequently used to support higher developer fees or accelerate their realization. While it is appropriate and necessary for developers to earn a fair fee for their work and risk, the mechanism by which that fee is supported matters. When additional capital is introduced through structures that are senior to, or effectively compete with, investor recovery—and that defer obligations into the future—the result can be a transfer of economic value from the investor to other stakeholders. In effect, the transaction is being capitalized in a way that prioritizes near-term feasibility and fee generation while embedding additional risk in the investor’s position.
This dynamic is particularly important because it is often obscured by the mechanics of deferral. The incremental capital used to support developer economics is not immediately visible as leverage but instead accumulates over time as a future obligation that must ultimately be resolved. In this sense, the issue is not the presence of developer fees themselves but the use of accrual-based or structurally senior capital to fund those fees at the expense of long-term flexibility and investor protection. Appropriate safeguards, therefore, should not only address the mechanics of accrual but also ensure that the introduction of new capital does not materially alter the intended balance of risk and return within the transaction.
Taken together, these mitigants do not eliminate the structural risks associated with deferral and accrual, but they can meaningfully improve alignment among capital providers and help ensure that the transaction remains workable in a downside environment. At a minimum, they reinforce a consistent principle: Capital structures should preserve the ability to respond to underperformance in real time, rather than defer its consequences into a future period where options may be more limited.
Closing Perspective
Ultimately, the question for investors is not whether a structure improves feasibility at closing but whether it preserves flexibility over the life of the investment. Transactions can almost always be made to work on paper through additional capital and deferred obligations, but structures that rely on deferral to bridge feasibility often do so by shifting risk into the future.
In doing so, they can limit the very tools investors depend on to manage that risk—most notably the ability to intervene early, restructure effectively, and replace counterparties when needed. For this reason, feasibility should not be evaluated in isolation. It must be considered alongside the structure’s ability to withstand stress and remain workable in a downturn. In practice, the most durable transactions are those that balance both objectives: achieving feasibility without sacrificing the flexibility required to protect the investment when conditions inevitably change.
John Nunnery is an executive vice president at PNC Bank.