Hollywood, Calif.— Legacy Partners broke ground on a new apartment tower in the heart of Tinseltown in February. Though most of the luxury apartments at 1600 North Vine will rent for whatever sky-high price Hollywood’s booming real estate market will bear, one out of five of the 375 units at this mixed-use, mixed-income project will be affordable to households earning up to just 50 percent of the area median income.

Mixed-income, “80-20” tax-exempt bond projects, in which 20 percent of the apartments are reserved for low-income families and the rest rent at market rates, are usually found in only a few high-rise markets, like New York City and Boston.

But as new high-rise apartment buildings crop up in markets from Hollywood to downtown Providence, R.I., 80-20 deals are beginning to appear along with them.

To build its tower, Legacy is using a $180 million low-interest mortgage funded with tax-exempt bonds issued by the Community Redevelopment Agency of the City of Los Angeles. That’s the largest allocation of these bonds ever made in California to an apartment project, said Jim Andersen, a senior vice president at Legacy. When the building is finished in late 2008, the $260 million project will also receive equity from the sale of 4 percent low-income housing tax credits to help subsidize these affordable apartments. Legacy is still crunching the numbers on how much these credits will contribute to the project’s financing after construction has finished.

Market forces shape bond deals

The deal is unusual for Legacy, which hasn’t done a mixed-income, tax-exempt bond project since the 1980s, when the rules for the program were looser.

It’s also unusual for downtown Hollywood, which until recently was a low-rent, low-rise neighborhood, more known for attracting runaways than for new apartment towers.

But Hollywood is experiencing an apartment boom. For example, just a block away from Legacy’s project, Camden Property Trust is planning to build 306 high-rise, luxury apartments at 1540 North Vine.

And with that apartment boom comes high rents. Legacy’s luxury apartments should earn an average $3.31 per square foot. For apartments ranging from an average 800-square-foot studio to two-floor penthouses, that means market rents that start at about $2,450 a month and rise to $6,000.

In contrast, tax credit rents in Los Angeles are just $540 a month for a studio apartment. According to Andersen, these tax credit rents are so low that they won’t even pay their own operating costs. So the rents at the market-rate apartments need to be high enough to make up the difference.

The market-rate rents also need to be high because the tax-exempt financing used at 1600 North Vine requires Legacy to pay its construction workers a “prevailing wage” that is similar to the wages paid to union construction workers. The rents at most suburban, garden apartment communities can’t support those high construction costs, Andersen said.

The project’s rent roll also needed to be large enough to support the cost of issuing $180 million in tax-exempt bonds, which could easily be several hundred thousand dollars.

Why include affordable apartments?

These high market-rate rents might help make the affordable apartments feasible, but they were hardly an incentive for Legacy to give those high rents up by committing to make a fifth of their apartments affordable.

That move was dictated by the Community Redevelopment Agency of the City of Los Angeles, which issued the bonds. The agency required Legacy to include apartments affordable to moderate- and very low income residents at the project.

Still, the tax-exempt financing that the affordable units made possible was an incentive to include them—especially considering the low interest rate on the project’s tax-exempt bond mortgage.

Although typical interest rates for tax-exempt loans are now only about 100 basis points lower than conventional, fixed-rate financing, the tax-exempt mortgage on 1600 North Vine, provided by Deutsche Bank Berkshire Mortgage, has a 35-year term.

In contrast, even a fixed-rate loan would probably need to be refinanced in 10 years and refinanced again 10 years after that, and who knows where interest rates will be then? Historically, the low, floating rates provided by tax-exempt mortgages have been cheaper than conventional, fixed-rate financing by an average of more than 200 basis points, Andersen said.

Legacy is working with Fannie Mae to credit-enhance the bonds.

Also, tax-exempt financing is relatively flexible. If the property is sold, the loan can be assumed by the new buyer. If the property increases in value, the loan can increase in size.

“As zoning laws change and as cities require more and more inclusionary housing, it will impair land prices, and developers can rationally look at low-floater [tax-exempt] bonds as an alternative,” Andersen said.