San Jose, Calif. A $66 million bond deal done last year by the redevelopment agency here may have forged a path other municipalities can use to tap their state volume cap in a new way.
Instead of making loans to affordable housing developers with the proceeds from taxable bonds, as they had done in the past, San Jose officials found a way last year to use tax-exempt private activity bonds to finance the loans.
The tax-exempt bonds could be sold at interest rates about 1.5 percentage points lower than taxable debt, so the deal allowed the city to generate an estimated 120 extra units of affordable housing for local residents.
“That is the incremental amount they could fund just on the interest savings alone,” said Peter Ross, a principal with Ross Financial Services in San Francisco, the financial adviser for the San Jose Redevelopment Agency (SJRA) on the deal. Paying tax-exempt interest rates will allow SJRA to save about $1 million per year in debt-service costs, increasing San Jose’s affordable-housing financing capacity up front by an extra $40 million to $50 million, he said.
The innovative transaction won the 2005 Deal of the Year award from The Bond Buyer, the daily newspaper for the municipal finance industry.
“This is one of the most creative methods of financing needed affordable housing,” said California Deputy Treasurer Laurie Weir, the former executive director of the California Debt Limit Allocation Committee (CDLAC). The committee is the agency that allocates private-activity bonding authority to projects throughout the state.
Model for other cities
“San Jose was the trailblazer for the program,” she said. “It can serve as a model to other cities and possibly other states for increasing the amount of financing available at the local level for affordable housing.”
The program worked because CDLAC, which normally restricts its allocation of private-activity bonding authority to housing transactions in which the private developer is a sponsor, adjusted its procedures to allow municipalities to instead issue the bonds themselves using tax-increment funds to back them.
The proceeds of the tax-exempt bonds could then be used to fund gap loans, which are intended to make up the difference between an affordable housing project’s expected rents and the cost to develop the property in San Jose, one of the most expensive housing markets in the U.S.
“Many developers of affordable housing need to get gap loans from city governments, and very often those bonds have to be taxable under the tax code, and sometimes that becomes a deterrent because of the high cost of debt,” said Ross.
How redevelopment works
In California, redevelopment agencies, set up by local governments to redevelop or rehabilitate areas designated as “blighted,” are required to set aside 20% of the tax-increment revenue they collect for affordable housing.
The agencies pay for their projects with the extra property tax revenue – known as “tax increment” – generated once an area has been redeveloped and property values increase.
“We’ve been aggressively using set-aside money to finance these projects, albeit on a taxable basis,” said Julia Cooper, San Jose’s deputy director of finance. “In Santa Clara County, the cost of constructing housing is extremely high, so the only way our projects really pencil [out] is when there are significant loans from the city for those projects.”
Selling taxable bonds backed by set-aside funds doesn’t pose a problem, because the federal tax code doesn’t impose restrictions on what the proceeds of such bonds can be used for.
More hoops to jump through
Loaning tax-exempt bond proceeds to developers, though, triggers a host of restrictions on both what items the funds can be used to pay for and when they have to be spent, according to Bruce Serchuk, an attorney with Nixon Peabody, which served as bond counsel on the SJRA deal.
“Because deals had traditionally been done on a taxable basis, no one had paid attention, frankly, to the hoops that needed to be jumped through,” he said. But the San Jose deal was different. “Down to an invoice level, we had to review each and every cost that was going to be financed to see whether it was financeable, and within the timing restrictions,” he said.
In addition to the $66.2 million in variable-rate tax-exempt financing made possible by the CDLAC program, the redevelopment agency’s July 2005 bond sale included $10.4 million in fixed-rate tax-exempt bonds that refunded debt issued to finance housing grants, and $119.2 million in fixed-rate taxable bonds.
The deal included projects at nearly every stage of development, from design to construction to near-completion, some of which the city had already tapped its $50 million line of credit to fund.
Ordinarily you plan for the facts to be right,” said Serchuk. “Here, because we hadn’t planned for tax-exempt financing, we had to go back and see whether we met those [tax code] limitations and to what degree we did.”
Every little bit counts
The deal refunded some projects already done on a taxable basis as well as financing some new projects. In all, the transaction encompassed 1,821 rental units in 11 different projects, Cooper said.
Given that amount of housing, 120 extra affordable units might not sound like such a big deal. But in San Jose, the metropolitan center of pricey Silicon Valley, affordable housing of any kind is scarce.
A study released last fall by the National Housing Conference found that San Jose was one of the most expensive housing markets in the U.S., both for renters and homeowners.
The price of a median single-family home in the San Jose metropolitan area climbed 3.7% to $747,000 in the fourth quarter of last year, from $720,200 a year earlier, according to data from the National Association of Realtors, making its housing market the priciest in the country.
The San Jose disadvantage
Low-wage workers are at a bigger disadvantage in San Jose’s rental market than anywhere else in high-rent California, according to data from the National Low Income Housing Coalition (NLIHC). A minimum-wage worker living in a one-bedroom apartment in San Jose would have to put in 168 hours of work just to pay the rent, the NLIHC found.
“Affordable housing projects have been lagging because the cost of building them has been higher than the profits developers can obtain by doing them,” said David Baum, chief financial officer for the SJRA.
“This is a way to make them more attractive for developers and then to make the programs more affordable.”
The projects financed by the tax allocation bond deal are set up to serve families that earn between 30% and 60% of the area median income, which would make the units affordable to families earning from $31,650 to $63,300 a year.
“The mayor and the [city] council have taken it seriously to produce affordable housing here and that’s probably the No. 1 legacy of this mayor,” said Baum. During Mayor Ron Gonzales’ eight years in office, San Jose has produced about 10,000 units of affordable housing, Baum said.
