With the compliance periods for initial low-income housing tax credit (LIHTC) properties now ending, the question of how to recapitalize and rehab those projects is commanding policymakers’ attention.

As first enacted in 1986, properties developed under LIHTC had to enforce affordability standards for 15 years. In 1989, Congress extended the use restrictions to 30 years. In addition, some states (which are responsible for allocating the credits) required extended affordability periods. The most notable of these are California and Nevada, which require 50 years of compliance, and Utah, which requires 99.

Many LIHTC properties also benefit from additional funding from programs like HOME and Farmers Home Administration, which require longer-term affordability commitments.

Many of the 170,000 units developed with LIHTCs between 1986 and 1989 will soon be eligible for conversion to market rate. Most will need recapitalization that may well force them out of affordability. Properties in markets where market rents have significantly outpaced the measured hikes allowed with LIHTCs are particularly threatened, as owners eye potential income gains.

While many projects have provisions granting nonprofit organizations or public agencies the right of first refusal to purchase the buildings at expiration, these organizations will often be hard-pressed to find the funds to purchase and maintain the buildings.

Tenants of LIHTC properties are not protected the way tenants of units with direct federal subsidies are. Although residents of former project-based Sec. 8 units receive Sec. 8 enhanced vouchers, displaced LIHTC residents will not be offered such benefits. The loss is thus twofold--with each apartment converted, a unit of affordable housing is lost, and a low-income household is in need of an affordable home.

The main challenge is recapitalizing projects that no longer generate tax credits, said Jenny Netzer, managing director of housing and community investing for Lend Lease Real Estate Investments.

“A high number of the early tax credit deals had other long-term restrictions, and many states imposed longer-term affordability requirements,” she said. “The real issue isn’t maintaining affordability, it’s recapitalizing the properties.”

Because the original investors in the projects were committed to 15 years, the funds raised at the time were enough to modernize or rehab the properties to last that length of time. As a result, most of these properties are “tired,” said Netzer, and in need of additional rehab. At the same time, the original investors are focused on getting out of the projects, she said. In many cases, the developer at the lower tier is buying out the other interests, while some are being bought by third parties, and a few are being re-syndicated with new tax credits.

“The vast majority of the property managers and owners at the local level, even those that aren’t nonprofits, are responsible owners,” said Netzer, and as such are committed to ensuring that the properties remain viable community assets and, in most cases, affordable. “One of the great attractions of this program is that nobody is looking to make a killing on the exit.”

Public policy vacuum

What is particularly challenging about the expiring tax credits is that there is no public policy in place to handle the situation on a wholesale basis, said Steve Rodger, also of Lend Lease. As a result, each owner has to come up with a property-specific plan for recapitalizing projects, and each one takes “an enormous amount of time and energy.”

Rodger described the dichotomy he faces in Chicago. One property in his portfolio is worth a significant amount of money and could command high rents or sale prices if brought to market, but it also has access to ongoing tax exemptions, low-interest rehab loans, bonds and other subsidies that would provide solid benefits to the partners if the property remains affordable.

At the same time, those resources aren’t available for a property in another Chicago neighborhood where affordability is most needed.

Katie Alitz of Boston Capital estimates that about 20% of expiring tax credit properties will lose their affordability restrictions. “There are lots of resources and people in the business who want to try to recycle these properties and keep them affordable,” she said, “but that will depend upon the availability of new tax credit money.”

A few states are taking note of the situation and responding by setting aside new tax credit money to support properties with expiring subsidies. In Michigan, for example, $2.5 million, or 14% of last year’s tax credit allocation for the state, was set aside for the preservation program. This year it’s $3.5 million, or 20%. On Jan. 2, the first day of the program this year, 16 applications were received, that totaled $400,000 more than the allocation.

The California Housing Partnership Corp.’s report, “The Tax Credit Turns Fifteen: Conversion Risk in California’s Early Tax Credit Portfolio,” claims that more than 4,500 units are at “high risk” of conversion to market rate.

A recent report by the Chicago Rehab Network cites expiring affordability agreements, but says that more pressing is the lack of operating and replacement reserves for the majority of the city’s LIHTC properties. It projects “a future of deferred maintenance, rising vacancies and ever-deepening budget shortfalls,” all factors likely to contribute to conversion to market rate as soon as restrictions expire.

Other states are also beginning to look into the issue. The Wisconsin Housing and Economic Development Authority has established an “Affordable Housing Tax Credits Year 15 Task Force.” The Washington State Housing Finance Commission is working with the Federal Home Loan Bank to establish an information clearinghouse about properties for sale in the state, in an effort to preserve long-term affordability.

At the same time, national intermediaries, most notably the National Equity Fund and the Enterprise Social Investment Corp., are working with nonprofit sponsors who are committed to permanent affordability in order to acquire the properties at the end of the 15-year investment period at a nominal price. The MacArthur Foundation has dedicated $40 million to assist nonprofits in preservation and to fund purchases of at-risk properties by “qualified preservation purchasers.”