In 2008 anyone trying to develop an affordable housing project using the Low Income Housing Tax Credit ("LIHTC") program under Section 42 of the Internal Revenue Code, learned the meaning of the word "frustration". As the economy plunged downward, purchasers of low income housing tax credits became scarcer than Bear Stearns executives. Horror stories ran rampant through the industry. Equity investors who issued Letters of Intent were pulling out of deals days before closing. Equity investors who were willing to stay in deals would only agree to do so if they could drop their pricing by 5-10%. Syndicators were calling their long-term development clients into meetings to warn them the times were only going to get tougher, and that if they had projects on the drawing board, they should figure on waiting six months to a year to find an investor. Unfortunately, these weren't just "stories", these events were actually happening.
As the pool of investors shrank prices being paid for tax credits began to plummet. Many of the large purchasers of tax credits, like Fannie Mae, were no longer buying credits. Prices being paid for tax credits dropped from the high $.80s low $.90s at the beginning of 2008, to the low $.70s at the end of 2008. More often than not, even at that price, a developer was lucky if they could find someone to buy the credits, creating huge gaps in the financing necessary to develop a project.
At the end of 2008, the affordable housing world wasn't holding out much hope for 2009. Even the most optimistic syndicators were saying that they couldn't see many equity investors getting back into the market before the second half of 2009. Projects that had approvals in hand, and were ready to put a shovel in the ground were stalled. Many long time housing experts were worried that the entire LIHTC program might be in jeopardy.
Congress took heed of the problem, and through the good efforts of many State housing agencies and other groups dedicated to affordable housing development, added provisions to the American Recovery and Reinvestment Act of 2009 (the "Act") that will hopefully jump start the stagnant affordable housing world and the LIHTC program.
Housing advocates tried to push through a number of stimulus proposals. As passage of the Act grew closer four main proposals remained in the Act. Two of the proposals passed (and the remainder of this article will focus on those two proposals), and two were dropped. One of the proposals dropped was an "accelerator" which would allow an investor to take 200% of the regular credit amount for the first three years. The other proposal dropped was a five year credit carry-back. The two proposals that survived are a gap financing tool using HOME funds, and a program whereby States can exchange their allocated tax credit dollars for actual dollars.
I. HOME GAP FINANCING
As stated above, the drop in tax credit pricing has created financing deficits in many tax credit projects. Let's use a very simple example; assume Dave Developer is in the business of developing affordable housing, and Dave has an approved affordable housing development project the will cost $6,000,000 to build. Dave applies to his local State housing agency for 9% tax credits, and is awarded $600,000 in annual tax credit dollars. Because it's a 10 year credit, Dave has $6,000,000 in tax credits to sell to an investor. If Dave was building his project in early 2008 he could probably sell his tax credits for around $.90 for each tax credit dollar he was allocated over the ten-year term. So Dave could raise $5,400,000 ($6,000,000 x .90) in equity, and would generally make up the difference he needs ($600,000) to build the project by getting a permanent loan from a bank, or he might combine the loan with an allocation of State or Municipal HOME funds. If Dave is a non-profit developer there are a number of other financing vehicles he can pursue to close the gap that are available only to non-profits. Let's assume Dave wants to build his project today. Rather than selling his tax credits at the early 2008 price of $.90, if he's lucky enough to find an investor, he's only going to be able to sell his credits for around $.72. So instead of receiving $5,400,000 for his credits, he's only going to receive $4,320,000 ($6,000,000 x .72). Instead of having a funding gap of $600,000, he now has a funding gap of $1,680,000. Generally, because of rent restrictions and other factors, affordable housing projects cannot support huge permanent loans, so additional obtain a larger loan isn't the answer. Without a source of funds to fill in the hole in financing Dave's project is dead in the water. One of the purposes of the HOME gap-financing portion of the Act is fill in the huge gaps created by the decrease in the price paid for tax credits by investors.
Simply put, the HOME gap-financing portion of the Act appropriates $2.25 billion dollars in additional HOME funds ("HOME Funds"). By way of background, the HOME program is authorized under Title II of the Cranston-Gonzalez National Affordable Housing Act. HOME is the largest Federal block grant to State and local governments designed exclusively to create affordable housing for low-income households. Under the Act the additional HOME Funds are made available to State housing credit agencies (and in some cases municipalities), based on their 2008 funding formula. The HOME Funds will be distributed competitively under the State's Qualified Allocation Plan to developers who already have a tax credit award. Interestingly, funding is largely subject to rules governing the tax credit programs, not the corresponding HOME requirements.
Housing projects with awards in 2007, 2008 and 2009 are eligible to receive these additional HOME Funds. Awards of HOME Funds are not limited to projects with 9% tax credit "awards", but also 4% bond deals. Priority will be given to projects that can be completed within three years. The HOME Funds must be expended quickly. Seventy five percent of the must be committed within one year from enactment of the Act. Owners must then expend seventy five percent (75%) of the HOME Funds within two years and one hundred percent (100%) of the HOME Funds must be expended within three years. Most commentators believe that these requirements are to be applied programmatically, not on a per project basis, i.e. of all the HOME Funds that a State gives out, seventy five percent (75%) must be expended within two years, not seventy five percent (75%) of each project. Failure of the owners to meet these deadlines may result in a re-distribution to other projects. Any HOME Funds not expended within three years revert to HUD. The HOME Funds will not reduce eligible basis. Most commentators anticipate that the HOME Funds will be made available to projects in the form of so-called "soft loans", which is how HOME monies are traditionally brought into projects.
II. THE EXCHANGE PROGRAM
The Act's second major attempt to stimulate the LIHTC equity market is the Exchange Provision. This provision allows State housing agencies to exchange a portion of their housing credits for cash grants from the Treasury Department. The law permits housing agencies to exchange up to 40% of the State's 2009 credits, plus 100% of the State's unallocated 2008 credits and any credits returned in 2009, all at a rate of $.85 per credit. This is a major advantage to developers whose best price at the end of 2008 was, as mentioned above, somewhere in the low $.70s.
To facilitate the program, the Treasury Department is responsible for granting exchange funds to States; State housing agencies then apply those funds as subawards for the construction or acquisition and rehabilitation of qualified low-income housing. Importantly, the subaward does not reduce the taxpayer's basis in the property. Subawards are subject to the same rent, income and use restrictions that apply under Section 42. Under certain conditions, subawards can be made with or without an allocation under Section 42.
Many questions exist regarding the implementation of this new program, and the lack of guidance to date has forced State agencies to develop their own interpretations of the law and methods for making the program work. In particular, two new obligations of State housing agencies participating in the exchange program have placed added burdens on the already limited resources of these agencies. First, housing agencies must establish a process for determining whether the developer has made good faith efforts to obtain an equity investor before making a subaward to that developer. Implementation of this vague provision is left to the States. Second, States are required to perform asset management to ensure that properties maintain qualified low-income status during the compliance period. State housing agencies are permitted to collect reasonable fees from owners to cover the costs of such activities, or they may contract out their asset management duties. They must also impose restrictions, including a requirement for recapture of funds, on subawards made under the exchange program, in order to further monitor compliance. Any recaptured funds are repaid to the Treasury.
The program is currently set to last through 2010. Any exchange funds not used by January 1, 2011 to make subawards must be returned to Treasury. Similarly, any subawards returned to the housing credit agency after January 1, 2011 must be returned.
III. SUMMARY
Even with the stimulus provided by the Act, most commentators feel that affordable housing development will face rough times for the foreseeable future. The HOME Gap Financing Provisions and the Exchange Program should provide a short term jump start to affordable housing development. Many people who practice and work in this area hope that the provisions of the Act will keep things moving forward long enough for the investment community to re-group and re-energize and return to the affordable housing world. In any event the affordable housing world is crossing its fingers and holding its breath in the hope that affordable housing again becomes a viable and vibrant industry. The downturn in the economy has only enhanced the need for clean, safe and affordable housing.
This article is intended to serve as a summary of the issues outlined herein. While it may include some general guidance, it is not intended as, nor is it a substitute for, legal advice. Your receipt of Good Company or any of its individual articles does not create an attorney-client relationship between you and Sheehan Phinney Bass + Green or the Sheehan Phinney Capitol Group. The opinions expressed in Good Company are those of the authors of the specific articles.
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