The federal government currently encourages the private sector to develop affordable housing through a variety of tax incentives, U.S. Department of Housing and Urban Development (HUD) subsidies and credit allocation tools.
As part of its overall deficit reduction and federal downsizing effort, Congress is likely to diminish or eliminate many of these programs during the 104th Congress (1995-1996). As a result, many firms involved in affordable housing may see their businesses shrink. A few years from now, the early to mid-1990s will probably be remembered as a high water mark for federal encouragement of affordable housing. This article reviews the outlook for the six most important federal housing programs and policies.
Section 8 projects
From the mid-1960s through the mid-1980s, the federal government induced private developers to build and operate affordable housing projects through tax benefits and deep rental subsidies, primarily under the Section 8 program. More than half of the 1.5 million Section 8 units were financed with 40-year Federal Housing Administration (FHA)-insured mortgages and rental subsidy contracts of five to 20 years. Most of these subsidy contracts will expire over the next few years.
The shrinking federal budget cannot accommodate renewal of all these contracts at their current rents, which are above market comparables for many of the units which have expiring subsidies. What then becomes of these properties and their more than $20 billion in loans over the next few years will be an agonizing epilogue to the nation's housing policy of past decades.
The U.S. Congress, HUD and private industry are in a complex debate over whether any contracts will be renewed, at what rent levels and, more importantly, how to treat notes for non-renewed projects, which will not be able to service their debt without Section 8 rents.
A bifurcation of these loans or outright forgiveness of debt by FHA will occur, potentially triggering devastating tax consequences due to taxable gains from cancellation of indebtedness under Section 108 of the Internal Revenue Code. Foreclosures are also expected, resulting in loss of ownership, tax benefits, management contracts and recapturing of depreciation, which is another devastating tax consequence. The National Multi Housing Council (NMHC) and the National Apartment Association (NAA) are advocating policies that will minimize losses to owners and renew at least some of the expiring contracts.
Certain companies, especially those with Resolution Trust Corp. (RTC) and other distressed asset management and refinancing experience, stand to benefit from this massive restructuring of low-income housing. Opportunities will include buying defaulted notes from HUD and managing and working-out these assets as a contractor or joint venture partner with HUD.
Beyond HUD, another unnoticed wave of workout business lies ahead. Several federal agencies operate loan guarantee programs, including the Small Business Administration, Department of Agriculture and Veteran's Administration, control billions of dollars in notes and real property. Soon, these agencies may realize they can generate substantial income by engaging the private sector to manage, refinance and dispose of these assets. Companies with strong political acumen, and the right mix of management and capital markets skills, stand to benefit.
While the project-based Section 8 program was the lead affordable housing policy of the 1970s and 1980s, the Low-Income Housing Tax Credit (LIHTC), created in the 1986 tax bill, is the primary multifamily housing policy of the 1990s. To receive the LIHTC, projects must allocate either 20% of units to households earning less than 50% of median income or 40% of units to households earning less than 60% of median.
The LIHTC creates approximately 100,000 units of affordable housing annually. Virtually no affordable housing is built today without the LIHTC equity subsidy. The other federal housing programs play various supporting, gap-filling roles in tax credit projects. At press time, a bill had been introduced in the House of Representatives to eliminate the LIHTC at the end of 1997. At a cost to the Treasury of $2.2 billion annually, the LIHTC is a prime target for congressional budget cuts. Further, both the Internal Revenue Service and Congress' fiscal watchdog, the Government Accounting Office (GAO), have launched in-depth investigations of the program, based on a perceived high incidence of non-compliance. Nevertheless, the program has a strong constituency and may survive the 1995 budget battles. Elimination of the LIHTC would essentially end private sector development of new and rehabilitated, low- and moderate-income housing, and intensify the affordable housing shortage in the United States. NMHC and NAA are lobbying to keep the tax credit permanent.
Secondary market agency Fannie Mae is the single most important private institution in the affordable housing industry. Fannie is actually a private institution with public sector origin, publicly conferred competitive advantages and publicly mandated affordable housing obligations. In 1992, the Congress created statutory affordable housing investment requirements for Fannie Mae and Freddie Mac, which led Fannie to aggressively increase its participation in affordable multifamily finance. In addition to buying and securitizing loans for LIHTC deals, Fannie Mae is the single largest investor in LIHTC equity, buying approximately $ 1 00 million in credits annually and providing credit enhancement for multifamily tax-exempt bonds.
The final rules implementing the 1992 law are due out in late 1995. Some affordable housing advocates had hoped that Fannie would be forced to cross-subsidize risky affordable housing loans out of its profits on market rate loans. It appears, however, that the final rules will not lead to this result.
Fannie's approach is to work diligently to bring affordable housing loans up to its underwriting standards, while avoiding subsidization. Due to its market dominance, future innovation of any scale in the affordable housing field will have to comport with Fannie's underwriting terms. No further statutory changes are in immediate sight.
Tax-exempt bond financing
Over a period from 1980 to 1995, state and local governments issued $50 billion in tax-exempt bond financing for multifamily housing resulting in approximately 1 million units of housing, according to Saybrook Capital Corp., a finn specializing in refinancing existing bond issues. Interest rates on tax-exempt debt are typically 125 to 200 basis points below taxable debt. The subsidy or value added to a project by tax deductibility allows either an increased number of lower income units, higher development costs or lower equity contributions. Projects must meet the LIHTC low-income targeting requirements.
The Congress will consider proposals for a flat tax or simplified tax system in 1996 and 1997. The flat tax and some of the other proposed schemes would eliminate the deductibility of state and local interest payments from federal taxes and thereby do away with the subsidy to multifamily housing. In reaction to the possibility of tax reform, the market has already reduced the spread between bond and taxable financing.
Federal Housing Administration
The FHA mortgage insurance programs provide multifamily developers with new construction and rehabilitation loans at more liberal underwriting terms than the private market. While FHA-backed projects are not required to target any specific portion of their units to lower-income tenants, FHA often backs projects which are older, require more rehab, are in less desirable locations and serve low- to moderate-income populations.
FHA was a dominant market force in the early 1980s. Today, FHA's role is spotty, originating substantial volume in areas of the country with competent FHA field offices and no loans in other areas. Total initial endorsement volume for 1994 was $3.4 billion. For those mortgage bankers and developers who can navigate FHA's highly regulated and slow-moving origination process, the final product is worthwhile. But Congress is expected to end subsidization of the FHA multifamily insurance fund starting next year which will require tighter underwriting and increased mortgage insurance premiums. With Fannie Mae and other lenders squeezing FHA's business and Congress ending funding, the forecast for FHA is uncertain at best.
Tenant, based rental assistance
Many private apartment owners rent their units to recipients of Section 8 tenant-based rental subsidies. Approximately 1.5 million families receive such assistance. In some urban and low-income markets, Section 8 recipients add noticeably to the demand for multifamily housing. During 1995 and 1996, Congress will tilt the nation's housing policy to rely more on tenant-based assistance and less on property-based strategies, such as public housing and project-based Section 8. Currently, many private owners shy away from Section 8 recipients, due to special legal protections afforded to them above and beyond the protections granting Act and state and local law.
Congress also plans to end the so-called "federal preference rules," which require that nearly all Section 8 assistance goes to extremely low-income people. This policy backfired by creating dysfunctional concentrations of poverty in many buildings and neighborhoods. Federal policy now will move back toward a mixed-income approach.
Patrick Dober is vice president on the Washington, D.C.-based National Multi Housing Council/National Apartment Association Joint Legislative Staff with principal responsibility for finance and housing issues.