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IRS to modify compliance monitoring standards

Despite momentum for low-income housing tax credit (LIHTC) and bond-cap increases on Capital Hill, the Internal Revenue Service (IRS) seems to be tightening its monitoring standards for tax-credit housing projects. Industry officials warn that forthcoming monitoring standards for low-income housing tax credits could have a dramatic impact on the household qualification process and the way state credit agencies monitor LIHTC developments, including tenant fraud and tenant income misrepresentation.

"The biggest concern is the household qualification process," says Ruth Theobald, vice president and compliance monitoring consultant for Pewaukee, Wis.-based Affiliated Capital Corp. "Everything pivots on it."

New rules, same game Earlier this year, the IRS proposed several amendments to LIHTC rules that deal with compliance monitoring standards. These proposed changes would require state agencies to do more on-site inspections, submit annual compliance monitoring reports to the IRS and conduct a tougher review of low-income certification and supporting documents. These rules, however, will not be effective until the IRS publishes a final regulation, which is expected early next year.

"We always had these rules, but the IRS has now underscored and emphasized these regulations more dramatically," says Theobald. "If owners cannot provide proper income documentation for tenants, households will not qualify for tax credits. Documentation is the key. The IRS is determining whether an investor has earned credit. The IRS seems to be focusing on [issues] that have never been defined before."

Russ Kaney, director of housing investments for Madison, Wis.-based Heartland Properties Inc., says state credit agencies that alert the IRS to any LIHTC noncompliance also have become tougher in monitoring and allocating tax credit projects.

"You are seeing a lot of state agencies taking a hard look at the market," says Kaney. "They are rejecting a lot of proposals. They are going to community sites and interviewing a lot of people. They are rejecting proposals even if there is not too much supply. State agencies are actively selecting the affordable development projects."

Theobald notes that consistency is the key in the qualifying process of low-income tenants, and that owners and developers must be consistent in how they make adjustments. "A good example is when a raise in income is calculated for the household," she says. "Sometimes a raise puts the household above income maximum. Making adjustments to one specific household to help qualify to demonstrate they qualify is not acceptable. We have to project the income for 12 months."

The low-income housing tax credit program - first created through the Tax Reform Act of 1986 and made permanent in 1993 - is the nation's most popular and successful affordable housing program. Developers and syndicators who receive tax credits sell them to investors, who, in turn, use them to offset their annual federal tax bills for about 10 years. Under the LIHTC program, developers of rental housing must rent 20% of the rental units at 50% of the area median income, or 40% of the units at 60% of the area median income.

Theobald says there are still a lot of gray areas and undefined regulations that need clarification from the IRS. However, the IRS has just completed the final draft of its Audit Guidelines for Low-Income Housing Tax Credit Projects, a report that is expected to be out this summer. "I think the audit manual will serve as a tool to clarify some of the rules," says Theobald.

LIHTC professionals who have seen the final version - including Michael Novogradac, managing partner at San Francisco, Calif.-based Novogradac & Co. LLP - say the new version will not differ much from the original draft guidelines, which were criticized by the industry for their conservative position on several issues including developer fees.

Tax-exempt bonds gain momentum Meanwhile, LIHTC and tax-exempt bond cap increases, which have suffered severe setbacks in the past, seem to be gaining momentum in the United States. If signed into law, the proposed legislation (H.R. 175) would increase state authority annually to allocate LIHTC from the current $1.25 per capita to $1.75 per resident and index it to inflation in future years. Industry activists argue that the static $1.25 cap has eaten away the LIHTC program's purchasing power and that the cap ought to be inflation adjusted.

Other legislation (H.R. 864) proposes to raise the annual tax-exempt bond cap for states to $75 per resident, or $225 million per state, as well as to index the cap to inflation. The use of tax-exempt bond financing has become popular over the last several years, and more states have been allocating a substantial amount of funds from their bond volume to affordable housing.

"Unless we raise the bond cap and LIHTC cap, we cannot meet the demand for affordable housing," says R. Randy Lee, president of New York-based Leewood Real Estate Group. "In terms of both LIHTC and bonds, there is a shortage. There are probably many projects that are viable and could get built if funding was available."

Lee urged Congress to expedite and pass the cap increases to meet the growing demand for affordable housing nationwide.

"Those projects that could have been funded two to three years ago cannot make even the cut list today," he adds. "There is good opportunity to get affordable housing going because of low interest rates and availability of financing. Rising interest rates will clearly have an adverse impact because they will change the economics. The lower the interest the fewer credits you will need to make the projects. If rates go up, you will need more credit units."

Kaney of Heartland Properties, which is active in Illinois, Iowa, Minnesota, and Wisconsin, says there are plenty of lenders for affordable projects, but not many tax credits. He says towns in the Midwest with a population of 50,000 or more are seeking affordable housing projects.

"In the Midwest, it's easier to get construction financing for affordable projects," says Kaney. "We have a lot of banks that understand this area and they consider construction financing for affordable housing a profit center for banks. Permanent financing is considered a struggle for projects with less than 50 units. Permanent financing likes bigger transactions."

Mendel Nudelman, managing director and head of real estate in the Chicago office of Minneapolis-based American Express Tax & Business Services, says the size of the affordable housing projects is becoming smaller as state agencies want them to spread out to different locations, cities and towns. "Each development is becoming smaller these days - from 200 and 150 units to 50 or 60 units," he says, adding that tax-credit competition is fierce. "You have more syndicators in the field. In order for them to keep growing, they need more deals."

Nudelman adds that corporations continue to invest heavily in affordable housing through syndicators and that affordable-housing financing has not been a problem. However, he says interest in tax-exempt bond financing has waned this year. "There was a lot of hype about tax-exempt bonds last year, but they have not been coming this year," he says. "Tax-exempt bonds are far more complicated."

Novogradac disagrees, noting that tax-exempt bonds remain popular, as evidenced by the allocation of $942 million for affordable multifamily bond projects in California in 1999 - a record high. Bond allocation toward affordable multifamily projects in California last year was $852 million.

What is troubling with bonds, says Novogradac, is the decline in yields. "Highly-leveraged tax-exempt bond yields are declining and that is because of accounting issues," he says. "Tax-exempt bond transactions are not as attractive as tax credit transactions because of book accounting issues. That is clearly true."

Tax credits and tax-exempt bond financing in demand Robert Walsh, managing director of Mineola, N.Y.-based PW Funding, says demand for tax-exempt bonds continues to grow, with plenty of money available for affording housing financing. "During the first three months of 1999, we have provided financing of $20 million to affordable housing properties nationally," he says. "In 1999, you see more lenders willing to provide financing for affordable properties. You also see more tax-exempt bond financing than in previous years. There is difficulty in getting sufficient tax credits."

Ed Marron, president of New York-based CreditRE Mortgage Capital LLC, says tax-exempt bonds remain in short supply. "There is a big demand for tax-exempt bonds," he says. "I don't think there has been any substantive change in the affordable housing arena in the past six months. Business is as usual. The private sector remains extremely active and supply remains well behind the demand."

He adds that both low-income housing tax credits and tax-exempt bond financing allow the private sector to provide affordable housing. "There is a crying need for quality affordable housing," says Marron. "Despite the buoying economy, there is always a group of people who need affordable housing and there is always a need to replace aging housing stock. There is a huge replacement need."

Robert Schneiderman, executive vice president of New York-based Parallel Capital Corp., says the cost of financing multifamily housing has not increased, which provides opportunities for more affordable housing. "The cost of financing really focuses on establishing rents," says Schneiderman. "We really have not seen a dramatic increase in the cost of financing."

Bill McGuire, senior vice president for Dallas-based Malone Mortgage Co., says tax credits and tax-exempt bond financing remains attractive. "Tax-exempt bond financing for affordable housing is hot," says McGuire, adding that the Department of Housing and Urban Development's Hope VI program, which was launched in the mid-1990s to tear down troubled public housing projects for redevelopment into affordable housing, is also a great program.

Industry officials say there is a growing demand for rehabilitating and redeveloping older high-rise public housing projects into properly scaled and family-friendly, single-family and townhome communities. "They are very much in demand in inner cities," says Tim Rowland, a senior underwriter at Norwalk, Conn.-based First Connecticut Group Inc. "In general, goals are clear for the cities. They want to eliminate any kind of high-rise. They are more interested in townhouse kind of properties. It's everywhere. They want to encourage low-rise townhouses for affordable housing."

Rowland says Archbishop Walsh Homes in Newark, N.J., is a good example of a high-rise public housing project being replaced by townhomes. Under the Hope VI program, a 198-unit townhome development at the Archbishop Walsh Homes site is part of the Newark Housing Authority's effort to eliminate high-rise public housing and replace it with high-quality, affordable, low-rise townhouses.

"Good housing is difficult to get in inner cities," says Rowland. "There is more demand than supply. "

Likewise, demand for tax-exempt bonds continues to grow, while supply remains low. And only time will tell what effect the IRS' tightening of compliance monitoring standards will have on the affordable housing market.

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