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Supply/demand numbers favor affordable housing investing

All eyes may still be on Congress and the status of the LIHTC, but investors are still pouring money into the affordable housing industry to meet the increasing product demand.

Right now, affordable housing is a hot market for investors. The primary reason being a lack Of supply and great demand for such projects.

"Investors find these projects appealing for several reasons," says Rory Brown, managing director for Ocwen Financial Corp. "As a real state investment, many of the usual cashflow risks are mitigated because the demand for affordable rental housing far exceeds supply and occupancy rates are usually above 90%."

"Housing affordable to low income people is in short supply," agrees John Bohm of the National Assisted Housing Management Association.

Providing affordable housing also allows corporations to reduce their tax exposure while Brown and, "last but not least, many investors welcome the opportunity to serve the community while enhancing their bottom line."

However, all is not perfect in the world of affordable housing, and the leading problem seems to be talk of sunsetting the Low Income Tax Housing Credit plan.

"If HUD pursues policies which encourage crowding, properties will deteriorate and lower income families and senior citizens will find their housing options reduced," Bohm says.

Sunsetting the LIHTC

Just how sunsetting proposals have affected the industry depends on who you speak with. Some say the program is too strong to die out completely while others fear the lack of stability e [email protected] gram.

"Housing authorities are concerned that HUD's occupancy proposal would take control away from them in an era where the national consensus is to give them more flexibility," Timothy G. Kaiser, executive director of the Public Housing Authorities Directors Association says. "By increasing occupancy levels federally, HUD would diminish the ability of local public housing managers to provide a good living environment for residents."

Dr. William C. Baer, professor of Urban Planning and Development at the University of Southern California conducted a study that suggests HUD's July 1995 policy, or a similar plan, could damage the affordable housing industry. In his study, he concludes that increased occupancy requirements suggested by the HUD proposal would diminish the supply of affordable housing, and our society places a high value on noncrowded living environments. Baer also found that the valuable services that are provided by housing managers would be reduced if occupancy levels were increased. Finally, he decided that HUD's occupancy proposal contradicts its own policies and is simply a form of rent control.

However, Jim McAuliffe, senior investment officer of Boston-based John Hancock Financial Services, says, "It has mobilized the industry and made everyone realize that we need to keep Washington aware of how good and effective this housing program is."

Due to the success of the program, many say it will not disappear altogether. In fact, the government has considered keeping the program but only on an annually renewable basis.

A changing industry

There have been quite a few changes in the affordable housing industry and not all of them involve the federal government. Brown says that the market is becoming greatly more competitive as the number of developers seek to initiate affordable housing projects.

McAuliffe adds that this influx of corporate investors has created higher standards for reporting in the industry.

However, many of the changes do focus around the legislature that governs the industry. Because of all the changes in legislature, affordable housing professionals now have the responsibility of keeping up with the latest information.

"The amount of information on the rules and regulations governing the affordable housing tax credit has increased dramatically," Brown says. "Seminars on these investments are becoming more common, and books and articles on the subject more readily available."

Financing affordable housing

Of course, talks of sunsetting have not only affected what an interested party needs to know about affordable housing projects, but it has also affected the financing of such developments. A developer must have a much better quality project in order to qualify for particular loans or subsidies because financial institutions are not willing to take the risk now. However, there is a lot of capital available for this market if one has the quality product and credit to deserve it.

"With good real estate and a qualified developer, we will invest," says McAuliffe. "If the credits are good, but the real estate is not, we will not invest. We are real estate driven.

Typically, a tax credit investor must have a large, fairly predictable tax bill to use affordable housing tax credits," says McAuliffe. "Although the program has been around since 1986, corporate investment in tax credits really only began around 1990 Today, many Fortune 100 companies have invested in this type of credit and are familiar with it. There is a lot of money out there looking to invest in affordable housing."

Because of the reduction of federal programs, debt issuance for affordable housing will likely rise significantly in the coming years. "Given the bleak outlook for federal affordable housing funding, we expect tremendous growth in issuance in this sector," says Wendy Dolber, head of Standard & Poor's Public Finance Housing Group.

When considering whether to develop an affordable housing project, there are several things to keep in mind.

"The most important criteria for deciding whether to invest in tax credit properties, or any multifamily rental properties for that matter, should be whether or not the project will generate cashflow adequate to service the debt and maintain the property,"says Ocwen's Brown. "Because of the guidelines established to regulate tax credit properties, an experienced management team is critical to the long-term success of an affordable housing development."

In order to maintain value over time, a project must offer quality services with adequate recreational and communal facilities, adds Brown.

Boston Financial's Affordable Senior Housing: A Low-Income Housing Tax Credit Guide suggests taking in the following considerations for general tax credit development.

* Income limits relative to market/mixed income properties. This means that if you are looking to develop in an area where rents are equal to or less than tax credit rents, then the project may be prosperous. However, if the market rents are in excess of the tax credit rents, then cross-subsidization may be a better bet.

* Income levels relative to costs. Tax credit projects work best where median incomes are great enough to offset a fairly high level of tax credits, and both development and operating costs are low enough that the project is feasible without subsidies.

* State agency environment. Because each state varies, developers must review the state's ranking system published in its Qualified Allocation Plan, or QAP, to determine whether the property is likely to be approved. The QAP will indicate the agency's requirements and preferences for allocating credits. Also, depending on the state, demand for taxexempt bond issuance may exceed either the authority's supply or the state's interest in issuing the bonds, but where there is enough bonding authority and state willingness to issue bonds, HFA bond issuance can be an excellent financing source.

* Local community and government environment. Receptivity to tax credit projects varies by community and property type. Where a community is supportive of a particular need or activity, access to those services may be of considerable value to a developer and may become a factor in deciding where to locate a tax credit development. In general, affordable seniors housing is better received than a conventional multifamily project, and rehabilitation is more accepted than new construction.

* Credit enhancement. In the case of a developer needing to obtain credit enhancement for tax credit financing, the individual enhancer must approve the underwriting standards for the property. no credit enhancement is required, the rating agencies will generally approve the bond underwriters, issues, and the rating agencies, underwriting standards will have to be met.

* Minimum dollar amount of improvement for rehabilitation. Tax credit projects must include a minimum amount of improvement costs to qualify. This the greater of $3,000 per unit or 10% of the eligible basis in the project.

* Ten-year continuous holding period for acquisition credit. Reno. properties receive credits at the 4% level, which is applied to the cost basis so long as the immediately preceding owner has continuously owned the property for at least the previous 10 years. An exception exists for properties foreclosed on by HUD.

* 130% bonus. A list is published and updated regularly with the localities and census tracts that qualify for 130% of the tax credit allocation otherwise available. The bonus is awarded to areas considered difficult or particularly expensive to develop or difficult to finance. The bonus can be critical to the value of a given property's tax credits. Developers should investigate early in the planning stages to determine whether sites and areas quality for the bonus.

* Timing. Developers must be prepared to proceed for considerable time without allocations or cash. Developers who are prepared to wait for credits may be more successful, because in this competitive process, if one project is not prepared to "take down" credits by year's end, the credits will often be awarded elsewhere to another project.

Senior affordable housing

As a niche market of the affordable housing industry, seniors affordable housing is doing very well despite sunsetting talks. All three categories of seniors' affordable housing. assisted living, congregate residences and continuing care retirement communities, have occupancy rates of 95% or better.

The assisted living sector, which consists of housing designed for frail seniors needing help in routine activities, has the highest occupancy rates in the industry at 97%, according to The State of Seniors Housing 1995, conducted by Coopers St Lybrand L.L.P. and the American Seniors Housing Association (ASHA). Meanwhile, congregate residences, which offer independent living units with congregate services, and continuing care retirement communities, which have a combination of congregate services as well as skilled nursing, both have occupancy rates of 95%.

The report points out that 49% of survey respondents plan to or are currently developing stand-alone assisted living communities in response to these high occupancy rates, while 31% state that they were either developing assisted living facilities with a skilled nursing component or providing some assisted living services to occupants of independent living residences. Another 36% say they plan to develop congregate housing with assisted living capabilities.

But like other segments of the affordable housing market, seniors housing demands are much higher than its supply.

"It is my personal observation that the state housing agencies do not award enough credits to elderly affordable projects, therefore, occupancy is always high," John Hancock's McAuliffe says. "I believe we can do so much more of this type of housing."


The joint Legislative Program of the National Multi Housing Council (NMHC) and National Apartment Association (NAA) is proposing in its 1996 federal public policy agenda to urge Congress to reform the Medicaid system and tighten its loopholes concerning long-term care coverage to force more seniors to take personal responsibility for financing their long-term care needs. It is also advocating that restrictions be reduced on the term of contracts between operators and tax-exempt owners, and it hopes to prompt Congress to increase the exclusion of gain from the sale of a principal residence for a person 55 years of age or older from $125,000 to $200,000, provided that the gain in excess of $125,000 up to a total of an additional $75,000, is placed in a trust for the sole purpose of providing long-term care, used to gain admission to or ongoing residence in a qualified continuing care retirement community or use to purchase tong-term care insurance.

The low income housing tax credit can provide a substantial source of capital and therefore a valuable opportunity for developers, including those of seniors housing. But developers must be cognizant of the critical issues in accessing and utilizing tax credits, according to Boston Financial.

The ultimate challenge that now faces the affordable senior housing market is financing housing and services, while keeping rents affordable for low- and moderate-income residents. However, under Treasury regulations, rent charged by a residence must include services "required as a condition of occupancy," report Boston Financial.

If meals and other services are mandatory, their costs must be included in the rent. In the majority of cases, this inclusion will push rents above the tax credit limit.

Even if services are optional and purchased separately, there is the issue of how a resident who meets the tax credit income limits has the resources to pay for those services. Many seniors have assets or rely on their adult children to contribute to their care. Developers must be careful that income from assets and contributions by adult children are within the tax credit guidelines.

Financing seniors affordable housing

In financing a seniors affordable housing project, the tax credit only covers the property not the services. A developer must go elsewhere to fund these services and expenses in order to keep the rent prices below the tax credit line.

"Usually, developers try for some sort of real estate tax abatement, grant money or subsidized financing from state or local authorities to cover these types of expenses," McAuliffe of John Hancock says.

Seniors housing firms generally secure debt financing from regional and local banks or government sponsored loan programs to finance their growth, reports Coopers & Lybrand and ASHA.

Low Income Housing Tax Credits

One would think the concept of low come housing tax credits would appeal Republicans. Housing programs, once ministered by the federal government rough the Department of Housing and urban Development, have dramatically creased as of [email protected] when the low income housing tax credits were introduced. If there was one way to reorganize HUD, or eliminate it as some Republicans wish, then the low income tax credit program fits their political purpose. But, e biggest threat to the credits came on a Republican tax bill, which wanted it to be "sunsetted" by 1997 and meant that the credit made permanent in 1993 would no longer be permanent.

"With the downsizing of HUD, the low income housing tax program becomes the only program that is out there to bring new product on-line, and it's one that is seen as a very Republican program in that it is states-right oriented," says Michael Novogradac, managing partner with Novogradac & Co. LLP in San Francisco. "There are a lot of reasons why the Republican Congress should support it."

Apparently not. The Republican chairman of the House Ways & Means Committee proposed a sunset on the tax credits which the full House supported. The Senate, however, passed the tax bill without the sunset, yet in conference the sunset was left in, explains Novogradac. in the end, President Clinton vetoed the bill, and the credit is still permanent. Proponents of the sunset were mostly of the mind that all programs should be sunsetted, but there are indications that Republicans are backing off on this issue.

"I don't think anyone would argue that there is a severe shortage of affordable housing for families and elderly in the country," says Mark Schnitzer, an executive vice president with Related Capital Co. in New York. "The private sector has not been able to provide affordable housing without some sort of incentive."

While the demand for low income housing is still strong, the tax credit program produces about 100,000 new affordable multifamily units per year (over the last seven years, affordable housing units built or rehabilitated average between 91,000 and 111,000 annually), and since its inception has produced in excess of a million new units.

The way the program works is that each state is allocated annually $1.25 in credits for each resident. So a state with one million people gets tax credits of $1,250,000, and individual developers apply to the state to use the credits. What has happened though is that major companies realized they could use the credits and, as a result, Corporate America has become large investors in the tax credit business.

Related Capital raised $300 million from corporate clients to invest in low income housing tax credit projects, plus an additional $40 million from individuals.

"When a person gets a credit allocation for a project, he or she goes out and tries to find an equity investor to put up the equity for building the project, and that is the crowd we look for," says Schnitzer.

Another company that has been leader in raising private capital for affordable housing has been Boston Financial. "What we do is raise money from individuals and corporations to invest in properties that have the tax credit as their benefit component. We also property manage as well as asset manage those properties," says Georgia Murray, a senior vice president with Boston Financial.

There is a definitive amount of tax credits each year so there is not an increasing amount of housing, but what is increasing is the corporate investor's appetite for those credits and the interest in the corporate market, Murray says. "Corporate interest started picking up in late 1992 and early 1993, and the prices paid to developers in terms of cents per dollar credit were $0.50 to $0.52 at the beginning of 1993 and about $0.62 to $0.63 at the beginning of 1996."

Heller Financial recently teamed up with the Richman Group to provide a guarantee for the tax credit investor. In exchange for taking on performance and compliance risk, Heller gets a fee. Investors still get a good return after taxes, but it's a lower return than they would get if they bought into a non-guaranteed tax credit deal. "If they want to go into an unguaranteed fund they maybe able to get an 11 or 12% return on their investment," says John Petrovski, senior vice president and regional manager of Heller Financial, "but in the terms of the investment, they are taking on real estate compliance risk and real estate performance risk for 15 years."

Fannie Mae and Banc One join forces

to finance affordable housing construction

Recently, Fannie Mae and Banc One, Columbus, Ohio, combined efforts and worked out details on an advanced commitment affordable housing program.

Banc One has entered into a master funding agreement with Fannie Mae which will allow Banc One affiliate banks to provide construction financing with advances made by Fannie Mae.

Under the Forward Commitment Financing program for targeted affordable multifamily new construction projects, Banc One Capital Funding Corp., a Fannie Mae DUS lender, has been under-writing and committing to make permanent mortgage loans on affordable rental housing projects prior to the commencement of construction. Forward commitments have been available previously but only on a case-by-case basis. The forward Commitment Program will provide a programmatic approach to advance rate lock permanent financing and construction financing, while equity can be simultaneously secured through the sale of tax credits to one of the Banc One Tax Credit Funds.

The program has already been put to use in financing five projects comprising of 644 units of Targeted Affordable Housing in Texas, Ohio, Indiana and Michigan.

Ten Commandments of financing tax credit housing

I. Thou shalt build what the state want built.

Review the QAP. Note the product type location, income levels and cost limits.

II. Thou shalt suffer from tax credit paranoia.

Incur more than 10% of cost by the end of the first year. By the end of the second calendar year the projects should be placed in service. Note the tax credit allocation agency's deadlines.

IV. Thou shalt understand marginal issues and emphazise "cliff effect" issues.

Marginal issues affect how much credit you will get. Cliff effect issues determine whether you will get any credits. Be extremely conservative with cliff effect issues.

V. Thou shalt not get credits thou does not need.

The state is required to perform a financial feasibility test at the reservation date, the allocation date and the sources and uses of cash may cause a reduction in the credits you can ultimately claim.

VI. Thou shalt not focus only on the credit price

Getting the "highest" credit price may make for good cocktail party conversation, but be sure to review the contributions, first year credit warranties and repurchase obligations.

VII. Thou shalt disclose issues as they arise.

Address issues up front. This allows room to plan around to deal with issues and situation. Waiting to deal with issues afterward may be deadly.

VIII. Thou shalt commit to long-term affordable housing limits.

A building with tax credits must be a qualified building for 15 years, otherwise credits could be recaptured. After 15 year there will be deed restrictions for at least 15 more years.

IX. Thou shalt organize the financing team as soon as feasible.

This includes the construction lender, permanent lender, equity buyer and any party providing seller carryback financing or a good ground lease.

X. Thou shalt use experienced counsel.

Michael J. Novogradac, CPA, is publisher of the LIHC Monthly Report, managing partner of the San Francisco-based national certified public accounting firm Novogradac & Co. LLP, CPAs, and the author of the Low Income Housing Tax Credit Handbook.

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