The number of Low Income Housing Tax Credit (“LIHTC”) properties that have reached the end of their 15 year compliance period has grown significantly over the last 3 to 4 years. This increase in “Year 15” transactions isn’t really a surprise to the affordable housing industry, or at least it shouldn’t be. During the late 1990s and early 2000s, the growth of the LIHTC program was quite remarkable. Now that wave of affordable housing is reaching a critical stage in the life cycle of the program as the tax credit compliance periods end. Why is this period of time critical? Here are some things to consider.
A typical new construction property that was awarded tax credits in 1998 took a year to build and started delivering tax credits around the turn of the century. This property is now in its 15th year of the compliance period and is, coincidentally, 15 years old. As a result, it will go through a transition period, if that hasn’t started already. The debt may need to be refinanced and a limited partner/investor may need to exit the partnership. Either scenario presents all sorts of interesting challenges.
When dealing with the limited partner who is exiting the partnership, there are a few situations that may occur, some more probable than others:
In each situation, some type of transaction is going to occur. It is the last option — the sale of the property — that is of concern. By the time a LIHTC property reaches year 15, it often needs some upgrades or repairs to remain competitive. Why?
Properties are sold based on different investment strategies. A non-profit buyer would probably want to maintain affordability long term, provide services to the residents, and do good things such as non-profits are inclined to do. Affordable housing developers might want to buy the deal and resyndicate it, usually sooner than later. However, more often than not, market rate buyers (i.e., not affordable housing developers or owners) are acquiring these properties.
Although market rate buyers’ acquisition may not sound like a problem, it is from an affordability perspective. Given that the nature of a buyer tends to predict the investment strategy of an asset, it is reasonable to expect that when the extended use period expires and affordability restrictions are lifted, these affordable housing properties are at risk of being converted to market rate properties.
And why not? The restrictions have dropped off allowing the owners to renovate the property and increase the rents to market rents. As a result, the low income residents who can’t afford the higher rent are displaced, and the buyer can sell the property and walk away with profits. Even if they don’t sell the property, they have created significant value through the increased rents. That seems like a reasonable investment strategy for some but for those concerned about availability of affordable housing units, it is an issue. That investment strategy will only widen the gap between the number of low income households looking for affordable housing in our communities and the number of affordable units available to be rented.
The Joint Center for Housing Studies at Harvard University stated that the shortfall for extremely low-income renters nearly doubled from 2003 to 2013, to a deficit of 3.9 million.
For a moment, let’s assume that one of the factors is a flat supply of affordable units. As market rate buyers acquire expiring LIHTC transactions, the outcome will be a reduction in affordable units. Combine this with other critical factors such as a growing number of rent-burdened households, increasing market rents, and more people moving from home ownership to rental housing, and the end result is a growing need for affordable rental housing. The situation will become worse as more affordable multifamily rental properties are converted to market rate at a faster pace.
For these reasons, preservation of our existing affordable housing stock is critical.
State agencies are helping to curb the tide by creating preservation set-asides in their allocation plans. This means that each property that is allocated credits in a preservation set-aside is one more property that will remain affordable for 30 or more years. However, perhaps more emphasis needs to be placed on preservation within the Qualified Allocation Plans. The preservation set aside may be over-subscribed in some states, but consider the transactions that are never submitted to the agencies for an allocation of tax credits. This can occur when the LIHTC developer planning to submit an application to the state agency was an unsuccessful bidder on a property and lost it to a market rate buyer. The impact of that result has been discussed in previous paragraphs.
Remember, affordable housing developers who are planning to immediately resyndicate the property into the LIHTC program commonly have purchase offers filled with uncertainties such as financing contingencies and an award of tax credits from the state. Consequently, they are out-bid by market rate buyers who are more nimble and can execute on a more conventional basis.
Recent statistics show that 80% of affordable housing property buyers are investment companies and high net-worth individuals. This is a substantial loss of opportunity to sustain affordable housing units. For example, using a ratio of 1:4, for every 5 applications submitted to a state agency to maintain LIHTC, there are 20 other transactions that have been sold to market rate buyers as a result of the property not being submitted.
What can be done to help change the course of this trend?
One approach is to continue to put a spotlight on how preservation of existing units impacts the affordable housing community. Of course, new construction also contributes to providing much needed housing. It is hard to increase available affordable housing with a meaningful impact without new construction. But rehabilitation provides a lower cost alternative.
It is compelling to consider that building a new 100-unit building in a major market may cost more than $30 million. Yet an existing property may be renovated for tenants in that community for $17 million while creating the same number of affordable units. The total tax credits allocated to these properties are $25 million for new construction and $9.3 million for rehabilitation. These are real world examples.
Another solution would be to expand the financing options available to affordable housing advocates as they work to acquire “at risk” properties. When compared to the current LIHTC equity market, there are very limited equity sources to acquire properties when they are in years 11 to 15 of the compliance period. However, a small portion of industry experts are introducing new options for affordable housing owners and PNC Real Estate is one of them.
PNC Real Estate has developed a platform that provides an alternative to tax credit investing whereby investors invest in “preservation” funds that acquire public welfare investments such as former LIHTC transactions.
In an industry where many fund investors find it difficult to acquire product in specific markets at reasonable yields, these preservation funds offer another vehicle for investing in affordable housing. Equity from the funds facilitate the acquisition of the fee simple or partnership interests in properties. The properties are held for a period of time, and then can be sold as a LIHTC syndication transaction thereby extending the affordability period for, in most instances, another 30 or more years. To date, PNC Real Estate and its affiliates have acquired more than 1,800 units, with another 692 units scheduled to close prior to year end.
Today, options such as traditional equity and mezzanine debt exist in the market. While these capital sources vary greatly in terms of strategy and structure, the good news is that many are helping to reduce the number of affordable housing units that will be converted to market rate units in the future. Preserving existing affordable housing is a challenge that is growing every year and is expected to continue over the next decade and beyond. There is plenty of work to be done in the effort to preserve affordable multifamily housing for low-income families across the U.S.
John Nunnery is Senior Vice President and Manager of Preservation Investments for the Tax Credit Capital group at PNC Real Estate. This article was prepared for general informational purposes only and does not purport to be comprehensive. The information and views do not constitute legal, tax, financial or accounting advice or recommendations to engage in any transaction. The views expressed in this update are subject to change due to market conditions and other factors.
The Joint Center for Housing Studies of Harvard University. The State of the Nation’s Housing 2015.
Marcus & Millichap. 2014 TCG LIHTC Market Activity Update, 2015.