In the forums, I've seen some confusion about how affordable housing is defined. For some it means anything below market rate and for others it means LIHTC or Section 8. From a lending perspective, affordable housing includes LIHTC, Section 8, workforce housing and any other form of subsidy. Any project that qualifies as affordable housing qualifies for better terms than a market rate multifamily projects, and, because the definition is broad, it's easier for new developers to get into affordable housing than you may think. As an underwriter, I've seen market rate developers move into the LIHTC space by working with an affordable housing consultant, and I've also seen workforce housing projects with units restricted to 80% of AMI qualify for affordable housing loans. In order to solve the affordable housing crisis, we need all types of housing, so it's important for developers to understand how affordable housing is defined and financed. Note that this is only applicable for commercials loans for 20+ units.
Below are distinctions between the different types of affordable housing:
1) Workforce housing: Generally rent to tenants who have incomes ranging from 80% to 120% of area median income, as defined by HUD. Rents are generally at or close to market rate. Banks offer construction financing, and HUD offers mortgages for these types of properties. The same bank that provides the construction financing can generally place the permanent mortgage as well.
2) Section 8: Section 8 HAP contracts are given to properties by HUD. They are typically 20 years in length, and rents in the contract are generally set at market rate levels. Tenants living in Section 8 units pay 30% of their income towards rent, and HUD pays the difference between the Section 8 contract rent and the tenant's portion to the landlord. Banks offer construction financing and HUD, Fannie and Freddie offer mortgages for these types of properties. The same bank that provides the construction financing can generally place the permanent mortgage as well.
3) 4% Low Income Housing Tax Credits (LIHTCs): 4% LIHTCs are much more complicated than the two types of properties detailed above. However, experienced developers can partner with affordable housing consultants to secure 4% LIHTCs for a deal. Rents for these deals are set well below market and need tax credits in order to be viable. The 4% LIHTCs are awarded to projects each year and only limited by the amount of tax credits awarded. So, if your project meets all of the tax credit requirements, and the funding limit for that year has not been reached, your project will be awarded the credits. The amount of funding varies from state to state. Novogradac has excellent resources for learning more about 4% LIHTCs along with a list of affordable housing consultants. HUD, Fannie and Freddie offer mortgages for these types of properties, banks offer to buy the tax credits in the deal and will also provide construction financing.
4) 9% Low Income Housing Tax Credits (LIHTCs): 9% LIHTCs are the most competitive and typically only awarded to the most experienced developers with the highest scoring projects. Rents for these deals are set well below market and need tax credits in order to be viable.
Novogradac has excellent resources for learning more about 9% LIHTCs. HUD, Fannie and Freddie offer mortgages for these types of properties, banks offer to buy the tax credits in the deal and will also provide construction financing.
Any market rate development can be converted into affordable housing (as defined in #s 1-4). There are acquisition/bridge loan products that provide financing of existing market rate developments that will be repositioned as affordable housing developments.
If you're interested in learning more, I'd suggest attending this free webinar hosted by KeyBank on 3/25/21 from noon to 1pm EST https://bit.ly/3rOPZHz and/or reaching out with any questions. Getting affordable housing developed is my passion, so I'd be happy to assist in any way.
@Laura Janosko this is a great breakdown--thanks for taking the time! I've always wanted to get into lower-income housing since one can provide a much needed service where there is little supply.
To your point, however, seen very tall barriers to entry in this space once you start dealing with directly subsidized development (like LIHTCs). One of my professors is a developer heavily involved in raising capital commitments for these and says competition is fierce for those credits. And with recent tax legislation, there is less of a market to sell them (although I don't know if that will keep up given the fickle nature of our national leadership). Do you have any thoughts on this?
We have a few clients who keep their rental properties on HAP contracts, which seems to be a way easier way to break in. My only concern is not having control over rental rates, and one is at the mercy of the regulators setting them. If you have experience with those, what successes and failures have you seen?
Your professor is correct that there is fierce competition in the affordable housing space. There’s competition to acquire properties and stiff competition for 9% LIHTCs. In some states there is also competition for 4% LIHTCs when there are more projects than tax credits. My suggestion would be to develop workforce housing, purchase a property with an existing Section 8 contract or acquire an underperforming market rate property and work with an affordable housing consultant to reposition the property for a 4% LIHTC allocation.
The purchasers of tax credits are typically banks and insurance companies looking to offset their taxes. The price these companies are willing to pay for the tax credits varies based on the corporate tax rate, but they are typically close to a dollar for dollar transaction. As long as there’s a corporate tax of more than 0%, there is still going to be value in buying a dollar worth of tax deduction for less than a dollar. Additionally, banks need Community Reinvestment Act (CRA) credits, and one of the ways to get CRA credit is to purchase tax credits in a CRA market. This all a long-winded way of saying that there is still value in purchasing tax credits, which is primarily driven by the corporate tax rate and CRA credits.
Completely agree that an easier way to break into affordable housing is with a subsidized property. HUD sets rents contract rents at the same level as market rate and generally increases them slightly each year. The subsidized properties perform the best out of all asset types in terms of vacancy (averaging 3%) and also perform better in terms of collections, as a large portion of rents are guaranteed by the government. To a lender, it's significantly less risky than a market rate or even a LIHTC deal.