Developers are faced with a decision as LIHTC credits have a shorter shelf life.
In the affordable housing space, low income housing tax credits (LIHTC) are the lifeblood for most developers. Construction managers may not realize it, but these federal financial vehicles fuel their workloads as well.
As a dollar-for-dollar federally guaranteed reimbursement on affordable housing investments – including the construction and purchase of the property – this system has supported 2.4 million homes and 95,000 construction jobs since its creation in 1986. It is generally celebrated by both sides of the political spectrum because it is a sustainable solution to the housing crisis and encourages private sector investments, generating a default rate of less than 0.1 percent.
Recently, LIHTC allocations to states have been expanded as part of the comprehensive overhaul to the federal tax code, but there is a catch: most credits are issued with an expiration date. Typical LIHTC appropriations in California have a shelf life of 55 years, but most states allocate them at shorter terms. As the funding clock winds down like the last few seconds of an NBA game, developers are faced with a major decision – and fouling is not an option.
The following are five basic options for affordable housing owners to consider as time runs out:
1. Do nothing and absorb a major reduction in rent revenues – Without the LIHTC (which can be securitized and backed by investors), it is hard to bridge the gap between affordable-rent revenues and market-rate costs. This path most likely leads to a bankruptcy within five years, and neither the owner nor tenants are protected.
2. Convert the property into a market-rate apartment complex – Aside from the harsh reality of having to remove the tenants from their homes (possibly by force), it’s not very cost-effective. Often, evictions are expensive legal battles that can take years, depending on a state’s stand on squatters’ rights. Also, once the building is cleared out, it has to be brought to market with a hefty sales push and possibly renovated (or torn down and rebuilt from scratch) to make it competitive. It could be five years before this option breaks even.
3. Sell the asset to a market-rate developer – Liquidating a long-term LIHTC portfolio is a very popular option, and in a hot market there might be aggressive buyers who take on the short-term costs detailed above. Some might want to test this option to accurately gauge the value, but it is important to consider the human toll that is at stake. After presiding over a multifamily or senior community for so long, it’s hard to simply kick the tenants out. It’s also not the only economic choice.
4. Rehabilitate the community – An attractive venture for owners, investors and residents, alike, affordable rehabilitation has emerged as a mainstream construction niche in recent years. Since new construction investments (as a rehab or ground-up project) can be matched by freshly minted LIHTC, this option checks all the boxes for developers who don’t want to evict tenants – provided that they know what they’re doing on the construction and government relations fronts. It is also more environmentally sustainable than going the tear-down route.
5. Sell the community to an affordable housing rehabilitation specialist – A renovation will have its challenges – the hardest of which can be figuring out how to remodel kitchens and bathrooms without having to put tenants in a hotel. There is also a daunting amount of bureaucracy to navigate. The three agencies that award LIHTC (the departments of Housing and Urban Development, Agriculture and Veterans Affairs) only award them to the most deserving projects, and investors need to be courted in order to share the risk if the project fails. These are some of the main reasons why it could be best to bring in an experienced affordable housing rehabilitation specialist who knows how to manage the construction and the financing. With LIHTC and additional funds from local and state agencies that support everything from clean energy upgrades and job creation to education programs and the arts, a good specialist should be able to offer a competitive price.
The path one chooses might be dictated by the property, itself. Not all affordable housing communities are the same, and some are just not the right fit for even the most aggressive rehabber. For instance, if a property has a generally high HUD score but there is damage lurking on the inside, such as a pest infestation or mold, those problems could disqualify the building from being investible. A lower HUD score could make it doable, since the necessary remediation costs could be priced into the deal, but the unseen dangers with high scores make it riskier.
Not all problems are insurmountable. Complex engineering challenges, such as failing retaining walls and noncompliance with natural disaster safety codes, are not necessarily deal-breakers. A good rehabilitation specialist can build a construction team with experts in seismic retrofitting, flood remediation and levee engineering.
Crime is another wild card to consider. If a community is in a well-known high-crime area, it could be ripe for a mission-based rehabilitation specialist who sees it as an opportunity to turn around the neighborhood. There could be public safety partnerships and funding opportunities available for the endeavor, which would make the economic equation more realistic and complementary to a quality renovation that is heavy on security-related amenities, such as lighting, gates, cameras and smart landscaping that opens lines of sight.
Of course, a buyer can only plan for these solutions if the problems are known ahead of time. Affordable housing sellers should be open and honest about their properties if they think rehabilitation is right for them.
Anand Kannan is responsible for leading the preservation and development teams at Community Preservation Partners LLC, which owns more than 7,500 units across the United States, under a variety of transaction structures. He can be reached at akannan@cpp-housing.com. For more information, visit www.cpp-housing.com.
