View the LIHTC Matrix Graphic

Bankers have learned the hard way that financing Affordable Housing (AH) projects is fraught with perils.

Most perils stem from the fact that income restrictions are imposed and enforced with deed restrictions or land use restriction agreements.  These constitute permanent clouds on the title that cannot be modified or removed through foreclosure.  Consequently, traditional loan structures, loss mitigation measures and workout / liquidation strategies won't work with these properties.

The AH finance serpent has two heads:  homeownership and rental housing.

Homeownership:

There are three (3) components to financing single-family home ownership:

1)    land acquisition and subdivision infrastructure development (A&D);

2)    interim construction for individual single-family dwellings (IC); and

3)    term loans for the homebuyers.

A&D Loan

Banks typically structure A&D loans so that the loan is retired (paid off) when between 10% and 25% of finished lots are left in inventory.  In an AH project, the equation has to be altered because the AH lots may never be absorbed (sold).

In a single-family home subdivision, there is only one way to accommodate the AH buyers.  That is to create a significant and substantial price differentiation between the AH buyers and traditional buyers.  If traditional sales do not occur at a sufficient pace, the developer cannot generate sufficient profit to accommodate the AH restrictions imposed on AH sales.

Developers are necessarily transaction-oriented, meaning that every project they engage has to stand on its own and produce a profit, based on their projections.  Bankers have the same attitude.

The municipalities imposing AH restrictions are not concerned with unit cost or absorption timing (how fast they sell).  They are concerned only with the developer delivering product to the targeted income group.

What happens is that the developer must increase prices to traditional buyers in order to cover the city-mandated AH buyers.  This creates an interesting dichotomy within the prospective customer base.  The traditional buyers wonder why they are being asked to buy part of their neighbor's house.  The AH buyers celebrate because their neighbors are forced to buy part of their house for them.  Municipalities sometimes make the situation worse by mandating that the AH homes be scattered throughout the subdivision, look alike, have similar square footage, similar construction and similar amenities to other homes in the neighborhood.  This is done so as not to "stigmatize" the AH buyers.

IC Loan

These loans are typically structured as revolving lines of credit, with restrictions on the number of speculative or model homes that will be financed.

I have banked for several homebuilders with either captive or at-large sales staff over the past 30 years.  I am told that one must develop 7 prospects to get 1 buyer to closing in a traditional sale.  The prospect-to-buyer ratio for AH sales can reach 30 to 1.  Many do not qualify for the loan.  

AH buyers are difficult to find, process and finance.  Unfortunately, the result in the AH subdivisions is that you wind up with a checkerboard pattern of bypassed lots, which do not enhance the subdivision, other homeowners' property values or the community at large.

Difficulties also arise in the appraisal and valuation processes.  Imagine you are an appraiser doing your market research in connection with an assignment from a federally-insured and regulated financial institution.  You see two sales on the same street, maybe even next door to each other, basically identical.  One home sold for 50% to 70% of the one you are asked to appraise.  What do you do?  What do you do if you are the county tax assessor?

Rental Housing:

AH rental housing projects cannot typically be financed with conventional bank loans because the tenant income limits and rent level restrictions will not generate positive cash flow.

Enter the Low Income Housing Tax Credit ("LIHTC").  The LIHTC was designed to replace the HUD project-based housing program, which was a massive failure.  Part of the 1986 tax reform act, the LIHTC allows developers to receive a 10-year federal income tax credit amounting to either 4% or 9% per year of the depreciable cost basis in what would appear to be an apartment complex.  These are actually social programs with housing and mixed-use components.

The tax credits can be sold for cash in order to provide equity to make the projects appear feasible at inception.  Both versions of the LIHTC apply only to projects with varying degrees of tenant income and rent restrictions.  The 4% credit attaches automatically to any project receiving tax-exempt funding.  The 9% credit is allocated by state housing finance agencies annually on a competitive basis in amounts based on state population. This is the type of tax credit which has been allocated to the developer of the Hotel Clovis. 

Both types require a bank to enable the projects to move forward because the equity generated by the sale of the credits does not come into the project at inception.  It is injected incrementally, based on certain milestones being achieved.

This is critical.  Banks who view this as a typical commercial real estate construction and term loan receive a rude awakening.  These are not real estate transactions, this is structured finance.  The developer, its principal(s), the tax credit investor, the general contractor and the social service providers all have to be researched, examined for creditworthiness and structurally tied into the deal.

The safest way for a bank to get involved in these transactions is to be both the buyer of the tax credits and the structured finance provider.  In the current economic environment, most banks and a large part of corporate America do not need tax credits because they are not profitable or do not anticipate any federal income tax liability.

These projects generally fail due to curtailed or inadequate equity injections at one of three (3) points:

1)    failure to complete construction and put the project into service;

2)    failure to attain sustained occupancy level (normally defined by the industry as 90% occupancy for 90 days); or

3)    the annual tax credit stops after 10 years, but the developer has committed to a much longer period (typically 40 years) of tenant income and rent restrictions.

Bankers or municipalities still sitting at the table when these events occur had best take a deep seat and be prepared to get out the checkbook.  There is no way out.  All that has to be done to verify this is to initiate an internet search on "affordable housing lawsuits".  I did and found 1,680,000 references in 0.31 seconds.

The only comfort is in knowing that the unfortunate investor in the associated tax credits will be much worse off.  That investor will eventually get a letter from the IRS seeking reimbursement of all previous tax credits taken, together with interest and penalties. Bankers or municipalities considering engaging in financing these projects must enter into these transactions well-informed and, well-advised or be ready to walk away.