California Agencies Consider Changes to Cost Containment Policies

Published by Mark Shelburne on Tuesday, August 30, 2016 - 12:00am

California Tax Credit Allocation Committee (TCAC) and California Debt Limit Allocation Committee (CDLAC) Executive Directors Mark Stivers and Jeree Glasser-Hedrick issued an important joint memo dated August 15 proposing eight policies addressing the cost of low-income housing tax credit (LIHTC) developments. While directly pertinent to affordable rental housing in California, the proposals reflect what has been a national conversation.

Background

The topic of cost has received a great deal of attention in California. State leaders’ consideration dates back as far as 1993.

More recently, in the summer of 2011 TCAC, began a public discussion around the following “Problem and Goal Statement”:

Occasionally TCAC and other funding sources make awards to extremely costly projects. TCAC-awarded projects generally may be more costly than necessary, fostering the public perception that affordable housing is too expensive. Effective in 2012, TCAC reservations would go only to cost-reasonable projects, and outlier-cost projects would no longer be awarded by TCAC or other funders.

This public discussion led to changes in TCAC regulations to reflect the addition of new or changed policies.

In 2014 TCAC, CDLAC and two other state housing agencies issued a study of what factors influence the cost of building affordable rental housing in California. The primary conclusion was multiple factors are significant, with no one cause explaining all or even most of development budget line-items.

A more recent analysis of the cost of building affordable housing in California can be found in TCAC’s recap of 2015. The average overall cost per unit of all developments was $335,499, or 0.3 percent lower than 2014. Among new construction developments, the cost per unit was $390,315, which is 4.7 percent more than the previous year. As compared to 2011, costs were up 23.2 percent. (By contrast, the overall cumulative rate of inflation over the same time period was less than 6 percent.)

August 15 Memo

Earlier this year TCAC and CDLAC convened a “High-Cost Task Force” to consider the issues involved. The memo’s eight policy proposals, described below, are an outcome of the deliberations. The first two items are to be implemented by TCAC and CDLAC, while the rest would be included in draft regulations for 2017.

1. Omit costs not in basis from the sources and uses of tax-exempt bond (TEB) developments.

According to the memo, including the value of donated land or other waived costs artificially inflates the development budget. Since this information is not necessary to process TEB applications, there is no reason to include it in the sources or uses. The amounts are needed in applications for 9 percent LIHTCs because they are part of the tiebreaker.

2. Calculate developments’ lifetime rent benefit.

In addition to showing costs, future staff reports will include a calculation of the estimated lifetime rent benefit. Below is an example 188 unit project in Los Angeles County (prepared by Novogradac valuation professionals), with all units set at 60 percent area median income (AMI).

 

Blog Chart California Cost Study Chart 1
Click to Enlarge

 

Most LIHTC properties in California have some units at 30, 40 and 50 percent AMI levels, meaning the savings amount would be greater than the amounts estimated above. It is worth highlighting that these dollar estimates do not incorporate other benefits from the development of affordable rental housing, including job creation and neighborhood improvement.

3. Limit TEBs per-unit.

Under IRS Code Section 42, at least half of a development’s land and building costs must be financed by TEBs in order to be eligible for a 4 percent LIHTC allocation of 100% of a project’s qualified basis. In other words, if total land and building costs are $10,000,000, then the amount of bond financing has to equal or exceed $5,000,000 in order to receive tax credits for 100% of the project’s qualified basis.  Historically, tax-exempt bond proceeds finance substantially more than 50% of a project’s land and building costs.

CDLAC has proposed limiting TEB awards on a per-unit basis. The result of this proposal would be to effectively cap the amount a project could spend on land and building costs at no more than twice these limits. The proposed per-unit limits on TEB awards are listed below, alongside the implied budget limits on land and building costs.

 

Blog Chart California Cost Study Chart 2
Click to Enlarge

 

4. Use the developer fee as an incentive to minimize costs for 9 percent new construction developments.

This is the most complex of the policy proposals. The matrix below depicts how the proposal would affect a development with $15 million in costs.  First, TCAC would calculate a project’s high-cost percentage, which equals a project’s eligible basis divide by adjusted threshold basis limits.  As the high-cost percentage increases, the amount of developer fee that a developer can earn decreases, as does the amount of the developer fee that can be paid out in cash from development sources.

 

Blog Chart California Cost Study Chart 3
Click to Enlarge

 

TCAC says it is considering increased limits in high-opportunity areas, one idea is to provide the increase for a project in an area that meets all of the following criteria:

  • Within a city with a population of at least 50,000;
  • Within a county with a two bedroom threshold basis limit of $300,000 or more; and
  • Deemed to have the highest opportunity rating by UC Davis’ Regional Opportunity Index for Places.

Per TCAC, the proposal would not apply to rehabilitation applications so as to avoid incentives to reduce the acquisition price or scope of work, or to TEB financed developments since minimizing gaps provides an adequate incentive to limit uses.

5. Require committee approval for high-cost developments.

TCAC would no longer have the ability to approve applications with a high-cost percentage calculation greater than 130 percent. Developments in areas where construction is more expensive may be able to use a higher threshold basis.

6. Decrease the required minimum unit size.

TCAC regulations specify minimum unit sizes allowed for LIHTC units. TCAC is proposing to reduce these minimums and notes that reducing the total square feet needed to qualify will allow developers to construct smaller apartments using fewer building materials. The reduced sizes are below.

 

Blog Chart California Cost Study Chart 4
Click to Enlarge

 

7. Allow existing community space to be smaller than the minimum.

Some developments proposed for rehabilitation already have community areas. Under this proposal, TCAC would have the ability to waive the minimum size for such areas to allow a less expensive reconfiguration of an existing space.

8. Prohibit basis for the cost of parking over state standards.

The memo says a California statute enacted in 2015 supersedes local parking requirements for transit oriented, senior, and “special needs” developments. Therefore, TCAC is proposing to exclude the cost of parking in excess of these standards based on either the actual cost per space or an assumed amount (e.g., $10,000 each). Not allowing costs in excess of statewide standards to count as eligible basis would mean that developments would need to increase funding from other sources if they provide parking in excess of standard.

Next Steps

TCAC and CDLAC will carry out the first two items on their own. The remaining proposals will be in draft regulations issued later this year. As always, interested parties will have an opportunity to comment.

Outside of California, it’s worth noting that in 2017 the U.S. General Accountability Office will release the third of three reports on the LIHTC program. That third report will include an analysis of costs and will likely factor into ongoing conversations about how to control development costs.

Conclusion

The challenges of building and renovating affordable apartments can result in larger development budgets than some observers might expect. The reasons for this are many, including providing project amenities that are needed to serve special tenant populations, making project design choices to garner local support, and incorporating energy efficiency and green features. LIHTC professionals have a shared responsibility to be aware and consider the potential implications of both developments and policies.

Please contact a Novogradac professional with any questions.