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California Institutes LIHTC Rent Increase Cap

Published by Thomas Stagg on Monday, April 15, 2024 - 1:23PM

California affordable housing properties financed by low-income housing tax credit (LIHTC) equity have a new ceiling for rent increases after the California Tax Credit Allocation Committee (CTCAC) approved new regulations.

At its April 3 meeting, CTCAC approved updated regulations that include a general cap on rent increases on a household basis. The CTCAC cap is different than the new ceiling instituted by the U.S. Department of Housing and Urban Development (HUD), as it applies at the tenant level and has a different calculation.

How are the Limits Calculated?

The maximum increase in rent in a 12-month period for a LIHTC household in California is now the lesser of:

  • 5% plus the percentage increase in cost of living, or
  • 10% of the lowest rental rate charged for that household during the previous 12 months.

The new regulation does not apply to the initial rent charged on vacant units. The initial rent for vacant units is still subject to the standard LIHTC limits, but once a household moves into a unit, the rent increases for that household cannot exceed the limits outlined above.

The cost-of-living adjustment (COLA) is determined in accordance with CA Civil Code Section 1947.12. The COLA to be used is the Consumer Price Index for All Urban Consumers (CPI-U) for the metropolitan area as published by the United States Bureau of Labor Statistics in April for the applicable geography. It’s assumed that CTCAC will annually provide the CPI-U to use for each area, however, it is important to note that both CA Civil Code Section 1947.12 and United States Bureau of Labor Statistics define metropolitan areas differently than the areas for which HUD publishes income limits. For example, San Francisco and Oakland are in two different areas for HUD income limits and have very different LIHTC income and rent limits. However, they are both in the same metropolitan area (San Francisco-Oakland-Hayward metropolitan area) for determining the CPI-U for the CTCAC rent cap.

CTCAC will need to address the timing of the implementation of the rent cap on an annual basis. As mentioned above, the COLA is based on the CPI-U as of April of each year. However, COLA is not effective until August. Therefore, the COLA increases work on a fiscal year from August to August, which does not match well with the HUD income limit release cycle of April 1 each year. If you are increasing a tenants rent June 1, 2025, the maximum increase would be based on the COLA from April 2024, plus 5%. If you are increasing a tenants rent Aug. 1, 2025, the max increase would be based on the CPI-U from April 2025.

Owners will need to pay close attention to the change in CPI-U released in April to determine the cap for increases after August of that year. Owners also need to pay closer attention to the timing of rent increases to avoid running afoul of the rules.

Under the new regulations, the max increase for Los Angeles this year would be 8.8%. If you had a tenant living in a two-bedroom home paying $1,000, you would be able to increase their rent to $1,088, as long as the $1,088 is less than the LIHTC limit. If you increased rent June 1, 2024, you would not be able to increase their rents again until June 1, 2025. As a reminder, the limit is based on the actual rent charged to the tenant: If the neighboring household in a two-bedroom home was paying $1,500, you would be able to raise their rent by $132 to $1,632, assuming $1,632 is less than the applicable LIHTC rent limit.

The following is the current rent increase cap (effective from Aug.1, 2023-July 31, 2024) for the selected areas in California is as follows:

Blog Graphic: Current Rent Increase Cap for Selected Areas

Exceptions

The new regulations allow the executive director of CTCAC to grant a waiver if the property owner can show that a rent increase beyond the allowable amount is necessary to ensure the financial stability or integrity of the property. 

The process and criteria for receiving a waiver have not been established. In the April 3 meeting, the committee requested that CTCAC staff establish a more formal waiver request process and that until the formal process and criteria have been established, the executive director provide monthly reports to the committee regarding any waivers granted. 
There are also three exceptions under which a property owner can exceed the limit without a waiver:

  • If the increase allows rent to reach 30% of the monthly income of the household occupying the apartment;
  • If the property has terminated project-based rental assistance or operating subsidy through no fault of the owner (as described in Section 10337(a)(3)(B)); or
  • If a household transfers to another home on the same property with a different bedroom count or higher area median income designation as required by a regulatory agreement or deed restriction, due to a change from the household’s initial income or occupancy.

The exceptions are designed to allow LIHTC developments to be able to use federal subsidies such as Section 8 and allow households to transfer. However, there are still many questions as to how these exceptions will work and what sort of documentation will be required.

To Whom Does it Apply?

The regulations apply to properties financed by equity from 9% LIHTCs or 4% LIHTCs paired with tax-exempt private activity bonds that receive an allocation of LIHTC after April 3, 2024. In addition, it applies to all ownership or tax credit transfers requested after April 3, 2024. CTCAC will not approve a transfer of ownership unless the owner can certify that in the five calendar years before the transfer day, but not earlier than April 3, 2024, they complied with the rent increase rules. Therefore, even if the new regulations do not apply to your development, if you are planning to transfer ownership in the next five years, you would need to start applying the regulations immediately.

As part of the regulatory comment process, CTCAC clarified that the exit of the limited partner at Year 15 generally would not be considered a transfer event that would trigger the new rent control provision.

Impact

It is too early to know the full impact of this rule but below are some potential effects to consider:

Compliance Monitoring

Many commentators were concerned about the additional burden this will place on properties from a compliance standpoint. Compliance software will need to be updated to monitor rent increases at the tenant level. Owners will also need to pay close attention to the Aug. 1 date when the new limit increase becomes effective, particularly when the limit goes down, to make sure they are using the correct limitations.

There are also lots of questions about how the rent cap will work in practice with LIHTC properties, such as:

  • How are changes in utility allowances included in the calculation?
  • How is rental assistance factored into the calculation?
  • Is all rental assistance treated the same, or is only specific rental assistance excluded from gross rent under IRC Section 42(g)(2)?

Owner Transfers

There was also concern that this may make it more difficult to transfer properties after Year 15. Potential buyers will need to add modeling for anticipated CPI-U changes into their rent growth assumptions. Potential buyers will also need to pay close attention to actual tenant rent, as they may not be able to assume all units can be taken to the max LIHTC limit. They will also need to consider unit turnover assumptions more closely in cases where the spread between the max LIHTC rent and rent charged to a tenant is less than the limit on increases for the year. 

Sellers may find it more difficult to sell their developments, or they may choose to let the extended-use period expire to avoid having to comply with the additional regulatory requirements of transfers.

Tenants

Tenants obviously will see the most benefit from this rule. However, there is concern that this provision will have an unintended consequence of causing owners to set rents at the max each year. Since owners will have to worry about the cap being lower than the LIHTC limit in any given year, owners may be less likely to phase in large increases. For example, if the increase is 10% for a specific year, owners may feel compelled to increase tenant rents the full 10% since they do not know what the cap will be in future years and if the increase is not used in a given year, it is not carried forward.

2024 Case Study

The cap for Aug. 1, 2023, to July 31, 2024, is 8.8% for Los Angeles. However, the 2024 income limits released April 1, 2024, for Los Angeles increased by 10%. Developments that are subject to the regulations would have to comply with the lower 8.8% increase for Los Angeles. This will lead to lower rent for existing tenants, but also lower revenue for owners in a period where increasing costs, especially insurance rates, are making it more difficult for a development to cover their expenses. For vacant units, an owner would still be able to charge the LIHTC max.

Conclusion

The good news is that the regulations do not impact existing developments, unless there is a transfer event, so the industry will have some time to adjust to the rules as new developments that receive a tax credit allocation after April 3, 2024, begin to be placed in service. However, for acquisition-rehabilitation developments and owner transfers after April 3, 2024, the caps will be effective immediately. Owners should begin putting policies and procedures in place to help comply with this requirement. Novogradac can assist with establishing policies and procedures and in monitoring for the new requirements as well as compliance with CTCAC and IRS requirements.

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