How to Unleash Underutilized Private Activity Bonds to Build More Affordable Rental Housing

Published by Michael Novogradac on Monday, September 12, 2016 - 12:00am

In 2015, 13 states didn’t allocate any private activity tax-exempt bond (PAB) cap to affordable rental housing, according to the Council of Development Finance Agencies (CDFA). Meanwhile, also in 2015 $65 billion in available PAB cap went unused, $54.5 billion of which was carried forward to 2016. And from about 30 states according to the CDFA, an aggregate $10.5 billion could not be carried forward and was abandoned last year. A rough estimate indicates this lost resource just in one year could have made possible 80,000 more affordable apartments. At a time when affordable housing needs throughout the United States are so great, now is the time to review how to unleash this bond cap so more affordable rental housing can be built.


Blog Graph 2015 Abandoned PAB Volume Cap
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Program Basics

Like the broader category of municipal bonds, interest income from PABs is generally exempt from federal and often state income tax. Historically, this income tax exclusion allowed housing bond issuing agencies to sell bonds to investors at lower interest rates, which in turn led to housing bond-financed mortgages, both single family and multifamily, to be at a lower rate than comparable market-rate mortgages. However in recent years this has become less common, because of the low interest rate environment, the fallout from the mortgage crisis, and a variety of other factors.

For 2016, states are allocated the greater of $100 per capita or $302 million for multiple PAB-eligible purposes (known as the PAB volume cap). State bond agencies issue bonds themselves or allocate PAB cap to other bond issuing agencies. Bond issuing agencies have up to three years to use PAB cap before the cap authority expires. Eligible uses include transportation infrastructure, industrial development activities, student loans, and housing.

More specifically, one of the statutorily-eligible PAB purposes is building, acquiring and/or rehabilitating rental properties for households at or below 60 percent of area median income. The bonds may be used for short-term (e.g., for construction financing) or permanent loans. Upon meeting certain requirements, properties with PAB financing also generate 4 percent low-income housing tax credits (LIHTCs). In exchange for reduced tax liability, investors, often financial institutions, make equity investments in partnerships to partially fund acquisition, construction, and/or rehabilitation.

The good news for those in need of affordable housing is that in 2015 $6.6 billion of bond cap was used for the production and renovation of affordable rental housing. 

Historic Context

With interest rates at all-time lows, existing property cash flow can generally support more PAB debt financing. Similarly, the amount of equity investment per dollar of tax credit, or equity pricing, is higher than before the 2008-2009 recession. As such, investment equity generated from tax credits is at all-time highs. The combination of higher supportable bond debt and tax credit equity means less financing is needed from other sources and PAB deals are more feasible now than in recent memory.

This greater feasibility of PAB financed rental housing comes at a time when, by any measure, there is a tremendous need both for new affordable rental housing and rehabilitation of the existing stock. More than 11 million households pay more than half of their income toward rent, and there are only 31 affordable apartments for every 100 extremely low-income households. Many of the 1.5 million federally assisted, privately owned apartments are decades old and in need of repair, yet also are at risk of no longer being affordable. The 1.1 million units public housing also are aging and have tens of millions of dollars of unmet need for repairs.

Three Steps to More Affordable Rental Housing

The first step in unleashing PABs for affordable rental housing is simply for states to allocate more of their PABs to rental housing. The second step is to ensure no PAB authority is allowed to expire and to increase utilization so less bond cap is carried forward. The third step is to get more residential rental housing built per dollar of PAB bond cap.

Step One: Allocate More to Residential Rental Housing

In 2015 a total of 15 states reported not losing any PAB volume cap. At a minimum, these states should allocate more PABs for rental housing. Responding to the affordability crisis is the highest and best among the eligible uses. While the other purposes have merit, creating and rehabilitating apartments meets an essential need for low-income households. Second, rental housing is the only PAB activity which produces substantial additional federal resources, and as such, each dollar of PAB cap allocated to rental housing provides the most federal tax subsidy of all PAB-eligible activities. The 4 percent LIHTC is a unique benefit forgone by allocating PABs to any of the other activities. The value of the tax credit can double to quintuple the present value benefit of the precious PAB resource. 

At a minimum, recycled bonds should be used for other uses, so every state harvests the benefits of the tax credits for affordable rental housing in their state.

Step Two: Avoid Expiring PAB Cap and Increase Utilization

The second step in unleashing PABs for affordable rental housing is to ensure no PAB authority is allowed to expire and increase utilization so less bond cap is carried forward. The policies below could help increase the utilization of PABs. Some are within state housing agencies’ control; the rest depend on other state decision-makers.

  1. Change policy requirements. When applying for PAB financing, properties are often expected to meet objectives beyond federal requirements.  Asking properties to meet more expansive requirements is questionable when a resource is underutilized. Requirements such as deeper income targeting, provision of services, and added design features should only apply when there is competition for the bond resource.
  2. Make applications more efficient. Finding developable land and securing zoning is a challenge. Ideally the process of requesting PABs would not be an added impediment. States should take steps to lessen the application burden, such as enhanced coordination among other funding sources, having an open application cycle and quicker processing. 
  3. Provide additional gap subsidy. The level of financing necessary to fund project costs based on the amount of equity generated can result in debt service that is too high for the feasible rents. Other funding sources, such as HOME, Community Development Block Grant or Housing Trust Fund loans, equity from state LIHTCs and other support can help bridge the gap.
  4. Secure strategic local support. Like state agencies, many cities, counties and housing authorities can provide gap subsidies. These jurisdictions can also help reduce development costs by donating land, waiving impact/tap fees, expediting permits and allowing a favorable property tax treatment (depending on state law).
  5. Help with DDAs/QCTs. Properties in difficult development areas (DDAs) and qualified census tracts (QCTs) realize a 30 percent basis boost. Agencies could help developers find opportunities in these locations. If enacted, the Affordable Housing Credit Improvement Act of 2016 would allow state agencies to apply these additional credits to properties for reasons other than being located in a DDA or QCT.
  6. Educate developers. Often a limiting factor is lack of knowledge among developers about how the PAB and 4 percent LIHTC programs work.

These are among what are many proposals to increase utilization.

Step Three: Generate More Affordable Rental Housing per Volume Cap Dollar

Allocating agencies should seek to generate more rental housing from existing resources.  One way to do that sounds like an oxymoron: Limit the PAB bond award. Why would this work? To be eligible for the maximum amount of LIHTCs, a development needs to use PABs to finance at least half of its land and building costs. As such, if PAB bond volume is limited to 52 percent to 55 percent of these costs, then more bond cap will be available for other developments. Any additional amount of needed debt financing could be covered by taxable debt issued at the same time, known as a taxable tail.


Using the 4 percent LIHTC to finance the construction and preservation of existing affordable housing stock is a proven, effective way to use PAB allocations. While the housing affordability crisis among the most pressing public policy challenges we face, LIHTC funding is a proven way to not only increase the affordable housing stock, but to bring supplemental resources into play, providing even more benefit.

For more information, Novogradac offers a webinar and handbook on PABs. Also, our professionals are available to help