‘Fixing’ the 4% LIHTC Rate Pays Significant Dividends

Published by Jim Campbell on Monday, October 4, 2021
Journal Cover Thumb October 2021

After years of advocacy, education and lobbying by the Affordable Housing Tax Credit Coalition and others in the affordable housing community, the Consolidated Appropriations Act of 2021 was signed into law Dec. 27, 2020, effectively “fixing” the 4% low-income housing tax credit (LIHTC).

This change, which established a floor for the Internal Revenue Code Section 42 tax credit applicable for eligible acquisition costs or for eligible costs financed through a tax-exempt bond structure, resulted in a number of benefits to the industry and some negative consequences. Not least among the benefits is no longer having to explain to those not steeped in the arcane details of LIHTC why a 4% credit was not in fact a 4% credit.

For those so steeped and otherwise active in the business of developing affordable housing using LIHTCs, the other primary benefit is the substantial increase in credits, and hence equity, represented by the value of the credit going from 3.07% (where it was shortly before the fix was enacted) to 4.00%–a 30% increase. While there are some offsetting effects from the introduction of the 4% fix into the LIHTC markets (which will be discussed below), the bottom line is a significant net gain on the sources side of a development’s sources and uses.

That gain can be substantial enough to move a number of prospective housing developments nationwide from infeasible–without substantial “gap” subsidy–to feasible. In high-cost jurisdictions that have significant resources dedicated to providing soft funding to fill financing gaps, such as Washington, D.C., this increase on a particular deal may be enough to eliminate the need for local gap funding or at least greatly reduce the amount of local gap subsidy dollars required. For every dollar added to LIHTC equity resulting from the 4% floor, a dollar is freed up from local sources for additional affordable housing. In other jurisdictions, where local gap funding sources are not so bountiful, the added source generated by the 4% floor can tip the balance between creating more feasible affordable housing developments. In many cases, developments which previously only worked with highly competitive 9% credits (often the only deep subsidy available), now work with just tax-exempt bonds and 4% credits.

To be competitive in the competition for 9% credits, developers are often put in the position of having to play pretzel-maker–manipulating their program, unit mix, income targeting, target demographic and even location–to score points under the qualified allocation plan- (QAP-)driven competition. “Point mining,” rather than thoughtful development planning and design, dictates the process. To succeed in the competition for 9% LIHTCs, developers often have to skew the income targeting of their development to extremely low-income residents. Certainly, a worthy goal, but not always consistent with the income level of existing residents when the goal is preservation of existing affordable housing, nor consistent with the goal of achieving true mixed-income community. The 4% floor will allow many proposed developments to avoid this dilemma.

In Baltimore, which has limited resources available for gap funding, the new construction of approximately 115 units of mixed-income affordable housing–a key component of a comprehensive neighborhood revitalization plan–can now be made financially feasible with a tax-exempt bond/4% LIHTC structure. Assuming state subsidy generally available with a bond transaction and limited additional city subsidy with our nonprofit partner, it appears that we will be able to move forward without having to go through this competitive 9% LIHTC process. Since 9% competitive rounds in Maryland are annual and it can often take a proposal two, three or more rounds to succeed, an added benefit of the 4% fix is timing. This important community development can happen now–when the housing is needed–rather than two, three or four years down the road.

In Washington, D.C., we are working on an 83-unit preservation/substantial rehab development. Unfortunately, this type of development does not score well in the selection criteria for local gap subsidy dollars. Until the 4% floor was put in place, the opportunity to preserve and renovate these units did not have a strong likelihood of success. With actual 4% credits, enough additional tax credit equity will be generated to enable the redevelopment to proceed with tax-exempt bonds and no new additional gap subsidy by the District of Columbia.

As the development community reassesses properties in its pipeline, as well as explores new development opportunities, state housing finance agencies have seen the volume of straightforward tax-exempt bond and 4% LIHTC deals increase significantly. This has put pressure on state bond allocation caps. According to Tiber Hudson LLC, the largest nationwide counsel for state housing finance agencies related to tax-exempt bond transactions, almost one-half of all states are now oversubscribed or at parity with their bond cap. And the trend seems to be continuing. To deal with this volume pressure, some states have implemented competitive application rounds for tax-exempt bonds with 4% credits and other states are now considering doing so. Also, a number of states are taking advantage of historically low taxable bond rates to structure financing with a hybrid of tax-exempt and taxable bonds; of course, limited by the requirement that at least 50% of eligible costs be covered by the tax-exempt financing. To take pressure off the bond allocation, the Affordable Housing Tax Credit Coalition, state agencies and others are advocating in Congress for an increase in the tax-exempt bond allocation and a reduction in the 50% test to 25%.

The increased volume of transactions using 4% LIHTCs has also influenced the tax credit equity market. When push comes to shove, the LIHTC market is about supply and demand. If the supply of available credits goes up, the demand for those credits from the investor community must go up as well; or there will be an adjustment in pricing and other business terms of the investment. With the 4% floor, it seems that the supply of available credits has gone up more significantly than investor demand, resulting in a slight reduction in equity pricing for 4% deals. The amount of decrease seems to range from $.01 to $.05, influenced by numerous factors. One factor which helps mitigate the price reduction is that developments using 4% LIHTCs are often now better capitalized, with somewhat reduced leverage, making them slightly more attractive equity investments. This reduction in pricing could be addressed by steps to increase demand, such as proposed increases in corporate tax rates, strengthening Community Reinvestment Act requirements and increasing the participation of Fannie Mae and Freddie Mac in the market as the Federal Housing Finance Agency called for Sept. 1. In any case, the modest reduction in pricing resulting from the 4% floor is clearly offset by the increase in credits, to the strong advantage of each affordable housing development using 4% bonds.

Everyone in the affordable housing community working to increase housing opportunities for low- and moderate-income people knows how desperate the need is. Establishing the 4% floor for LIHTC equity with tax-exempt bond financing has proven to be an important and vital tool for increasing the supply of decent, safe and affordable housing throughout the county.

Jim Campbell is a co-founding principal of Somerset Development. He leads the company in identifying, analyzing and packaging the financing of Somerset’s real estate development portfolio.