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Four Reasons HUD’s Section 108 Program Works with Historic Tax Credits

Published by Teresa Garcia on Friday, September 2, 2022

Journal Cover September 2022   Download PDF

Since 1974, the U.S. Department of Housing and Urban Development’s (HUD’s) Section 108 Loan Guarantee program has offered flexible financing for local community and economic development activities. It’s a potent financing tool that can go hand-in-hand with tax credit investments, such as the historic rehabilitation tax credit (HTC).

How the Section 108 Program Works

Under Section 108, HUD guarantees the loan between the private sector and a state or local government that receives Community Development Block Grants (CDBG). The recipient can borrow up to five times the amount of its most recent annual CDBG grant allocation and pledges future CDBG allocations as security for the Section 108 loan.

Borrowers have two basic options for using Section 108 loan funds:

  1. Re-lend the funds to a third-party business or developer, or
  2. Expend funds on the development directly or through a sub-recipient partner.

Eligible activities under Section 108 include:

  • Acquisition of real property,
  • Rehabilitation of publicly owned real property,
  • CDBG-eligible housing rehabilitation,
  • Construction, reconstruction or installation of public facilities, and
  • Related relocation, clearance and site improvements.

How Section 108 Complements the HTC

HUD sources shared with the Novogradac Journal of Tax Credits four reasons why the Section 108 program works so well with HTCs.

1. Flexibility on collateral. The Section 108 program allows for various types of collateral, including real estate, cash, equity, letters of credit, corporate and personal guarantees, machinery and equipment, accounts receivable and pledges, since communities pledge their CDBG funds as primary security. As a result, it enables borrowers to explore a range of collateral security options, particularly for third-party loans.

2. Davis-Bacon Act requirements. Davis-Bacon Act and Related Acts Regulations require paying laborers local prevailing wages for work on public works or public buildings with federally funded or assisted contracts. Both Section 108 and HTC developments are subject to Davis-Bacon rules, so there is no additional wage-related burden when combining Section 108 with HTC.

3. Flexibility to structure debt service payment schedule. The maximum repayment period for Section 108 is 20 years, but borrowers can request interest-only payments for the first few years, pending HUD approval. This flexibility can be especially beneficial to some HTC developments with longer construction timelines and ones that will likely take a few years before revenue stabilizes, such as hotels and affordable housing developments.

4. Complementary objectives. For economic development projects, the purpose of Section 108 is to provide a public benefit by financing economic revitalization that benefits local communities. In this way, its purpose complements the public benefits achieved by the HTC. Both programs encourage community investment, often benefiting low-income people and communities by driving capital into underinvested areas and creating local jobs.

Case Study: 21c Museum Hotel in Lexington, Kentucky

The First National Bank Building in Lexington, Kentucky, was built in 1913 by renowned New York-based architectural firm McKim, Mead & White. At 16 stories high, the building has been a landmark in downtown Lexington for decades. However, the building became largely vacant in recent years until a Section 108 loan helped finance its adaptive reuse into the 21c Museum Hotel Lexington in 2016. The boutique hotel has 7,000 square feet of exhibition and event space, a contemporary art museum, a restaurant and 88 guest rooms. One of the hotel’s most popular guest rooms is the Harmon Room, a mid-century-styled room named after fictional chess prodigy Beth Harmon from the TV series “The Queen’s Gambit,” which is partly set in Lexington. 

The hotel redevelopment was financed using federal HTCs, new markets tax credit financing and a $6 million Section 108 loan, which marked the city of Lexington’s first participation in the Section 108 program. “From our perspective, the interest was in taking a historic building in our community that’s considered to be the city’s first skyscraper and turn it into a high-end hotel, creating 150 jobs in our downtown core,” said Charlie Lanter, Lexington’s commissioner for housing advocacy and community development.

The hotel closed briefly in 2020 due to the pandemic but was able to reopen.

“[HUD] offered a refinancing option and we were able to work with them to push out the principal payments for several years, pay interest only and not default on the debt,” said Lanter. “The way the 108 loan works is they’re borrowing against our CDBG allocations. The city receives $2 million of CDBG a year. If the project were to default on the $6 million, HUD would recoup by not giving us CDBG until it’s paid. As I understand it, no Section 108 loan has ever defaulted, so we never had a concern that was going to be an issue.”

Conclusion

Section 108 is a flexible, low-cost financing source that can help incentivize community and economic development. When asked what other municipalities should know about the Section 108 program, Lanter said not to be afraid of it. “It can be a little intimidating if you’ve never done it,” said Lanter. “It sounds scary when you talk about borrowing against your own CDBG allocation, but it’s a safe move and you can create opportunity in your community.”

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