At first glance, the U.S. Department of Housing and Urban Development (HUD) Section 108 loan guarantee program looks like a perfect fit for the opportunity zones (OZ) incentive. In practice, the two aren’t often paired.

Numerous Section 108 projects are located in OZs. Since the OZ incentive launched in 2018, there have been information sessions detailing how to combine Section 108 and OZs, but not a lot of twinning in financial stacks.

It should work and the key reason is eligibility areas. Community Development Block Grant (CDBG) entitlement communities and states which disburse the CDBG funds to smaller units of government are eligible for the Section 108 loan guarantees. Because OZs are generally low-income communities, there is a significant overlap between OZs and areas that are eligible for CDBG funding.

How Section 108 Works

The HUD Section 108 loan guarantee program allows recipients to receive low-interest loans and is available on a rolling basis. The program uses the framework of the CDBG program and guarantees loans between the private sector and a state or local government that receives the CDBG funds. Government agencies can then relend the funds to a third-party business or developer or use the money on the development directly or through a sub-recipient partner.

The key is that Section 8 functions as a CDBG multiplier: CDBG recipient entities can borrow up to five times their annual CDBG allocation.

Entities can use Section 108 loans to acquire real property; rehabilitate publicly owned real property; conduct CDBG-eligible housing rehabilitation; build, reconstruct or install public facilities; and do related relocation, clearance and site improvement.

Subrecipient entities–such as public housing authorities, economic development organizations, community development corporations and nonprofits–may receive Section 108 funds. Section 108 borrowers may also pass through Section 108 financing to for-profit developers of OZ properties.

How Section 108, OZs Fit

Section 108 is presumably attractive as a leverage source for OZ projects because it can fill funding gaps and has streamlined reporting requirements. Most OZs meet the requirements under the presumptive benefit regulations, allowing access to the funds based on a presumption that the investments benefit eligible residents.

However, John Sciarretti, a partner at Novogradac and head of the Novogradac Opportunity Zones Working Group, said the requirements for a Section 108 loan aren’t always met by OZ projects. For instance, housing requires at least 51% of the benefit to go to low- or moderate-income households.

“You have to have a significant amount of affordability,” said Sciarretti.

Over the five years of the OZ incentive, most residential development has been market-rate housing with less than the required affordability ratio, which automatically reduces the number of properties that could qualify for Section 108 funds.

Challenges, Opportunities

Some OZ developers likely opt out due to possible complication from federal requirements, as well as the need for a government entity to get the loan and reloan to the project. When funds become co-mingled, they become subject to federal requirements, which can lengthen and complicate the development.

But the Section 108 program–which also pairs well with the new markets tax credit incentive–is particularly handy for specific types of developments, such as mixed-use properties involving affordable housing or projects that require public infrastructure to be upgraded.

Sciarretti said increasing interest rates may make a Section 108 loan more attractive. He also said rural properties might be more likely to pursue Section 108 loans.

“The scale is smaller and the financing is tighter in the rural marketplace,” Sciarretti said. “That might make it more attractive.”

Clock is Ticking

A major issue for combining Section 108 and OZ financing is that the OZ incentive has a deadline of Dec. 31, 2026, for investments to qualify for benefits (barring new legislation to extend the incentive).

However, developers can check with local community development leaders. Since Section 108 applications are accepted on a rolling basis and the program is noncompetitive, it may be a good fit for the structure of an OZ development.