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New HUD Rules Facilitate Tax Credit Deals

Published by Jennifer Hill on Friday, October 1, 2010

Journal cover October 2010   Download PDF

The U.S. Department of Housing and Urban Development (HUD) issued a final rule in August prohibiting required escrowing of tax credit equity and announcing other changes to reduce burdens on tax credit transactions. Previously, the Federal Housing Administration’s (FHA’s) multifamily mortgage insurance regulations required a substantial portion of the tax credit sales proceeds to be placed in escrow at the time of initial endorsement to assure project completion. Recognizing that this practice inhibited the construction of low-income housing tax credit (LIHTC) properties with FHA-insured mortgages, policymakers included a provision in the Housing and Economic Recovery Act of 2008 (HERA) that barred HUD from continuing to require equity escrowing.

Commenting on the former requirement to escrow tax credit equity, Susan Wilson, a Novogradac & Company partner who specializes in HUD auditing procedures, said: “It was lowering investors’ yields, so they were lowering the price they would pay for tax credits.” FHA-insured mortgages are one of the only attractive lending avenues currently open to LIHTC developers, she added, and she expects syndicators to increase their investments now that upfront escrowing is no longer mandatory.

The requirement had also resulted in increased costs and complex financing structures because in many cases it forced developers to take out bridge loans until the escrowed proceeds were released so that investors’ yields would not be adversely affected. Without a bridge loan, an investor would have had to place the entire equity amount in escrow upfront instead of paying equity in installments, thus reducing the investor’s yield after taking into account the time value of money. HUD acknowledged this consequence when it published the final rule, which the agency said would relieve mortgagors of the need to take out costly bridge loans and allow them to retain more of their tax credit proceeds.

In conformance with Title VIII of HERA and HUD’s final rule, HUD may no longer require tax credit sales proceeds to be placed in escrow to ensure that a project is completed, nor can it require payment from escrow of the initial service charge, carrying charges, or legal and organizational expenses incident to the project’s construction. Instead, the mortgagor can deposit 20 percent of the LIHTC equity with the FHA or another amount the Federal Housing Commissioner deems to be sufficient, which when combined with the mortgage proceeds covers those costs. However, the rule does not prevent HUD from requiring escrowing for other purposes, such as for working capital.

The rule applies to sales of historic and new markets tax credits (NMTCs) as well as LIHTCs. Proceeds from tax credits or funds provided by a grant or loan from a government agency will, with the commissioner’s approval, no longer have to be fully disbursed before mortgage proceeds can be realized.

 “HUD’s getting more in tune with how tax credits operate and they’re doing everything they can to entice developers in that industry,” Wilson said, citing further conditions that HERA placed on FHA loans, including the removal of required subsidy layering and mortgagor cost certifications for LIHTC projects. HUD implemented those changes in July of 2009.

Further details about the elimination of HUD’s tax credit equity escrow requirement can be found in the August 23 Federal Register notice at, under “other guidance” in the LIHTC menu.

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