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Washington Wire: Common-Sense Suggestions to Increase PAB Cap Use for Affordable Housing

Published by Michael J. Novogradac on Tuesday, November 1, 2016

Journal cover November 2016   Download PDF

In a time of dramatic need for affordable rental housing–studies indicate there are just 31 affordable apartments available for every 100 extremely low-income households and more than 11 million households pay more than 50 percent of their gross income on rent in the United States–$65 billion in available private-activity tax-exempt bond (PAB) cap wasn’t used in 2015.

Those funds, which could have been used to finance the construction or renovation of hundreds of thousands of affordable residential rental properties, stayed on the sidelines. Making it worse is that only $54.5 billion was carried forward to this year. The $10.5 billion that was abandoned because it was not used within three years is estimated to be enough to build or renovate 80,000 affordable apartments.

The use of PABs varies widely–in 2015 according to the Council of Development Finance Agencies (CDFA), 13 states didn’t issue any of their PAB cap to affordable rental housing, while 15 used enough to retain their entire cap. Both ends of that spectrum need help.

PAB Basics

Congress allows PABs to finance certain activities that serve a government purpose, even if those activities provide a private benefit–including the construction, acquisition or rehabilitation of rental properties for households at or below 60 percent of the area median income (AMI). Upon meeting certain requirements, properties with PAB financing can generate 4 percent low-income housing tax credits (LIHTCs).

Interest income from PABs is generally exempt from both federal and state income tax, which has historically allowed housing bond issuing agencies to sell bonds at lower interest rates for bond-financed mortgages than what is traditionally available for market-rate mortgages (although historically low interest rates during recent years made that less common).

There is plenty of PAB authority available: for 2016, states were allocated the greater of $100 per capita or $302 million for multiple PAB-eligible purposes. A year earlier according to CDFA, $6.6 billion of bond cap was used for affordable rental housing–meaning less than 10 percent of available PAB funds were used.
What can be done to boost use of PABs? There are several areas in which changes should be considered to maximize the benefits of PABs, starting at the top.

Federal Legislative Changes

PABs finance development in local communities, but use is governed by federal law. Some changes to increase PAB use would require federal legislation:
Institute a permanent floor for 4 percent LIHTCs. This is on the front burner for most affordable housing advocates, especially after Congress did the same for 9 percent LIHTCs last year. Making 4 percent LIHTC (and PAB) financing more attractive would lead to an increase in bond use. The good news is that there is bipartisan legislation, the Affordable Housing Credit Improvement Act (S. 2962 and S. 3237) sponsored by Sens. Maria Cantwell, D-Wash., and Orrin Hatch, R-Utah, now before Congress to do this.

  • Extend state discretionary basis boost to bonds. Since July 30, 2008, state housing credit agencies can designate specific 9 percent LIHTC properties that are not in difficult development areas (DDAs) and qualified census tracts (QCTs) to receive up to a 30 percent basis boost. The Cantwell-Hatch bill (S. 3237) has a provision to empower states to extend that potential basis boost to bond transactions to make more bond-financed developments financially feasible.
  • Exclude qualified PABs from the corporate and individual alternative minimum tax (AMT). PABs are already excluded from regular federal income tax, but excluding them from the AMT–which comes into play for nearly every potential investor in PABs–would make investment in the bonds more attractive.
  • Extend HERA 9 percent LIHTC rural income limit flexibility to 4 percent LIHTC deals. The Housing and Economic Recovery Act of 2008 allowed 9 percent LIHTC property owners to use the greater of the national nonmetro or area median income (AMI) when determining rents and income limits, which made them more financially feasible. Extending that to 4 percent LIHTC transactions would make bond developments in rural areas more financially feasible.
  • Change the tax code so that more types of facilities are exempt from the PAB volume cap. Such things as airports, docks and qualified public educational facilities are exempt from the cap and increasing the list of cap-exempt facilities would allow states to allocate more of their PAB cap to residential rental housing. Better yet, legislators could exclude residential rental property from the cap–making PABs an uncapped resource.

Federal Regulatory Changes

While Congress must make some of the changes that could help, others are simply regulatory changes, such as:

  • Streamline USDA’s process. The USDA’s processing time and other requirements sometimes force tax credit allocators to repeatedly roll over allocations for purchase and preservation of USDA projects that are already in the pipeline.

Changes for States in Need

While most states left bond money on the table in 2015, 15 didn’t lose any PAB volume cap, according to CDFA. Those states–which would benefit from a higher PAB cap–could make changes beyond the previously mentioned federal legislative changes:

  • Use bonds exclusively for affordable rental housing until demand in a calendar year has been met. Affordable rental housing would get a boost if it was the first focus for PABs in those cap-using states. LIHTCs have leveraged an average of $51 million on each $100 million in bonds issued in recent years, a dramatically more efficient than other uses. And even more importantly, it addresses a compelling state need throughout the nation:  affordable rental housing.
  • Recycle the volume cap and use those bonds for other uses. Since PAB developments paired with 4 percent LIHTCs create a benefit that doesn’t exist for other uses of the bonds, housing should be the first use of PABs. Capped-out states could then recycle the bonds for other uses.
  • Limit PAB awards. States could limit the amount of PABs issued to eligible developments to maximize housing production. If PAB allocations to developments is limited (say to 55 percent of those costs), then more bond cap will be available for other developments. If needed, additional debt financing could be covered by taxable debt issued at the same time, known as taxable tail.
  • Encourage ground lease structures that minimize land costs. PABs must cover at least 50 percent of the basis of a residential rental property’s land and building. A ground lease structure eliminates the cost of land from bond-covered financing, meaning more bond financing is available for the rest of the property–or for other developments. 

Changes for States with Cap Room

For the 35 states plus U.S. territories where some bond cap was lost in 2015, here’s a change that could help:

  • Change state and regional policy requirements. When applying for PAB financing, properties are often expected to meet objectives beyond federal requirements, which is a debatable policy for an underused resource. Those goals are often good (e.g., deeper income targeting, provision of services), but those standards should apply only when there’s competition. Indiana, for example, has taken the common sense approach of removing its scoring threshold for 4 percent deals–properties are scored, but there’s no minimum. 

State Housing Agencies Changes

While state housing agencies can’t change federal law, they can take steps to increase PAB use in their jurisdiction.

  • Make applications more efficient. Finding developable land and securing zoning is challenge enough. The process of requesting PABs shouldn’t 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. They also can reduce challenges for such things as allowing developers to easily combine a portfolio of smaller developments into one bond transaction, benefitting from the economy of scale.
  • Require developers rehabilitating large properties with a rental subsidy to apply for 4 percent credits first. There is intense competition for 9 percent LIHTCs, so state agencies could require developers to first apply for 4 percent LIHTCs and PABs if the developers have a rental subsidy in place and are rehabbing a large property. That preserves 9 percent credits for those that need it most–and creates more PAB use.

Across-The-Board Ideas

Some changes go beyond specific government agencies:

  • 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 fees, expediting permits and allowing a favorable property tax treatment, depending on state law.
  • Provide additional financing options with the bond program. The bottom line for PAB use is often the bottom line–making financing work out. Increased use of the cap would likely follow the development and promotion of new taxable or tax-exempt financing techniques that increase a given development’s borrowing capacity.
  • Provide additional gap subsidies. The level of financing necessary to fund development costs based on the amount of equity generated can result in debt service that’s too high for the feasible rents. Other funding sources, such as HOME, Community Development Block Grants or Housing Trust Fund loans; equity from state LIHTCs; and other support can help bridge the gap. For instance, Maryland started its Rental Housing Works program, which targets gap financing for multifamily bond and 4 percent LIHTC deals. Maryland has more than tripled the issuance of bonds since the program started.


PABs are an underused resource for much-needed affordable housing in America. The adoption of some of the aforementioned changes–even if it’s only a few of them–would almost certainly lead to more affordable rental housing.

That means more jobs, more development and, most importantly, more housing for those who need it most.

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