Editor's Note: Michelle Yarbrough Korb is special counsel in the Real Estate Practice Group of Pepper Hamilton LLP, resident in the Pittsburgh office. Her practice focuses in the affordable housing industry with an emphasis on development, including the utilization of low-income housing tax credits, federal programs and programs offered by individual states, as well as the Federal Home Loan Bank's Affordable Housing Program. In this exclusive two-part Q&A, she describes programs that support affordable housing development.

Q: How do developers figure out all of the incentives and financing choices they face in the affordable housing market?

A: If you are a real estate developer looking to enter the affordable housing marketplace, you have likely seen the acronym LIHTC (low-income housing tax credit) but may be wondering how one works with a public housing agency (PHA) to obtain operating subsidy or project-based vouchers (PBVs).  If you are dealing with a public housing agency's aging housing stock in need of revitalization or in the market for additional rental units, you may be wondering if a unit may be both a public housing and LIHTC unit. 

In either case, you may be concerned with gap financing (CDBG, HOME, AHP, CFFP) and have likely seen headlines regarding Choice and RAD. 

Q: Can you demystify the acronyms and describe how both developers and public housing agencies frequently pursue affordable housing development?

A: If you are a traditional real estate developer, you may be wondering about the “government money” out there for the development of affordable housing and how you may enter this market.

The development of affordable rental housing is frequently funded in large part with an allocation of LIHTCs.  The 9% LIHTC (also known as the 70 percent present value credit) supports new construction.  The 4% LIHTC (also known as the 30 percent present value credit) (a) supports a project financed by tax-exempt bonds or (b) may be applied to building acquisition costs with a rehabilitation project under certain circumstances. 

Obtaining LIHTCs is highly competitive (with perhaps the exception of the “automatic” 4% LIHTC for a project financed by tax-exempt bonds).  Developers must apply for an allocation of LIHTCs from the state allocating agency (thus each state will have its own acronym or shorthand – e.g., PHFA (PA), IHDA (IL), Florida Housing (FL)).  Each state allocating agency has its own unique process and deadlines set forth in its Qualified Allocation Plan (QAP).  The application is not something that may be quickly “thrown together.”  It typically takes months to assemble an application.

LIHTCs are a dollar-for-dollar reduction in federal tax liability in exchange for providing financing to develop affordable rental housing; it is claimed pro rata over 10 years.  In order to use LIHTCs, a partnership structure is typically utilized.  A single purpose owner entity limited partnership is organized with a developer controlled entity serving as the managing general partner, an investment fund serving as the limited partner and the syndicator serving as a special limited partner.  The developer will negotiate with the syndicator with respect to the terms of the equity contribution to the owner entity in exchange for the LIHTCs and depreciation on the affordable housing development. 

Q: What are the main advantages and requirements for LIHTCs?

A: LIHTCs are particularly desirable because they are not a funding source that needs to be repaid.  Of course, such funds do not come without conditions.  The development will be subject to a 15 year compliance period and a 15 year extended use period during which the development must be operated in accordance with LIHTC requirements such as (a) 20 percent or more of the residential units in such project are both rent-restricted and occupied by individuals whose income is 50 percent or less of area median gross income (AMI) or (b) 40 percent or more of the residential units in such project are both rent-restricted and occupied by individuals whose income is 60 percent or less of AMI (whichever is elected at the time of application). 

There are other considerations like the timeframe for completing the development and placing it in service as well as restrictions on the fee the developer may earn.  LIHTC investors will also have requirements such as guaranties to be given by the developer.

Q: What about gap financing?

A: While an allocation of LIHTCs will likely be the primary funding source for an affordable housing rental development, an allocation alone may not be sufficient.  Thus, gap financing may also be required.  Often, a project will not support a traditional construction/permanent loan, so other options must be explored.  Local government, including a redevelopment authority, may be willing to provide financing on more favorable terms (e.g., cash flow only repayment requirements).  Additionally, there may be programs on a state level.  A few programs that one may consider include:

• CDBG (Community Development Block Grant Program) – Larger cities and counties receive formula funding (the entitlement component) and states funnel funding to smaller communities (the state and small cities component).  Activities in support of the development of low or moderate income housing including clearance, site assemblage, provision of site improvements and provision of public improvements and certain housing pre-construction costs (e.g., conducting preliminary surveys and analysis of market needs) are eligible uses of CDBG funds.  With a few exceptions, CDBG funds may not be used for the construction of new permanent residential structures or for any program to subsidize or assist such new construction.
• HOME (HOME Investment Partnership Program) – State and local governments (participating jurisdictions) provide HOME assistance.  For rental housing, at least 90 percent of benefiting families must have incomes that are no more than 60% of the U. S. Department of Housing and Urban Development (HUD)-adjusted AMI. In rental projects with five or more assisted units, at least 20% of the units must be occupied by families with incomes that do not exceed 50% of the HUD-adjusted AMI.  Participating jurisdictions must ensure that HOME-funded housing units remain affordable in the long term (20 years for new construction of rental housing; 5-15 years for construction of homeownership housing and housing rehabilitation, depending on the amount of HOME subsidy).  Finally, participating jurisdictions must match every dollar of HOME funds used (except for administrative costs and Community Housing Development Organization (CHDO) predevelopment loans for projects that do not move forward) with 25 cents from nonfederal sources, which may include donated materials or labor, the value of donated property, proceeds from bond financing, and other resources.
• AHP (Affordable Housing Program) – This is a competitive grant program offered by Federal Home Loan Banks for housing and community development.
• Because LIHTC eligible basis (i.e., depreciable development costs that may be included in the calculation of LIHTCs) will be reduced by the amount of federal grants (i.e., funds which originate from a federal source and which do not require repayment) made to fund the cost of a building, great care must be used in structuring a transaction that involves grant funds.

Finally, if you are working with a PHA on a development, the PHA may be able to provide a loan on favorable terms using financing sources available to it.

Tomorrow: Subsidies from public housing agencies and the use of third-party developers by PHAs.