Preservation of Affordable Multifamily Housing

State Housing Bonds Preserve Affordable Rental Housing in Massachusetts

by Nancy Andersen, Manager, Rental Development, and David Keene, Manager, Rental Preservation

In Massachusetts and other states, private activity tax-exempt bond financing has become a popular tool for preserving affordable housing because of the below-market interest rates and the low-income housing tax credits that are available when this financing source is used. After January 1, 2002, the total volume of tax-exempt bonds that may be issued by a state each year is limited to the greater of $225 million per state or $75 per capita, amounting to roughly $463 million in Massachusetts. In recent years, the state has allocated approximately 30 to 40 percent of its total private activity bond volume cap to the Massachusetts Housing Finance Agency (MassHousing). The agency divides its available cap among single and multifamily housing activities.

Tax-exempt bond financing is particularly useful for preserving low-income housing for several reasons. Because interest paid on the bonds is tax-exempt, investors can accept a lower nominal interest rate than they might require on a taxable investment. Additionally, the bonds can be structured as fixed-rate loans for as long as 40 years. Lower borrower interest rates resulting from the tax exempt financing, combined with the longer repayment period, contribute to reduced debt service for affordable housing developers using this resource.

Source: NHT as of April 2007

Tax-exempt bonds can also enable affordable housing developers to take advantage of an additional subsidy resource. If 50 percent or more of a preservation project’s cost (total development costs including land) is financed with tax-exempt bonds, the entire project can qualify for LIHTCs typically referred to as “4 percent tax credits.”*  These can be sold to LIHTC investors to raise equity capital for the project.

Banks can participate in tax-exempt bond activity, in support of both affordable multifamily housing preservation, and their own bottom line, in multiple ways. Banks may issue either short-term construction or longer term permanent credit enhancement through letters of credit. These letters may result in fees received by the bank and a better rated, and more marketable, bond for the project sponsor. Banks may also purchase bonds, either to hold in portfolio or to bundle and sell as securities. Banks may also purchase the 4 percent LIHTCs associated with tax-exempt bond deals in which they do not purchase the bonds for their own portfolio. In addition to a positive bottom-line impact, banks may receive positive CRA consideration for investing in tax-exempt bonds that specifically support affordable housing.

How Massachusetts Uses Tax-exempt Bonds

MassHousing has become a leader in using tax-exempt financing in combination with low-income housing tax credits to preserve at-risk affordable rental housing. The MassHousing criteria for the use of private activity bond volume cap for preservation of affordable rental housing are: (1) risk of conversion to market-rate housing, (2) risk of loss of habitability; and (3) need for moderate-to-substantial capital replacements.

Risk of conversion to market-rate housing is defined as when:

• All existing low-income use restrictions have expired, or the owner can take unilateral action to opt out of all such use restrictions within the next 18 months.
  
  
• The value of the property as market rate housing is likely to be as high or higher than its current value as subsidized housing.
  
  
• The existing owner has indicated an interest in converting to market-rate housing, or to sell to an entity that will convert to market-rate housing.

The other two criteria, risk of loss of habitability and moderate/substantial capital needs, are defined on the basis of “imminent” rehabilitation needs within one to three years. This threshold of capital needs has been set at varying amounts, from $10,000 per unit to as high as $35,000 per unit.

Massachusetts has also targeted its LIHTC program to support affordable multifamily housing preservation programs. The various Qualified Allocation Plans (QAPs) issued by the Massachusetts Department of Housing and Community Development (DHCD) have set aside 35 to 50 percent of tax credit allocations for at-risk preservation projects.

At-risk preservation projects are determined under the QAPs as:

• A project whose owner can prepay an FHA-insured or MassHousing-financed loan (or prepay and opt-out of a Section 8 project-based contract) within nine months of the date of the tax credit application. In addition, the project cannot be subject to any other use restriction that would effectively limit the owner’s ability to convert the development to nonaffordable use.
  
  
• Distressed or foreclosed properties at risk of being lost as affordable housing without an infusion of new capital or a new ownership structure. Such distressed and at-risk properties are evaluated based on a capital needs study that indicates at least $10,000 per unit of new capital is needed to address immediate repair and replacement needs.

Results in Massachusetts

MassHousing has originated more than $1 billion of loans to preserve nearly 30,000 units of affordable rental units in 193 developments. Over half of this $1 billion of lending involved tax-exempt private activity bonds. The remaining half involves refinancings of debt only, or refinancings with 9 percent tax credit equity investment.

MassHousing has also used tax-exempt bonds creatively to preserve public housing units. MassHousing issued tax-exempt bonds and used the proceeds to make loans to the housing authorities. The loans were secured by annually appropriated federal public housing subsidies, known as “capital funds.” By capitalizing a portion of each housing authority’s expected stream of capital funds over the next 20 years, MassHousing enabled these local public housing authorities to undertake substantially greater rehabilitation than would have been possible year-to-year, thus assisting in the modernization of this distressed, federally assisted public housing stock. In all, 509 units of public housing received $14.8 million in loan funds, enabling roughly $29,000 in rehabilitation and modernization per unit.

Overall, the use of tax-exempt bond financing combined with 4 percent tax credits has provided a powerful tool to MassHousing to preserve at-risk properties. This successful strategy will continue and likely accelerate in the future as more at-risk properties approach their mortgage maturity in the next five-to-ten years.

For further information, contact Nancy Andersen or David Keene at the Massachusetts Housing Finance Agency at (617) 854-1000.

*Although there is a cap on the amount of tax-exempt bonds a state can issue each year, there is no statutory limit to the amount of 4 percent LIHTCs that can be issued.