Preservation of Affordable Multifamily Housing

Saving America's Affordable Rental Housing Stock: The Need and the Role of National Banks

Young residents of Friendship Court in Charlottesville, Virginia.   by Michael Bodaken, President, National Housing Trust and Todd Nedwick, Assistant Director, National Preservation Initiative, National Housing Trust Preserving affordable rental housing has become a crucial strategy toward solving the housing dilemma facing communities all across America. Our nation’s supply of its most affordable apartments is decreasing at an alarming rate. According to the Joint Center for Housing Studies at Harvard University, from 1993 to 2003, the number of apartments that rent for $400 or less declined by 1.2 million because of conversions to higher cost rentals, gentrification, abandonment, or demolition. More than 1 million additional federally assisted or insured rental apartments are at risk over the next several years as owners contemplate opting out of the federal programs and converting their properties to more expensive housing. The National Housing Trust (NHT) is a leading national nonprofit engaged in housing preservation through public policy initiatives, lending, and real estate development. Over the last 13 years, we have saved more than 21,000 affordable apartments in 40 states and the District of Columbia. We believe the impending expiration of federal housing contracts presents an opportunity to reinvest in and safeguard affordable housing for another generation of families and seniors. At the Trust, we have seen firsthand the successes that can occur when innovative local, state, and federal policy leaders, dedicated mission-driven housing developers, and private lenders commit to preserving affordable housing. The key to preservation is deploying sufficient resources in a timely, responsible fashion. In this article, we describe how national banks can play an essential and profitable role in housing preservation and provide examples of how some banks are already playing a key role. We also observe that state and local policy leaders are recognizing that preservation is sensible public policy and show how they are increasingly devoting otherwise scarce resources to preservation. In short, intelligent investment in bridge financing, and bond or tax credit equity purchasing can earn a lender the prevailing market rate and harness efficiencies that ultimately benefit low-income renters. Rehabilitated properties received less than $40,000 in tax credit equity for each apartment. Each newly constructed apartment received approximately $65,000 in equity. Source: NHT How Did We Get Here? The federal assisted housing story begins in 1937 with the National Housing Act. The act committed the United States “to remedy the unsafe and unsanitary conditions and the acute shortage of decent, safe and sanitary dwellings for families of low income in rural or urban communities that are injurious to the health, safety and morals of the citizens of the nation.” In 1949, Congress established as a cornerstone of national policy “the realization as soon as feasible of the goal of a decent home and a suitable living environment for every American family.” Congress reaffirmed this policy in 1968, declaring that “the highest priority and emphasis should be given to meeting the housing needs of those families for which the national goal has not become a reality.” Between 1965 and 1974, private builders were offered below-market interest rate Federal Housing Administration-insured loans for affordable units reserved for low-income families and seniors. The program was highly successful, generating the development of more than 600,000 homes during this decade. These properties are often referred to as “older assisted housing.” Apartments created under the Section 8 New Construction / Substantial Rehabilitation (NC/SR) program are typically referred to as “newer assisted housing.” The program was made part of the Housing and Community Development Act of 1974 during the Nixon/Ford administrations. Designed for private operation, this program provided federal insurance as an option. All these units received project-based subsidies. This program produced almost one million apartments between 1974 and 1983 in nearly every community in the nation. Rural areas have also benefited from the U.S. Department of Agriculture’s Section 515 program, which has subsidized the development of more than 400,000 units of affordable rental housing. Lastly, the federal Low Income Housing Tax Credit (LIHTC) program has subsidized the production and preservation of more than 1.4 million rental units since its inception in 1987. This program is authorized under the federal tax code but is administered primarily by state housing finance agencies. Many federally assisted homes have rents well below market rents. But today their future in high-cost housing markets is threatened. Many properties have increased substantially in value, giving owners the incentive to opt out of the federal programs and convert the housing to market rate. Compounding these market developments, many federally assisted homes have “expiring subsidies,” as the 15- to 40-year term of affordability required under the various programs comes to an end. Other properties are suffering from physical deterioration and need significant capital improvements. In any of these cases, the nation loses essential resources, unless these properties are saved. The opportunity to preserve HUD-assisted or insured multifamily housing presents itself in a variety of scenarios, most of which are triggered by an owner’s decision to leave the HUD programs by selling the property, opting out of the Section 8 contract, or prepaying the FHA-insured mortgage. More and more owners are considering their options. According to HUD data, contracts on more than 900,000 Section 8 units will expire over the next five years. The unpaid principal balance on the loans on these properties is well over $50 billion. What roles can national banks play to preserve affordable housing? Lenders can, and are, playing a crucial role in preservation. Consider the following examples: Sharing in the risk of predevelopment financing. The most difficult aspect of pursuing preservation projects occurs in the predevelopment phase. In order to evaluate the financial feasibility of preservation plans, studies must be completed, and professionals must be engaged. Should the transaction proceed to a closing, all of these costs are recouped. However, if the project does not move forward, most or all of these are sunk costs. This is a tremendous challenge for undercapitalized nonprofits. Both financial institutions and nonprofit developers would benefit if they shared in this risk. Banks could agree to provide predevelopment dollars for a particular project, matched in part by the nonprofit developer, in exchange for a more substantial and/or longer term participation in permanent future financing of the project. Lenders’ more substantial roles might include direct purchase of tax-exempt bonds, direct purchase of low-income housing tax credits, or provision of construction loans. Investing in intermediaries such as CDFIs. Community development organizations are also raising funds to finance predevelopment and interim development loans at below-market rates to local nonprofit developers. Banks are providing key investments to capitalize these funds. For example, the NHT Community Development Fund provides early financing to developers to help them purchase and renovate affordable apartments. Bank of America and SunTrust Bank are major investors in the fund. To date, loans totaling more than $7 million have been made to help save more than 4,700 apartments. These loans have leveraged $390 million in private financing to fund affordable housing preservation. Providing favorable permanent financing terms. We are seeing more and more lenders use 40-year private placements as a means to preserve affordable housing, particularly in high-cost areas where the purchaser needs additional proceeds to make the financing work. The NHT recently preserved and improved Galen Terrace Apartments (see sidebar) in Washington, District of Columbia. We received a 40-year amortization on tax-exempt bonds privately placed with MMA Financial that yielded proceeds of $4.5 million. Amortizing the bonds over a shorter 30-year term would have caused a gap of $350,000, more than $4,000 per unit. Providing standby letters of credit to help enhance the credit rating of 501(c)(3) bonds. This is particularly useful when used with so-called “Lower Floater” type bonds when the interest rate of the bonds varies over time. The letter of credit can help reduce the interest rate, ultimately lowering the cost of permanent financing and making the transaction more economically feasible. Thus, for the purchase of Walden Oaks, a Section 8 property in Woodstock, Illinois, First Chicago Bank and Trust provided a $550,000 letter of credit to enhance a $3,425,000 seven-year mini-permanent participation loan issued by the Local Initiatives Support Corporation, the Housing Partnership Fund, and Enterprise Community Partners. The acquisition enabled the Hispanic Housing Development Corporation to preserve 192 rental units at risk because of strong market pressures. Purchasing tax credits. LIHTCs are increasingly being used to help purchase and renovate existing multifamily housing. The same firm that provides the bridge and the take out financing can purchase the property’s tax credits. In any given year, LIHTCs are used to preserve and improve more than 60,000 apartments throughout the United States. The total amount of tax credit funding is more than $2 billion. Times Have Changed: Preservation Is a Priority for State and Local Housing Agencies In response to substantial reductions in federal support for affordable housing at the same time as the loss of assisted affordable housing has accelerated, many states, cities, and counties are increasing resources dedicated to affordable housing preservation and development. For instance, nearly all states now prioritize preservation in their competitive LIHTC programs. Similarly, nearly all state housing trust funds now support preservation activities, and many funds prioritize them as preferred activities. At the local level, some counties dedicate tax revenues to affordable housing preservation. Several local governments facilitate landlord participation in the project-based Section 8 program by providing a guarantee, pledging their own resources to replace federal Section 8 payments to landlords when the federal government fails to meet its obligations. For more information on state and local preservation policies, visit the public policy section of NHT’s Web site. Conclusion We are now faced with an opportunity to safeguard hundreds of thousands of affordable homes that serve as the foundation of vibrant communities. Never has the opportunity to harness market forces to do social good been greater. The resources exist. The choice is ours. For additional information, visit NHT or e-mail Michael Bodaken or Todd Nedwick. Return to Top U.S. Department of Housing and Urban Development (HUD) Preservation Tools A number of federal tools and programs exist to help preserve the subsidized affordable housing stock. These tools provide incentives to owners to remain in the federal programs, provide funds for property rehabilitation and gap financing through grants or loans, or help facilitate the transfer of a subsidized property to a nonprofit, mission-driven organization. For further information, visit HUD or the Federal Housing Administration. Mark-to-Market Debt Restructuring Applicable Properties: Project-based Section 8 properties with an FHA-insured or HUD-held mortgage and where Section 8 contract rents are above market rate. Description: The HUD-insured mortgage is bifurcated into two mortgages. The first is sized to an amount that is supportable at market rate rents. The remaining unpaid principal balance is structured as a HUD held note that is serviced with 75 percent of surplus cash. The restructuring allows owners to finance rehabilitation needs and cover operating expenses. Repair escrows are provided for immediate capital needs, and increased deposits to reserve accounts are made to address long-term physical needs. In addition to cash flow, owners receive fees based on operating performance and a return on investments required by the program. Mark-Up-to-Market Applicable Properties: Project-based Section 8 properties owned by a for-profit or limited dividend entity with Section 8 contract rents that are below market rents, but in excess of 100 percent of HUD's published "fair market rent." Description: Provides incentives for owners with below market rents to remain in the Section 8 program. Owners are permitted to increase rents up to the lesser of market rate levels or 150 percent of HUD's published "fair market rent." The increased cash flow resulting from the higher rents may be used to recapitalize the property and increase distributions to owners of limited-dividend projects. Mark-Up-to-Market for a Nonprofit Transfer Applicable Properties: Project-based Section 8 properties being transferred to a nonprofit organization when Section 8 contract rents are below market rents. Description: Provides resources for nonprofit, mission-driven organizations to acquire and preserve Section 8 properties. Nonprofit buyers are permitted to increase rents up to the lesser of "post-rehab" market rents or 150 percent of HUD's published "fair market rent." Mark-Up-to-Budget Applicable Properties: Project-based Section 8 properties owned by nonprofits when rents are below market. Description: Provides resources for nonprofit owners to recapitalize a Section 8 property. Nonprofit owners are permitted to increase below market rents up to 150 percent of FMR (or higher if HUD permits) if project needs are justified. Higher rents allow nonprofit owners to support additional debt for rehabilitation or to increase contributions to the replacement reserve for future repairs. FHA Risk Sharing Loans Applicable Properties: All types of eligible properties provided that the loan results in affordable housing. Description: Insurance for mortgages of multifamily housing projects with loans that are underwritten by a Housing Finance Agency (HFA). HUD and HFAs share in the risk of the mortgage. HFAs may elect to share from 10 to 90 percent of the loss on a loan with HUD. The HFA reimburses HUD in the event of a claim pursuant to terms of the risk sharing agreement. Section 236 IRP Decoupling Applicable Properties: Properties with mortgages subsidized through the Section 236 program. Description: Original Section 236 financing provides ongoing interest reduction payments ("IRP") in amounts that reduce the effective interest rate on the mortgage to 1 percent. In a decoupling transaction, the Section 236 mortgage is pre-paid, and the previously budgeted IRP's are retained. The anticipated flow of funds from the IRP can be leveraged to support debt in addition to what can be supported by the net operating income, providing additional funds for rehabilitation needs. HOME and CDBG Grants Applicable Properties: States and localities administer these programs and determine eligible properties. Description: These are federal block grant programs that provide state and localities with a source of funding to meet their community development and affordable housing needs. Rehabilitation of subsidized rental housing is an eligible activity that competes with other types of uses. Project-based Vouchers Applicable Properties: Rental units assisted under certain federal housing programs (e.g., rental rehabilitation and public housing) cannot be assisted with project-based voucher assistance. Description: Project-based vouchers are a component of a public housing agency (PHA) housing choice voucher program. A PHA can attach up to 20 percent of its voucher assistance to specific housing units if the owner agrees to rehabilitate the units. Rehabilitated units must require at least $1,000 of rehabilitation per unit to be subsidized, and all units must meet HUD housing quality standards. Return to Top Galen Terrace Development Budget Sources of Funds Tax-Exempt Bonds $ 5,660,000 LIHTC Equity 4,702,000 City Loan 3,252,000 Total $13,614,000 Uses of Funds Acquisition $ 2,777,000 Rehabilitation 5,393,000 Soft Costs Including Financing 5,444,000 Total $13,614,000 Source: NHT Return to Top

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