Facilitating the Combination of 9% LIHTC’s with Section 202 and Section 811 Barbara Gualco, Mercy Housing Kevin Knudtson, Community Economics, Inc. This proposal was presented at our October 15th TCAC meeting. After taking input from discussion at that meeting a new possible solution to the timing issue is listed here: Modify 10325(f)(8), 4th paragraph of the TCAC regulations to add the following: Projects with awards of Section 202 or Section 811 funding shall not be subject to the requirement that construction begin within 150 days. Instead, Section 202 and Section 811 projects may qualify for all 20 points under this category by achieving 15 points from items A through D, above, and demonstrating that they have submitted a complete firm commitment application to HUD. Background The HUD Section 202 Supportive Housing for the Elderly and Section 811 Supportive Housing for Persons with Disabilities programs have been around for many years and have gone through many changes. In their present forms, both provide capital advances – essentially 40 year forgivable loans – along with project-based operating subsidies to new construction, rehabilitation or acquisition/rehabilitation projects. The operating subsidy that comes with 202/811 funding, known as Project Rental Assistance Contract, or PRAC funding, allows owners to charge tenants no more than 30% of household income while receiving a monthly subsidy from HUD to pay the balance of the operating expenses and reserves. PRAC funding is equivalent to Section 8 or McKinney subsidy programs in its ability to allow a project to serve the lowest income households. Until recently, the programs were available exclusively to nonprofit sponsors which precluded the use of low-income housing tax credits. When the program was opened up to limited partnership owners, as long as they were controlled by a nonprofit general partner, the use of 4% tax credits with the programs began in earnest. However, 9% credits have rarely been used with the Section 202 and 811 programs. Until last year, the biggest obstacle to using 9% tax credits with a Section 202/811 project was the treatment of 202/811 funds as federal funds for tax purposes which required that the funds be subtracted from basis. With the modification to Section 42 in 2008, this barrier has been removed. Now Section 202/811 sponsors are giving 9% credits a more careful look. In many cases, they are being pushed by cash-strapped local governments who see the 9% credits as a way to make Section 202/811 projects feasible with little or no local contribution. However, in California, several important barriers to combining Section 202 with 9% tax credits remain. These issues are described below. Bridging the impasse between these programs would provide California nonprofit housing developers with more options for developing projects. Therefore, we think it makes sense to brainstorm possible solutions and to check to see if there is consensus among NPH membership around one or more of these solutions. Following the description of each problem possible solutions are presented as a way to begin the discussion. Problem #1: Timing The competitiveness of the 9% allocation process requires applicants to promise that construction financing will close and construction will begin within 150 days of the credit allocation. This is problematic for Section 202/811 projects. Prior to closing, Section 202/811 projects must submit a “firm commitment” application to HUD which includes, among other things, final construction pricing, a third party cost estimate, construction drawings with plan check approval and all financing commitments. The timing of HUD’s review and approval of this package can vary and can take anywhere from four to six months or more to complete. Once its processing is complete, HUD issues its firm commitment, which has a 90 day term during which the project must close. If a Sponsor gets a TCAC commitment first, coordinating the timing of the submittal of the firm commitment application and HUD’s review and approval of the application with the timing of the 9% credit application and allocation would be extremely difficult. If a sponsor is unable to meet the TCAC deadline to start construction because of delays in HUD’s processing, the credits – and perhaps the scoring of the sponsor’s future application – is at risk. Getting a firm commitment first also presents timing problems. Sponsors with a pending firm commitment application who also submit a 9% tax credit application assume the risk that their projects will not be successful in the 9% competition. In this case, such sponsors would need to wait until the next 9% allocation to try again which would require waiting as few as three or as many as nine months to reapply. It is a near certainty that such a delay would affect construction pricing which would, in turn, necessitate pulling the firm commitment application from HUD in order to re-price and resubmit at a later date as well as put the HUD award at risk. This process is inefficient, risky and expensive for developers and it leaves those sponsors who have scarce and deeply-targeted Section 202/811 awards with only the 4% tax credit option. TCAC regulations have a long track record of prioritizing projects which capture scarce and deeply targeted subsidy (the RHS preference in the rural setaside for example and McKinney funding in the nonprofit setaside, as examples) in order to ensure that those projects – and their subsidies -- move forward efficiently. Possible Solutions: A. Change HUD’s firm commitment processing Section 202/811 projects to make it more compatible with the tax credit allocation process. Because the Section 202/811 process is deeply entrenched and fragmented, this seems like an unlikely solution. B. Add a new TCAC setaside for Section 202 and Section 811 projects. TCAC could create a new Section 202/811 setaside in which 202/811 projects would compete for 9% credits outside of the geographic competitions. This would allow the applications to achieve less than full points and still be competitive. The question of how to size such a setaside would be very important since, unless one of the other nonfederally mandated setasides is reduced commensurately, the new allocation would be taken collectively from the geographic areas. C. Add a preference for Section 202 and Section 811 projects within an existing setaside. The homeless assistance projects are now prioritized within the Nonprofit Setaside. Similarly, RD 514/515 projects with rental assistance have been prioritized (up to 14%of the setaside) within the Rural Setaside. If a project qualifies for either of these priorities, it wins in the setaside even if it has a lower score than other projects. These programs are comparable to 202/811 in their scarcity and in their depth of affordability. TCAC has prioritized these projects to ensure that they are not forced to place their federal awards at risk by applying and failing for tax credits. This is a sensible approach to the fragmented world of affordable housing finance. D. Award full readiness points to Section 202 and Section 811 projects without requiring a 150 day start. This idea avoids the political difficulty of carving out a new setaside or amending an existing one. Allowing Section 202 and 811 projects the ability to garner full readiness points without committing to a 150 day closing would provide these projects with the opportunity to score full points and compete for credits without creating a conflict with HUD’s process. In effect, TCAC would be trading some “readiness” for long-term, deep affordability. If this modification were enacted, it wouldn’t be necessary to create or modify a setaside since 202/811’s could compete within their geographic area. In other scoring areas, they would compete on their own merits. Problem #2. Affordability Restrictions In order to compete effectively in the 9% tax credit competition, applicants generally need to promise to restrict rents at levels below 50% of the area median income. Section 202/811 projects effectively serve households at or below 20% of the area median income due to the PRAC operating subsidy. The HUD Capital Advance regulatory agreement restricts occupancy for all units to households at no more than 50% of median income. As long as the PRAC remains in place, of course, all units are likely to occupied by households with much lower incomes, typically around 20% AMI. The TCAC affordability restrictions necessary to score full points (generally around 45% of AMI, on average) are problematic for Section 202/811 projects due to HUD’s longstanding policy of not permitting enforcement of restrictions from subordinate lenders more deeply targeted than its own. HUD’s position is that any vacant unit should be filled by the first qualified household – meaning the first qualified household earning less than 50% of area median income (AMI) -- on the project waiting list. The HUD requirements for the affirmative fair housing marketing plan, for example, would generally not permit sponsors to skip the first qualified household on the waiting list simply because that household qualified as a 40% AMI, for example, rather than the 30% AMI level the unit might be restricted at by TCAC. In this example, HUD’s expectation would be that the sponsor fill the unit with the first available tenant with an income less than 50% of AMI and ignore the TCAC requirement for 30% AMI. In fact, negotiations with HUD staff and State HCD staff to permit the use of MHP funds in Section 811 projects concluded with HCD agreeing that their AMI restrictions would really be treated more as targets and would not be imposed in situations where a deeply targeted unit was available but an HCD-qualified household was not immediately available. The type of solution agreed to between HUD and HCD would be much more difficult to negotiate with a tax credit investor relying in the delivery of credits based on compliance. In other words, while HCD may be willing negotiate away its own affordability requirements with HUD, there is no precedent for TCAC or tax credit investors to do the same. Under HUD’s current policy of not permitting the enforcement of affordability restrictions more restrictive than its own, Section 202 and Section 811 projects would be unable to compete effectively for affordability points in the 9% competition. Possible Solutions A. TCAC could agree not to enforce affordability restrictions below HUD’s Section 202/811 regulatory levels (50% of AMI) until after the PRAC operating subsidy expires. It is during period in which the owner receives PRAC subsidies that the project will serve a more deeply targeted population than most tax credit projects. After expiration or nonrenewal of the PRAC the owner would be obligated to charge un-subsidized rents consistent with the rents used to garner points in the 9% TCAC competition. B. HUD could agree to allow the deeper targeting required to garner full TCAC affordability points not to exceed the proportionate share of financing that the tax credit equity represents in a given development. HUD has allowed deeper targeting by approving requests such as allowing a homeless preference in PRAC funded units in 202’s. HUD has indicated that they have been agreeing to deeper targeting as long the targeting does not exceed the proportionate share of the secondary financing. The older Section 202 projects with HAP contracts were required to demonstrate that 40% of the units in any given development were targeted to extremely low income households. Problem #3. Impact on the 9% Competition Some sponsors have expressed concern about what impact Section 202/811might have on the already competitive 9% credit allocation process. Some further thinking on how the current process might be modified is necessary before this can really be assessed. We do know this, however. In 2008, HUD funded eight Section 202 projects in California. They ranged in size from 43 to 90 units and totaled 492 units. Virtually all Section 202 projects are syndicated now, though it is likely that some sponsors would continue to utilize 4% credits even 9% credits become an option. If half of the Section 202 projects (four per year) applied for 9% credits they could request as much as $7 million in annual credit. If the solution were something like D under Problem #1 above, these requests would come through the geographic apportionments and succeed or fail based on the competitions in those areas. If the solution was to create or modify a setaside as described in B or C, perhaps assigning annual credit on the order of $1.5 million, the approximate credit amount for two average sized projects) would be appropriate. There were six Section 811 developments funded in 2008, ranging from six to 25 units which totaled 86. We are not currently aware of any Section 811 projects that have been syndicated in California, although it is possible there may be a few. Nearly all Section 811 projects would qualify for the Small Project setaside. Conclusion In general, it is good public policy for TCAC to prioritize projects that compete for and win scarce federal resources that allow for very deeply-targeted housing. Since the first mixed finance Section 202/4% LIHTC projects have closed and many more have been proposed, many NPH members have been working through many difficult issues raised by the combination of these programs. A significant amount of the difficult, trailblazing work is underway. Timing and Affordability Restriction issues are the two big hurdles to combining HUD Section 202/811 with 9% LIHTC. In the current financial climate, local public agencies are strapped for cash and want sponsors to seek 9% tax credits on Section 202 and Section 811 projects. If NPH members agree that these are compelling facts, we should brainstorm solutions and lead the way to implement the best of these.
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