Multi-Family Affordable Housing: Opportunities and Legal - - PowerPoint PPT Presentation

Multi-Family Affordable Housing: Opportunities and Legal Considerations

Navigating Financing Options and Structuring Transaction and Financing Documents Today’s faculty features:

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Stuart D. Poppel, Partner, Berman Indictor & Poppel, Philadelphia Sheldon P . Winkelman, Partner, Honigman Miller Schwartz & Cohn, Detroit Christopher L. LaGrand, Deputy Director, Michigan State Housing Development Authority, Lansing, Mich.

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Multi-Family Affordable Housing: Legal Considerations

Low Income Housing Tax Credit

Presented by: Stuart D. Poppel Berman, Indictor & Poppel LLP poppel@biplawgroup.com 215.825.9732

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

I. HISTORY, ALLOCATIONS AND ADMINISTRATION 1. History

• The Low Income Housing Tax Credit (“LIHTC”) was created by the Tax Reform Act of 1986 and

recently celebrated its 25 year anniversary!

• The LIHTC program is not a funding program which provides monies directly to parties

developing affordable housing.

• Instead, under the LIHTC program a credit against federal income tax is provided to parties

developing affordable housing which meet certain criteria and that satisfy a detailed set of requirements regarding tenant eligibility and occupancy for an extended period of time.

• Among housing programs, the LIHTC program is unique in that (i) its benefits are not provided in

the form of monies but rather as tax benefits and (ii) it is administered by the Internal Revenue Service and not the United States Department of Housing and Urban Development (or the Department of Agriculture with respect to federal rural housing programs).

• The LIHTC program is currently the largest federal program designed to promote the

development of affordable housing - in 2013 the program is expected to allocate approximately $7.0 billion in federal tax credits and produces annually approximately 100,000 rental units.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

2. Administration of the LIHTC Program

• Both the federal government, through the Internal Revenue Service (“IRS”), and

states, through state housing finance agencies, have a role in administering the tax credit program.

• The basic rules and regulations governing the LIHTC are federal rules codified at

Section 42 of the Internal Revenue Code of 1986, as amended (26 U.S.C. § 42) and Internal Revenue Service regulations found at Treasury Regulations 1.42 et seq.

• Each state housing finance agency (an “HFA”) is given a significant role not only

with respect to regulatory oversight of the tax credits utilized in that state but also with the authority to allocate the tax credits to those eligible parties as the state HFA selects pursuant to selection criteria the state HFA establishes.

• As a result, although the basic rules of the LIHTC program are the same throughout

the country, each state’s HFA is free to impose additional restrictions and requirements on recipients, as well as to structure its LIHTC application in ways to encourage certain types of LIHTC developments (for example, developments that preserve existing affordable rental housing).

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

3. Allocation by IRS to States of Tax Credits

• Each year the IRS allocates a certain amount of LIHTC to each state using a formula established

in Section 42 of the IRS Code. This is known as the formula allocation.

• In 2013, the amount of tax credits to which each state will be entitled to allocate is $2.25 per

each resident of the state with a minimum of $2,590,000 for each state. The amount is adjusted for inflation each year.

• The IRS, issues a Revenue Procedure that sets forth the state HFA ceiling authority for the

LIHTC Program, and then a few months later the IRS issues Resident Population Estimates for each state so that the amount of LIHTC available to each state can be determined.

• All states, the District of Columbia, and United States possessions such as Puerto Rico and the

U.S. Virgin Islands have LIHTC authority.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

3. Allocation by IRS to States of Tax Credits (cont.)

• A project owner may claim LIHTCs on their federal tax returns for each of the first ten years after

their project is “placed in service” (which is discussed below).

• An allocation of tax credits from an HFA is really a one-time allocation of ten years of tax credits
• as a result, a project that receives an allocation of $1 million in tax credits and is in full

compliance with the LIHTC rules and satisfies all tenant leasing requirements would be entitled to claim $1 million of tax credits against federal taxes for each of the first ten years after their project is placed in service and the owner has started the period to claim credits.

• In a given year, in addition to what the Formula Allocation, states are permitted to allocate LIHTC

the state HFA receives due to the return by recipients of tax credits allocated in a prior year as well as tax credits from the previous calendar year that the state HFA did not allocate.

• Tax credits that are not allocated by a state HFA within 2 years are lost by the state and placed

by the IRS into a “national pool” of unused tax credits, which the IRS then reallocates each year to states that utilized their entire LIHTC authority for the prior calendar year.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

4. Administration by States

• Section 42 of the Code requires state HFAs each year to prepare an allocation plan that

identifies the states' priority housing needs and contains selection criteria for awarding tax credits - that plan is known as the Qualified Allocation Plan (“QAP”).

• State HFAs are required under Section 42 to allocate no more LIHTC than necessary to allow

the low income housing development to proceed, and so a state HFA must evaluate factors as the reasonableness of development costs and the sources and uses of project funds.

• An HFA is an agency which the state authorizes by statute to make allocations of LIHTC; states

may have more than 1 HFA (though only New York does).

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

4. Administration by States (cont.)

• Once an LIHTC project has been “placed in service”, the state HFA is responsible for confirming

that the developer incurred the costs it indicated it would incur in its LIHTC application and that those costs support the amount of tax credits that were previously allocated by the state HFA.

• The state HFA is also responsible for monitoring the LIHTC project for compliance with federal

requirements concerning household income, rents, and project habitability.

• If events of noncompliance occur, the state HFA is required to file a Low-Income Housing Credit

Agencies Report of Non-Compliance with the IRS (using IRS Form 8823) and if the noncompliance is not corrected within a given period of time, the IRS may recapture previously used or issued tax credits and also disallow tax credits for future years.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

5. Turning Tax Credits into Development Funds

• Once a project receives a tax credit allocation from the state HFA, the tax credit developer

usually will sell those tax credits to private investors.

• This is done so that the developer can turn that stream of tax credits (and other tax benefits that

may be available from the project, such as depreciation and other losses) over a ten year period into current dollars that it can use in financing the development of the project.

• Due to certain tax rules regarding the ability of individuals to utilize tax credits, the tax credits are

generally used by corporations to offset federal income taxes on their corporate income.

• Rather than a developer trying to arrange with a corporation or several corporations to make

investments into the development (which was more common in the early years of the tax credit program), developers sell their tax credits to tax credit investors, who may be syndicators (investors who package tax credit developments together to sell to other investors) or direct investors (such as banks, business corporations or insurance companies).

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

5. Turning Tax Credits into Development Funds (cont.)

• The tax credits, once allocated by the HFA to the developer entity, are not directly transferable

by the developer entity.

• In order to “sell” the credits the developer needs to form a pass-through entity such as a limited

partnership or limited liability company (“LLC”) and admit an equity investor as a partner (generally a limited partner) or member and provide to that investor an allocation of the project entity’s tax credits

• LIHTC under tax rules are allocated in the same manner as tax losses, so that an allocation of

99.5% of the losses in a partnership or LLC to an equity investor brings along with it the right of that investor to claim 99.5% of the LIHTC as well.

• Note that not all federal tax credits work this way - for example, historic rehabilitation tax credits

follow the profits in an entity, and not losses.

• Partners in a limited partnership or LLC claim the tax credit by filing with their IRS tax return a

copy of IRS Form 8609, the Low-Income Housing Credit Allocation Certification, which is issued by the State HFA to the project entity after the development is placed in service.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

6. Tax-Exempt Bonds Generating Tax Credits

• In addition to tax credits that are allocated by each state HFA pursuant to its Qualified Allocation

Plan, a second type of tax credit is made available under Section 42.

• These credits are known as the “4%” or “30 percent present value” credit (discussed in more

detail below) and are generated due to the issuance of tax-exempt private activity bonds which are subject to the state’s volume cap authority.

• To generate LIHTC, the bonds must satisfy the following requirements:

1. The interest on the bonds must be tax-exempt under federal law (Section 103 of the Code); and 2. The bonds must subject to the volume cap limitations (Section 146 of the Code); and 3. The bonds must be qualified private activity bonds (Section 141 of the Code). The type of private activity bond that is applicable to housing is usually the “exempt facility bond” under Section 142(a)(7) for projects that are qualified residential rental projects under Section 142(d).

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

6. Tax-Exempt Bonds Generating Tax Credits (cont.)

• Unlike with the tax credits allocated by the state HFAs, the 4% credits generated by tax-exempt

bonds are usually provided by each state to LIHTC owners on a non-competitive basis, i.e. on a first come, first serve basis.

• State housing finance agencies usually issue their tax-exempt volume cap through either their

QAP or through a separate Request for Proposals.

• The amount of each state’s volume cap is adjusted each year in the same way that the amount
• f LIHTC that may be allocated by a state HFA is adjusted each year, through the use of the IRS

Resident Population Estimates multiplied by the 2013 level of $95.00 of volume cap authorization for each resident of the state (with a minimum volume cap authority per state of $291,875,000 ).

• Qualified Residential Rental Project requirement - 95 percent or more of the net proceeds of the

tax-exempt bonds are required to be used to provide “qualified residential rental projects” (which has a similar meaning as “qualified low income housing project” discussed below).

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

6. Tax-Exempt Bonds Generating Tax Credits (cont.)

• 50% Rule - if 50% or more of the aggregate basis of the buildings plus land in a qualified

residential rental project is financed with the proceeds of a qualified private activity tax-exempt bond which is subject to bond volume cap, no tax credit allocation is necessary and the entire costs of the qualified residential rental project for which tax credits may be claimed (as determined under the rules for eligible basis discussed below) are eligible for the 30% present value credit (i.e. 4% credit).

• However, if this 50% test is not met, then only the portion of the qualified residential rental

project that is financed with the proceeds of qualified private activity tax-exempt bonds is eligible for the 30% present value test.

• So if only 40% of the aggregate basis of the buildings plus land is financed with tax-exempt

bonds, then tax credits may be claimed on only 40% of the project’s eligible costs.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

II. GENERAL OVERVIEW OF THE CREDIT I. Types of Developments that May Claim LIHTC

• A. Qualified Low Income Housing Project
• Tax credits are only allowed for a “qualified low income housing project.”
• Under Section 42(g), 2 fundamental requirements need to be met:

1. Project must be residential rental property available to the general public; and 2. Project must meet either the 20/50 or 40/60 minimum set-aside.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

• I. Types of Developments that May Claim LIHTC (cont.)

1. Project must be residential rental property available to the general public. 2. For purposes of Section 42, the definition attributed to the term “residential rental property” generally is the same as applied to qualified tax-exempt rental housing bonds under IRC section 142. This definition focuses on the following issues.

• a. Functionally Related Facilities - In addition to the actual residential units,

functionally related and subordinate facilities may be included in the project’s eligible basis and hence eligible for tax credits if (i) they are available to all tenants and (ii) the project owner charges no additional fees for their use. Functionally related facilities would include a playground, swimming pool, parking garages and community centers, so long as no additional fees are charged for their use.

• b. Scattered Site Project - A scattered site project will be treated as a single project

under the LIHTC program if all of the units in the buildings are rent-restricted. A scattered site is a project where multiple buildings with similar units are not located in proximity to one another, but are owned by the same party and financed under the same agreement. Under the LIHTC program, you may not have a scattered site project that involves market rate units.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

I. Types of Developments that May Claim LIHTC (cont.) c. Mixed Used Building - If a building consists of both residential and nonresidential areas, the nonresidential portion will not preclude the residential portion from qualifying for the tax credit. Allocations must be made on a reasonable basis to ensure that the costs for the non-affordable rental units portion of such a mixed-use building are not included in the credit computation.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

• 1. Types of Developments that May Claim LIHTC (cont.)

B. Low-Income Unit Requirements

• A low-income unit is any unit in a building that is both rent restricted and occupied by

tenants who meet the income limitation applicable to the project. In addition : (i) The unit must be suitable for occupancy, meaning that the unit must meet the local health, safety, and building code requirements. For guidance in these areas, look to the local code requirements relevant to the building, as well as guidelines provided by HUD. (ii) The unit cannot be used on a transient basis. This rule focuses on the intent of the low-income housing credit to provide long-term solutions for affordable housing to low-income households. A unit will not be considered as used on a transient basis as long as the initial term of the lease is at least 6 months. Month-to-month leases can then follow the initial 6-month term. An exception to this rule is that single room occupancy housing may be rented on a month to month basis. There is also an exception for transitional housing for the homeless. (iii) The unit cannot be occupied by full-time students. There are certain exceptions under Section 42 allowing student occupancy in limited circumstances

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

II. 2. Minimum Low-Income Set-Aside Requirement

• All projects using LIHTC must satisfy the minimum set-aside requirement no later than

the close of the first year of the credit period.

• The first year of the credit period is either the tax year in which the LIHTC building is

placed in service, or at the election of the tax credit project owner, the next succeeding tax year.

• The project owner elects the minimum set-aside test on Part II of Form 8609, which is

the form by which the tax credit entity claims the tax credits. There are 2 possible set- asides: a. The “20/50” Test - at least 20 percent of the rental units in the project must be both rent restricted and occupied by tenants with incomes at or below 50 percent

• f the Area Median Income (“AMI”); OR

b. The “40/60” Test - at least 40 percent of the rental units must be both rent restricted and occupied by tenants with incomes at or below 60 percent AMI.

• c. New York City Special test - available only to projects located in New York City,

this test requires buildings to maintain 25 percent occupancy at rent restricted levels and with tenant incomes at or below 60 percent AMI. This test is in lieu of the 40/60 test.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

2. Minimum Low-Income Set-Aside Requirement (cont.)

• The “Deep Rent Skewed” Test - this test applies to projects which consist of both low-

income and market-rate tenants, where the rent charged to the low-income units is significantly less than those charged to the market rate units.

• Under this test, in addition to the general set-aside test elected by the project owner

(i.e. either the 20/50 or the 40/60 test), at least 15 percent of all low-income units in the project must be occupied by individuals having incomes at or below 40 percent AMI (rather than 50 percent or 60 percent).

• The minimum set-aside tests consist of both household income limitations and rent

restrictions, both of which are affected by the Area Median Income figures. The AMI are determined by HUD and are published on an annual basis. Once a project owner has elected the minimum set-aside, i.e. either the 20/50 or the 40/60, that election is irrevocable and the elected set-aside must be satisfied during each year of the IRS Compliance Period (as defined below).

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

2. Minimum Low-Income Set-Aside Requirement (cont.)

• Income Tiering - in addition to meeting the minimum set-aside test, the LIHTC project
• wner may agree as part of its tax credit application to meet other tenant income

requirements; for example, the LIHTC owner who elects the 40/60 set-aside may also agree to reserve 20% of the project units to tenants whose income is at or below 40% AMI. II. 3. Income Limitations

• In determining the income limitations applicable to an LIHTC tenant, all of the applicable

income standards are adjusted for family size according to HUD standards.

• Under the LIHTC, all occupants of a unit are considered in the determination of family size -

no relationship among the occupants needs to exist.

• To determine the appropriate household income figure for purposes of the LIHTC program,

refer to the HUD published table relating to “very low income” (which is defined by HUD as being an income level at or below 50 percent of the area median income).

• On an annual basis, HUD prepares tables at this 50% income level and provides

corresponding income figures for family sizes ranging from one to eight persons.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

3. Income Limitations (cont.)

• The area median income must always be adjusted to reflect the size of the household. The

four-person family is considered to be a guideline and is used by HUD to compute the 50 percent figures.

• HUD does not publish a table which specifically corresponds to the 60 percent area median

income level.

• Therefore, if the project owner chooses the 40/60 set aside and therefore has LIHTC units

that may be leased to tenants who are at the 60% income level, the project owner would refer to the HUD income levels for 50% of area median income and multiply by 1.2.

• The project owner is required to review and document the tenant household’s income at

least annually throughout the IRS “Compliance Period”, which equals the ten years during which the LIHTC is claimed and the five years thereafter during which the IRS has the right to recapture previously claimed tax credits in the event of noncompliance with the LIHTC rules.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

3. Income Limitations (cont.)

• Once a tenant is initially qualified to occupy an LIHTC unit, increases to a tenant's income

will not disqualify the tenant from continuing to lease the LIHTC unit if certain rules are followed.

• As a general rule, an initially qualifying tenant will be treated as continuing to satisfy the

income test as long as the tenant's income does not rise above 140 percent of the applicable income limit (that is, increases up to 140 percent are considered de minimis).

• If a tenant's income increases above 140 percent, the unit will continue to be treated as a

qualified LIHTC unit if another unit in the building of comparable or smaller size which subsequently becomes vacant is rented to tenants who satisfy the applicable income test. This is referred to as the “Available Unit Rule”.

• For projects electing the Deep-Rent Skewed set aside, the threshold is raised from 140

percent to 170 percent.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

4. Types of Tax Credits – Acquisition and Rehabilitation

• Under the LIHTC program, there are different rules for how tax credits may be claimed

depending on whether the credits are being claimed for new construction, substantial rehabilitation or the acquisition of the project, as well as whether the financing for the project is “federally subsidized.” The different rules are as follows:

• New construction/substantial rehabilitation - project owners may claim a tax credit equal to

70% of the present value of their eligible costs in connection with the new construction or substantial rehabilitation of a qualified residential rental project.

• For purposes of the LIHTC program, for a building to be “substantially rehabilitated” the

project owner must incur costs in rehabbing the building of at least $6,200 per LIHTC unit (this is the figure for 2012) or 20% of the adjusted basis of the building prior to its rehabilitation, whichever is greater.

• The 70% present value credit is also known as the 9% credit, for the reasons discussed

below.

• To claim the 70% present value credit, the new construction/rehabilitation work cannot be

“federally subsidized”, which means financed with the proceeds of tax-exempt bonds.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

II. 4. Types of Tax Credits – Acquisition and Rehabilitation (cont.)

• If the building is financed with the proceeds of tax-exempt bonds, it is considered to be

“federally subsidized” and not eligible for the 70% present value/9% credit.

• Exclusion from Eligible Basis of tax-exempt bonds. LIHTC owners using tax-exempt bonds

have a choice in structuring the use of tax-exempt bonds:

• (i) the project owner can include the tax-exempt bond loan in its cost calculation of the

project’s eligible basis (a concept described below) and claim the 30% present value credit instead of the 70% present value credit (i.e. claim the 4% credit and not the 9% credit), or

• (ii) the project owner can exclude from its cost calculation of the project’s eligible basis the

amount of the tax-exempt bonds and claim the 70% present value/9% credit on the remaining eligible basis.

• The term “federally subsidized” was changed by the Housing and Economic Recovery Act
• f 2008. Prior to the change, “federally subsidized” meant a loan of federal funds bearing

interest below a certain interest rate.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

4. Types of Tax Credits – Acquisition and Rehabilitation (cont.) 5. Acquisition of existing buildings - under Section 42, in addition to being able to claim tax credits on the costs of new construction or substantial rehabilitation expenses, an LIHTC project owner may claim tax credits on the costs of acquiring an existing building if certain rules are met (this is known as the Acquisition Tax Credit), including the following: (i) the project owner must perform a substantial rehabilitation on the existing building (meeting the greater of $6,200 for 2013 per unit or /20% adjusted basis test) (i) if the building is acquired and then demolished, no acquisition tax credit is available; (ii) the building must be purchased (as opposed to a gift) and be purchased from an unrelated party; and (iii) there must be a period of at least 10 years between the date of acquisition by the LIHTC owner and the date it was last placed in service or substantially improved, subject to certain waivers and exceptions set forth in the tax credit rules.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

4. Types of Tax Credits – Acquisition and Rehabilitation (cont.)

• If the acquisition of the building qualifies for the Acquisition Tax Credit, then the project
• wner may be entitled to claim a tax credit at the 30% present value/4% level on the

acquisition price of the building, excluding the cost of the land and generally not to exceed the appraised value of the property (less the appraised value of the land).

• Note that a project can qualify for one of the three credits or a combination of the credits.

For example, the same project can be eligible for the 4% credit, based on the cost of acquiring an existing building, and the 9% credit, based on the amount spent to substantially rehabilitate that building if the rehabilitation was not federally subsidized.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

5. Placed in Service

• Placed in service is a concept that has different meanings depending on whether the LIHTC

building is newly constructed or substantially rehabilitated:

• A. New construction - for buildings that are newly constructed, the building is considered

placed in service as of the date on which the building is ready and available for its assigned function For residential rental property, that is the date when the first unit in the building is certified as being suitable for occupancy in accordance with local law (usually evidenced by a certificate of occupancy).

• B. Substantial Rehabilitation - for buildings that are substantially rehabilitated, the placed

in service date is the end of the 24 month period in which the project owner’s qualified rehabilitation expenditures are made. An LIHTC owner may elect to place the building in service prior to the end of that 24 month period so long as the $6,200 per unit and 20% of adjusted basis test is met at the time the placed in service is elected.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

III. HOW THE LIHTC IS COMPUTED

• 1. Calculation of the LIHTC

LIHTC is calculated as follows: QUALIFIED BASIS * APPLICABLE PERCENTAGE = LIHTC APPLICABLE PERCENTAGE

• This is the percentage set each month by the IRS so that the qualified basis of a project

multiplied by that percentage will yield over the 10 year period in which the tax credits are claimed either 70 percent of the present value or 30 percent of the present value.

• The percentage changes every month based on interest rates - during periods of low

interest rates, the Applicable Percentage is lower.

• For March 2013, the Applicable Percentages were 9.00% (for the 70% present value credit)

– this is true for projects that have an allocation of tax credits in 2013 and 3.19% (for the 30 percent present value credit).

• Once made, an election of the Applicable Percentage (this is called a tax credit rate lock) is

irrevocable.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

• 1. Calculation of the LIHTC (Cont.)

QUALIFIED BASIS Qualified Basis = APPLICABLE FRACTION * ELIGIBLE BASIS APPLICABLE FRACTION

• The Applicable Fraction is the lower of the (i) number of occupied “low income units”

versus the total rental units in the project, or (ii) the total floor space of occupied “low income units” versus the total floor space of all rental units in the project.

• In a project where all of the residential rental unit are LIHTC units, the Applicable Fraction

will be 100%.

• Note that it is possible that each year during the Tax Credit Period, the Qualified Basis may

be different if what were intended to be market rate rental units are converted and leased to LIHTC tenants - such a change would cause an increase to the Applicable Fraction (and could under certain circumstances result in more tax credits).

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

• 1. Calculation of the LIHTC (Cont.)

ELIGIBLE BASIS

• Eligible Basis is perhaps the most important term in the LIHTC program. A project’s

eligible basis will determine how much tax credit it will be entitled to receive, but there are various rules as to what costs are includable in eligible basis and which

• nes are not.

ELIGIBLE BASIS = ADJUSTED BASIS AT THE END OF 1ST YEAR OF THE CREDITPERIOD

• Eligible basis is computed not as of the placed in service date but as of the end of

the first year claiming tax credits.

• What is includable in Adjusted Basis? A cost is includable if it is for residential rental

property and is depreciable, or is depreciable and used in a common area or provided as a comparable amenity to all residential rental units in the building.

• The key concept here is whether the item to be included in eligible basis is

depreciable under Section 263 and 263A of the Internal Revenue Code, i.e. it relates to the cost of constructing or rehabbing the LIHTC building.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

• 1. Calculation of the LIHTC (Cont.)

Particular Eligible Basis Inclusions (i) Hard construction costs. (ii) Soft construction costs such as building permits, architect fees and engineer fees. (iii) Legal fees (but see exclusions below). (iv) Impact fees - these previously were not includable but the IRS released Revenue Ruling 2002-9 and indicated they are now includable in eligible basis. (v) Developer Fees (subject to several limitations and exclusions, see below). (vi) Land preparation costs related to a specific, depreciable asset - if the land preparation is so closely associated with a particular depreciable asset such as a building that the land preparation will be retired, abandoned or replaced contemporaneously with the depreciable asset, it is includable in eligible basis. (vii) Costs of constructing comparable market rate units. (viii) Certain personal property. (ix) Certain site improvements. (x) Certain construction loan costs and fees, such as construction loan interest and origination fees.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

• 1. Calculation of the LIHTC (Cont.)

Particular Exclusions from Eligible Basis. (i) Land - the costs of acquiring land or making site improvements with respect to the land. Neither are any developer fees relating to acquisition of land or legal expenses relating to the acquisition of land. If a cost is associated with both land and building, such as surveys or environmental reports, then an allocation of the cost between land (not includable in eligible basis) and building (includable in eligible basis) should be made. (ii) Interest, origination, closing fees and other expenses of any permanent financing. (iii) Advertising, Reserves and Lease-up expenses (iv) Organizational and Syndication expenses, as well as developer fees relating to both and legal expenses relating to the syndication and legal fees relating to the

• rganization of the tax credit entity.

(v) State Housing Finance Agency tax credit application, reservation, allocation and compliance fees – this prohibition was made clear by the IRS in Revenue Ruling 2004-82 issued in August 2004. (vi) Costs of constructing commercial or retail or non-residential portions of the building. (vii) Historic rehabilitation credits - eligible basis is to be reduced by the amount of any historic rehabilitation credits claimed by the LIHTC entity.

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Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

• 1. Calculation of the LIHTC (Cont.)
• Eligible Basis is reduced by receipt of Federal Grants - under Section 42 of the Code,

Eligible Basis is reduced if (the 10 years claiming tax credits) the LIHTC owner receives a federal grant for the LIHTC project and uses such federal grant to construct the project.

• The IRS in Section 42 of the Code does not impose any limits on the total eligible basis that

may be permitted, nor does it establish limits on particular categories of costs includable in eligible basis. There are however two concepts in Section 42 that serve to limit eligible basis:

• 1. A state HFA may not allocate more credit to a building than an amount

necessary to assure project feasibility and its viability as a qualified low-income housing project throughout the credit period. 2. The LIHTC rules give a state HFA the ability to impose its own limits on eligible basis or categories within eligible basis, which state HFAs have generally done.

• Eligible Basis also includes costs of constructing ancillary facilities to the residential

rental property. The key is whether the facility is functionally related and subordinate to the residential rental units.

• These would include facilities for use by the tenants at no additional charge, such as

parking, swimming pools, community rooms and common areas.

37

Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

1. Calculation of the LIHTC (Cont.)

• Eligible Basis Boost - Under Section 42(d) of the Code, an LIHTC project is allowed a

30% boost to its eligible basis if it is located in a Qualified Census Tract or a Difficult Development Area or if the State HFA determines that such an increase is necessary.

• 30% boost is applicable only to new construction or rehabilitation costs - the costs of

acquisition used in claiming an Acquisition Tax Credit are not eligible for this 30% boost.

• What is a Qualified Census Tract or a Difficult Development Area? These are

determined on an annual basis (usually) by HUD.

• Qualified Census Tract – area where the poverty rate is at least 25% or where 50% or

more of households have an income less than 60% AMI. No more than 20% (based

• n population) of a metropolitan statistical area may be designated as a Qualified

Census Tract.

• Difficult Development Area – an area with unusually high construction, land, or utility

costs relative to its area median income.

38

Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

IV. Rent and Income Restrictions and Claiming Credits 1. Rent Restrictions

• Gross rent paid by the tenant in an LIHTC unit cannot exceed 30 percent of the

applicable income restriction elected for the project (either 50% AMI or 60% AMI) adjusted for family size.

• Therefore, an increase in the area median income level will increase the allowable

rent charged to a tenant while a decrease to the area median income would reduce the rent allowed to be charged. However, a rent floor exists under Section 42 to protect the building owner from rents falling too low.

• Calculation of Maximum Rent is made differently than Calculation of Maximum

Income: – As discussed above, to determine a household’s maximum income for a unit, reference is made to HUD’s income limitations for 50% AMI as modified by HUD based on the number of individuals occupying the tenant’s household. – However, in determining the maximum tax credit rent that may be charged to an LIHTC unit, no reference is made to the actual number of individuals living in the tenant’s LIHTC unit. – Instead, a designated number of persons is deemed to occupy a household based on the number of bedrooms in the unit. This is referred to as the “imputed income limitation.”

39

Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

1. Rent Restrictions (cont.)

• A studio apartment is considered to be occupied by 1 individual. Apartments with one
• r more separate bedrooms are deemed occupied by 1.5 individuals per bedroom.
• Once the number of persons deemed to occupy a household is determined, the

maximum rent that may be charged is no more than 30% of the applicable income limitation (so if the 20/50 set-aside was elected, the income limitation would be 50% AMI for the number of people deemed to occupy the household).

• Note that this gross rent figure includes an allowance for utilities, on the assumption

that the tenant will be paying its own utilities.

• To calculate the net rent that may be charged to the tenant, an LIHTC owner needs to

subtract from this maximum gross rent a utility allowance figure (there are several different ways to determine the appropriate utility allowance).

• The rent limitations apply only to what is collected from the tenant – therefore amounts

that are received by the LIHTC owner in the form of Section 8 or operating subsidies

• r other rent supplements that are not paid for by the tenant do not reduce the

maximum gross rent that may be charged to the tenant.

40

Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

2. Term of Restrictions COMPLIANCE PERIOD AND EXTENDED USE PERIOD

• The “Compliance Period” is the 15 year period beginning with the first year in which

the tax credits are claimed. LIHTC is subject to recapture by the IRS during this period.

• In addition to the Compliance Period, Section 42 also requires that the LIHTC owner

maintain the LIHTC building(s) as affordable for an additional period which is at least 15 years after the Compliance Period.

• This additional period is known as the Extended Use Period. State HFAs are free to

increase the length of this Extended Use Period beyond 15 years.

• To evidence the obligation of the LIHTC owner to maintain the LIHTC project as low

income housing during that Extended Use Period, the LIHTC owner must execute and record a document known as an Extended Low-Income Housing Commitment in favor

• f the state HFA which outlines the Extended Use Period restrictions.
• The Extended Low-Income Housing Commitment must be recorded against the

LIHTC project prior to the end of the first year in which tax credits are claimed.

41

Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

3. Computing the LIHTC to be Claimed.

• The LIHTC is claimed in the same amount for each of the ten years in the tax credit

period, except if the first year or first 2 years are partial years as discussed below.

• To claim the credit in each year, the LIHTC project must satisfy its elected set-aside

during that year (i.e. the 20/50 or 40/60).

• In addition, the Qualified Basis is determined to ascertain how many of the rental units

in the LIHTC development have been qualified as LIHTC units.

• To qualify an LIHTC unit, it must be at least initially leased to and occupied by an

LIHTC tenant and the unit be rent restricted as discussed above.

• Once a unit is qualified as an LIHTC unit, it remains that way even if it later becomes

vacant, so long as the next available unit of comparable or smaller size in the LIHTC building is rented to a qualifying LIHTC tenant and the LIHTC rent restrictions are imposed.

42

Multi-Family Affordable Housing: Legal Considerations Low Income Housing Tax Credit

3. Computing the LIHTC to be Claimed (Cont.)

• For the first year in which tax credits are claimed, a calculation is done as to the

number of months each LIHTC unit was leased to a qualified LIHTC tenant

• Amount of LIHTC that may be claimed in that first year is apportioned based on the

number of tax credit unit months the LIHTC owner had in the first year, over the maximum number of tax credit unit months it could have had if all LIHTC units were leased to LIHTC tenants during each month (this is calculated for each month of the first credit year).

• The portion of the allocated LIHTC that is not claimed in this first year (and possibly

the next year due to the timing of leasing the LIHTC units), may be claimed by the project owner in the 11th year (and possibly the 12th year).

• This is an issue in determining the amount of equity an investor will provide, as tax

credit equity pricing generally follows a time value of money approach, so the more LIHTC that can be claimed in the first year generally the higher the return for an investor and could result in an increase in the equity investor’s contributions.

Multi-Family Affordable Housing: Legal Considerations

April 10, 2013

HUD-Insured Financing

presented by Sheldon P. Winkelman Honigman Miller Schwartz and Cohn LLP 2290 First National Building 660 Woodward Avenue Detroit, MI 48226-3506 (313) 465-7606 swinkelman@honigman.com

44

HUD/FHA Basics

• HUD/FHA multifamily insurance provides borrowers the opportunity to obtain

financing for, among other things, the purchase, construction and/or rehabilitation of rental housing consistent with the federal housing policy of assuring all Amercians the availability of safe, sanitary and descent housing

• This type of financing is available either for new construction, the acquisition

and/or rehabilitation of existing projects or the refinancing of existing projects (whether or not currently financed with HUD-insured financing), for market rate rental projects, so-called “blanket mortgages” for cooperative and condominium projects and for special purpose projects such housing for the elderly and the handicapped

• HUD is not a lender. Instead HUD’s loan programs cause HUD’s to “insure” a

lender against almost all of the loss which a lender may incur in a particular loan transaction if the loan meets the requirements of HUD’s loan programs

• Tenant eligibility in projects financed with HUD-insured financing is not

necessarily restricted by income.

45

HUD/FHA Basics (cont)

• Income restrictions are only required with respect to projects in which rental

subsidies have been attached to

• the project as a whole
• to a percentage of dwelling units in a project; or
• to the applicable tenant
• We are not dealing here with HUD Public Housing; instead with affordable

housing privately developed (both profit-motivated and non-profit) and by private parties in partnership with public bodies

• As such, what is “affordable housing?” Some say
• Rental housing provided with the benefit of some form of governmental assistance
• Rental housing provided with the benefit of some type of governmental assistance to occupants

who are economically incapable of paying market rates utilizing either the IRC Section 42 rental limitation or something else

• For our purposes, we’ll be referring to the latter
• HUD financing is provided by HUD-approved lenders, which including mortgage bankers, commercial banks,

state housing agencies and others

46

Statutory and Regulatory Framework

• The original legal authority granted to HUD to make loans or grants and later to insure

mortgage loans for affordable rental housing is found in the National Housing Act of 1934,

• Pub. L. 84-345, 48 Stat. 1246 (codified as amended at 12 U.S.C. §§ 1701-1750 (2006)

(which was expanded to include such loans and grants in 1959) and Regulations found at 24 C.F.R.

• An article entitled “Affordable Housing-An Intimate History”, 20 J. Affordable Housing &

Community Dev. L. 193 (2011), written by Charles L. Edison, very thoroughly traces the history of government-assisted affordable housing from 1918 until the present

• This industry is fond of using numbers to refer to the various HUD loan programs. For the

most part, such numbers refer to sections of the National Housing Act, as it has been amended over the years.

• Section 207 was the original workhorse program for the construction of market rate rental

apartment developments which served as a pattern for many later programs which were targeted at low and moderate-income families and others

• As such, it is necessary to dispel the mistaken impression that HUD only functions in the world of so-called affordable

housing

47

Specific Loan Programs

• Although there were prior FHA (and later, HUD) loan programs which

targeted low income families in very limited circumstances; such as 221(d)(3), such programs did not gain momentum until the early ’60s.

• The following slides describe those HUD loan programs most often

utilized for affordable rental housing construction or the rehabilitation

• f existing projects, including
• Section 202
• Section 8
• Section 221(d)(4)
• Section 223(f)
• Section 223(a)(7)
• Risk-Sharing

48

Specific Loan Programs (cont)

• While each HUD loan program has its unique features, these

loans are generally

• 35 to 40 year self-amortizing, fixed interest rate, permanent loans, plus, if

applicable, an interest only construction period

• Fully non-recourse with very limited carve-outs (such carve-outs were only

recently added as a requirement)

• Loan to value ratios vary from 85% to 90%
• Locked out for prepayment for a short period and prepayable thereafter with a

declining prepayment charge---not a yield maintenance calculation

• Readily assumable
• Other than in very limited circumstances, no limitation on permissive

distributions to the owners other than to comply with

• HUD’s requirements that only “surplus cash” maybe distributed no more often than

semi-annually; and

• Such other constraints as may be imposed on the borrower under any source of

junior financing, real estate tax abatement programs or otherwise

49

Specific Loan Programs (cont)

• Section 202---housing for the elderly—originally

HUD made very low interest rate loans directly to non-profit developers of affordable multifamily housing developments for the elderly

• In 1990, this program was restructured to create a program for the

handicapped and replaced these low interest rate loans with capital advances and rental assistance

• In 2000, this program was expanded to include limited dividend

sponsorship so long as the general partner is a non-profit thereby

• pening the door for LIHTC syndication opportunities
• This has been a very popular program with more than 350,000

dwelling units having been built

• Many of these project are currently undergoing preservation

transactions

50

Specific Loan Programs (cont)

• Section 8 ---a program to augment the construction of new or substantially

rehabilitate existing affordable multifamily housing whereby HUD pays to the

• wner, on a monthly basis, the difference between HUD’s determination of the

market rents in a given community and 25% (later raised to 30%) of the eligible tenant’s income

• The funds generated under this program provided a relatively assured source
• f project revenue to induce lenders to make either HUD-insured or

conventional loans for these types of projects

• The lending industry’s acceptance of this certainty of rental income has varied over the years

as lender’s concerns about Congress’ willingness to continue to fund the Section 8 program has varied over the years

• This program generated about 850,000 units of affordable housing

but ended In 1983 with respect to new construction/substantial renovations

51

Specific Loan Programs (cont)

• Section 8 (cont)---
• Despite the fact that there have been no new Section 8 funds provided on a

project basis since 1983 for new construction or substantial rehabilitation of affordable housing undertaken after that date, Section 8 Housing Assistance Payment Contracts (so-called “HAP Contracts”) entered into by HUD pre-1983 have continued and are extendable unless an owner chooses to opt out of the program, the project goes into default or other unique circumstances arise

• The availability of pre-1983 HAP Contracts is a major driver for the

preservation of existing affordable housing

• Arising from HUD’s concerns about the declining portfolio of descent

affordable housing, HUD continues to consider approaches to strengthen the continued use of pre-1983 HAP Contracts, including the opportunity under the right circumstances to have the contract rents increased and, very recently, to transfer such contract rights to other projects where adverse circumstances have affected the original project

52

Specific Loan Programs (cont)

• Section 221(d)(4) --------just as Section 207 was the original

workhorse driving the construction of market rate multifamily rental housing, this section has become the workhorse for the development and rehabilitation of affordable rental housing since it was adopted.

• 221(d)(4) is geared at the development of new multifamily housing or the

substantial rehabilitation of existing rental house for occupancy by low and moderate-income families

• Despite this, there are no income limitations contained in the law or the applicable
• regulations. As such, this type of HUD-insured financing is used for the develop or

rehabilitation of both market rate and affordable housing

• As a practical matter, it is difficult if not impossible to distinguish between projects

financed under this program which are geared at low income families from those which are market rate driven

53

Specific Loan Programs (cont)

• Section 223(f) --------This program, adopted in 1974, provides a means to

finance the acquisition of a rental housing project (affordable or otherwise) or to refinance an already owned project, in both cases where substantial rehabilitation is not required

• If substantial rehabilitation is required, the HUD program applicable would be Section 221(d)(4)
• The advantages of HUD-insured financing under Section 223(f) over Section 221(d)(4) is that

it’s a one-step closing with

• an escrow established for non-critical repairs to be completed usually over a period of one year post

closing;

• The owner/borrower is not required to have deferred improvements completed by a licensed general

contractor; and

• The payment of Davis Bacon wages for the repairs to be made is not required

54

Specific Loan Programs (cont)

• Section 223 (f) (cont) ------
• For the refinancing of an existing project,
• cash-out is permitted; and
• Applicable whether or not
• the existing financing is HUD-insured; or
• HUD has had any other involvement with the project prior

to the refinancing

55

Specific Loan Programs (cont)

• Section 223(a)(7) -----------This program is essentially the same as

Section 223(f) except:

• Applicable only to refinance existing HUD-insured financing

Loan amount limited to the lesser of

• The original amount of the HUD-insured loan to be refinanced; and
• The unpaid balance of the existing HUD-insured loan, with certain items to be added
• As such, this loan program provides a method to possibly reduce the interest rate and

borrow out equity build-up on a relatively accelerated basis

• The principal advantage of this type of loan is the relative ease of closing since HUD

already has undertaken the insurance risk

56

Specific Loan Programs (cont)

• Risk Sharing -----Starting in 1992, HUD undertook pilot programs involving

risk-sharing with lenders in order to spur the production of affordable rental housing

• This concept is intended to increase the willingness of lenders to make these types of loans by

causing HUD to accept the bulk of the risk of default

• Arising at least in part from HUD’s very unfortunate experience with its now-defunct co-

insurance loan program, the current programs are limited to such arrangements with state and local housing finance agencies, Fannie Mae, Freddie Mac and the Federal Housing Finance Board

• Currently being used in connection with the Federal New Issue Bond Program, a relatively

recent and by now fully committed part of Federal economic stimulus efforts

• The regulations for the Housing-Finance Risk Sharing program are at 24 C.F.R. and guidance

can be found in Chapter 6 of U.S. Dep’t. of Housing & Urban Development, Handbook No. 4590.01, Housing Finance Agency Risk Sharing Program (1995).

57

How Does It Work?

• How does a developer/sponsor of affordable housing navigate through

this multiplicity of information, subsidy programs and the like to arrive at the best financing approach?

• The usual best first step is to consult with a HUD approved lender and become at

least partially familiar (or retain counsel which is familiar) with HUD’s multifamily accelerated processing (MAP) procedures and the HUD Multifamily Program Closing Guide under which most HUD-insured loans are now being processed and closed

• For this reason these lenders are often referred to as “MAP” Lenders
• This shifted much of the processing and initial underwriting which HUD used to do to the

MAP Lender

• HUD recently updated its Multifamily Accelerated Processing (MAP) Guide (HUD

Handbook 4430.G) and its Multifamily Program Closing Guide

58

How Does It Work (cont)

• Quoting from the MAP Guide, HUD explains MAP as follows:
• MAP is intended to:
• A. Establish a process that significantly reduces the amount of

HUD review time.

• B. Strike a careful balance between expedited processing and

ensuring an acceptable level of risk management for HUD’s multifamily mortgage insurance programs.

• C. Have in one volume, the MAP Guide, the basic information

required for loan origination by the Lender and for review by HUD staff.

• D. Bring Handbook and Notice instructions current and maintain

up-to-date instructions through amendments to the MAP Guide.

• E. Provide the Lender with predictable and consistent underwriting

guidelines, thus facilitating efficient processing and better service for borrowers.

59

How Does It Works (cont)

• Because HUD places confidence in the MAP lender’s integrity and competence, HUD

permits a MAP Lender to prepare much of the documentation for a loan submission for mortgage insurance, including critical underwriting analyses

• This being the case (and recognizing that HUD’s statutory, regulatory and contractual

arrangements leading up to a closing are almost exclusively with the lender), every MAP lender should be able to provide advice as to the best possible HUD loan program

• In theory, every MAP lender SHOULD
• come up with the same conclusions (e.g. loan amount, estimated timeframe for closing, etc.) with respect to a

particular set of facts and circumstances; and

• Be able to close and fund a given loan transaction within the same period of time

60

How Does It Works (cont)

• Unfortunately, this is not always true. Items which can

vary this are, among others

• The physical location of the MAP lender in relationship to the project

location and the applicable HUD insuring office

• The MAP lender’s familiarity with the applicable HUD insuring office
• The MAP lender’s experience with project location, type and unique

characteristics

• The MAP lender’s history with similar projects which may have gone into

default or experienced adverse circumstances

• The bureaucracy of the MAP lender which may require satisfaction of

tiers of review and the like

• Any limitation on the authority granted by HUD to the applicable MAP

lender

61

How Does It Works (cont)

• Once a loan program and MAP lender have been identified, the MAP lender

goes through a process intended to lead to HUD’s undertaking to insure a loan to be made by the MAP lender

• Depending upon the loan program selected, the application process

typically begins with a “concept” session with HUD---the so-called “Pre- Application” process

• Assuming that HUD likes what it sees and hears at the concept session, an

actual loan application may then be filed with HUD

• There are extensive items to be submitted to HUD with the MAP lender’s loan

application which are often time consuming and expensive to accumulate, including market studies, appraisals, engineering reviews and environmental

• reports. Fees are also due HUD at various stages through this process

62

How Does It Work (cont)

• HUD constantly reviews its standard processing time. Currently the following

apply (at least in theory) from the date of the filing of a complete application

• Pre-application----45 days
• Firm commitment-----60 days
• In fact,
• the average processing time (from submission to commitment Issuance) for the

223(f) and 223(a)(7) programs was 90 days FYE 2010 and 123 days FYE 2011. Time to Close (commitment issuance to closing) for this group was 70 days FYE 2010 and 72 FYE 2011

• For the 221(d)(4) program, the average processing time (from pre-app submission

to commitment issuance) was 235 days FYE 2010 and 284 days FYE 2011. Time to close was very comparable to 223(f) loans.

.

63

How Does It Works (cont)

• HUD does not allocate to the MAP lender complete underwriting responsibility—it reserves

to itself review and sign-off on certain matters including environmental consideration and the borrower’s fair marketing program for the project

• In practice, many HUD insuring offices second guess much of the MAP lender’s work in

putting together the application

• Assuming no adverse issues arise during HUD’s review of the application, the process

results in HUD’s issuance to the MAP lender of HUD’s commitment to insure the loan which permits the loan to be closed within a 90 day period (subject to extension) thereafter

• Note that with respect to certain types of loans, the local HUD insuring office must submit

the application to the National Loan Committee.

• Submitting to the National Loan Committee adds time and uncertainty to the process
• HUD is considering liberalizing those loan applications which need to be reviewed by this

process

64

How Does It Works (cont)

• This permits the parties to begin to prepare for closing; which consists, among other things, of
• Negotiating and entering into a loan commitment between the MAP lender and the

borrower

• While there are industry standards and customs which may apply, each MAP

lender’s loan commitment varies since, among other things, the ultimate source of funding of the loan is not know until the interest rate is locked

• Locking-in an interest rate for the loan
• MAP Lender’s counsel (with assistance from borrower and its counsel) prepares

drafts of all of the closing documents and accumulates all of the others closings items (the “Review Set”)

• The Review Set is then submitted to the applicable HUD insuring office for both

program (i.e., business) and legal review

• Once the Review Set is approved, the HUD insuring office schedules the closing
• It is hoped that the scheduled closing date is substantially prior to the expiration of

the HUD commitment and the MAP lender’s commitment

65

How Does It Works (cont)

• Current HUD’s procedures require that its review take no more than 20 days

following a complete submission of the Review Set. As a practical matter, it

• ften takes longer
• Given these time considerations, depending upon the complexity of the project, it is

reasonable to assume that the closing and funding of the loan will take not least than 6 months (and often much longer) from when the decision is made to pursue HUD- insured financing

• During this period any number of adverse circumstances may arise, such as
• Interests rates may increase from the interest rate used for purposes of the loan application
• Zoning or other government requirements may become more stringent and/or prior approvals may

expire

• Borrower’s principals/investors may have died, changed their minds about participating or incurred

adverse experiences with HUD

66

How Does It Works (cont)

• For LIHTC projects,
• Deadlines imposed by the allocator of the LIHTC may expire
• The LIHTC investor’s commitment to invest may expire
• Cost of construction/rehabilitation may increase with the general contractor not being willing to

stick with the originally guaranteed maximum upset price

• Tenants occupying the project will have changed, some of whom may not qualify to live in the

project post closing

• For projects to be acquired,
• Purchase Agreements may expire
• Fire or other casualty could affect the project
• Project occupancy or its physical condition may have soured
• As such HUD-insured financing is not for the faint of heart or for those in a hurry

67

Legal and Business Considerations

• HUD-insured financing is generally considered extremely favorable and,

during depressed economics times, may be the only financing available

• Several legal and business issues confront a potential HUD borrower and

there are some structuring approaches which may be beneficial when considering utilizing HUD-insured financing

• Legal and business considerations:
• HUD’s bureaucracy and the complexity of HUD’s programs
• HUD’s unwillingness to permit participation in its programs to those with adverse HUD or

conventional loan experience

• The need to integrate HUD’s rules and procedures with other sources of funds
• HUD’s unwillingness to negotiate or change its procedures, documents, funding mechanisms,

default consequences or items of the like in light of unique facts and circumstances

• An example of this is HUD’s required form of borrower’s opinion

68

Legal and Business Considerations (cont)

• In general, the lack of an efficient mechanism to appeal a decision made by a HUD insuring
• ffice
• The inability to lock in an interest rate much before closing
• The lack of a publicly available marketplace to determine whether a MAP lender is quoting

the very best interest rate and terms for the loan

• Possible large reserve requirements to assure the (i) availability of funds to make capital

improvements in the future and (ii) to overcome potential operating deficits

• Inflexibility dealing with troubled projects
• Serious civil and criminal sanctions for wrongful acts — See attached Exhibit A
• The inability to distribute or otherwise deal with the project’s revenue other than in

accordance with HUD’s rigid requirements; among other things, which are audited annually

• HUD conducts annual project and management inspections; adverse findings can have

serious consequences

• No junior financing permitted other than on VERY restricted terms
• Project must be managed by a HUD approved property management company
• Structural considerations
• HUD rules require that if surplus cash is not distributed as soon as it is deemed available for

distribution, it may not later be distributed if the loan subsequent goes into default or if certain other circumstances arise.

69

Legal and Business Considerations (cont)

• Since general partners are often reticent to distributing all the available

surplus cash to limited partners because they want to retain some for unknown future contingencies, consideration should be given to structuring the borrower entity with an entity as the limited partner, the general partner of which is the general partner (or an affiliate) of the general partner of the borrower

• HUD’s 2530 procedures impose sanctions on those with adverse HUD
• experience. In an effort to avoid damage to one’s track record with HUD,

some participants in HUD programs therefore prefer to be identified as a non-managing investor (or some such label)

• The lowest loan amount produced by using various criteria is how HUD

determines the size of the loan which it will insure.

• For new construction or substantial rehabilitation, the loan amount can

increase under certain circumstances if there exists an identity of interest between the owner/borrower and the general contractor

• Creating such an identity of interest is often done and terminated upon

completion of construction

70

Where We Are Today

• With national home ownership falling, multifamily development, both preservation and

new construction, is more important than ever. HUD sees itself as being a relevant not dominant player in this area

• For HUD’s 12 month fiscal year ending 9/30/11, HUD has estimated that HUD

programs represented approximately 20-25% of the multifamily finance market

• At 2/1/11 HUD had 823 loans in process and at 10/1/11, HUD had 690 loans in

process, with the fall-off seemingly attributable to a 2010 risk mitigation determination which imposes tough mortgage credit criteria on borrowers. Borrowers and lenders are becoming more comfortable with the new requirements so the volume is likely to pick up despite the new requirements

• New loan program procedures and loan documents became effective for HUD

commitments issued after 9/1/11 causing significant back-ups in processing and closing loans. It is estimated that it will take a year or more before this settles out

71

Exhibit A – Federal Statutes

EXHIBIT A FEDERAL STATUTES1 CRIMINAL STATUTES 1. Section 1715z-19, Title , U.S.C., "Equity Skimming Penalty", provides, among other things, whoever willfully uses or authorizes the use of any part of the rents, assets, proceeds, income or other funds derived from the property during a period when the mortgage note is in default or the Project is in a non-surplus cash position, for any purpose other than to meet actual or necessary expenses, shall be fined not more than $250,000 or imprisoned not more than 5 years, or both. 2. Section 1001, Title 18, U.S.C., "Fraud and False Statements", provides, among other things, that whoever knowingly and willingly makes or uses a document or writing containing any false, fictitious, or fraudulent statement or entry, in any matter within the jurisdiction of any department or agency of the United States, shall be fined not more than $10,000 or imprisoned for not more than five years, or both. 3. Section 1010, Title 18, of the U.S.C., "H.U.D. Transactions", makes it a criminal offense to make a willful false statement or misrepresentation to any Department or Agency of the United States as to any matter within its jurisdiction. 4. Section 1010, Title 18, U.S.C., "H.U.D. Transactions", provides, in part: "Whoever, for the purposes of...influencing in any way the action of such administration makes, passes, utters or publishes any statement knowing the same to be false...shall be fined not more than $5,000 or imprisonment of not more than two years, or both. 5. Section 1012, Title 18, U.S.C., "Department of Housing and Urban Development Transactions", provides in part: "Whoever, with intent to defraud, makes false entry in any book of the Department of Housing and Urban Development, makes any false report or statement to or for such Department...or whoever receives any compensation...with intent to defraud such Department or with intent unlawfully to defeat its purposes shall be fined not more than $1,000 or imprisoned not more than 1 year, or both.“

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Exhibit A – Federal Statutes – (cont)

EXHIBIT A FEDERAL STATUTES1 CIVIL STATUTES 1. Section 1715z-4a, Title 12, U.S.C., "Double Damages Remedy for Unauthorized Use of Multifamily Housing Projects Assets and Income," provides for a double damages civil remedy for the use of assets or income in violation of any Regulatory Agreement or any applicable HUD regulations. 2. Section 1735f-15, Title 12, U.S.C., "Civil Money Penalties Against Multifamily Mortgagors", provides, among other things, civil money penalties in addition to any other civil remedy or criminal penalty to be paid by the mortgagor through personal funds for (1) violation of agreement with HUD to use nonproject funds for certain specified needs of a project (e.g., payments to the replacement reserve account) as condition of receiving transfers of physical assets, flexible subsidy loan, capital improvement loan, modification of mortgage terms or workout agreement. The penalties can be as much as the amount of loss the Secretary would experience at foreclosure sale or sale after foreclosure and (2) certain specific violations of the regulatory agreement, the penalties can be as much as $25,000 for each

• ccurrence.

[1] This list is found on www.HUD.gov at http://www.hud.gov/offices/adm/hudclips/handbooks/hsgh/4370.2/43702x1HSGH.pdf

9890809

Multi-Family Affordable Housing: Legal Considerations Presentation April 10, 2013

Christopher L. LaGrand

Funding Sources Used in State Financings

• Tax-exempt and taxable bond proceeds (direct loans and conduit

loans)

• State Preservation funds
• State Reserve fund loans
• HOME Investment Partnerships (HOME)
• Neighborhood Stabilization Program (NSP)
• Community Development Block Grant (CDBG)
• HUD Hope VI/Replacement Housing Factor funds
• Project-based vouchers
• US Rural Development financing
• Commercial loan/development loan
• Low Income Housing Tax Credit (Housing Credit) equity
• Historic credit equity
• Brownfield equity

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State Housing Finance Agencies (HFAs)

• States have entities called Housing Finance Agencies

(HFA’s) that with a couple of program exceptions administer

• r

allocate the state housing financing resources.

• The District of Columbia, New York City, Puerto Rico, the

Virgin Islands and Guam also have similar HFA’s.

• While this presentation will focus on the programs

administered by the Michigan State Housing Development Authority, the HFA in Michigan, the HFA in your state or territory likely administers similar programs and activities in a similar manner.

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MSHDA History

• Established in 1966 as "an independent public body corporate and politic
• f the State of Michigan."
• Active in multi-family development during the 70’s and 80’s.

– This period of time has often been referred to as “the hey day of subsidized multi-family development”.

• Paired bonding through the 90’s and into the 00’s.

– The concept is to use savings from economic bond refundings and high interest rate multi-family mortgages to fund new multi-family production at below tax-exempt mortgage rates.

• MSHDA’s Homeownership program became a more meaningful program in

2005 when the State of Michigan increased our income and purchase price limits to closer match the federal limits.

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Direct Loan Programs

• The Authority has financed multi-family rental housing since 1966,

using the proceeds of tax-exempt and taxable bonds and other available moneys.

• During this period of time, the Authority has been able to finance

such housing through several federal housing programs.

• For these mortgage loans, the Authority generally charges an

interest rate that is below market. Most such mortgage loans participate in one or more of the federal tax credit programs.

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Direct Loan Programs: Parameters

• MSHDA offers tax-exempt and taxable loans for the development of

affordable rental housing. Loans will be provided to the extent the following objectives are met:

• 1. Create and preserve affordable rental housing that achieves at

least one of the following public benefits:

• Family units serving low-income households, or
• Senior housing, (excluding congregate transactions) including proposals

supporting successful aging in place, or

• Housing in rural communities, or
• Supportive housing integrated and supported by necessary services, or
• Workforce housing provided in high-cost areas, or
• Mixed and Adaptive Reuse buildings supporting downtown housing, or
• Meets the needs of Native American housing, or
• Produces any of the above in the context of another state or federal

program that meets any of the Authority’s other priorities. 78

Direct Loan Programs: Parameters continued

• 2. The housing must contribute to the strengthening
• f communities through site and design standards.
• 3. The longest term of affordability possible.
• 4. The loan must be a long-term earning asset.
• 5. Rehabilitation transactions must address the

physical needs of the property, including those directly related to the enhancement of resident livability and functionality.

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Conduit or Pass Through Loan Program

• The Authority provides "conduit" or "pass-through" bonds to

finance the construction and/or acquisition and rehabilitation of affordable rental housing for low-income Michigan households.

• These obligations are limited rather than general obligations of

the Authority, are not secured by the Authority's capital reserve capital account, and are not backed by the moral obligation of the state of Michigan.

• The bonds are secured solely by the project and some form of

credit enhancement provided by the borrower, and Authority staff does not underwrite these loans. This type of financing is commonly referred to as "pass-through" financing.

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Preservation Loan Programs

• Pursuant to the Preservation Programs, the Authority will

issue Bonds which will finance the acquisition and rehabilitation by new owners of existing properties which currently provide housing for low and moderate income individuals and families.

• If the related mortgage loans are prepaid from sources
• ther than the Authority, the rental restrictions that

currently apply to such properties may expire.

• In exchange for receiving Authority financing as part of the

Preservation Programs, the new owners will agree to extend the period of time during which rental restrictions will apply to the properties.

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MSHDA Operating fund and Reserve fund Loans

• In certain circumstances, MSHDA provides an
• perating fund or reserve fund loan to a

transaction.

• These loans are generally provided at prevailing

taxable municipal rates so as to provide the Authority with a reasonable opportunity to refinance the loans through a taxable bond issue at a later date.

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HOME Investment Partnerships Program (HOME)

• HOME is authorized under Title II of the Cranston-Gonzalez

National Affordable Housing Act, as amended. Program regulations are at 24 CFR Part 92.

• HOME provides formula grants to States and localities that

communities use-often in partnership with local nonprofit groups-to fund a wide range of activities that build, buy, and/or rehabilitate affordable housing for rent

• r

homeownership or provide direct rental assistance to low- income people.

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HOME Investment Partnerships Program (HOME)

• HOME is the largest Federal block grant to State and local governments designed

exclusively to create affordable housing for low-income households. Each year it allocates approximately $2 billion among the States and hundreds of localities

• nationwide. The program was designed to reinforce several important values and

principles of community development: – HOME's flexibility empowers people and communities to design and implement strategies tailored to their own needs and priorities. – HOME's emphasis on consolidated planning expands and strengthens partnerships among all levels of government and the private sector in the development of affordable housing. – HOME's technical assistance activities and set-aside for qualified community- based nonprofit housing groups builds the capacity of these partners. – HOME's requirement that participating jurisdictions (PJs) match 25 cents of every dollar in program funds mobilizes community resources in support of affordable housing. 84

Neighborhood Stabilization Program (NSP)

• NSP is administered by the U.S. Department of Housing and Urban Development (HUD) and

MSHDA to aid in the purchase of foreclosed or abandoned homes and to rehabilitate, resell, or redevelop these homes in order to stabilize neighborhoods and stem the decline of housing values of neighboring homes. There are three rounds of Neighborhood Stabilization Program funding:

• NSP1, a term that references the NSP funds authorized under the Housing and Economic

Recovery Act (HERA) of 2008, provided grants to all states and selected local governments on a formula basis;

• NSP2, a term that references the NSP funds authorized under the American Recovery and

Reinvestment Act (ARRA) of 2009, provided grants to states, local governments, nonprofits and consortia of entities on a competitive basis; and

• NSP3, authorized under the Wall Street Reform and Consumer Protection Act, will provide

funds on a formula basis to states and selected local governments. 85

Neighborhood Stabilization Program (NSP)

• MSHDA's combined funding from NSPI, NSP2 and NSP3 exceeds $327

million.

• MSHDA allocates the federal aid to assist local leaders in government,

planning and development throughout Michigan in their effort to rebuild and reinvent their communities.

• The $224 million Michigan received in 2010 through NSP2- the nation's

largest amount awarded to any single government entity - helped launch an unprecedented effort to remove blight and revitalize neighborhoods in 12 of the state's largest municipalities. The NSP2 funds are being used to acquire and develop more than 6,000 foreclosed, abandoned and vacant properties in Michigan, demolish 2,500 structures and rehabilitate or build 1,500 homes.

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Community Development Block Grant (CDBG)

• Community Development Block Grant Program: The Community Development Block

Grant (CDBG) program is a flexible program that provides communities with resources to address a wide range of unique community development needs. Beginning in 1974, the CDBG program is one of the longest continuously run programs at HUD. The CDBG program provides annual grants on a formula basis to 1209 general units of local government and States.

• The CDBG program works to ensure decent affordable housing, to provide services

to the most vulnerable in our communities, and to create jobs through the expansion and retention of businesses.

• The annual CDBG appropriation is allocated between States and local jurisdictions

called "non-entitlement" and "entitlement" communities respectively. States distribute CDBG funds to non-entitlement localities not qualified as entitlement communities.

• HUD determines the amount of each grant by using a formula comprised of several

measures of community need, including the extent of poverty, population, housing

• vercrowding, age of housing, and population growth lag in relationship to other

metropolitan areas. 87

HUD HOPE VI funds

• The HOPE VI program serves a vital role in the Department of Housing and

Urban Development's efforts to transform Public Housing.

• The specific elements of public housing transformation that have proven

key to HOPE VI include: – Changing the physical shape of public housing – Establishing positive incentives for resident self-sufficiency and comprehensive services that empower residents – Lessening concentrations of poverty by placing public housing in non-poverty neighborhoods and promoting mixed-income communities – Forging partnerships with other agencies, local governments, nonprofit organizations, and private businesses to leverage support and resources

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HUD HOPE VI funds

• Eligible Applicants: Any Public Housing Authority that has severely

distressed public housing units in its inventory is eligible to apply.

• HUD HOPE VI funds fund:

– Capital costs of major rehabilitation, new construction and other physical improvements – Demolition of severely distressed public housing – Acquisition of sites for off-site construction – Community and supportive service programs for residents, including those relocated as a result of revitalization efforts

• HUD HOPE VI funds provide assistance to smaller communities in the

development of affordable housing that is undertaken in connection with a Main Street revitalization effort.

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Replacement Housing Factor (RHF) Funding

• Capital Fund Grants that are awarded to PHAs that have removed units

from inventory for the sole purpose of developing new public housing

• units. The Capital Fund formula rule at 24 CFR 905.10(i) provides that a

PHA may receive RHF grants for public housing units demolished or sold for a period of up to five years. A PHA may only be given RHF funding for public housing units that have not already been funded for replacement public housing units under public housing development, Major Reconstruction of Obsolete Public Housing (MROP), HOPE VI, or any other programs that would otherwise provide replacement housing.

• What are the eligible uses of RHF funds?

A PHA may only develop or acquire public housing rental units with RHF

• funds. All replacement housing must be undertaken in accordance with

public housing development regulations found at 24 CFR Part 941, which includes requirements for mixed-finance development.

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Project-based vouchers

• Project-based vouchers are a component of a public housing

agencies (PHAs) 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 either rehabilitate or construct the units, or the owner agrees to set-aside a portion of the units in an existing development. Rehabilitated units must require at least $1,000 of rehabilitation per unit to be subsidized, and all units must meet HUD housing quality standards.

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USRD financing

• Section 515 of the Housing Act of 1949, as amended, (42 U.S.C.1485)

provides USDA Rural Development with the authority to make loans to any individual, corporation, association, trust, Indian Tribe, public or private nonprofit organization, which may include a faith-based or community organization, consumer cooperative, or partnership to provide rental or cooperative housing and related facilities in rural areas for very- low, low, or moderate income persons or families, including elderly persons and persons with disabilities. Rental assistance (RA) is a tenant subsidy for very-low and low-income families/persons residing in rural rental housing facilities with USDA Rural Development financing. $4.5 M in RA will be available for new construction in Fiscal Year (FY) 2013.

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Commercial loan/development loan

• Commercial banks, often through their Community Development Banking unit,
• ften offer and/or provide financing to support affordable housing developments.

These products include: – Multifamily Rental Housing lending – Construction and interim financing for rehabilitation and new construction of multifamily affordable rental housing. – Construction Financing – Loans for new construction and rehabilitation of residential and commercial properties. – Tax Credit Projects – Construction financing and bridge financing for development of affordable rental housing using low income housing tax credits. – Credit Enhancements – Letters of Credit and other products to support bond financing and/or other third party transactions. – New Markets Tax Credit Financing – Loans at below-market interest rates and equity-like financing for eligible projects, with a focus on commercial and non-profit projects.

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LIHTC equity

• Equity support for low income housing development is often

secured by forming a limited partnership that will own the property.

• In exchange for ownership of the vast majority of the interest in

the property, investors make periodic cash contributions during the construction period and/or during the early years of project

• peration.
• Contributions are made in exchange for the tax credits received
• ver the first 10 years of operation. In addition, the investors may

pay for any other benefits of ownership, which can include excess cash flow that may be experienced, any surplus depreciation generated by the development, and any residual value the property may have when it is sold.

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Historic credit equity

• Owners of historic properties may be eligible for an income tax credit when they

rehabilitate their historic property per U. S. Department of Interior standards. On federally-approved rehabilitations, owners can receive a one-time credit against federal income taxes owed equal to 20% of the cost of the project's qualified rehabilitation expenditures. To qualify: – The property must have an income-producing end use, i.e., commercial, retail, office, rental residential, or industrial; or be used in the owner's business; – the property must be listed individually on the National Register of Historic Places, OR qualify as a contributing structure in a designated National Register historic district; – the property owner must exceed the adjusted basis of the property on the cost of rehabilitation; – the proposed rehabilitation must meet historic design guidelines for the program as outlined in the Secretary of the Interior Standards for Rehabilitation.

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Historic credit equity: state

Thirty states have established state historic tax credits to provide additional financial incentives for the rehabilitation of historic properties. Most of the state programs are based on the federal historic rehabilitation tax credit program, although application processes, award amounts, and award procedures vary by state. State historic tax credits can be used in conjunction with the federal credits for income-producing properties. Many state programs also offer historic tax credits for rehabilitation of owner occupied residential properties.

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Brownfield equity

Tax-based programs help a brownfield project’s cash flow by allowing resources normally spent to pay taxes to be used for site assessment or cleanup. This can help site redevelopers find financing to address contaminated properties.

• Most brownfield-related tax incentives aim to offset cleanup costs or provide a buffer against

increases in property values that would raise tax assessments before the site preparation costs are paid off. About half of the states offer some type of tax incentive, including:

• Deferral of increased property taxes (North Carolina, Texas, and Connecticut);
• Remediation tax credits (Illinois, Ohio, and Wisconsin);
• Property tax abatements for prospective purchasers taking sites through a state

voluntary cleanup program (Kentucky);

• Cancellation of back taxes (Wisconsin);
• Rebates of sales taxes to offset cleanup costs (New Jersey);
• Tax incentive “menu” to enhance redevelopment financial flexibility (Missouri);
• Job creation and affordable housing tax incentive “bonuses” (Florida); and
• Business tax offset (Michigan). [Recent change in law to direct grant program]

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Contact Information

Christopher L. LaGrand Deputy Director for Housing Development Michigan State Housing Development Authority 735 East Michigan Avenue Lansing, MI 48912 Rental Development Division Main Phone: 517-373-6880 Direct Phone: 517-373-6010 E-mail: lagrandc@michigan.gov

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