Opportunities Exist for Turning Around Distressed Projects Using LIHTCs, Other Resources
By Caitlin Jones & A. J. Johnson
10 min read
The low-income housing tax credit (LIHTC) and other federal resources offer potential ways to turn distressed real estate assets into viable affordable rental housing projects, according to speakers at a recent conference. These potential new deals even include troubled LIHTC properties now in their 10-year tax credit period.
In addition to the LIHTC, other federal resources mentioned included the “Mark-to-Market” program and fledgling Neighborhood Stabilization Program (NSP).
The speakers made their comments 10/28/08 on a panel at the National Housing & Rehabilitation Association’s 2008 Fall Forum conference in Boston, MA.
Opportunities Under NSP
Under NSP, $3.92 billion in federal grants has been allocated to states and localities with high home foreclosure rates, high levels of sub-prime loans, and high percentages of at-risk mortgages, to enable them to fund projects to purchase and redevelop foreclosed and abandoned homes and certain other properties in distressed neighborhoods, in order to help to help stabilize these communities.
Properties can be acquired for resale, rental, or redevelopment. The U.S. Department of Housing and Urban Development (HUD), which runs the program, recently announced the 308 grantees (all 50 states plus numerous cities and counties), grant amounts, program requirements, and timetable. Grantees have until 12/1/08 to finalize their plans detailing how they plan to spend their grants.
Grantees are mostly expected to focus the spending on projects to purchase, renovate, and redevelop foreclosed homes for re-sale, rental, or other eligible uses. However, Washington, DC attorney Mary Grace Folwell, of the law firm of Ballard Spahr Andews & Ingersoll, LLP, pointed out possible opportunities for use of NSP funds for LIHTC projects – both pending pipeline deals that already have credit awards, and new projects.
“Two requirements of these funds make it a possibility, an opportunity, to help tax credit projects in the pipeline that need a little gap financing,” she said. First, the program has a tight timetable and mandates compliance with HUD procurement and environmental review requirements for NSP-funded projects. Folwell noted grantees have but 18 months to obligate their grant funds to specific projects, and that LIHTC projects typically satisfy HUD procurement and environmental projects anyway.
Equally important, she noted each grantee must spend 25% of its allocation to serve households at 50% or less of the area median income (AMI), and that HUD has urged localities to look at spending some of their funds on rental projects. “Existing (LIHTC) projects in the pipeline would be a very easy way” for grantees to meet this requirement, Folwell said. She recommended that developers who have pending LIHTC projects in qualified distressed neighborhoods alert the NSP grantee of this fact.
Folwell said it will depend on the specifics of each grantee’s plan as to whether there are opportunities for use of NSP funds for LIHTC projects in a particular area. But she indicated that support for LIHTC projects is possible under several of the program’s eligible uses of funds. One is for the purchase and rehabilitation of foreclosed or abandoned homes and residential properties (including multifamily housing). A second is for the purchase and redevelopment of “blighted” existing structures, which don’t necessarily have to be foreclosed or abandoned.
Folwell, though, suggested the best “opening” for LIHTC projects is under a final eligible use, for redevelopment and demolition of vacant properties. She noted, for example, that NPS funds could be used to help finance construction of a new LIHTC project on a vacant site in a highly distressed neighborhood. Folwell said HUD has noted that properties don’t have to be foreclosed or abandoned under this particular use, but that funding for rehabilitation costs isn’t permitted. Funds used for demolition can only be for blighted structures.
Another possible use of NSP funds would be for bulk purchases of multiple foreclosed homes for redevelopment into scattered-site rental housing using the LIHTC. However, there are a number of obstacles to these deals, including lack of interest by tax credit equity sources.
Folwell noted enormous sums of money will be available under the program. California and its local grantees have an aggregate allocation of $525 million, for instance.
HUD has created a Web page that has a list of grantees, program requirements, and links to other resources. (http://www.hud.gov/ offices/cpd/communitydevelopment/ programs/neighborhoodspg/). A number of grantees have posted their draft action plans online.
“˜Gold’ in Failed Condos
WinnDevelopment, a Boston-based developer, owner, and manager of affordable and market-rate multifamily housing, has selectively mined gold from failed condominium projects. To do so, it has acquired completed or nearly completed projects at a sharply reduced price, brought in the LIHTC and other resources, and converted these properties into affordable or mixed-income apartment deals.
Larry Curtis, managing partner of WinnDevelopment, said failed condo projects are generally well-built and well-located with high-quality units. “Good developers build a lot of good buildings; they just had bad timing,” he noted. “We basically see people building inventory for us to buy at a later date, and turn into rental housing, often utilizing [the] housing programs du jour.”
Curtis said “positives” from the creation of affordable rental housing from failed condo projects include: less risk to the developer and lower cost than building new; “immediately deliverable” housing credits for investors; instant affordable housing for the community; and no “NIMBYism” issue. “It’s hard to say that the building is going to ruin the neighborhood when the building is already there,” he noted.
As an example of the opportunity in this area, Curtis described Winn’s new Parkway Heights development in Everett, MA, five miles north of downtown Boston. The original developer completed the mid-rise building for $10 million, intending to sell it out as $350,000 luxury condos, but failed when the market soured. Winn paid roughly $2.1 million for the property, after the developer agreed to a sharp write down in his original equity investment, and Winn paid a loan prepayment fee on behalf of the developer to the mortgage lender. Winn obtained a new first mortgage of $5.9 million from the Massachusetts Housing Partnership, supportable from 25% of the property’s projected rental income, and funded the rest of the $23.8 million project cost from roughly $15.3 million in equity raised from obtaining and selling federal and state housing tax credits, and nearly $2.5 million in original owner equity. Winn opened the mid-rise building as a mixed-income apartment project, with 74 one- and two-bedroom units. Forty-seven are tax credit units, with an average monthly rent of $1,088, limited to households at or below 60% of area median income. The remaining 27 are market-rate apartments averaging $1,600 per month in rent. Amenities include an indoor parking garage, stainless steel appliances, granite countertops, and walk-in closets. The project’s annual net operating income is $528,030, according to Winn’s 2009 stabilized budget.
Curtis said key to the deal was the fact that the original developer had not yet placed the condo project in service. As a result, Winn, for federal tax purposes, was able to “step into the shoes” of the original developer and assume his project costs, thereby maximizing the housing credits received. Panel moderator and Bethesda, MD CPA David Reznick, of Reznick Group, an accounting and consulting firm, stressed the importance of Winn’s being able to step into the shoes of the original sponsor and thereby preserve the eligibility of the project for housing credits. He noted lenders can unwittingly cause an empty failed condo project to become ineligible for LIHTCs down the road if they permit units to be rented, because the property then is treated as having been placed in service. Reznick advised LIHTC developers eyeing a failed condo property to warn the lender about this potential pitfall, regardless of whether the lender accepts their proposed purchase price for the building.
(For story on another condo redevelopment project by Winn, see Tax Credit Advisor, November 2007, p. 1.)
Mark-to-Market
Another potential tool for turning around certain troubled multifamily apartment assets, including existing LIHTC projects, is HUD’s Mark-to-Market (M2M) program, said Washington, DC attorney Monica Sussman, a partner in the law firm of Nixon Peabody LLP.
To be eligible for M2M, projects must have a HUD-insured mortgage and project-based Section 8 rental assistance (not vouchers). One subset of M2M, a Mark-Down-to-Market transaction with debt restructuring, is especially valuable for situations where a project has run into financial difficulties from surrounding conventional rents falling below the project’s Section 8 rents. In this kind of transaction, HUD replaces the existing HUD mortgage with a new, smaller first mortgage, sized to the reduced income from the lowered Section 8 rents, and issues a note for the remainder of the outstanding mortgage balance. The amount of subordinate debt can be increased above this level, such as if additional debt is needed to finance planned renovations to the property. If the project is to be transferred (i.e. sold) to a nonprofit buyer as part of this transaction, HUD transfers the subordinate debt note to the nonprofit, which it can forgive if it wishes.
Sussman said there is an opportunity for developers to do a tax credit transaction post Mark-to-Market. Even though the nonprofit must be the general partner in the new project partnership, she said a for-profit developer can be a special limited partner in the transaction, and collect a developer’s fee, management fee, etc.
Sussman said M2M can also be used to restore financial viability to a troubled existing LIHTC project, and facilitate the owner’s exit from the project, if desired.
As an example, Sussman described an existing project for which HUD approval is being sought for a Mark-Down-to-Market with debt restructuring transaction. The tax-exempt bond-financed LIHTC project, now in the eighth year of its tax credit period, has 800 total units, of which around 600 have project-based Section 8. The property has been squeezed financially as surrounding conventional rents have dropped, to the point where the owner has been covering the operating deficit. In this situation, Mark-Down-to-Market with debt restructuring is envisioned as the solution to the present difficulties, and to enable the owner, who’s no longer in the affordable housing business, to stop feeding the project and exit from it.
Reznick noted this transaction also would be a “salvation” for the tax credit investor in this particular project, preventing a potential foreclosure and tax credit recapture event.
Sussman said that the parties to the original project (HUD, bond issuer, tax credit agency) have all indicated a willingness to take steps and make accommodations to support the proposed transaction.
Reznick and Sussman said a second time through the M2M process can also be a way to restore financial viability to a project that went through M2M before, but which has since stumbled, such as the result of weak original underwriting or too little rehab.
Finally, Sussman said an owner can not only repeat the M2M process for a property, but can also request HUD approval for an “additional funds” transaction, to generate additional dollars to pay for renovations or other enhancements to a property. One possible source of the additional funds is housing credit equity.
