Three Decades of Qualified Contracts
By Abram Mamet
10 min read
Impacts and Solutions for the Extended-Use Period
When the Low Income Housing Tax Credit program was created in 1986, it was a far cry from the robust development engine it is today. As the program developed, Congress sought to strengthen its impact and broaden its appeal, and by 1990 it had lengthened affordability requirements from 15 years to 30 years (with the first 15 years known as the initial compliance period, and the latter 15 known as the extended use period), while also building in a release valve for owners to leave the LIHTC program early.
This early exit process—known as a Qualified Contract (QC)—allows owners to file with their state or local Housing Finance Agency (HFA) and offer their property for sale based on a regulated value formula (the formula to determine the price of the property is a federal statute, meaning that any changes to this formula must be made by Congress). If purchased, a new owner would be bound to existing LIHTC compliance for the remainder of the property’s extended use period. Critically, however, if the property did not sell after a year on the market, affordability requirements would be lifted, and the owner could begin charging market-rate rents to tenants after a three-year transition period. Existing tenants unable to afford the new unrestricted rents could be displaced after a three-year period.
Though originally intended as an emergency measure for owners in need to exit the affordable market, it has today become a pathway for owners looking to exit the LIHTC program early by either selling subsidized properties at well-above market value or converting affordable housing into market-rate units well before the expiration of the property’s extended use period.
The Rise of Qualified Contracts
Until very recently, QC activity was rather limited and was simply not on advocates’ minds as a significant threat to existing affordable housing stock. In August 2012, the Department of Housing and Urban Development issued a report that widely dismissed QCs. “Perhaps because it is so complex and uncertain,” the report states, “the syndicators and experts interviewed for this study report that the QC process has rarely been used.”
In the decade since HUD’s report, however, QC activity has increased substantially. According to a National Council of State Housing Agencies (NCSHA) survey of state agencies, over 110,000 LIHTC-funded homes have been lost due to QC activity since the process was implemented in 1990; by 2016, QCs were causing a loss of about 10,000 units annually.
This number may not seem staggering at first. However, according to NCSHA, between 100,000 and 150,000 affordable units are constructed per year through the LIHTC program, meaning that QCs cause an immediate loss of at least 1/10 of the new and rehabbed units financed. Further, it is critical to understand that these are homes “for families,” says Moha Thakur, public policy and Mid-Atlantic Initiatives manager at the National Housing Trust (NHT). “That gets lost in the conversation about numbers. It’s not just 10,000 homes a year being lost. Yes, that’s a big number. But that’s also 10,000 families that are losing their homes.”
This is “the exact opposite” of the original intent of the Qualified Contract, says Jennifer Schwartz, director of tax and housing advocacy for NCSHA. Rather, by design, it used a complicated formula to determine the value of the QC property being placed on the market, with the intention to arrive at a modest number that would limit owners’ and investors’ returns. This formula is, in large part, derived from the original equity contribution of an investor, which was approximately 43 to 50 cents per dollar when the QC option was added to the tax code. However, as the LIHTC program quickly gained steam and popularity, prices for credits nearly doubled to between 90 and 95 cents per dollar, causing consistently inflated QC valuations.
This inflated valuation means that owners and investors either receive a substantial windfall upon sale or can exit the LIHTC program and begin charging market rent with no other penalties and the full program subsidy already in hand. “No one thought that this was going to provide this kind of windfall to investors,” says Schwartz.
The Push for Preservation
States and advocates are not without recourse, and there is robust activity aimed at mitigating the impact of QCs and preserving desperately needed affordable housing.
States are often at the front lines in the push to keep developers from exiting LIHTC affordability restrictions early using QCs, as they generally administer the tax credit and determine many of the administrative rules surrounding it. In recent years, that activity has been robust, and today, a vast majority of states either require or strongly incentivize developers to waive their right to file a QC in order to qualify for housing credits. According to an NHT analysis from earlier this year, 32 HFAs require an owner receiving housing credits to waive their right to a QC, while 12 others incentivize the waiver during the application process.
Though states utilize a variety of strategies to limit QC activity, Thakur says that the most effective is an explicit waiver within a state’s Qualified Allocation Plan (QAP). “The beauty of the LIHTC program is that it allows each state to adapt the QAP to its priorities and policies…and a developer upon receiving Housing Credits is agreeing to those terms [of the QAP].”
So, by including the waiver in the QAP, Thakur says, agencies can use their Housing Credit allocations to discourage or outright prohibit QCs, thereby ensuring that housing remains affordable for people.
However, even though many states have largely guarded against future properties’ ability to file for a QC, many properties were placed in service before QC waivers were required, thereby maintaining the threat that a substantial number of affordable units will convert to market-rate in years to come. Thus, says Schwartz, although there are guards against QC activity in the long-term, there is a real short-term likelihood that “we will have a lot of units lost in the meantime.”
Schwartz points to critical steps that the National Council of State Housing Agencies (NCSHA) encourages states to take to protect their existing housing stock from being lost to QCs. “States can increase their fees for filing for a QC, implement negative points if a developer is going to come back into the Housing Credit program if they’ve gone through a QC and work with the accountant who’s determining the QC price (which is based off of the formula, but of course because there is a formula, that can be challenged).” Still, Schwartz says, “the most powerful thing is just to not have that right to begin with.”
In harmony with states, mission-driven developers can also be powerful actors in the effort to preserve affordable housing by either stepping in to purchase the property or putting in a bid and triggering mandatory affordability requirements for the rest of the extended use period.
This intervention is fairly straightforward, says Thom Amdur, senior vice president of policy and impact at Lincoln Avenue Communities. “It’s a public process. When an owner files a QC with the state, the state calculates the formula price and then it gets put out to market for a year, during which time they engage a broker to market the property. The goal is to find someone to purchase the property at the QC price. Of course, the owner can decide whether to accept or not accept it. They’re not forced to. But if there is an offer and they decide not to accept the price, then it remains affordable through the end of its extended use period.”
Through this process of monitoring and intervention, Amdur says that Lincoln Avenue Communities has preserved more than 5,000 units of affordable housing from QCs across the country.
The biggest challenge to this kind of intervention seems to be the consistently inflated valuation of QCs, which prevents preservation developers from acquiring many QC properties. “For NHT as a nonprofit organization,” says Thakur, “I think we’re limited—as many nonprofits are—in terms of what our capacity is to buy a property that is valued greater than its actual value.
The Future of Qualified Contracts
Today, the QC environment is mixed. Certain states that have had QC restrictions for decades—such as California and Texas—have required owners to waive their right to a QC. In many cases, states with these long-standing policies have “never had a QC happen,” says Schwartz. However, in others, an increasingly difficult cost environment has caused a noticeable increase in owners filing for QCs. Georgia seems like a “ground zero” for the recent wave of QC applicants, says Amdur. Because the state didn’t have the waiver requirement until 2010, many properties that are now coming up on Year 15 are still able to file for a QC, since they were placed in service before the waiver was required.
Why Georgia is being hard hit is hard to know, says Amdur. Even within the state, there are not necessarily geographical trends or clusters of communities—such as the rent-spiking Atlanta metro—where most of the QC activity is concentrated. “It’s a real mix of properties and a mix of owners that have pursued it. So, I haven’t seen a pattern per se, at least from the publicly available data I’ve looked at, that would indicate a specific driving factor.”
“Most state QAPs prioritize preservation resources like private activity bonds and trust funds for older, HUD- assisted properties, limiting the amount of resources available for preservation developers like Lincoln Avenue Communities to acquire and extend affordability at QC properties. To Georgia Department of Community Affairs’ credit, they are currently in the process of updating their QAP to prioritize preservation funding to preserve properties that have filed for a QC.”
What is clear, however, is that as the cost environment for market-rate housing becomes more challenging, more eyes are on subsidized affordable housing as a strong, dependable investment. This increased economic attention ratchets up the pressure on LIHTC developments to not only serve their initial function of providing high-quality housing but also to provide investors with solid returns. “It used to be that very few properties were going through QC,” notes Schwartz, “because the market value wasn’t as high as it is now. Multifamily housing has become a much more valuable asset class over the last decade than it had been before.”
This means that, occasionally, “a small number of equity investors and other players in the market might pressure their general partners to pursue QCs, and maybe they have some forced-sale rights in their Limited Partnership Agreement to do so,” says Amdur. So even if it’s not the first choice of the general partner, the property may become vulnerable to the QC process.
This makes the preservation of those properties even more critical. “Generally speaking, the projects that have sought QCs are the most valuable from an economic standpoint. And from a community standpoint, those are valuable assets. Those tend to be in communities where there’s a big differential between the market rent and affordable rents. So those are very high-impact preservation opportunities.”
What Are Qualified Contracts?
The Qualified Contract process—laid out in IRC §42—allows for an owner of a Low Income Housing Tax Credit-funded development to opt out of the LIHTC program after Year 15 by filing a notice with their state Housing Finance Agency and placing the property on the market using a pre-determined formula. If the property does not sell within a year, then the owner is released from LIHTC restrictions.
