Income Averaging
By Pamela Martineau
8 min read
Broadening Eligibility in Affordable Housing Communities
Income averaging allows affordable housing developers to expand the range of people on the income strata who are eligible to live in affordable communities, while also helping projects pencil out. Administering income averaging can be tricky at times, although recent guidance by the Internal Revenue Service has helped allay concerns among many lenders and investors.
That’s the general perspective of affordable housing developers contacted for this story who use income averaging for some of their properties. Included in provisions in the Consolidated Appropriations Act of 2018, income averaging has been called a game changer for developers of Low Income Housing Tax Credit projects.
“Income averaging widens the affordability band of eligible residents who qualify (for a project),” explains Geoff Brown, president and chief executive officer of USA Properties Fund. “Anytime you can widen the income band within your community, you get more demand. We traditionally have had to turn away over-income people who want to live in our communities. With income averaging, you alleviate that. People with higher incomes are eligible to live in our communities as long as we offset them with lower income residents.”
Brown adds that people at lower income levels—such as 30 to 40 percent area median income—also are helped.
“You can capture more people at 30 to 40 percent AMI and make the deal work,” Brown says. “You don’t have to design your project any differently. It’s an opportunity to widen the income band.”
Income Averaging: An Explainer
Historically, the LIHTC program served families with incomes below 60 percent AMI. Income averaging allows for the averaging of incomes up to 80 percent AMI in a project, or as low as 30 percent AMI, as long as the average stays below 60 percent AMI. In many projects, the higher rents paid by households with somewhat higher incomes help allow families in lower income brackets, such as 30 to 40 percent AMI, to also live in the project. The higher rents also help the project break even.
Income averaging was intended, in part, to create greater income diversity in projects, while also opening housing pathways to working families making more than 60 percent AMI, such as earners at 70 or 80 percent AMI.
“It creates benefit in two ways,” explains Brian McGeady, managing partner at Pivotal Housing Partners. “It broadens the market, meaning if you are in a location that has a lot of people over 60 percent AMI, you broaden the marketplace you can serve. It also can potentially generate more rent, depending on the market location.”
McGeady says Pivotal operates a “handful” of projects that use income averaging. Pivotal wanted to do more projects with income averaging, but investors and lenders were initially concerned about the practice before the IRS came out with clearer guidelines on the rules in October 2022.
Prior to the IRS clarifying guidance, lenders and investors were concerned that if a person or family in one unit started earning over the AMI they had when they previously qualified, it could blow up the eligibility for the entire project by failing the Average Income Test (AIT). McGeady says investors are feeling more comfortable after the IRS clarification that such a scenario would not throw the whole project out of compliance, causing investors to lose tax credits.
“The risk of income averaging is that if you fall out of compliance, investors will lose their tax credits,” explains Peter Brehm, director of finance for Kittle Property Group, Inc. Kittle has a portfolio of about six projects with 1,500 units that use income averaging.
Most developers like to keep the average incomes at these properties around 57 to 59 percent to avoid going over 60 percent AMI should one or two units go over their stated income level.
Mike Roderer, senior vice president for development at Kittle Property Group, Inc., says income averaging has been a benefit for development projects.
“However, for capital and compliance, it has been more of a challenge,” Roderer adds.
Greater Challenges Including Market-Rate Units
Including market-rate units in a community that uses income averaging involves a complicated compliance process that makes some affordable housing developers avoid the practice. Projects with market-rate units must use the “next available unit rule” with income averaging. Under this rule, the amount of LIHTCs allowed on a project is driven by the building’s eligible basis and applicable fraction. The applicable fraction is the percentage of rental units in a building that qualify as low-income. It is calculated using either the number of low-income units or their square footage.
Ensuring that a project with market-rate units stays in compliance with LIHTC rules is a complicated matrix in which compliance teams must carefully monitor residents’ incomes, as well as the number and square footage of units in a project. If a household’s income exceeds 140 percent of the applicable income limit, the unit is considered over-income and all next available units in the building of smaller or comparable size must be leased to a low-income household until the applicable fraction can be met.
McGeady, of Pivotal, says his company won’t include market-rate units in income-averaging projects because the process is so complex and difficult to oversee.
“It is complicated to track,” says McGeady. “It can be done, but it is something we prefer not to do until we get a better handle on what it would look like…If you are doing all affordable units, it is straight income averaging and it is not that complicated. It is easy to use.”
McGeady says Pivotal will watch how other companies fare using market-rate units in income averaging and will reassess to see if his company might try it.
Serving A Wider Range of Brackets
Roderer, at Kittle, says income averaging has opened markets for affordable housing developers that might not otherwise have been viable. In some markets, there might not be enough demand for units at 60 percent AMI, but when 70 or 80, 30 or 40 percent AMI are factored in, the projects work. The projects work in part because there is such high demand for housing among those income brackets. Serving a wider range of residents also helps with local acceptance and funding.
Roderer says income averaging has been a helpful tool in communities where stakeholders are supportive of workforce housing, but also want residents with lower incomes served. Many funders, such as local governments, bonds or Qualified Allocation Plans, require that a project serve residents at 30, 40 or 50 percent AMI.
“The ability to get 70 or 80 percent AMI in those projects will improve your revenue stream,” McGeady says.
McGeady adds that income averaging also allows LIHTC projects to serve the “lost middle in the 60 to 80 percent AMI.
“If you look at how quickly market and rental rates have accelerated over the last several years, that lost middle in the 60 to 80 percent AMI range is in a tough spot,” he says. “They can’t qualify for most affordable properties and market-rate rents are now $600 to $700 more. Income averaging gives people in that 60 to 80 percent band more access to stable housing.”
Brown says that USA Properties believes strongly in the “fundamental philosophy” of income averaging.
“It has been a tremendously positive thing for the industry that allows developers more flexibility for their communities,” says Brown. “It allows developers to serve residents at higher incomes, where there is great need, and at lower incomes where there is also great need.
“Keep in mind that in this tight labor market, you have people with wages rising,” adds Brown. “Their wages are going over 60 percent AMI and they still need housing.”
Brown says that at the Vintage at Sycamore Project—a 99-unit affordable senior apartment community in Simi Valley—USA Properties “rented the 70 percent units just as fast as the 30 and 50.”
“It proves that there is big demand beyond our 60 percent units for affordable housing,” says Brown.
McGeady stresses that income averaging allows affordable housing developers to meet their mission of “providing a stable, safe place to live that gives our residents peace of mind.”
“We can provide stable housing and take that stress out of people’s lives,” he says. “There are a lot of benefits to physical health when you have stable housing.”
Brown says he hopes the IRS will continue to do everything it can to help investors feel comfortable with income averaging, “so they don’t feel any more risk than with a traditional affordable housing structure.” Although the compliance guidance the IRS issued in October 2022 “makes investors more comfortable now to invest,” he adds.
