Preservation’s Double Whammy

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5 min read

When low-income housing tax credit prices stratify – as they now are – and overall demand shrinks – as it now has – fissures open up in the marketplace. Some mixes of location, income band, and financing strategy that used to work in the happy Before Time no longer work in the Now. One such, near and dear to my heart and that of this issue’s readers, is preservation, being hit by a double whammy.

With weakening markets, preservation is more important than ever.

Preservation’s financing model – volume-cap tax-exempt bonds plus 4% as-of-right LIHTC – isn’t working at all.

Preservation is more important than ever.

With aggregate national housing demand flat or even shrinking (a byproduct of the recession), we don’t need more apartments in this country – we need more affordable apartments.

Although the current single-family weakness is creating apparent affordability in many places, this is a public-policy illusion, for what is affordable is in the wrong place, or the wrong income level, or the wrong physical configuration (single-family dwellings instead of more efficient multi-apartment buildings) and transitory. Homes constructed and sold may later be foreclosed upon and then rented for a while, but they will soon return to be owner-occupied, leaving those who need affordable or workforce housing out of luck.

New production may be the answer in some places and some niches (e.g., workforce housing in strong urban markets), but in the main, we need to reinvest in what we have, particularly with some judicious triage and selection.

That’s especially true for the LIHTC, both politically and socioeconomically, for several reasons:

  • Politically, LIHTC works because it is allocated based on current population, not growth in population. All too many housing programs have polarized, and excessive partisanship is a precursor to program extinction. By funding preservation, LIHTC assures that America’s rural Senators and Representatives see it work in their states and districts, a critical factor in the program’s unprecedented longevity and support in shifting political environments. The LIHTC dollar also goes further in the preservation states. High-growth markets like San Francisco, New York City, and Boston may get all the press, but the bang for the buck happens in low-growth states.
  • Socio-economically, no-sea no-sun no-CRA states that ordinarily would attract little Federal resources can use LIHTC to preserve, via acquisition-rehabilitation, their better properties in their urban cores. With much of non-coastal America showing level population, the LIHTC allows old obsolescent properties – trailer parks, outmoded HUD or RHS properties, bad public housing – to be reborn as LIHTC mixed-income mixed-finance preservation properties with new mission-oriented owners. That also means a flow of construction dollars into weak-economy states that otherwise would have enormous difficulty attracting inward investment.

Preservation’s volume-cap financing model isn’t working at all

For a dozen years, starting in roughly 1997, volume-cap bonds plus as-of-right 4% LIHTC worked quite well for normal acquisition-rehab properties, because the inventory that could be acquired was compatible with the implied financing assumptions:

  • Net Operating Income implies income levels 50-60% Area Median Income. To pay debt service on the volume-cap bonds, one needed positive NOI, and with the prevalent rates, income levels in the 50-60% AMI range – which worked for much of America.
  • The major cost was acquisition, not rehab. 4% LIHTC equity tends to fund 20-25% of the total acquisition cost, leaving the rest to be financed with debt. This in turn kept rehab in the $10,000-20,000 per apartment range, which seemed sufficient.
  • Losses were good – because they reduced taxes payable.

Today, sponsors trying to make the deal pencil have been pushed to trim rehab to what the financing can sustain, rather than what the property really needs. The resulting rehab, nicknamed  “rinse-and-hold,” is predicated on strong markets and rising cash flow, to do over time what should have been done up front. It’s proven shortsighted and has been discredited.  Meanwhile losses are bad (they reduce GAAP earnings), consolidation (FIN 46) is worse, and very few people will buy 4% credits.

Developers with acquisition properties in the disrupted pipeline have been patching their sources with gap fillers (TCAP or state-level resources) but these won’t be enough because they’re finite.

Where does that leave preservation?

Unhappily, nowhere. Right now preservation is being selected against by the arithmetic of a legacy financing structure, an utterly brainless outcome that strands much of the country without a tool for its most urgent affordable housing need. If preservation matters – and it does – we had better very quickly design a financing alternative to volume-cap to which we can attach the 4% LIHTC.

Build America Bonds, anyone?

Got a question you’re burning to have answered?  Email it to [email protected].

David A. Smith is CEO of CAS Financial Advisory Services, a Boston-based firm that optimizes the value of clients’ financial assets in multifamily residential properties, particularly affordable housing. He also writes CAS Financial’s free monthly essay State of the Market, available by emailing [email protected].