Tax-Exempt Debt, Housing Credits Allow Mixed-Finance Renovation of Small Public Housing Property
By Caitlin Jones & A. J. Johnson
10 min read
THE USE OF HOUSING credits and a little-known Fannie Mae program is enabling a public housing agency in Jackson, TN, to fund the comprehensive rehabilitation of an older small public housing property for elderly and disabled residents.
In a pioneer transaction sources say is replicable by others, the Jackson Housing Authority ( JHA) has borrowed against future capital funds it expects to receive from the U.S. Department of Housing and Urban Development (HUD), under the Department’s Capital Fund Financing Program. But instead of just using its capital funds alone, JHA leveraged them to obtain taxexempt debt that simultaneously qualified the deal for 4% housing credits for acquisition and rehabilitation expenditures for the project.
“Had it not been for the tax credits,” said JHA Executive Director Winston Henning, “we would only have been able to do about 50% of the work that we’re doing. Tax credits were crucial to the project.”
The McMillan Towers project, located in a city of 60,000 about midway between Memphis and Nashville, was described in recent interviews with the Tax Credit Advisor by Henning and other participants in the transaction: Thomas Nutt-Powell, of Capital Needs Unlimited, a Housing- Solutions member firm, Brookline, MA; CPA John Mackey, Reznick Group, Boston, MA; Eileen Neely, asset management director, Fannie Mae,Washington, DC; Boston attorney John Achatz, of counsel, Klein Hornig; and syndicators Lori Surdel and Brenda Champy, of Boston Capital Partners, Boston.
Rehabilitation, Reconfiguration
The nearly $13 million transaction will rehabilitate and preserve McMillan Towers, a 35-year-old public housing property made up of two eight-story towers connected by a common elevator bank. Roughly $6.7 million in construction will be done, including replacement of the elevators and roof, refurbishing of apartments and common areas, and other work. The number and mix of units will change in a reconfiguration designed to make the property more marketable, from the current 151 units (89 studios, 59 one-bedrooms, 3 two-bedrooms), to 124 units (7 studios, 114 one-bedrooms, 3 two-bedrooms).
Henning said the work will be done in stages. Renovations have begun on one tower that has been emptied. As each floor is finished, JHA will move in residents, including from the second tower. Once the second tower is vacant, work will begin on it. Henning said the goal is to have the property 95% leased by December 2008.
Financial Challenge
Henning said the McMillan Towers project was an outgrowth of a 10-year asset management plan completed by the authority in 2000, which examined each of JHA’s public housing properties. The authority, assisted by outside professionals including Capital Needs Unlimited, a financial advisor to JHA, subsequently developed and began implementing a strategy about what should to do about each property. JHA has already completed two acquisition/ rehabilitation projects of private multifamily properties using housing credits and tax-exempt financing. McMillan Towers will be the third venture and the first involving disposition of a property from JHA’s owned-and-operated portfolio. As with the first two, JHA will be acting as the developer, through an affiliate of a nonprofit corporation subsidiary of the authority called the Tennessee Housing Development Corporation (THDC).
Nutt-Powell noted JHA was faced by the same challenges as many other small- and mid-sized public housing agencies (PHAs) nationwide. It had a portfolio of aging public housing properties in need of significant renovations, without much chance of obtaining a HUD HOPE VI redevelopment grant from HUD, and limited financial resources to pay for expensive renovations. At the same time, HUD is prodding PHAs to shift to an “asset-based” system under which each property is supposed to be managed and stand on its own.
Henning said JHA in 1988 made about $2 million in “primarily cosmetic” repairs to McMillan Towers. After the long-term plan was done, JHA decided it wanted to keep the property. “But,” said Henning, “we had reached the point where we needed a major and comprehensive rehabilitation of the building.”
The preliminary price tag was $6-7 million. Henning said his initial preference was to renovate the property but keep it as public housing — owned by the authority and subsidized by HUD under an annual contributions contract. However, he said this proved infeasible as he explored different possible ways to pay for the renovation project, and ruled out each because it wouldn’t raise enough dollars to fund the entire cost.
These initial options included JHA saving up enough from the public housing capital funds its receives annually from HUD (about $1 million a year), and borrowing against future capital funds under HUD’s Capital Fund Financing Program (CFFP) program, through the issuance of bonds.
Under the CFFP program, a PHA can borrow against the stream of future capital funds it expects to receive from HUD, and pledge a portion of its future capital funds flow to repay the borrowing. PHAs can borrow through the issuance of bonds — tax-exempt or taxable — floated by or on behalf of the PHA, or obtain a conventional loan. Proceeds can only be used for the renovation or redevelopment of public housing units.
To date, CFFP has typically been utilized by large PHAs that have issued tax-exempt bonds to borrow. However, Nutt-Powell and Neely said small- and mid-sized PHAs generally can’t afford the considerable issuance costs it takes to float bonds.
Solution to Dilemma
The solution to Henning’s predicament, to fill the funding gap, turned out to be a combination of housing credits and taxexempt debt obtained under Fannie Mae’s Modernization Express loan program, which ties into HUD’s CFFP program.
Under Fannie Mae’s “Mod” Express program, PHAs borrow against their future capital fund dollars, by obtaining a loan from Fannie Mae. The PHA uses these funds to make a loan to the project under HUD’s mixed-finance program, and the PHA repays Fannie Mae from public housing capital funds it receives from HUD in the future.
For the McMillan Towers transaction, Fannie Mae made two tax-exempt loans to JHA totaling roughly $6.7 million that enabled the project to qualify for 4% housing credits. JHA obtained an allocation of tax-exempt private bond authority for the project from the state’s annual private activity bond volume cap. But instead of the authority being used for the issuance of taxexempt bonds, it was used for the tax-exempt loans made by Fannie Mae. In short, Neely said, JHA borrowed on a “private activity basis” from Fannie Mae.
Neely said Fannie Mae’s total fees to JHA were a little over $70,000.
Fannie Mae’s debt was sized larger than the amount needed to pay for construction costs, to enable the project to satisfy the “50% test” to qualify for an “automatic” award of 4% housing credits. Under this test, if more than 50% of the anticipated total cost of a low-income rental housing project is financed by the proceeds of a tax-exempt private activity obligation, the project can receive housing credits without an allocation from the state’s annual housing credit volume cap.
Fannie Mae’s two loans, interest income on which isn’t taxable to Fannie Mae, include a 3-year construction loan (fixed rate 4.51%) and a 20-year permanent loan (fixed rate 5.15%). After construction is completed, the short-term loan, of just under $3.7 million, will be paid off.
The Fannie Mae loans were made directly to JHA, and used by JHA, along with some public housing capital funds it had accumulated, to make loans to the new ownership entity to fund the project. JHA sold McMillan Towers to the new ownership entity.
Uses, Sources of Funds
The total development cost for the project is $12,965,899, including: $3,650,000 for the acquisition of the property; $6,616,050 for construction costs; $1,587,349 for soft costs; and $1,112,500 for a developer’s fee.
Funding sources totaled $12,965,899, and included: $4,774,967 million in tax credit equity from Boston Capital Partners, the syndicator that purchased the housing credits; a mixed-finance loan of $4,490,482 (40-years, fixed rate 0.1%) made by JHA; two conventional loans totaling $3,650,000; and a deferred developer fee of $50,450. The two conventional loans, used to finance the acquisition of the property by the new owner, included a seller take-back note of $2 million from JHA, and a purchase money note of $1,650,000.
The project received extra housing credits from being located in a qualified census tract.
Tax Credit Units
All 124 apartments in the rehabilitated McMillan Towers property will be housing credit units. Of these, however, 51 will be designated as public housing units restricted to public housing residents, with operating costs defrayed by “Section 9″ public housing operating subsidies received annually by JHA from HUD.
Rents on the remaining 73 units will be subsidized by project based HUD Section 8 vouchers earmarked by JHA for the project, under a minimum 10-year contract. Cash flow from the vouchers will be used to pay off JHA’s seller take-back note. JHA received the extra vouchers as the result of its disposition of McMillan Towers, and entered into a project-based voucher contract for the property.
Henning said out-of-pocket rent payments won’t really change for residents.
The financing package will not put any market-rate hard debt on the project. The mixed-finance loan will be deferred, with payments only due during the initial 15-year tax credit compliance period to the extent of any excess income from the public housing units.
THDC will receive a developer’s fee on the McMillan Towers transaction.
Replicable Transaction
Neely, Nutt-Powell, and other participants described the McMillan Towers deal as a transaction that is replicable by other PHAs and for other public housing properties.
Mackey suggested the McMillan Towers transaction will become a “prototype for how a lot of these [smaller] public housing transactions are going to be done in the future. They [properties] don’t have the rents to be able to support high-interest rate debt, but they do need revitalization.”
Achatz said the HUD and Fannie Mae documents developed for the transaction from negotiations can serve as prototype documents for similar other deals.
Neely said McMillan Towers was Fannie Mae’s first mixed-finance transaction using taxexempt debt and 4% housing credits under its Mod Express loan program. But she added there are other possible permutations. For instance, Neely said the 9% housing credit can be combined with taxable debt from Fannie Mae under the CFFP program, provided the PHA can compete successfully to obtain an allocation of housing credits from the state’s annual housing credit volume cap. She said Fannie Mae’s first deal of this type is set to close in December 2007.
Neely said Fannie Mae’s Mod Express program can be used for new construction of public housing as well as for rehabilitation, and for transactions where the developer is the PHA or another entity, such as a for-profit or nonprofit developer.
