The Challenge of Mixed-Income Housing

By &
8 min read

Tax Credit Advisor June, 2006: Mixed-income housing has become a frequent topic in discussions of the federal low-income housing tax credit (LIHTC), as state and local allocating agencies seek to promote income diversity.

Qualified allocation plans (QAPs) developed by state housing finance agencies direct the annual distribution of LIHTCs, and many encourage mixed-income housing. LIHTCs total over $5.5 billion (not including tax-exempt bond transactions) and shape the characteristics of approximately 125,000 units of rental housing each year. Other affordable housing programs also have policies on mixed-income that affect LIHTC properties.

The purpose of this article is to advance the discussion on mixed-income housing as it relates to the LIHTC program.

One Term, Multiple Definitions

Promoting income diversity is an important goal for any affordable housing program. However policy makers should understand the various options and consequences involved.

The first step is defining the term “mixed income housing.” Broadly speaking, it has at least five different meanings in the LIHTC context:

  • Communities and neighborhoods with a variety of household incomes and opportunities for meaningful interaction, including parks, schools, and shopping.
  • A development that functions as a single property from the perspective of the residents, but has separate ownership and financing for the affordable and market rate components. (The market rate units could be for-sale condominiums or townhouses.)
  • Affordable and market rate units owned by one entity (same financing), where rents for the market-rate units are significantly higher. (In this circumstance the market rate units pay for themselves, in that the rental income for these units covers their share of debt service and operating costs.)
  • All units affordable but at different levels, such as three quarters of the units for households at 60 percent of area median income (AMI) and one quarter targeted to 30 percent AMI. (Based on a family of four in Raleigh this represents $42,960 and $21,480, which is clearly a mixture of incomes. In more rural areas targeting some units to 40 percent or 50 percent AMI is more appropriate.)
  • Some units affordable (60 percent AMI or less) and the rest at market rate, but with similar rents for both. (In this case the latter are more accurately described as unrestricted, since all units are effectively charging “market” rents.)

This article offers no critiques of the first four listed meanings. In fact the North Carolina QAP strongly encourages mixed-income categories one and four in its very competitive LIHTC application process:

  • Approximately one fourth of the total available points relate to the site having a mix of housing, access to amenities and strong economic growth;
  • Every award from 2005 sought the bonus points for targeting some units at or below 50 percent AMI (30 percent in high-income localities).

Not surprisingly, category number two is seldom feasible outside major metropolitan areas. Recently completed projects in Boston and Seattle successfully combine LIHTC and market rate condominiums in the same buildings, but there are no equivalent properties in North Carolina.

Category number three is also rarely an option in our state. While a small number of submarkets have very high market rents, these cities often have circumstances that prevent the development of projects with affordable units.

The focus of this article is the remaining category of “mixed-income,” number five: both affordable and unrestricted units charging similar rents. The discussion below will describe problems created by this approach and dispel common misperceptions of how it works.

Additional Debt Service Burden

In creating the LIHTC program, Congress ensured that the federal government only subsidizes units with restricted rents and maximum household income limits. Units not covered by these rules do not generate LIHTCs and the resulting equity. Instead, the funding source for constructing market-rate units is debt, which unlike equity invested for LIHTCs must be repaid from rental income.

Accordingly, a development with unrestricted units will have a greater debt service burden, and will require more revenue from rents than one that is entirely affordable.

A common assumption is that the market rate rents are high enough to cover the cost of this additional debt service. Where this is possible, the housing fits in category three above. Unfortunately this is not the case in most of the nation, and the result is a property in category five. (This concern does not apply to the three other mixed-income categories.)

For example, by including 12 unrestricted units, a 60-unit project may forgo over $700,000 in equity. Debt service for the resulting larger loan amount is necessarily passed along to the tenants. The market rate units will carry the increased debt service only if their monthly rents are several hundred dollars greater than the LIHTC units, which again is rarely possible. Thus in this example, households occupying the 48 low-income units will have to pay at least $90 more each month.

Compliance and Investor Difficulties

One of the widely recognized strengths of the LIHTC program is the extremely high rate of compliance. This is an impressive fact given the many layers of statutes, regulations, procedures, notices, QAPs, and other restrictions imposed by all levels of government.

However, compliance becomes even more difficult when a tax credit property also contains unrestricted units. While the notion of separating LIHTC and unrestricted units is simple in concept, the practice of carrying this out can be very confusing. Inter-building transfers, available and vacant unit rules, applicable fraction and other issues complicate the picture. In the Essential Guide to Housing Credit Compliance, Second Edition, Anthony Freedman writes that these issues create numerous and serious obstacles to compliance. Some professional training seminars take half a day to explain the various rules involved in a mixed-income development. (This issue is not applicable to categories one, two or four.)

Partly because of these compliance challenges, LIHTC investors are usually far less interested in projects with unrestricted units. Other reasons why investors avoid mixed-income projects involve real estate considerations including different underwriting standards for these units and changes to the ratio of tax credits to tax losses (depreciation). This lack of interest can translate into lower equity pricing, more stringent terms, or a decision not to make an offer at all.

Lack of Evidence for Sociological Benefits

Another assumption behind combining LIHTC and unrestricted units is the beneficial effect on tenants. The theory is that low-income households will interact with individuals who would normally occupy more upscale apartment complexes.

Even if one accepts that this sociological purpose justifies substantially higher rents for low-income households (a philosophical issue not addressed in this article), there is scant evidence that such interaction occurs.

This lack of evidence is in part due to limited research on the subject. One exception is a paper entitled Mixed-Income Housing Developments: Promise and Reality by Alastair Smith, found at http://www. jchs.harvard.edu/publications/W02-10_Smith.pdf. The author does not distinguish definitions in the same manner as this article and asks different questions. The paper also describes some benefits to mixed-income housing besides income diversity, such as a positive effect on land use approvals.

However the study concludes that mixed-income housing’s “most questionable results are in achieving positive social or economic gains for low-income families through interaction with their higher-income neighbors.”

This conclusion matches anecdotal evidence of:

  • Site managers placing Section 8 voucher holders in unrestricted units whenever possible;
  • Owners designating some buildings in a project as market rate and others as affordable; and
  • Unwillingness of some tenants to live in this type of property.

The first two types of anecdotes can be understood as rational reactions by owners and managers to the financial and compliance difficulties described above. The third type of anecdote was described by a multi-state developer at a national conference. He suggested that LIHTC allocating agencies encourage separate unit entrances for mixed-income properties. The developer said that, based on his experience, higher-income tenants will not live in housing on a common hallway with affordable units.

The fact that in many cities a unit at 60 percent AMI carries a rent equal to the market rate exposes another mistaken assumption. In these localities the incomes of LIHTC-qualified households are often no different than the incomes of typical tenants found in unsubsidized apartments. Thus there is no real income heterogeneity, the original purpose of mixed-income housing.

Conclusion

The concept of mixed-income housing cannot be forced into one meaning, and the five definitions provided here are just a start. Ideally, the overall goal of mixed-income housing would work well in all forms, but unfortunately the financial realities of LIHTC projects cause unintended and problematic consequences when unrestricted units have rents similar to the LIHTC units. This reality should not deter policy makers from utilizing the other available options. The many benefits of income diversity in our communities are far too important to ignore.

Mark Shelburne is an attorney and policy coordinator for the North Carolina Housing Finance Agency’s (NCHFA) rental programs.