Housing Credit Basics NCSHB Educational and Development Workshop October 14, 2017 Denver, Colorado James Tassos Senior Legislative and Policy Associate National Council of State Housing Agencies

Housing Credit Background Program enacted as part of Tax Reform Act of 1986. Encourages the development of low-income rental housing. Contained in Section 42 of the Internal Revenue Code. Program administered by the U.S. Treasury Department. Credits allocated by state Housing Credit agencies. Credit is a dollar-for-dollar tax reduction for 10 years. Credit amount based on the cost of acquiring, constructing, or rehabilitating housing developments. Investors purchase Credits to offset federal tax liability. Equity from sale of Credits reduces debt, resulting in lower rents. Key attribute: private sector involvement.

Housing Credit Volume Cap Each state has a limited amount of Credit to allocate each year. Four components of Credit ceiling: — Per capita Credits – greater of $2.35 per resident or $2,710,000; — Carryforward Credits; — Returned Credits; and — National Pool Credits. Per capita Credit amounts indexed to inflation. 10 percent of Credits set-aside for nonprofits (material participation). If 50 percent of a development is financed with tax-exempt bonds, it does not count against the state Housing Credit ceiling because the bonds come out of the state’s private activity bond cap instead.

Housing Credit Development Requirements Minimum percentage of units occupied by low-income tenants. Households renting units subject to maximum income limits. Housing Credit unit rents also limited. Minimum 30-year affordability commitment. Developments must satisfy state qualified allocation plan (QAP). Credits cannot exceed amount necessary for financial feasibility. Developments must submit market study. Projects subject to IRS and state regulation/oversight.

Housing Credit vs. Market Rate Development Somewhat comparable hard construction costs, although market rate projects have much more flexibility in construction scope. Housing Credit deals have additional soft costs (i.e., developer fee, legal and accounting fees, certain financing costs, and project reserves) due to regulatory and compliance requirements. Market rate: structured to generate cash flow as rents increase with the market, and property appreciation generates gain at disposition. Housing Credit: restricted rents and market result in limited or no cash flow, and long-term affordability restricts upside at disposition. Developer fee is an essential incentive in Housing Credit projects. Developers often defer a portion of the developer fee to fill a funding gap, cover project operations, or until certain development milestones are achieved.

Housing Credit Income and Rent Restrictions Minimum set-aside election of: — 20% of units at 50% of area median income (“AMI”), or — 40% of units at 60% of AMI. Must meet minimum set-aside by end of first Credit year. Gross rent cannot exceed 30% of qualifying income for an assumed family size (based on number of bedrooms per unit). Assumed family size: 1 person for studio; 1.5 persons per bedroom. Gross rent must include an allowance for tenant-paid utilities. Income / rent limits change annually with publication of new AMIs. Rent will not decrease below original floor.

Housing Credit Rent Calculation Examples Area Median Income = $83,900 (Denver MSA) 2 bedroom unit: assumed family size of 3 persons (2 bedrooms x 1.5 persons per bedroom) 40/60 minimum set aside elected 3 person income limit = $45,360 30% of income limit = $13,608 Monthly gross rent (1/12) = $1,134 20/50 minimum set aside elected 3 person income limit = $37,800 30% of income limit = $11,340 Monthly gross rent (1/12) = $945

Housing Credit Affordability Commitment 15-year Housing Credit compliance period: — Continued tenant qualification required. — Possibility of Credit recapture for noncompliance. 15-year extended use period: — Extended use agreement but no Credit recapture. Early termination of 30-year affordability commitment: — Foreclosure. — Qualified contract. Qualified contract process: — Owner asks state to find buyer after 14th year of Credit period. — If no buyer found in one year, owner may opt out of program. — Many states require waiver of QC in order to receive Credits.

Qualified Allocation Plan (QAP) State must adopt a qualified allocation plan to allocate Credits. QAP must set forth Credit allocation priorities. QAP must give preference to: — Projects serving the lowest income tenants; — Projects with the longest period of low-income use; and — QCT projects contributing to a community revitalization plan. QAP must provide procedure for notifying IRS of noncompliance. Tax-exempt bond-financed projects must satisfy QAP. Competition for Credits is intense – nationwide demand of 3:1. States use selection criteria and scoring (points) to decide which developments receive Credits. QAP helps states achieve desired policy objectives.

QAP – Statutory Selection Criteria Project location; Housing needs characteristics; Project characteristics; Sponsor characteristics; Tenant populations with special housing needs; Public housing waiting lists; Tenant populations of individuals with children; Projects intended for eventual tenant ownership; Energy efficiency of the project; and Historic nature of the project.

Financial Feasibility Determination Credit cannot exceed amount the state determines is necessary for financial feasibility and long term viability as low-income housing. Agency must consider: — All sources and uses of funds; — Amounts generated by tax benefits (equity from Credits); and — Reasonableness of development and operating costs. Evaluation occurs three times (application, allocation, completion). State underwriting criteria: — Development cost limits/design guidelines; — Limits on developer and builder fees; — Operating expense projections; — Reserve requirements.

Applicable Percentage - Two Types of Credit Developments eligible for the 4% Credit (30 percent present value): — Acquisition of existing building from unrelated party. — New construction or rehab using tax-exempt bond financing. Developments eligible for the 9% Credit (70 percent present value): — New construction. — Substantial rehabilitation (minimum expenditure of $6,700 per unit or 20 percent of building’s basis during a 24-month period). Credit period begins when building is placed in service (unless owner elects to defer start of the Credit period). Investors receive a stream of Credits for 10 years.

Calculating Credit Amount Annual Credit amount = applicable percentage X qualified basis. Applicable percentage is 9% or 4% depending on project. Qualified basis is eligible basis x applicable fraction. Eligible basis: the cost of acquisition, construction and rehabilitation. Applicable fraction is the lower of 1) the number of occupied low- income units divided by total units or 2) floor space fraction. Land cost is not included in eligible basis. Up to 30% increase in basis for developments located in HUD- designated qualified census tracts or difficult development areas. Up to 30% increase in basis for certain developments designated by the state agency (state-designated basis boost).

Example of Credit Calculation Project: 100 total/70 low-income units (applicable fraction = 70%) Total development costs (including land) = $15,500,000 Land value = $500,000 Eligible basis = $15,000,000 Qualified basis = $10,500,000 ($15,000,000 x 70%) Applicable percentage = 9% Annual Credit = $945,000 ($10,500,000 x 9%) 10-year stream of Credits = $9,450,000

Housing Credit Investment Structures Investors buy Housing Credits to offset federal tax liability. Current investors: C-corporations, financial institutions, and insurance companies via direct investment or through syndicators. Direct investment: an investment directly into the project partnership that owns a development. Proprietary investment: an investment through a fund managed by a syndicator without other investors. Multi-investor investment: an investment through a fund managed by a syndicator with other investors. Secondary investment: purchase of some or all of a development from the original investor(s) during the 10-year Credit period.

Housing Credit Investor Risks and Benefits Market risk: ability to effectively assess market for development and remain competitive in the market throughout the compliance period. Construction and lease-up risk: units must be completed and rented to specified tenants to claim Credits. Tax risk: recapture of Credits taken in prior tax years and ability to claim future Credits due to project noncompliance or foreclosure. Tax benefits: 10-year stream of tax credits + depreciation/losses. Social benefits: shareholder relations + social responsibility. Other benefits: meeting CRA requirements + portfolio diversification.

Housing Credit Equity Calculation Equity pricing varies across the country and is typically based on the Credit amount, location of project, and equity market conditions. Pricing expressed as cents per Credit dollar. Historically strong equity market – prices range from 85 cents to over $1 per $1 of Credit (CRA drives up pricing in certain markets). In previous Credit calculation example, if investor pays $0.90 per Credit dollar, equity generated = $8,505,000 ($9,450,000 X $0.90). Equity generally paid in several installments during construction. Equity reduces necessary project debt, resulting in lower rents.

Compliance Monitoring State Credit agencies must monitor developments for compliance. Owners have strict recordkeeping requirements. Must certify that tenant incomes are within program limits. States monitor rents charged and calculate utility allowances. Compliance status affects eligible basis / tax credits claimed. States perform site visits to assess property condition. States also verify other development characteristics promised in QAP (income targeting, services, amenities, etc.). States report noncompliance to IRS via Form 8823. Noncompliance can lead to recapture of Credits from investors. Investors have a strong interest in maintaining compliance.

Housing Credit Recommended Practices Voluntary recommended practices designed to strengthen state Housing Credit administration. Developed throughout the history of the program by NCSHA working groups with input from all states and the Housing Credit industry. First set of recommended practices adopted in 1993. Recommendations revised several times since to address new program requirements and new challenges in state administration. Recommended practices and implementation by states favorably cited by the Congress and GAO during program reviews. Current effort underway to review all existing recommended practices and suggest new practices. Considering 46 separate recommendations on a variety of Credit allocation, underwriting, development, and compliance issues. Expect to adopt final recommendations in December 2017.

Housing Credit Recommended Practices 46 recommendations for Housing Credit administration Allocation Issues Sustainable development Qualified allocation plans Construction monitoring Local approval and support Capital needs assessments Developer/manager experience Extended use agreements State-designated basis boost Using the Credit for preservation Compliance Issues Compliance manuals Underwriting Issues Owner and manager training Development cost limits Tenant file review procedures Developer and builder fee limits Fair housing compliance Cost certification requirements Compliance in resyndications Operating/replacement reserves Operating expense projections Development Issues Market analysis

Current Challenges in State Administration Increasing rental housing needs. Growing demands on the program (i.e., serving various tenant populations, preservation of existing assisted housing, RAD). Balancing priorities and selection criteria in QAP (i.e., new construction vs. rehab, project siting, energy efficiency). Criteria for use of state-designated basis boost. Assuring reasonable Housing Credit development costs. Shortage of other funding sources for project finance. Aging housing stock and expiring affordability restrictions. Recapitalization of older Housing Credit developments. Growing portfolios for compliance monitoring.

Affordable Housing Credit Improvement Act of 2017 S. 548 Lead Sponsors: Senator Maria Cantwell (D-WA) and Finance Committee Chairman Orrin Hatch (R-UT). H.R. 1661 Lead Sponsors: Representative Pat Tiberi (R-OH) and Ways and Means Committee Ranking Member Richard Neal (D-MA). 21 Senate cosponsors and 104 House cosponsors. Near equal support from Republicans and Democrats for both bills. Strong support on the tax writing committees.

S. 548/H.R. 1661 Program Modifications Over 20 Housing Credit program modifications that would: Expand Housing Credit authority by 50 percent (Senate bill only). Strengthen the 4 Percent Credit/Tax-Exempt Bond program. Enhance the ability to preserve affordable housing using the Housing Credit. Facilitate development for hard-to-reach populations and in challenging markets. Provide new flexibility and streamline program requirements.

Outlook for Tax Reform Congress seeking to pass tax reform legislation by end of the year. Unified Framework explicitly retains the Housing Credit. While the Framework does not speak to Housing Bonds, it is our understanding that the negotiators have a general agreement to fully retain municipal bonds, including Housing Bonds. Tax reform is an opportunity to advance our Housing Credit and Bond priorities. ACTION ITEM: Increase cosponsorship.