Various Properties Are Candidates for Deals; Most States Favor Preservation
By Caitlin Jones & A. J. Johnson
12 min read
THERE ARE NUMEROUS and diverse opportunities for developers and owners to undertake preservation transactions — that is, the purchase and/or rehabilitation of existing apartment properties using the low-income housing tax credit (LIHTC) to continue their affordable rental use.
These opportunities, according to industry participants interviewed by the Tax Credit Advisor, are due to several reasons. First, most states in their LIHTC programs favor preservation transactions by having credit set-sides or some other preferences.
Secondly, there is a huge inventory of properties that are potential candidates for preservation transactions — older multifamily rental projects in need of rehabilitation and recapitalization to restore their physical and fiscal soundness. This universe includes properties insured and/or assisted by the U.S. Department of Housing and Urban Development (HUD) under various programs [i.e. Section 202, Section 236, Section 221(d)]; older properties with HUD Section 8 rent subsidies; distressed public housing projects; old USDA Rural Development Section 515 rural rental housing projects; old LIHTC and tax-exempt bond-financed projects; and other federally and state subsidized or assisted projects.
Many properties with government- insured mortgages have or will soon reach the point at which their mortgages can be prepaid, or at which they will mature, causing the use restrictions to go away. Owners — existing or new — can “resyndicate” these properties with new housing credits to generate funds to pay for needed rehabilitation while replenishing the projects’ financial reserves as part of an overall “repositioning” of a property.
According to data from the nonprofit National Housing Trust (NHT), after 2010, there will be a major increase for a five-year period in the annual number of units in HUD Section 236, 221(d)(3)BMIR, and 236/202 properties with mortgages maturing during these years. The annual unit estimates are 5,090 in 2008, 3,163 in 2009, and 7,617 in 2010, jumping to 29,964 in 2011, and peaking at 50,266 in 2012. For the period 2011-2015, the unit total is 182,568.
Section 236, 221(d)
Washington, DC attorney Shel Schreiberg, a partner in the law firm of Pepper Hamilton LLP, said HUD Section 236 and 221(d)(3) projects are good candidates for preservation deals with housing credits. “There are still hundreds of them out there,” he said, noting they are older, need work, and score well in most states in their credit programs.
According to NHT, more than 600,000 units of affordable rental housing were built between 1965 and 1975 under the Section 221(d)(3) and Section 236 programs.
Schreiberg and Washington, DC attorney Kristin Neun, a partner in the law firm of Hessel and Aluise, P.C., said Section 236 projects can be particularly attractive candidates when the existing mortgage interest subsidy stream (provided through an Interest Reduction Payment, or IRP, contract) is “decoupled” — after HUD approval — from the existing Section 236 mortgage. The remaining subsidy stream for the balance of the term of the IRP contract can be captured and applied to a new transaction, such as in conjunction with an acquisition/ rehabilitation using housing credits and other funding.
Neun also noted several recent transactions suggest a developing pattern that HUD Headquarters is willing to depart from traditional restrictive policies to support transactions that will prevent nonprofitowned older properties nearing the end of their use restrictions from being lost from the affordable housing inventory. She noted HUD historically has had policies that barred a nonprofit owner from receiving the benefit of any sales proceeds from a use-restricted Section 236 or 221(d)(3) project even if the proposed transaction would preserve the property as affordable housing for an extended period of time. Neun noted this induced nonprofits to hold properties and sell them unrestricted at the end of the mortgage term.
One of the recent transactions she referred to involved the sale by a nonprofit of a 268-unit multifamily project in San Diego called Bay Vista to The Amerland Group, a local affordable housing developer that received HUD approval to redevelop the project. The Section 221(d)(3) mortgage on the property was set to expire on 1/1/10; prepayment before then required HUD’s consent. Amerland structured a housing credit transaction in which more than $30,000 per unit in rehabilitation would be done and a new 55-year use restriction placed on the property. HUD Headquarters approved a plan, supported by the HUD Los Angeles office, which permitted 25% of the net proceeds from the sale of the project to be immediately available to the nonprofit seller for charitable purposes, and the rest deposited in a housing trust fund that the seller could tap to develop additional housing. Neun noted this structure provided sufficient incentive for the nonprofit to sell the project.
Neun noted HUD Headquarters has now developed a procedure for approving these types of transactions, though specific criteria for obtaining approval remains a project- by-project negotiation.
HUD Headquarters also has issued two recent memos that set forth, for certain actions, policies and uniform requirements and procedures that, if met, can enable an owner or developer to get HUD approval and move forward without needing to get a special waiver from the Department. Neun indicated these memos could facilitate and expedite more preservation transactions. One memo sets out requirements and procedures for prepayment of HUD flexible subsidy loans; the second outlines uniform requirements and procedures for owner requests to convert efficiency units to one-bedroom units in existing rental properties assisted and-or insured by HUD that have been plagued by significant vacancies. (See p. 14 for article on conversion memo.)
The HUD conversion memo could well help with preservation transactions involving HUD Section 202 projects — supportive housing for low-income elderly renters. Many of these projects have a high number of small efficiency units which are more difficult to market and keep filled.
Other Opportunities
According to NHT, there are about 300,000 Section 202 units nationwide.
Section 202 projects are owned by nonprofits, but HUD now permits the sale or transfer of 202 projects to a limited partnership to facilitate the rehabilitation using housing credits, provided a nonprofit is the general partner. A joint venture with another nonprofit or a for-profit developer is permissible.
Schreiberg said more sophisticated nonprofits have been rehabilitating Section 202 projects using housing credits, but that most nonprofit owners of Section 202s have been reluctant to sell. Also playing a part has been traditional restrictive HUD policies restricting what nonprofit sellers of 202s can do with the sale proceeds.
Schreiberg, though, said there is an attractive small subset of 202 projects, those developed in the 1980s, which aren’t subject to the usual HUD restrictions on use of sale proceeds, suggesting nonprofit owners of these might be more willing to sell to a new owner for redevelopment.
Another group of candidate projects are developments assisted by project-based HUD Section 8 rent subsidies. The current inventory includes projects with about 1.5 million units. There are different types of Section 8 projects, with some more attractive than others as possibilities for preservation deals.
Housing Credit Projects
NHT President Michael Bodaken believes the three major groups of existing properties that will make up the “next wave” of preservation transactions are projects with maturing HUD mortgages, Section 202 projects, and older housing credit properties.
“There is a tremendous amount of [LIHTC] product that is available to be recycled,” said broker Robert Sheppard, of the National Tax Credit Property Advisors unit of Marcus & Millichap, Seattle, WA. He said these are generally all post-1989 housing credit deals that have an extended use period of 30 years or longer; the pre-1990 deals with only 15-year compliance periods have generally all fallen out of the affordable stock, been recapitalized, etc., he noted.
Sheppard, whose firm brokers the sale of LIHTC properties, said his company is now working with about 100 LIHTC projects. He said he’s seen a “tremendous uptick” since mid-2007 in old housing credit projects being resyndicated and renovated with new housing credits, due largely to the availability of new capital structures for transactions.
According to the National Council of State Housing Agency’s 2005 State HFA Factbook, state housing agencies since the LIHTC program began in 1987 have allocated more than $7.4 billion in housing credits from their annual volume ceilings to produce 1.4 million low-income apartments, and financed over 500,000 additional low-income units with 4% housing credits and tax-exempt bonds.
State
Set-Asides, Preferences
According to NHT, state housing credit agencies in awarding new housing credits from their annual housing credit volume caps are exhibiting a strong preference for preservation projects. According to results of an NHT survey updated last spring, 46 states prioritize preservation in their LIHTC allocation programs, and 25 states reserve a portion of their annual credit authority — as a “set aside” — for preservation projects. Many states award extra points for proposed preservation projects in their scoring systems for tax credit applications.
According to a map prepared by NHT, as of April 2007, 12 states had preservation set-asides of 20% or greater for preservation projects (DE, IA, IN, MA, MI, MT, NC, ND, OH, OR, SC, WI). In its 2008 credit program, Delaware has reserved nearly 80% of its expected 2008 housing credit ceiling for a “preservation/rehabilitation” pool. Eligible for this are existing tax credit properties past their compliance period and eligible subsidized housing projects that are in need of substantial rehabilitation or at risk of loss of affordability, and substandard non-subsidized non-tax credit developments that need substantial rehab and can be converted into newly restricted and assisted affordable rental housing units.
Bodaken said a “significant number” of state agencies are also increasing or redeploying some of their tax-exempt private activity bond authority — with attached “automatic” 4% housing credits — for preservation projects. One advantage in many states of this route may be less competition for bonds than for 9% credits, and the ability to get more credits for larger projects; states often have a per project cap, sometimes relatively low, for 9% credit allocations.
Other Mechanisms
Another mechanism increasingly being used to preserve existing properties as affordable rental housing is the purchase of the general partnership interests in limited partnerships formed to own and operate affordable multifamily projects.
Mid-Atlantic nonprofit developer Homes for America, Inc. has used this approach successfully to expand the size of its housing portfolio for much less cost than outright acquisitions. (See article on p. 10.)
Another area of opportunity is the preservation of Rural Development Section 515 properties. These are older rural rental projects with Section 515 loans. Many Section 515 properties have rental assistance as well. Sources indicated a Section 515 property can be a good candidate for a preservation transaction with housing credits, to renovate and recapitalize the asset, if one can get RD to approve a subordination of the existing 515 mortgage. Terri Preston-Koenig, a partner in Virchow Krause & Company, Madison, WI, said RD will issue an owner a letter saying it will subordinate its existing 515 mortgage to new debt, which means that the 515 debt can be assumed by the new owner, and the developer can qualify for 9% housing credits.
RD approved a subordination of the 515 mortgages for a pair of recent sales of two separate portfolios of Section 515 projects, financed by the tax-exempt bonds, in South Carolina and Florida. Investment bank Merchant Capital LLC, Montgomery, AL, underwrote both bond issues.
John Rucker III, executive vice president of Merchant Capital, said the South Carolina state housing finance agency issued $27-28 million in tax-exempt bonds to finance the acquisition and rehabilitation of 24 small, scattered-site Section 515 properties in South Carolina being sold by one for-profit owner to a new owner. The new owner will obtain equity from the sale of the 4% housing credits to rehab the properties. Rucker said the bonds will be paid off in three years, and RD will place new financing on the properties at stabilization. Rucker said pooling the properties made the tax-exempt bond issue feasible; bond financing wouldn’t have been viable for such small properties individually.
In the second transaction, Rucker said the Florida Housing Finance Corporation issued $10 million in tax-exempt bonds to finance the acquisition and rehabilitation — also with 4% housing credits, plus state SAIL program dollars — of two large Section 515 projects in Florida. Again, both projects were owned by one for-profit owner and sold to a new for-profit owner. Rucker said in Florida some of the original Section 515 properties have been encroached by urban areas.
