Not So Golden a State

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7 min read

New California proposals may discourage affordable housing development

Throughout the U.S., people know new ideas and trends often come from California. But in one such case, some worry that the new ideas may drive developers and investors away from building affordable housing there.

The new idea comes from Mark Stivers, a former staff member at the California state legislature, who now serves as Executive Director of California’s Tax Credit Allocation Committee (TCAC).

Stivers had sent out shock waves in early June with an email to developers suggesting that the TCAC would grant, among other things, a mandatory right of first refusal on property refinance or purchase to non-profit entities. Negative reaction from developers and the financial community was swift and overwhelming. “The TCAC recognized they had pushed too far,” says an attorney whose clients include many of the state’s largest developers of affordable housing.

Then, on July 9, Stivers came back with what he described as “more narrow” proposal. “The current proposed regulations are much different,” says someone who received both emails, “but two provisions are particularly upsetting One targets Section 8 projects and another limits sales or refinancing proceeds based on an appraisal that does not value the welfare exemption.” Adds another prominent developer, “TCAC is proposing to reduce Tax Credit eligible basis for the 15 year Capital Needs (CNA) for any re-syndication of an existing affordable transaction. This would negatively affect the amount of equity in a re-syndication and acquisition/rehab transaction.”

Created by state law in 1987, the TCAC’s three voting members are the state’s Governor, Treasurer and Controller, all elected in statewide elections—which gives it prestige and leverage as it performs its duty “to fairly allocate federal and state tax credits to create and maintain safe quality affordable rental housing for low-income households in California” via “forming partnerships with developers, investors and public entities.” Most other states seem to handle such functions through their state government housing departments.

Emails, text messages, and telephone calls began as soon as Stivers’ July 9 email arrived. One prominent developer wrote to colleagues. “It’s difficult to understand.” Added another, “This has left everyone to whom I’ve spoken scratching their heads.”

“The concern is that the governing agency [TCAC] is too focused on ‘people making money’ and not recognizing the inherent risk, often to the degree of personal guarantees,” says Armand Tiberio, national director of the Seattle-based Tax Credit Group, Marcus & Millichap, whose clients include a diverse group of developers, syndicators, lenders, nonprofits, and investors. “You can’t expect the private sector to take on such risk and at the same significantly limit the amount of upside they might achieve. Risk must come with reward.”

Why is this happening now? According to a Drew Mendelson, Acting Communications Director for California State Treasurer John Chiang, who handles administrative tasks for the TCAC, the committee has taken action because, “High incomes and market rents in some of California’s regions create high buyer demand and values for some affordable housing properties. We would like to make sure the physical health of those properties is assured before equity gains are realized. And where some of the value is created by public action we’d like to see that value continue to benefit the properties.”

There’s more to it, say many developers. “This is happening now because the TCAC is worried about the perception of some recent transactions, including deals with project based Section 8 vouchers,” says a developer. “They’re worried that we are making too much money on some deals and something big will break in the news.” (This developer, as well as others cited here, did not want names used and look like “the only voices of dissent.”)

The developer adds: “Particularly worrisome is how TCAC wants to restrict distributions that developers are making on the backend from sales of LIHTC projects. This program has always been a public/private partnership and one of the main reasons for its success is the ability to attract private capital in order to create and preserve affordable housing. The proposed regulation upsets the balance of this partnership. The TCAC proposal also seems to overlook key factors including that the projects which TCAC has concerns about are from the early days of the program when there was little to any subsidy, investors often received a return of capital, and the affordability periods were generally only 30 years. It is unclear if TCAC staff has factored in the benefits of a re-syndication by an affordable housing developer to the residents, both physical improvements to the property and the extension of the affordability.”

A colleague has concerns that are even more specific. “There are at least three unintended consequences of what TCAC is proposing,” he says. “First, developers will be less willing to undertake new construction of 4% Tax Credit Bond projects, which will reduce the number of projects, because of the reduced return relative to risk that the developer takes on these projects. Second, more of the older projects will be sold to yield buyers as opposed to being redone with 4% tax credits and bonds. This means that fewer deals will receive increased rehabilitation, longer term affordability restrictions, and additional benefits like resident services which enhance a project and the quality of life for residents. And finally, there is a concern on what these changes will do to the favorable tax credit prices, interest rates, and other lending terms that California has received compared to other states on both 9% and 4% tax credit projects.”

Formal expression of developer concerns has come in a letter to Stivers signed by Ray Pearl, executive director of the California Housing Consortium (CHC), which describes itself as “possessing diverse membership that spans the development, building, financial, and public sectors makes us uniquely situated to provide a broad, united position that reflects the majority of the affordable housing community.” Pearl warns that “The proposed back-end limitations could significantly depress the supply of affordable housing by discouraging developers and investors.” His letter continues: “Our members have varying views about these proposals [but] the overwhelming majority find the proposals confusing and lacking sufficient clarity….”

The CHC concludes that “the scope of these “back end” changes are so significant that the affordable housing community should have a longer period of time to truly vet the proposal and understand all of its potential repercussions. More discussion, listening, give-and-take and adjustment seems inevitable. When this ends, say those watching the situation closely, some kind of change in back-end arrangements is going to happen.

To what degree will such changes be unique to California, and to what degree will similar policy debates emerge in other states? TCAC spokesperson Mendelson says “the public policy concerns involved here appear limited to higher income coastal markets, and have arisen now because the trend of high value sales seems to be increasing given the current market conditions.

”But it is important to remember, says a California developer, that “such high value sale trends in markets like San Jose are happening in other ‘hot spots’ and not just on the West Coast. Regulatory changes here could set a precedent for other states.” As Tiberio emphasizes, an inappropriate risk-reward balance in any state could “curtail development and the continued rehabilitation of our affordable housing stock.”