With demand for affordable housing outstripping the supply and returns matching the earnings from market-rate multifamily investments, real estate financiers and developers are scrambling for limited tax credit dollars.

Industry officials say all federal and local governmental programs combined to promote affordable housing - including Tax Exempt Bonds, HOPE VI and the Low-Income Housing Tax Credit (LIHTC), the nation's most effective and most popular affordable housing program - are unable to meet the growing demand for low-and moderate-income housing.

As a result, some financiers and developers are calling on the government to expand the scope of the LIHTC by increasing the tax credit limit at least four times.

Also, fresh from their victory last year to help defeat a House Ways and Means Committee proposal that would have changed LIHTC from a permanent program to a program that had to be approved annually by the U.S. Congress, industry leaders seem more bullish on the rapidly growing affordable housing market. They say ethnic and racial stigmas attached to "affordable housing" have almost disappeared. The term "affordable" is no longer looked down upon, and Fortune 500 companies are not only endorsing the LIHTC program but have become dominant players. Lately, pension funds and institutional investors have started to enter the affordable housing market.

"Now, since the tax credit program is permanent, we have seen developers come in with good track records and be able to work on affordable housing projects," says Georgia Murray, a senior vice president at Boston-based Boston Financial Group, one of the country's largest real estate syndicators. "LIHTC remains the only way to do affordable housing."

Established by the U.S. Congress in 1986 on a temporary basis and then made permanent in 1993, the LIHTC program allows each state to grant $1.25 per capital in tax credits annually for affordable housing. Developers and syndicators who receive tax credits sell them to both corporate and individual investors, who in turn, use them to offset their annual federal tax bills for approximately 10 years. The money raised by developers is invested in properties that qualify as affordable housing units.

Murray says $1.25 per capita in tax credits should be raised to at least $6 per capita.

"In order to meet growing demand for affordable housing, we need to increase it. Since it was established in 1986, it has never been increased," Murray says. "There is a lot of pressure on the program. We actually need to increase it to $6 per any increase will be helpful."

Murray says even other affordable housing programs such as HOPE VI, which was launched last year to tear down troubled public housing projects and redevelop them into affordable housing units, need the help of tax credit dollars to fill the gap. She says the HOPE VI program is currently being utilized in about two dozen cities across the country.

HOPE VI and LIHTC are the only two programs that are currently available for new construction of affordable housing, Murray says. And of these two, LIHTC is the larger and the more effective.

Michael J. Novogradac, managing partner of Novogradack Co. LLP, a San Francisco-based national certified accounting firm, says $325 million of tax credits are available annually. It translates into $5 billion to $6 billion in total annual construction of affordable housing across the country.

Novogradac says the industry is able to provide between 80,000 and 100,000 units of affordable housing units each year. Through the end of 1995, he says, about 1.07 million units were financed through tax credits nationwide.

"The low-income housing tax credit program is the biggest program for providing affordable housing. It accounts for half of all the multifamily starts in the country," says Marc Schnitzer, executive vice president and director of acquisitions at Related Capital Corp., a New York-based real estate financial services firm with $6 billion of assets under management. "It has been a great business."

Related Capital, the nation's largest acquirer of low-income housing tax credits that has raised $1.6 billion for 50,000 affordable units under LIHTC program, has been active in 40 states with the most focus in California, Florida, Massachusetts, Michigan and New York.

"At any given stage, we are involved in between 20 and 30 projects," Schnitzer says. "We are doing a lot of projects in California. We have a fund that is dedicated entirely to California."

Schnitzer says Related Capital, which has about 40 projects in California and maintains a regional office in Irvine, invested $60 million in equity in, California in 1995 and is expected to invest about $75 million this year.

In Massachusetts - where two of the nation's leading tax credit sponsors, Boston Financial and Boston Capital, are based - Related Capital has made a strong inroad as well.

In Springfield, Mass., Related Capital is currently engaged in rehabilitating the 500-unit Chestnut Park, which is scheduled for completion early next year. The firm is the developer as well as provider of equity in the project. In addition, Related Capital is a joint partner in the 450-unit Merrimack Plaza rehabilitation project in Lowell, Mass.

"The tax credit program has been very successful. It certainly has been used to the fullest extent. There is demand for more," Schnitzer says.

Related Capital raises about $350 million a year from Fortune 500 companies under tax credits.

"The tax credit program continues to be very well accepted. Every dollar that the tax credit has created has been purchased," says Richard J. DeAgazio, senior vice president of Boston Capital, which owns 1,845 properties in 48 states, representing 76,200 affordable apartment units. "There are 5.2 million units in unmet demands nationwide. It's estimated that it will be 8 million units in unmet demand by the year 2000"

With home ownership declining among poorer segments of the country's population, demand for rental affordable housing is likely to climb further.

The homeownership rate for the low-income group declined from 46% in 1974 to 41% in 1995, according to a recent study by the Joint Center for Housing Studies at Harvard University. Over the past 20 years, the number of renter households with incomes of $10,000 or less has grown from 7 million to 10 million, an increase of 43%.

The study blamed the rising number of poor families with children and elderly single-person households for the growth of low-income renters. Of the nearly 10.9 million renter families with children in 1993, about 3.6 million, or more than one-third, had extremely low incomes, less than 30% of area median, the study says. Another 1.4 million renter households with heads aged 65 and over had equally low incomes.

Boston Capital's DeAgazio says his firm is expected to raise about $250 million in equity from individual and corporate investors, resulting in about $600 million in assets of multifamily. Boston Capital raised $192 million in equity, or $409 million in assets, in 1995.

In October, Boston Capital, one of the nation's top sponsors of tax credit investments, opened the $40 million Boston Capital Tax Credit Fund IV, Series 28, that will invest in a nationally diversified portfolio of 46 affordable housing properties among 13 states. In September Boston Capital's most recent public tax credit program closed with investments of more than $25 million. Due to heavy demand, Series 27 was increased from its initial offering of $20 million to $25 million.

DeAgazio says the firm is planning to open the $35 million Series 29 in January.

"One of the keys to be successful in this business is providing developers with a one-stop financial package," DeAgazio says. "We see here a need to provide not only equity to developers, but also the debt portion."

To meet that need, Boston Capital recently tied with Arkansas-based investment bank Llama Co. and launched Boston Capital Mortgage Co.

DeAgazio says such one-stop programs expedite the process and make the affordable housing industry more efficient.

"The application for debt goes through different but parallel underwriting at the Boston Capital. However, the developer has to provide only one package to us," says DeAgazio, adding that the equity portion of the transaction is completed in eight to 10 weeks and the debt side may take from 60 to 75 days. "A lot depends on the developer, on their attorney and getting the proper materials to us."

He says that despite gaining some maturity and witnessing phenomenal growth, the affordable housing industry is still faced with a lot of challenges on several fronts: the mortgage financing side, guaranteed programs for financing and secondary debt markets.

"Making the program more efficient is a big task," DeAgazio says. "Other major challenges are being able to get the biggest banks involved in order to contain costs and increase efficiency. Evaluation and efficiency in permitting local site processes are also important."

He says affordable housing offers a number of advantages: Returns on affordable are generally 12% for both individual and corporate investors, foreclosures are very rare, and the industry remains counter-cyclical.

"Foreclosures are basically caused by two factors: not receiving the projected rent and vacancies. We have no problem in receiving rents because our rents are below the market rate. By having lower rents, we are able to attract renters and thus little vacancy," Deagazio says. "Also, we have more equity in our transaction than a typical real estate product. Although our operating costs are comparable to any kind of real estate, our debt service is lower."

A dearth of affordable housing units nationwide is perhaps the biggest plus for the industry.

"Supply and demand in affordable housing is very out of balance. It will take 100 years to catch up," DeAgazio says. "In addition, our little niche goes counter to the real estate world. When the economy is robust and you have an inventory factor, our rents are the cheapest. If we are in a downturn, the number of tenants will quickly increase. So we don't worry in our industry about cyclical moves."

He says affordable housing is well-financed and long-term.

"That is not to say there are no problems. The key is to identify them," DeAgazio says. "An area where a major employer moves out or a major military base closes down could be a trouble spot."

He says Boston Capital continues to work in both individual or retail as well as corporate areas to raise capital. The corporate market, however, is becoming increasingly dominant.

"LIHTC has become very attractive to corporate investors because it gives a high rate of return and it becomes socially responsible," DeAgazio says.

Industry insiders say the permanent status of the LIHTC and a surge of interest from Fortune-500 corporations to invest in affordable housing projects have made the tax credit program so effective.

During 1987-91, the program was dominated by mostly wealthy individual investors while corporations remained on the sidelines. "Now, it's overwhelmingly corporations," says Murray of Boston Financial, the country's first syndicator to tap corporations as early as 1990.

It was, however, not until 1992 that corporations really started to consider the tax credit program. They became active in 1993 and have stayed that way ever since.

Since the tax credit program became effective in 1987, Boston Financial established only eight individual funds as compared with 13 corporate funds since 1991. In 1994, Boston Financial exited the retail market completely.

Most investors remain corporations because they can take advantage of passive losses and individuals cannot. There are some limitations on individuals. For example, to use the maximum credits for any tax bracket, the investors must have at least $25,000 in taxable income in that bracket. Married couples filing separately may not use tax credits. Credits cannot be used to reduce the alternative minimum tax.

"Corporations can use both credit and losses. They also have no restriction on how much they can use," Murray says. She says it's also cheaper to raise capital from corporate investors.

While a tax credit fund may need about 100,000 investors for a $100 million fund, only about a dozen corporations may be enough for a similar size fund. Also, the probability to have repeat investors from corporations is greater than the retail market.

Murray says it's easier to make swift changes with corporate funds as compared with retail funds because of stricter regulations by the Securities and Exchange Commission in the individual market.

Because of increased competition among affordable housing providers and developers and rising development costs, yields also have been declining, and individual investors may not find it attractive anymore, Murray says.

"It still remains good for corporations because they can write off their losses" says Murray, whose firm raises between $225 million and $275 million a year in equity.

Typical buyers of tax credits are corporations that need tax credits to offset their tax liabilities, says Constantino Argimon, senior vice president of Equitable Real Estate, an Atlanta-based real estate investment adviser with more than 300 clients comprised of pension funds and international institutional investors.

He says pension funds are now also getting challenged to invest in affordable housing.

It's not a trend yet, but they are slowly diverting their dollars to the construction and renovation of low@ and moderate-income housing, Argimon says.

He says Equitable is currently involved with two pension funds, CalPERS and the Los Angeles Fire and Police Pension Fund. The two funds have committed $75 million to Equitable's California Community Mortgage Fund, a discretionary closed-end commingled fund that targets debt investments in community-based real estate projects throughout California.

The fund invests primarily in multi-family rental housing or economically integrated housing with set-asides for lower income tenants. It also targets projects such as retail, commercial and industrial facilities located in underserved areas to benefit lower income or disadvantaged individuals. Loan amounts range between $1 million and $5 million with a loan term of seven to 15 years.

Argimon says 50% of the California Community Mortgage Fund is earmarked for housing and 50% for commercial - food/drug store-anchored shopping centers.

Equitable also manages the Community Works Fund, a $40 million fund that provides first mortgage, long-term fixed rate loans on economically targeted investments such as affordable multifamily housing or commercial projects such as neighborhood retail in underserved areas. Projects must be either to-be-built or to-be-renovated using union labor. The fund's investor is Union Pension Plans.

"Pension funds could do more," Argimon says. "The primary reason is - at least amongst pension funds that like mortgage loan investing as opposed to fixed income investing - LIHTC business offers tremendous permanent loan financing opportunities. It gets beyond ETI (Economically Targeted Investments). It is built in tax code. It provides very powerful financial incentives."

He says times have changed, and the term "affordable housing" no longer carries any negative connotation in the real estate industry.

"Lenders have learned that products built under Section 42 of the LIHTC are very attractive, very well-built like any other garden variety products. They do carry returns on income level, and lenders are realizing that there is more security," Argimon says. "The owners of the tax credit are very motivated to keep projects in good working order."

Amos Smith, vice president of Johnson Capital Group, an Irvine, Calif.-based full-service mortgage banking and real estate finance advisory firm, says lenders need to have very aggressive and conservative underwriting standards in affordable housing.

"They cost so much more than they are worth. You might also have a risk to vacancy," says Smith, adding that those negative factors can be offset by a stronger market for affordable housing though. "You may be able to get benefits of the market."

Lawrence H. Curtis, associated general partner of Winn Development Co., a Boston-based developer of real estate that owns and operates 15,000 affordable housing units in 12 states along the East Coast, says getting financing for inner-city projects is already difficult.

"There are some lenders who will lend for projects only in better places but not in communities that are perceived riskier," Curtis says. "We as a developer have focused on poor communities."

He also says there is not enough funding available for affordable housing.

"We have very limited resources to build affordable housing," says Curtis, adding that the most effective way to make maximum use of limited tax credit dollars is through redevelopment and rehabilitation of existing facilities rather than building from scratch.

"One needs $10,000 per unit of tax credit to generate brand new affordable housing, for example. This compares with $2,500 per unit for existing facilities," Curtis says. "It's approximately four times more effective to buy an existing complex and rehab it than develop a new complex."

One of the major problems in developing a brand new affordable housing complex, he says, is the "not in my back yard issue."

Problems such as race, ethnic conflicts, school systems and traffic issues become nonissues when an already existing facility is converted into affordable housing. "There is already support for existing facilities," Curtis says. "Community is already there."

Prior to 1989, almost everything Winn developed was newly built, Curtis says. "Since 1989, virtually everything we have done is buy existing properties and convert them into affordable housing. Curtis says. "There are arguments on both sides on new vs. old."

He says most typical developers of office and other commercial projects don't look at affordable housing as a lucrative investment. "Most people have not developed expertise. It's a highly specialized expertise. We have always felt comfortable with affordable housing. We have done 30 tax-credit projects," Curtis says. "We want to do good work, and we want to make a reasonable profit."

He says the LIHTC is attracting some new players into the affordable housing business, but it still remains a complicated business. "It's so complex, so management-intensive - not only during the development process but also in running the building," Curtis says. "Housing has become more than just a roof over somebody's head. It's a lifestyle, in the inner city or wherever. One of the elements of successful projects is to build a community where people want to be. It should look like any other housing. Capital costs of these projects are no different than any other type of housing."

Demand for tax-exempt bond financial for affordable housing is also increasing says Patrick Colliton, senior vice president of originations at Arlington, Va.-based Washington Capital DUS Inc.

Washington Capital, which works with Fannie Mae, has already completed $86 million in bond financing for affordable housing so far this year and was expected to close another $111 million by the end of the year.

In October, the Housing Authority of, Gwinnett County and Fannie Mae announced an agreement on a financing structure to fund construction of 324 new affordable apartment units in suburban Atlanta. The agreement combined Fannie Mae's tax-exempt variable rate bond credit enhancement and new construction" products. It also used low-income housing tax credits.

"While this financing structure is unique to this property, it illustrates our solution-oriented approach to financing multifamily properties," says Thomas W. White, Fannie Mae's senior vice president for multifamily activities.

The innovative financing structure resulted in lower financing costs for the local Housing Authority, which issued the variable rate tax-exempt bonds, commonly known as "lower floaters", that financed the property. Fannie Mae issued a 24-month forward commitment to finance the apartment development called Herrington Woods. Washington Capital a member of Fannie Mae's multifamily Delegated Underwriting and Service (DUS) team of lenders, executed the transaction.

"We are doing more and more bond work. The demand has increased tremendously" Colliton says. "We feel it's a very good business."

Novogradac says tax-exempt bond financing is an attractive finance mechanism because the interest rates on such bonds are generally less than conventional long-term financing.

"In addition to the lower interest rates, such rental properties are also eligible for low-income housing tax credits," Novogradac says. "To Qualify for tax-exempt financing, rental housing developments must set aside a minimum number of units for use by low-income persons."

To qualify, at least 20%, of the units must be rented to families at or below 50% of area median gross income, or 40% of the units must be rented to families at or below 60% of area median gross income, Novogradac says.

He says states are authorized to issue tax-xempt bonds to finance the development of affordable rental housing. "Tax-exempt bonds are so attractive that the federal government is forced to limit the amount any one state can issue. The federal government also limits the types of projects that can qualify," Novogradac says.

He says every state is allocated the greater of $50 per state resident or $150 million of bond financing authority. In addition to affordable housing, these bonds can be used to finance other categories of projects, including single-family homes, student loans, pollution control facilities and industrial development projects.

Steven Fayne, managing director of Calabasas, Calif.-based ARCS Commercial Mortgage Affordable Housing Division, which deals primarily with bond financing, says incentives given by the government really work. "There is a lot of demand for affordable housing," Fayne says. "Now, for-profit developers can make it work on a big scale."

Fayne says his firm is currently involved in financing several affordable housing projects. They include the 250-unit Almaden Lake Village in San Jose, Calif. The property is being. developed by Salinas, Calif.-based New Cities Development Co. Approximately 20% of the units will be earmarked for low-income and moderate-income each, and the remaining is for market rate.

"It's a brand new construction that began this fall. It will be completed in December of 1997," Fayne says. "Fannie Mae is providing the take-out by enhancing the bond."

In addition, ARCS Commercial Mortgage is providing financing for two more affordable housing projects: a 450-unit complex in Tacoma, Wash., and a 235-unit Villas of Capri in Naples, Fla.

The Villas of Capri project, which began in September and is a brand new development, will be completed in the fall of 1997. The developer of the project is Miami-based Related Group.

Industry insiders say there is also a surge of interest from secondary market players in the affordable housing market.

One of the largest players in the secondary market is Freddie Mac, one of the largest buyers of home mortgages in the United States. Thomas J. Watt, senior vice president of multifamily at Freddie Mac, says his organization has an outstanding commitment of $500 million in affordable housing and, of that, about $150 million will be invested this year through the low-income housing tax credit program.

"We feel it's a very viable way to cover the very difficult gap between affordable housing and quality rental properties. This gap is too big," says Watt, adding that bridging the gap requires some sort of subsidy, such as the low-income housing tax credit program.

He says that of the nearly 70,000 apartment units financed by Freddie Mac in 1995, about 65,000, or 95%, were affordable to people of low@ and moderate-income means.

As of the end of the third quarter of this year, Freddie Mac had funded $989. 1 million in multifamily loans, of which 96.% met the definition of low and moderate income.

Watt says Freddie Mac's commitment to affordable housing is based on several reasons, including financial. "We look at it as a real estate business," he says. "Affordable properties are fundamentally sound from a real estate point of view."

He says there are a lot of opportunities to invest in inner cities but for larger lenders. "It's a very expensive business for a primary lender to get involved in," Watt says. "Smaller loans are also not safer loans. They don't have professional management. If a 10-unit property has long-term vacancy, it can be destructive."

Mike Caffey, vice president of expanding markets at Freddie Mac, says his organization has increased its commitment to low- and moderate-income housing by 75% over the last couple of years. "From the financial performance point of view, these loans have performed relatively the same as nonaffordable loans," Caffey says. "There is no reason not to be pursuing affordable housing."

Caffey, who specializes in single-family affordable housing, says there are a lot of affordable housing projects in urban areas and scope for expansion in rural areas could be even greater. "We are suggesting that rural areas probably have some significant needs for mortgage finance and affordable housing projects," Caffey says.

He says evaluating financial risks and ability of the borrower to pay the mortgage is the key for success. "We take a leadership role in trying to identify the risk a borrower is facing," Caffey says. "The challenge is how the industry can better evaluate the risks. How can we better measure the risks?"

Caffey says some factors such as weak credit history, poor payment habits, little or no reserve, no equity and nothing to fall back on provide the best recipe for disaster. "It's basically an accident ready to happen," he says. "We like to think more like mortgage score as opposed to credit score."

He says the affordable housing market has matured significantly over the last couple of years and remains an extremely significant part of Freddie Mac's business.

One sign of the maturity is indicated by the entry of commercial real estate brokerage firms into the arena.

Cushman & Wakefield, a New York-based national real estate services firm, has established an Affordable Housing Group based in Boston. The group, headed by Douglas Koch, focuses on valuation of tax-exempt properties, low-income tax credit assignments, traditional lender appraisal for properties with affordable housing components, and marketing and feasibility studies to assist owners, developers and others in affordable housing markets. Koch says about two dozen brokers from Cushman & Wakefield's offices nationwide are involved in his group.

One of the biggest issues facing the affordable housing industry is the transfer or rehabilitation of privately owned subsidized housing across the country.

Koch says these subsidies - provided under Section 8 of the U.S. Department of Housing and Urban Development, which has been under budgetary constraints in recent years - are expiring, and a large bulk is expected to expire, in the next two to five years. He says approximately 1 million housing units will be affected.

"That is a big issue right now," Koch says. "What is going to happen with those mortgages and properties?"

David Abromowitz, former chairman of the American Bar Association Forum on Affordable Housing and Community Development Law and head of the housing practice at the Boston law firm of Goulston & Storrs, underscores that sources for developing affordable housing in the country have not kept pace with the growing demand. "There is a growing need for affordable housing and dwindling resources," Abromowitz says. "One of the unfortunate things about most housing programs is that when they get widely accepted and usable seems to be the time when rules change."

He says the LIHTC program has been there for about 10 years, but it's only in the last two to three years that it has become widely acceptable.

"Is it going to shrink? Will the rules change because of the politics in Washington and because of the study of a couple of troubled cases?" asks Abromowitz.

He says everyone who owns a house knows housing is extremely expensive to maintain and operate. "That is true for low-income people or middle class or anybody else," Abromowitz says. "Many housing developments are now old enough and need overhaul. Just that demand of keeping with existing houses could suck up all existing resources that are available at federal and state levels."

Abromowitz says it's hard to imagine much new affordable housing development will take place in the near future when it's already becoming difficult to maintain and upgrade existing facilities.

"For decades, there have been programs to use tax-free bonds to develop affordable housing. It's a well-known system where again demand outstrips supply," says Abromowitz. "Both federal and state governments need to direct more dollars towards affordable housing."

Bill Archer changes position

House Ways and Means Committee Chairman Bill Archer (R-Texas), who unsuccessfully tried to sunset the Low-Income Housing Tax Credit (LIHTC) program last year, has changed gears.

In a meeting of the Housing Advisory Group in Washington, D.C., in October, Archer praised the affordable housing industry and said he favored continued utilization of the LIHTC.

He said tax code should provide incentives for the participation of the private sector in the production of affordable housing.

In regards to the pending Government Accounting Office (GAO) study of the LIHTC, Archer said he does not expect the study to include any broad criticism of the program. He did say, however, that whatever conclusions of the GAO study come to will be used to enhance the effectiveness of the LIHTC. He expects the study to be released in February or March of 1997.

Last year, Archer unsuccessfully tried to sunset the LIHTC, pending an investigation into the mismanagement of the tax credit program.

New Republican caucus formed to promote affordable housing

Underscoring a need for greater availability and affordability of housing in the country, five members of the U.S. Congress have formed the Republican Housing Opportunity Caucus.

The caucus was founded by Jack Metcalf (R-Washington) in September. Joining Metcalf as co-chairs and members of the Executive Committee are: Reps. Nancy Johnson (R-Connecticut), Rick Lazio (R-New York), Jerry Weller (R-Illinois), and Phil English (R-Pennsylvania).

The goals of the caucus are to encourage the development of innovative, cost-effective and efficient approaches to providing affordable housing. It will also give members of Congress an opportunity to discuss housing policies.

"To deal with the shortage of affordable rental housing, we need to blend the energy and capital of industry with the public spirit of government and the incentives we can offer through law," Metcalf says.

He says an existing model of private-public collaboration is the Low-Income Housing Tax Credit program.

He says the caucus has pledged to work in a bipartisan manner with other organizations and his Democratic colleagues.

An advisory committee, consisting of private and charitable organizations dedicated to affordable housing, has been formed.

Herbert F. Collins, chairman of Boston-based Boston Capital Partners, will chair the Advisory Committee. Other members of the Committee include: Local Initiatives Support Corporation President Paul S. Grogan; F. Barton Harvey III, chairman and CEO of the Enterprise Foundation; John T. McEvoy, executive director of the National Council of State Housing Agencies; Gerald M. Howard, senior staff vice president of the National Association of Home Builders; and Stephen D. Drieler, senior vice president of the National Association of