The Low Income Housing Tax Credit program has Congress looking at a much needed increase.

The nation's most popular and highly successful affordable housing program, the Low Income Housing Tax Credit (LIHTC), has survived several rounds of budgetary battles at Capitol Hill and is finally getting ready for a long overdue boost from congressional leaders -- a 40% increase in the per capita ceiling.

Senators Alfonse D'Amato, R-N.Y., and Bob Graham, D-Fla., have introduced legislation that would index the LIHTC per capita ceiling for inflation and make up lost ground since 1986. The proposed bill would increase the annual state authority to allocate tax credits from the current $1.25 per capita to an inflation-adjusted $1.75 per capita -- a 40% increase. The bill would also begin indexing the credit for inflation beginning in 1999. Similar legislation was scheduled to be introduced in the House of Representatives before this issue went to press by Rep. John Ensign, R-Nev.

If the pending legislation becomes law, it would be one of the biggest victories for the affordable housing industry since 1993, when the LIHTC program was made permanent. It would also mark the first increase ever to the credit cap since the program was first created through the Tax Reform Act of 1986. Industry activists have long argued that the static $1.25 cap has eaten away the LIHTC program's purchasing power and that it ought to be at least inflation-adjusted -- if not increased -- to $6 per capita to meet the growing demand for affordable housing.

"Congress will discuss the bill during the next session. It's very difficult to say what will happen with the bill, but chances are very good," says Richard J. DeAgazio, senior vice president of Boston-based Boston Capital, one of the largest owners of affordable rental housing in the country. "We have a good story to tell. This program has been the most successful program and has garnered a lot of support since the GAO issued its report on the low income housing tax credit last April."

In a comprehensive report in April, the U.S. Government's General Accounting Office (GAO) noted that LIHTC had exceeded the program's goals in helping meet growing low-income rental housing needs nationwide. Industry insiders say that the favorable GAO report has not only subsided talks of sunsetting the LIHTC program, but has also generated tremendous support for the program in the U.S. Congress.

Congressional officials declined to comment on the proposed legislation on the record, saying it was too early to talk about the fate of the bill. However, the GAO report had tremendous impact on lawmakers and the proposed bills will be looked upon very favorably when Congress returns in session next year. "Congress is committing to continue providing housing to low-income families. It is one of the ways we plan to expand the tax credit program," says a Congressional aide, who asked not to be identified. "Every dollar of tax credit brings $18 in private investment."

"When the program was first launched in 1986, LIHTC was generating approximately 125,000 affordable rental units a year," says DeAgazio. "The LIHTC program today provides approximately $3 billion in annual subsidy to low-income rental housing development and acts like a major catalyst for private sector investment. Since its inception in 1986, the LIHTC program has attracted more than $10 billion in private investments in tax credit development projects."

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 about 10 years. Under the LIHTC, developers of rental housing must rent 20% of the rental units at 50% of the area median income, or 40% of the units at 60% of the area median income. The average household income of tenants in LIHTC projects is only 38% of the area's media gross income, states a report from the National Council of State Housing Agencies. The study, known as The Low-Income Housing Tax Credit: the First Decade, was conducted by the Ernst & Young Kenneth Leventhal Real Estate Group.

"The Senate bill is a very significant development and very good news for the affordable housing industry. It will be the first time that low income housing tax credit per capita will be increased," says Michael J. Novogradac, a managing partner of San Francisco-based Novogradac & Co. LLP, a national accounting firm specializing in affordable housing. "It has never been increased since 1986."

In addition to the D'Amato-Graham bill that would index the LIHTC per capita ceiling for inflation, there is another bill in Congress that calls for restoring a tax-exempt bond volume cap to $75 per person, or $250 million for smaller states, from $50 per capita at present. The bill would also index the cap for inflation. The bond volume authority was reduced to $50 per capita in 1987. As a result, many states are allocating more money from their bond volume cap to affordable multifamily projects. The state of California has increased tax-exempt bond allocation for multifamily housing to $600 million this year from $400 million in 1996. Also, Texas plans to expand its volume cap allocation for affordable housing by 50% to $69 million in 1998.

"Tax-exempt bonds are seen as an attractive finance mechanism for the development of affordable rental housing because interest rates on such bonds are generally less than conventional long-term financing," says Novogradac. "In addition to the lower interest rates, such rental properties are also eligible for low-income housing tax credits. Tax-exempt bonds are so attractive that the federal government is forced to limit the amount any one state can issue."

Every state is currently 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 projects, including single-family homes, student loans, pollution control facilities and industrial development projects.

"Every state is different in how they apportion their bond volume allocation authority among the various categories of projects," says Novogradac. "Most states find that a fierce competition exists among the various categories of allowable uses as well as within each category among the specific eligible projects."

To qualify for tax-exempt bond financing, rental housing developments must set aside a minimum number of units for use by low-income persons. Like the low-income housing tax credit program, at least 20% of the units must be rented to families at, or below, 50% of an area's median gross income, or 40% of the units must be rented to families at, or below, 60% of a given area's median gross income.

"If proposed increases in both tax-exempt bond allocations and LIHTC caps are approved by the U.S. Congress and signed into the law, the affordable housing industry will be able to generate a total of between 200,000 and 250,000 affordable rental units -- an increase from between 100,000 and 150,000 units a year at present," says Novogradac. "This would be still short of the growing demand for affordable rental housing in the country. In the area of developing affordable housing, there can never be 'enough' money. Currently, there is a demand for several million affordable housing units in the country -- between 3 million and 5 million units. While 175,000 new families are becoming eligible for affordable rental housing every year, the supply of affordable housing is declining by 150,000 units annually."

Richard Thornton, executive vice president of Washington Capital, an Arlington, Va.-based mortgage banking firm, has financed more than 45,000 apartment units nationwide and notes tax credits and tax-exempt bonds together continue to be in a strong demand.

"More and more multifamily developers are now combining tax credits and tax-exempt bonds to finance their affordable housing projects. There is so much competition for bond allocations that some states are increasing qualification requirements," says Thornton, adding that competition for tax-exempt bonds is especially fierce in states of California, Florida and Texas. "They are asking developers to have the lender's commitment even before they apply for bond or tax credits."

Lawrence H. Curtis, general partner of Winn Development Co., a Boston-based developer of multifamily and affordable housing, states what has led to an already fiercely competitive tax credit and tax-exempt bond market is the entry of a large number of developers into the affordable housing area. "More and more players are getting into the industry and some of them have no experience in development of affordable housing," says Curtis. "Credit and bond allocation authorities also seem to have been relaxing underwriting rules. Credit awards are going to some projects whose developers have less experience in affordable housing. If the allocating agencies have poor underwriting rules, it can be very scary. There should be very strong underwriting rules for tax credit financing. If not, there could be some serious problems four or five years from now."

Winn Development Co. has been using both LIHTC and tax-exempt bond financing for rehabilitation and redevelopment, rather than building new projects. Housing and Urban Development (HUD) sponsored public housing projects are becoming especially attractive to developers. "There is a major inventory of HUD housing. It is becoming a more competitive sector," says Curtis. "The trend is toward rehabilitating rather than developing new buildings. We ourselves have been focusing on acquisition rehabs. Rehabilitating and redeveloping an existing project is more cost-effective. It costs just between 30 cents and 60 cents of a dollar to rehab a rental property."

James Dailey, managing director of property acquisitions at Boston Financial, Boston, recognizes that a large chunk of low-income housing tax credits are now going to the HOPE VI program, which was launched in the mid-1990s, to tear down troubled public housing projects and redevelop them into affordable housing.

"HOPE VI projects are apparently receiving large credits in many states. More and more credits are going to HOPE VI projects, funding the rehab and replacement of large public housing projects. There are huge demands for such projects. We have seen them in Massachusetts and in many other states, including Georgia and Michigan," says Dailey. "The market for scant tax credits has become so tight that many traditional tax credit developers are now exploring tax credit and development options in other states. A number of developers are now looking at other states. It's very tough for a developer to get a huge amount of credit from any one state. Generally speaking, many states are trying to get more credits in the hands of developers."

Jeff Goldstein, director of acquisitions at Boston Capital, says almost all states are allocating all of their tax credits. "There is a fairly intensive competition for tax credit projects by equity providers. That has driven prices up," says Goldstein. "As a result, yields on investments in affordable rental housing have also come down."

Goldstein declined to specify the rate of decline in yields, but industry insiders say cash on cash returns have dwindled to 9% range or below as compared with 14% three years ago and about 18% four to five years ago. Some industry insiders say tax credit yields will continue to fall as investors get more comfortable with the risk reward relationship. They argue that the perceived risk level in tax credit investments was quite high a few years ago as compared with today.

"The market has really matured. Despite a decline in cash on cash return, many investors have come to realize the safety in this type of investment. Although cash on cash return has fallen, your risk-adjusted return is still quite good," says Goldstein. "The current robust economic growth and a 24-year-low unemployment rate nationwide is unlikely to have any impact on the affordable rental housing market. The demand for affordable housing far outstrips the industry supplies. We start to see more market rate multifamily construction. Our properties are not competing against these properties, but we have to benchmark with these market rate properties."

According to U.S. Department of Commerce data, multifamily building permits climbed 9.8% , from a seasonally adjusted annual rate of 283,000 units in June, to 311,000 units in July. However, multifamily construction decreased 8.7%, from a seasonally adjusted annual rate of 301,000 units to 275,000 units. Meanwhile, interest by corporate investors in affordable rental housing continues to grow stronger. Lately, the participation of insurance companies, banks and pension funds has also started to grow. Likewise, wealthy individual investors, who virtually dominated the LIHTC investments during 1987 to 1991, has declined significantly.

"Even the new tax law that lowers capital gains tax and offers other limited tax incentives will be unable to attract individual investors to tax credit investments," says Novogradac. "They made tax law changes to enhance the attractiveness to individual investors. However, the credit is so much more attractive to corporations that tax law changes should not have a material impact."

According to the LIHC Monthly Report, a tax credit publication by Novogradac & Co., because of the new tax law, most taxpayers will be able to exclude gains from owner-occupied housing from capital gains tax. The elimination of the need to rollover gain on personal residences to avoid paying tax should make rental housing a more viable option for homeowners considering selling their residences. Before the new law, if a homeowner invested in a new home, an amount at least as large as the sales price of the old home, no gain would be recognized fort tax purposes. Under the new law, the first $250,000 ($500,000 for married couples) of capital gains on homes sold is exempt from tax -- no morerollover provisions. This makes renting an excellent option and favors residents seeking affordable housing communities, for some of these residents are elderly and qualify within the median income range to get this type of housing.

The reports adds that with this spark for rental demand for residences, long distance job transferees will typically try to avoid home shopping; therefore, they will rent until finding a permanent home. The new tax law eliminates this pressure so new movers are more likely to remain renters. Some of these renters are eligible for affordable housing residences and fall into the financial requirements to seek this type of housing.

The National Multi Housing Council (NMHC) estimates that the total number of in-movers to apartments will increase 7% to 7.3 million because of the new law. This includes affordable housing and the demand will keep increasing annually. Because many of these homeowners are likely candidates for the higher-end rental market, markets where low income housing rents and market rents are similar may see higher rents due to an increased demand in the affordable housing marketplace.

Section 8 refunding success Columbus, Ohio-based Banc One Capital Corp. announced the closing of a bond refunding issue that helped the Prestwyck Apartments, located in Wilmington, Del. The 41-unit community received Section 8 assistance pursuant to a Housing Assistance Payment (HAP) contract that will expire in the year 2000. Prestwyck Apartments carries a mortgage loan that is insured by FHA mortgage insurance. As a result of the refunding, and the sale of low coupon tax-exempt refunding bonds, the project's mortgage rate will be reduced from 10.5% to 5.80% upon expiration of the HAP contract in 2.5 years. Based on the savings generated by the refunding, Prestwyck Apartments will receive $45,000 for project repairs. HUD approval to proceed with this refunding transactions was received in approximately 20 days. Banc One Capital Corp. served as the sole underwriter.

FHLBA, North Carolina Bankers Association & CICNC team-up An innovative partnership between the Federal Home Loan Bank of Atlanta (FHLBA), the North Carolina Bankers Association and the Community Investment Corp. of North Carolina (CICNC) has increased affordable housing opportunities in North Carolina by providing additional local financial institutions more sources of funding. The new Affordable Multifamily Participation Program (AMPP) expands the sources of mortgage credit for affordable housing developments by creating a secondary market for CICNC-funded rental loan developments. AMPP brings additional liquidity and credit risk management to North Carolina financial institutions by enabling these banks to sell their CICNC mortgage participation interests to the FHLBA.

The first transaction through AMPP closed in November on a $750,000 loan for Graham Village Apartments, a 50-unit affordable housing community in Graham, N.C. With loans ranging from $300,000 to $3 million, CICNC has committed to finance 65 projects and more than $50 million in loans, representing 3,000 low income housing units to North Carolina.

Section 8 mark-to-market passed by Congress Mark-to market legislation was passed by Congress in Title V of the Veterans Administration, Housing and Urban Development (HUD) and the Independent Agencies Appropriation Act of 1998, which President Clinton signed into law on Oct. 27, 1997. Title V allows the mortgages on the stock of project-based Section 8 affordable housing to be restructured to provide budgetary relief while locking in an additional 30 years of required affordability to residents.

All FHA-insured projects in Section 8, whose rents upon renewal will exceed 120% of comparable market rents, are eligible for restructuring. Mortgage restructuring will be conducted by state housing finance agencies (HFAs), non-profit or private entities acting on behalf of HUD. Title V specifies that elderly projects, projects in very tight markets and non-profit projects will automatically be renewed with project-based assistance.

Also, Title V prohibits the restructuring of projects connected to other projects, whose owners or limited partners have engaged in material adverse actions. HUD will assist non-renewed projects desiring to transfer ownership to tenant organizations, tenant non-profits and public agencies.

NMHC recognizes three groups likely to rent * Job transferees and other long-distance movers * Owners over the age of 55 who have $125,000 of capital gains * Owners younger than 55 who want to simplify their housing

Upendra Mishra is a Randolph, Mass.-based writer who covers real estate issues and is a former real estate editor for the Boston Business Journal.