The sun shines on affordable housing

The 1996 Summer Olympics in Atlanta were as memorable as any in recent history. But while the nation's attention was focused on Kerri Strug's ankle, the U.S. women's softball team and the fatal bombing at Centennial Park, part of the local redevelopment triggered by the games was also unfolding nearby.

Only a half-mile from Centennial Park and next to the Olympic Village, where many of the athletes were housed, Centennial Place was beginning to rise on the site of a former public-housing site. The community was partially financed through the Hope VI federal grant program designed to rebuild severely distressed public housing. It was the first Hope VI mixed-finance project in the United States.

Its fourth and final phase completed and occupied only late last year, the $60 million Centennial Place consists of 738 units: 538 garden apartments and 200 townhouses. The units break down as follows: 42% are market-rate, 41% are eligible for Section 8 (public housing vouchers) and 17% are low-income.

At the heart of all this action was Los Angeles — based SunAmerica Affordable Housing Partners (SAAHP), which worked on the project with St. Louis-based McCormack Baron & Associates. A limited partnership assembled by SAAHP funded the complex and garnered a 9% Low-Income Housing Tax Credit (LIHTC) in the process.

Centennial Place was familiar territory for SAAHP. The company has been a major national player in tax-credit-based financing since the late 1980s by investing in more than 670 projects totaling more than 100,000 units of affordable housing and more than $6.2 billion in development costs. With 160 employees in 12 regional offices, including a large in-house asset-management division, the company is the nation's largest direct equity investor in LIHTCs.

The path to tax credits

The road that led to Centennial Place, and to many other low-income housing projects before and since, began in 1989, said Mike Fowler, president of SAAHP. Kaufman and Broad Inc., a financial services company, spun off its housing operations and changed the company's name to Broad Inc. Around this time, with the federal LIHTC program having been created in 1986, Broad Inc. began to look at affordable housing as a way to shelter some of its tax liability.

In 1993, Broad Inc., which had owned Sun America Life Insurance Co. for more than 20 years, was renamed SunAmerica Inc. to emphasize its position as a financial-products corporation. In January 1999, SunAmerica merged with New York — based American International Group, a “AAA” rated financial services company.

“Originally, we were buying [tax-credit properties] for our own account,” said Fowler, who's a tax CPA and formerly oversaw Kaufman & Broad Inc.'s tax department.

SAAHP's product eventually evolved into a fairly elaborate form. Typically, the company owns 99% of a low-income apartment property as the limited partner, and the developer owns 1% as the general partner, said Alan Fair, SAAHP senior vice president. “Fee simple ownership is what drives the tax credit,” he explained, because the credit runs in proportion to a party's equity ownership in the property.

SAAHP takes a portion, usually the majority, of its interests in these limited partnerships and transfers them into investment partnerships in which other corporations can invest as limited partners. SAAHP credit enhances the partnerships through various guarantees. These include: construction completion guarantees, tax-credit guarantees, 15-year unlimited operating-deficit guarantees and gap financing to mitigate interest-rate risk on permanent mortgage financing.

“We took a lot of the real estate risk out of the program,” said Fowler. The fact that a recapture event could result in the investors' retroactive loss of the tax credit is one of the specific risks with a tax-credit property.

Although SAAHP's first sale of a tax credit — based product was in 1992 to a corporate investor, “in the very beginning, people had no idea what this was and couldn't figure it out,” said Fowler. “Initially, the program was not fully accepted by the financial community. However, the majority of money invested in SAAHP's product now is from institutional investors.”

Of course, SAAHP's well-capitalized parents play a big role in all this. “We had an advantage in that we could warehouse deals with our own funds,” said Fowler. Similarly, the company's resources and equity role in its partnerships differentiates the partnerships from syndicators, which typically assume only a transitory principal risk. Fowler notes that SAAHP always acts as a principal first and only later, depending on many factors, decides whether to resell the tax credits through its investment partnerships.

Ironically perhaps, although parent SunAmerica's growing income has given SAAHP an essentially “unlimited capacity to buy,” said Fowler, a limiting factor, starting in the mid-1990s, has been tightness in the tax credit allocations. Even if it meets the statutory and regulatory requirements, a low-income housing project's odds in state lotteries can get as low as one in three.

Though the situation varies by state, deeper rent-skewing can earn more points with state housing regulators and increase the chances that a project will get the credit. The result is that “rent-skewing is prevalent, varies materially from agency to agency and is often in excess of what the IRS requires,” said Fair.

There can also be a temptation, he notes, to go too far in the pursuit of approval. “You have to be very careful what you bargain for,” he cautions, because winning the LIHTC can become a Pyrrhic victory. One risk, ironically, especially for a project in a middle-income area, is that it might attract too few low-income residents to meet the tax credit's requirements.

“Tax-credit projects can become highly structured deals,” essentially a hybrid of real estate economics and tax-credit (equity) economics, Fair concluded. Although the debt terms are more important in 4% deals, it's not uncommon for a 9% deal (financed with taxable debt) to have equity funding, a first-lien mortgage and a second-lien mortgage, plus an external grant from a governmental unit or a non-profit agency, he added.

Yields, too, have continued to evolve. Fowler noted that in the early 1990s, 45 cents per dollar of tax credit (for a 10-year stream) was typical, with yields “well north of 15%.” Currently, however, the market is around 75 cents to 80 cents per credit with yields around 7% to 8%.

Partners and projects

Although SAAHP has been involved in deals on market-rate and historic rehabs, “95% of our focus today is affordable housing,” said Fowler. Less than 10% of the company's total equity is in market-rate housing, which is typically a “byproduct” of other work, sometimes a way to build a relationship with a developer.

Also, occasionally market-rate developers have been attracted to affordable housing by teaming up with SAAHP, Fair added. “The majority of our business is with repeat developers,” he added, although new developers are constantly receiving awards of tax credits.

In addition, some states restrict how many projects can be awarded to one developer in a year. As a result, “there's a constant need to be in the market and talking to people,” Fair said.

Currently, SAAHP's projects are mostly “suburban stand-alone” properties, usually with only one lien, said Fowler. Typical of these is The Tuscany on Lakepointe, a 168-unit, $15 million project about 25 miles north of Dallas. It consists of 72 two-bedroom, two-bath units; 39 three-bedroom, one-bath units; and 57 three-bedroom, two-bath units, all ranging from 1,000 to 1,150 sq. ft.

Like Centennial Place, it's a “60/40” project, with 40% of its units restricted to tenants with no more than 60% of the area's median gross income. Unlike the Atlanta property, however, it was financed with tax-exempt bonds, so it falls into the 4% tax credit category.

A somewhat different property is The Victory, at West 41^st Street and Tenth Avenue in New York City. The $120 million project, now well under way, will be a 45-story building with 416 apartments: 88 studios (502 to 523 sq. ft.), 242 one-bedrooms (630 to 656 sq. ft.) and 86 two-bedrooms (1,080 to 1,107 sq. ft.). There will also be almost 11,000 sq. ft. of ground-level retail. One hundred of the units are reserved for low-income tenants, with the remainder at market rents. The tax credit is 4%.

With housing costs continuing to match or outpace the inflation rate nationwide, it's safe to conclude that SAAHP's programs have a secure future. “We understand real estate,” said Fair, “and we've also come to understand the peculiarities of the tax credit,” with all of its variations from state to state. He predicts that SAAHP's menu of guarantees “will be valued more as time goes on because of the uncertainties” in the current economy.

“We have to play with the market that's out there,” said Fowler. “Adaptability is critical to our ongoing success.”

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Scott Baltic is a Chicago-based writer.

A tax-credit primer

The federal Low-Income Housing Tax Credit (LIHTC) was created by the Tax Reform Act of 1986 and is governed by Section 42 of the Internal Revenue Code.

Although created at the federal level, the LIHTC is administered and distributed by the states, which receive an annual allocation at the rate of $1.50 per capita. In 2002, the rate will increase to $1.75 per capita, with adjustments for inflation beginning in 2003. From the creation of the LIHTC through the end of 2000, the rate was $1.25 per capita.

Developers apply to state housing agencies for the LIHTCs. If their applications are approved, developers then market those credits, often through a syndicator, in order to raise equity for the apartments.

For a project to be eligible for the credit, at least 20% of its units must be rented to tenants making 50% or less of the area median gross income (AMGI), or at least 40% of the units must be rented to tenants making 60% or less of the AMGI. These income figures are determined by the U.S. Department of Housing and Urban Development (HUD) and published annually. Eligible projects must operate under these restrictions for 15 years.

The LIHTC is available in two amounts: 4% and 9%. A tax-credit allocation is equal to, roughly speaking, 4% or 9% of a project's qualified costs. Simply stated, the 9% credit is for the construction or substantial rehab of a building with taxable funds, and the 4% credit applies to the use of tax-free funding, such as industrial revenue bonds. The purchase of an existing building to be “substantially rehabilitated” also receives a 4% credit. Depending on the circumstances, a single building can qualify for more than one credit allocation.

Although the credit can be claimed by any legal entity, including an individual, corporation or trust, LIHTC programs are most commonly structured as limited partnerships.
— Scott Baltic