Affordable Housing 101

Affordable housing is built as a result of strong partnerships between governments, housing developers, community leaders, and private financial institutions.

Generally, a project will be considered financially feasible if:

1. The developer can secure financing for the total costs of acquiring and developing the housing facilities (TDCs)
2. Net operating income from the project will be sufficient to pay the debt service on the project after completion

TDCs are the expenses that the developer can reasonably expect to incur in order to complete the project. This includes “hard costs” or the costs of purchasing the property and making improvements to the property and “soft costs” or all the other costs and fees, such as professional services, financing fees, licensing and permits, and similar charges that likely will be incurred to complete the project.

To project net operating income, the developer must identify the income levels of the targeted residents, determine how much these individuals or families can afford to pay, and project other income that can be earned from laundry facilities, commercial space, parking, etc. Income and affordability levels are often dictated by loans and grants from federal, state, and local programs. Most of the housing built by CHC members is for families and individuals with incomes of 30-60% of the area median income (AMI), with rents set at 30% of their monthly household income.

Because the projected net operating income from affordable housing developments is lower than that from market rate developments, developers generally have to secure financing from a variety of sources.

Typically, a project’s sources of funds can be divided into three major categories:

1. Equity
2. “Senior” debt
3. “Subordinate” debt

Equity

Equity is the money contributed by the developer to the project. While this usually includes some direct investment from the developer, it is primarily secured from the tax credit investors.

Low Income Housing Tax Credit (LIHTC):

Congress created the federal housing credit in 1986 to enable low-income housing developers to raise equity for their projects. Each year, the U.S. Department of the Treasury issues tax credits to states for allocation to low-income housing projects. In 2014, each state received a maximum of $2.30 per resident, which amounted to $88 million in federal housing credit for California.

Projects developed with the federal housing credit can be either new constructions or renovation of existing rental buildings, but must meet certain rent and income limits. The state agency charged with administering the credit (i.e. California Tax Credit Allocation Committee) develops additional regulations for allocating the credits. In California, priority is given to projects that are located near amenities such as public transit, public parks, public libraries, schools, senior centers, etc. and provide services such as adult education, health and wellness, and skill building classes, child care, and after school programs.

Because the amount of tax credits generated through a typical project far exceed most developers’ tax liability, other for-profit entities with large tax liabilities (“investors”) or syndicators who act as a broker between the developer and the investors, form a limited partnership with the developer. The partnership then allocates nearly all of the tax credits to the non-developer partners in exchange for equity in the project. In California, the amount of equity per dollar of federal housing credit can range from $0.90 to $1.16.

There are two kinds of tax credits within the LIHTC program:

The “9 Percent” Credit:

The 9 percent credit is designed to subsidize 70% of the eligible development costs (“eligible basis” or costs incurred during the construction period excluding land, off-site improvements, commercial costs, and costs above state limits, i.e. portions of developer fees or architectural fees that are considered excessive). This credit is oversubscribed – requests for more than twice the amount available.

The “4 Percent” Credit:

When 50% or more of a project’s eligible costs (“aggregate basis” or land plus any depreciable fixed assets) are financed with tax-exempt private activity bonds, developers can receive the 4 percent credit, which is designed to subsidize 30% of the eligible basis. This credit, while much lower in value, has no cap. However, the ability of California developers to use the 4 percent credit is highly dependent on the ability of state and local funding to fill the gap due to its lower value. As a result, over the past 10 years, use of the 4 percent credit has significantly declined.

In response to the high cost of developing housing in California, in 1987, the state legislature authorized a state housing credit. The amount of the state credit was capped at $70 million, which, once adjusted for inflation, totaled $103 million in 2014. The state housing credit can only be used with projects receiving federal housing credits and not located in difficult to develop areas (DDAs) or qualified census tracts (QCTs) or, if located in DDAs or QCTs, with projects where 50% of the units are for individuals with special needs. CHC is currently working on increasing the amount of state credit available in California.

Tax credit equity is paid in installments. Typically the investor will put in 10-20% up front, then make one or two payments during the construction period, and then a final payment at or after completion.

New Markets Tax Credits (NMTC):

The NMTC attracts private capital investment in areas where the poverty rate is at least 20 percent or where the median income of the community is at or below 80 percent of the broader area median income.

While the credit is not available for investments in projects that involve solely residential rental housing, the credit is available for investments and loans for certain mixed-use projects and certain other types of housing development, as long as at least 20 percent of the gross rental income from the building is from non-residential rentals.

Historic Rehabilitation Tax Credit:

The federal historic tax credit can work in conjunction with an affordable housing project that is rehabilitating a historic building certified by the National Park Service. The amount of credit available under this program equals 20% of the qualifying expenses of the rehabilitation.

Senior Debt

“Senior” debt refers to debt that must be paid off first. This usually takes the form of traditional, commercial loans from private lenders.

New affordable housing projects are typically first financed with an acquisition and construction loan. These are short-term loans that mature in 12 to 36 months. They are sized based on a percentage of the TDC and typically include reserves, developer guarantees, and other additional security for the lender.

Once the project is fully constructed and has been occupied at a certain level and for a certain period of time (“stabilized”), the construction loan is typically paid off from a combination of sources, including some or all of the following: a senior permanent loan, typically with a maturity of 15-30 years, one or more subordinate loans, and tax credit equity.

When loans are financed from the proceeds of tax-exempt bonds issued by a governmental entity, bonds are usually issued at the outset of the financing to fund a “construction-to-permanent” loan that converts from the construction phase to the permanent phase upon stabilization.

Lending institutions are incentivized to lend to affordable housing developers in order to meet their commitment under the federal Community Reinvestment Act (CRA), which requires commercial banks to serve the credit needs of low- and moderate-income communities and to take steps to provide equal access to responsible financial products and services to traditionally underserved populations.

Subordinate Debt

“Subordinate” debt refers to all loans that are payable after all payments due on the senior debt have been made. Because affordable housing projects do not typically generate a great deal of net operating income, most projects make use of one or more (sometimes as many as 5-7) subordinate loans to provide sufficient sources for TDC. Subordinate loans may be funded at the time of the initial construction/acquisition loan but are more often funded at or after completion and used to retire the senior debt.

Federal Programs:

Community Development Block Grant (CDBG)

The CDBG program provides communities with resources to address a wide range of unique community development needs. The annual CDBG appropriation is allocated between States and local jurisdictions called “non-entitlement” and “entitlement” communities respectively. Entitlement communities are comprised of central cities of Metropolitan Statistical Areas (MSAs); metropolitan cities with populations of at least 50,000; and qualified urban counties with a population of 200,000 or more (excluding the populations of entitlement cities). States distribute CDBG funds to non-entitlement localities not qualified as entitlement communities.

HUD determines the amount of each grant by using a formula comprised of several measures of community need, including the extent of poverty, population, housing overcrowding, age of housing, and population growth lag in relationship to other metropolitan areas. Over a 1, 2, or 3-year period, as selected by the grantee, not less than 70 percent of CDBG funds must be used for activities that benefit low- and moderate-income persons. More information is available on HUD’s website.

HOME Investment Partnerships (HOME) Program

The HOME Program provides formula grants to States and localities that communities use – often in partnership with local nonprofit groups – to fund a wide range of activities including building, buying, and/or rehabilitating affordable housing for rent or homeownership or providing direct rental assistance to low-income people. HOME funds are awarded annually as formula grants to participating jurisdictions. The program’s flexibility allows States and local governments to use HOME funds for grants, direct loans, loan guarantees or other forms of credit enhancements, or rental assistance or security deposits. More information is available on HUD’s HOME Resource page.

Project-Based Vouchers (Section 8 and VASH)

The Section 8 Housing Choice Voucher program is the federal government’s major program for assisting very low-income families, the elderly, and the disabled to afford decent, safe, and sanitary housing in the private market. The program is administered locally by public housing agencies (PHAs). A family that is issued a housing voucher is responsible for finding a suitable housing unit of the family’s choice where the owner agrees to rent under the program. A housing subsidy is then paid to the landlord directly by the PHA on behalf of the participating family and the family pays the difference between the actual rent charged by the landlord and the amount subsidized by the program.

Project-based vouchers are a component of a public housing agencies (PHAs) housing choice voucher program. A PHA can attach up to 20 percent of its voucher assistance to specific housing units if the owner agrees to either rehabilitate or construct the units, or the owner agrees to set-aside a portion of the units in an existing development.

The VASH program combines Housing Choice Voucher rental assistance for homeless veterans with case management and clinical services provided by the Department of Veterans Affairs (VA). HCVs are generally intended to be tenant-based, but some vouchers are project-based, meaning that the vouchers are tied to a specific development. PHAs can choose to project-base up to 100% of their HUD-VASH vouchers (so long as no more than 20% of their overall voucher allocation is project-based). If a community opts to project base some portion of its HUD-VASH allocation, HUD and VA approval is required. More information is available on the HUD’s VASH page.

USDA Rural Housing Service

The USDA Rural Housing Service Provides loans in rural areas to finance homes and building sites. Rural Rental Housing Loans are direct, competitive mortgage loans made to provide affordable multifamily rental housing for very low-, low-, and moderate-income families; the elderly; and persons with disabilities. More information is available on the USDA Rural Development website.

Housing Opportunities for Persons with AIDS (HOPWA)

HOPWA was established to provide housing assistance and related supportive services for low-income persons living with HIV/AIDS and their families. HOPWA funds may be used for a wide range of housing, social services, program planning, and development costs. These include, but are not limited to, the acquisition; rehabilitation; or new construction of housing units; costs for facility operations; rental assistance; and short-term payments to prevent homelessness.

Two types of grants are made under the HOPWA program. HOPWA formula grants are made using a statutorily-mandated formula to allocate approximately 90 percent of HOPWA funds to eligible cities on behalf of their metropolitan areas and to eligible States. HOPWA competitive funds are awarded on the basis of a national competition. More information is available on HUD’s HOPWA page.

Legacy Programs

The HUD 202 program provided capital advances to finance the construction, rehabilitation or acquisition with or without rehabilitation of structures that will serve as supportive housing for very low-income elderly persons, including the frail elderly, and provides rent subsidies for the projects to help make them affordable. More information is available on HUD’s Section 202 Portal. Unfortunately, there has been no funding for HUD 202 since 2012.

The HUD 811 program provided funding to develop and subsidize rental housing with the availability of supportive services for very low- and extremely low-income adults with disabilities, allowing persons with disabilities to live as independently as possible in the community by subsidizing rental housing opportunities which provide access to appropriate supportive services. More information is available on HUD’s Section 811 Portal.

The HUD 236 program provided an interest rate reduction payment to subsidize debt service costs, effectively operating as a subsidy to the developer to reduce the cost of the project and thus the rent levels needed to support it. Projects using this program were often coupled with Rental Housing Assistance Payments in order to reach lower-income households. Under Section 236 two rent schedules were worked out for residents with incomes at or below 80% of AMI-one: (1) a “market rent” based on the cost of a market rate mortgage, and (2) a “basic rent,” a figure based on a one percent mortgage. The tenant paid the greater of the basic rent or 25% of his/her income, but in no case would rent payments exceed the market rent.

California State Programs:

CA Housing Bonds (Prop 46/Prop 1C)

Prop 46 of 2002 and Prop 1C of 2006 allocated a total of $4.9 billion of voter-approved bonds to fund several important housing programs administered by the Department of Housing and Community Development (HCD), including:

Multifamily Housing Programs (MHP) – MHP offers deferred payment loans to assist the new construction, rehabilitation, and preservation of permanent and transitional rental housing for lower income households. MHP is divided into two funding programs, one for housing generally and one for supportive housing. In the 2014-2015 state budget, MHP received an additional $100 million from the state’s general fund. More information is available on the HCD MHP page.

Infill Infrastructure Grant Program (IIG) – IIG provides grants to assist in the new construction and rehabilitation of infrastructure that supports higher-density affordable and mixed-income housing in locations designated as infill. More information is available on the HCD IIG page.

Transit Oriented Development (TOD) Housing Program – Under the TOD program, low-interest loans are available as financing for rental housing developments that include affordable units. In addition, grants are available to cities, counties, and transit agencies for infrastructure improvements necessary for the development of specified housing developments, or to facilitate connections between these developments and the transit station. More information is available on the HCD TOD page.

Joe Serna Jr. Farmworker Housing Grant Program – This program provides Grants and loans to assist development or rehabilitation of various types of housing projects for agricultural workers, with a priority for lower income households. More information is available on the HCD JSJFWHG page.

Veterans Housing and Homeless Prevention Program (Prop 41)

In June 2014, voters approved Prop 41, which authorizes $600 million in existing bond authority to provide multifamily housing, such as apartment complexes, to low-income veterans and supportive housing for homeless veterans. After setting aside funds for bond issuance costs, default reserves, and program administration, approximately $545 million is available for development assistance and operating subsidies, over the next several years. HCD, in collaboration with the California Housing Finance Agency (CalHFA) and California Department of Veterans Affairs, is in the process of designing, developing, and administering the program. The Agencies expect to be able to offer approximately $75 million in the fall of 2014 through a competitive process. More information is available on the HCD VHHP page.

Affordable Housing and Sustainable Communities (AHSC) Program

In June 2014, the Legislature and Governor approved a state budget that included $130 million in 2014-2015 and at least 10% of ongoing revenue (estimated at $200-$300 million per year starting in 2015) from the Greenhouse Gas Reduction Fund for the AHSC Program. Among other things, the program will provide grants and affordable housing loans for infill and transit-oriented development and infrastructure. Projects funded by the AHSC Program will demonstrate how they support reduction of GHGs by increasing accessibility of housing, employment centers, and key destinations via low-carbon transportation options (walking, biking, and transit), resulting in fewer vehicle miles traveled. More information is available on the Strategic Growth Council AHSC page.

Mental Health Services Act (MHSA) Housing Program

Jointly administered by the California Department of Mental Health and CalHFA on behalf of counties, the MHSA Housing Program offers permanent financing and capitalized operating subsidies for the development of permanent supportive housing, including both rental and shared housing, to serve persons with serious mental illness and their families who are homeless or at risk of homelessness. MHSA Housing Program funds will be allocated for the development, acquisition, construction, and/or rehabilitation of permanent supportive housing. More information is available on the CalHFA MHSA page.

Local Programs:

Redevelopment Boomerang Funds

When California eliminated redevelopment agencies in December of 2011, local governments lost the largest source of state funding for affordable housing. Across the state, redevelopment was responsible for over $1 billion in direct funding for affordable housing with its 20% tax increment set-aside. A portion of those former tax increment funds come back to local jurisdictions as both a one-time lump sum from their former Low and Moderate Income Housing Fund and an ongoing bump to their property tax. Some local governments will dedicate these “boomerang funds” for affordable housing development.

Inclusionary Zoning and In-Lieu/Linkage Fees

In order to meet the requirements of their communities’ general plans for the provision of affordable housing, many local governments have instituted a variety of techniques to enable the private market to help provide affordable housing. Inclusionary housing policies require a market rate developer to include a percentage of affordable units into its overall development plan. In the alternative, the developer may pay a fee in-lieu of constructing the affordable units. These fees are then used to finance affordable housing development.

In recent years, this practice has been under attack in California. In Palmer v. City of Los Angeles, the California Court of Appeals held that provisions of a specific plan requiring developers of new rental housing to rent a portion of the units at restricted rents conflict with the Costa Hawkins Act, which was enacted to permit developers to set initial rents on newly constructed and voluntarily vacated units in jurisdictions with rent control. The court also found that the alternative of paying an in-lieu fee did not save the inclusionary requirement because payment of the fee was “inextricably intertwined” with the mandate to impose rent restrictions.

Linkage fees are a form of impact fee assessed on new commercial developments or major employers based on the need for workforce housing generated by new and expanding businesses. Revenues generated by the fee are then used to help fund the development of affordable housing opportunities within accessible commuting distance to the employment center.

Quasi-Government Agencies:

Federal Home Loan Bank – Affordable Housing Program (AHP)

The purpose of AHP is to subsidize the interest rates on advances or loans made by the Federal Home Loan Bank system to a member bank and to provide direct subsidies to these banks. The banks then pass these subsidized interest rates and direct subsidies on to housing developers to hop them support the development of affordable rental housing. The subsidies must be used to finance the purchase, construction, and/or rehabilitation of rental housing, at least 20% of the units of which will be occupied by and affordable for very low-income households for at least 15 years.

Fannie Mae/Freddie Mac (GSEs) – National Housing Trust Fund

The National Housing Trust Fund was established as part of the Housing and Economic Recovery Act of 2008 (HERA) and would provide grants to states to increase and preserve the supply of rental housing for extremely low- and very low-income families, including homeless families, and to increase homeownership for extremely low-income families and individuals. HERA requires Fannie Mae and Freddie Mac to transfer a percentage of their new business to finance the Trust Fund. However, soon after the bill passed, the financial crisis hit, the GSEs were taken into conservatorship, and the Federal Housing Finance Agency suspended any payments to the Trust Fund. Now that the financial condition of the GSEs has improved considerably, starting January 1, 2013, all GSE profits have been swept to the Treasury (a combined net income of $151 billion during the first three quarters of 2013). Under HUD’s Proposed Rule for the Housing Trust Fund Allocation Formula, California would receive an estimated $889,400,000 for every $5 billion invested in the Trust Fund.