Bridging the Housing Gap with PABs and LIHTC Funding

The pandemic has worsened the housing affordability crisis in the United States, especially for low-income households. As reported by the National Low Income Housing Coalition, New York State has seen over eight million affordable homes for very low-income families, but a staggering 712,000 homes remain missing from the state. This implies that the quest for rent across America remains a challenge; thus, for New York residents, at least $40 per hour will be required to afford a two-bedroom apartment.

 

An available strategy is expanding tax-exempt Private Activity Bonds (PABs) to support the development or rehabilitation of affordable rental housing. When combined with 4% Low-Income Housing Tax Credits, PABs provide much-needed funding, but localities must bid for projects and receive supplemental subsidies to cover funding shortfalls. States also play a significant role in determining PAB volume for multifamily affordable housing.

 

Here, we have a guide dedicated to the ins and outs of PAB, including eligibility, benefits, and challenges. If you want to deepen your knowledge of PABs, this article can be your go-to resource.

Private Activity Bonds (PABs) – An Overview 

Private Activity Bonds (PABs) represent a distinctive financial mechanism grounded in the tax code that aims to entice private investment in public-private projects. Such municipal bonds enable local governments to borrow money on behalf of private entities at no tax charges through tax-exempt obligations for qualified projects such as affordable housing, student loans, and infrastructure improvements. PABs reduce borrowing costs by exempting interest income from federal taxation, giving investors an attractive option.

 

PABs are divided into two types: one supports government-related projects and the other fund’s private projects that yield public benefits.

 

Strict rules define what constitutes a “public benefit,” and facilities such as gambling facilities, golf courses, and stadiums are not included. Because these bonds reduce tax revenue by creating exemptions, Congress has capped at the annual level the issuance of such bonds by imposing a volume cap-the greater of $335 million or $110 per capita in 2022.

 

The combination of PABs with Low-Income Housing Tax Credits can be especially valuable during development or rehabilitation. Although PABs offer great benefits, their cost and complexity remain high and demand careful planning and coordination between governments and private entities.

Combining PABs with 4% LIHTC 

Private Activity Bonds (PABs) are a significant source of financing when used in conjunction with the 4% Low-Income Housing Tax Credits for affordable housing projects. Because PABs can only be issued by state, local, or quasi-governmental entities, such as HFAs, they are issued under very low volume caps, so they compete vigorously among government units for the use of those limited funds.

 

Projects will qualify for 4% LIHTCs provided they meet the “50% rule,” where the PAB proceeds would pay at least 50% of construction costs. Any housing developed with these bonds and tax credits must also qualify as affordable, typically by having 20% of units priced below 50% AMI for households or 40% at 60% AMI. 

 

While the 4% tax credit provides a lower subsidy than its 9% counterpart, developers often need to secure the financing gap to make projects financially viable. This additional funding typically comes from other federal programs like the HOME or Community Development Block Grant (CDBG) programs, but local governments can also support these projects by prioritizing them for housing trust funds or other subsidies. Without these additional sources, many projects may struggle to proceed. 

Key Strategies for Enhancing PAB Utilization 

Strategy	Description
Prioritize Housing	Allocate more PABs to affordable rental housing to maximize the impact of 4% LIHTCs.
Recycling Bonds	Ensure unused bonds are recycled for other uses rather than being carried forward or wasted.
Streamline Applications	Make the process easier and quicker by reducing unnecessary steps and improving coordination.
Gap Financing	Secure additional federal and local funding to close financing gaps in PAB-funded projects.
Limit PAB Awards	Cap PAB allocation per project to stretch resources and fund more developments.
Taxable Tail Financing	Use taxable debt to cover additional financing needs beyond the PAB cap.

A Three-Step Approach to Maximizing Affordable Housing through PABs 

States can take several strategic steps to unlock the potential of Private Activity Bonds (PABs) for affordable rental housing. By refining policies and improving the allocation process, this valuable financial tool can be used to build more rental units.

 

Step 1: Allocate More PABs to Affordable Rental Housing

 

• Increase Focus on Housing: States should allocate more of their PAB volume cap to affordable rental housing. This use of PABs maximizes the federal tax subsidy, primarily through the 4% LIHTC, a unique benefit lost when PABs are allocated elsewhere.  

• Recycling Bonds: At a minimum, states should recycle unused bonds for other purposes, ensuring no PAB volume cap is wasted. 

 

Step 2: Avoid Expiring PAB Authority & Improve Utilization 

 

• Utilize All PAB Allocations: States should ensure no PAB authority expires and reduce the volume carried forward by increasing utilization rates. 

• Policy Changes: When resources are underutilized, additional requirements like deeper income targeting or added design features should only be applied when competing for bonds. 

• Efficient Applications: States can streamline the application process by improving coordination among funding sources, allowing an open application cycle, and speeding up approvals. 

• Provide Gap Subsidy: Additional financing sources (e.g., HOME, CDBG, and state LIHTCs) should be used to bridge the gap between project costs and the equity generated by 4% LIHTC. 

• Local Support: Cities and counties can provide critical local support, such as donating land, waiving fees, or expediting permits to reduce development costs. 

• Educate Developers: States should offer more education to developers about how to effectively combine PABs with 4% LIHTCs. 

 

Step 3: Generate More Housing per PAB Dollar

 

• Limit PAB Allocation Per Project: Allocating agencies can stretch their PAB volume by limiting the amount awarded to each project. Limiting PABs to 52-55% of development costs can make additional funds available for other projects. 

• Taxable Tail Financing: Any extra financing can be obtained through taxable debt, allowing developers to maximize their use of available PABs without exhausting the bond cap. 

Eligibility and Usage of Private Activity Bonds for Affordable Housing 

Under federal law, both PABs and 4 percent LIHTCs are structured with stringent qualification requirements. In the context of affordable rental housing, at least 95 percent of the bond proceeds must fund residential rental properties financed through either construction financing or permanent loans under those bonds. Units developed with these bonds will be required to remain affordable for at least 30 years, including a 15-year compliance period followed by an additional 15 years in an extended use period.

 

At least 50 percent of eligible project costs must be financed with PABs to qualify for the 4 percent LIHTC. This is known as the “50 percent test.” States can set their goals for PAB allocations in line with local housing needs or development goals.

Benefits of Private Activity Bonds (PABs) 

PABs provide significant benefits when used for affordable housing projects, particularly when combined with 4% LIHTCs. The federal government allocates PABs yearly to each state to fund projects with public benefits, such as infrastructure, hospitals, and affordable housing.

 

PABs are especially valuable for affordable multifamily rental housing because they automatically unlock the 4% LIHTC, offering both lower-cost financing through the bonds and additional equity through the tax credit. 

 

Although 4% LIHTCs provide a lower subsidy than the competitive 9% LIHTCs, they are available now, making them more accessible. This combination of bond financing and tax credits is particularly effective for projects with lower development costs, such as preservation efforts or projects that require light rehabilitation.

 

PABs and 4% LIHTCs can become powerful tools for expanding affordable rental housing when additional subsidies are available. 

Steps to Increase Affordable Rental Housing through PABs 

To maximize the potential of PABs for affordable rental housing, states can follow three key steps.

 

First, states should allocate more of their PAB volume cap to affordable rental housing. Rental housing is the only PAB-eligible activity that generates substantial federal resources through 4% LIHTCs, making it the best use of this resource in addressing the housing crisis. Additionally, recycling unused bonds ensures no PAB cap goes to waste.

 

Second, states should avoid allowing PAB authority to expire and work to increase utilization rates. This can be done by streamlining the application process for PABs, removing unnecessary requirements, and providing gap financing through programs like HOME or the Community Development Block Grant. Local governments can further support these efforts by donating land, waiving fees, and expediting permitting processes. 

 

Third, states can generate more affordable housing per PAB dollar by limiting bond awards to 52-55% of project costs. This ensures more projects can be funded while allowing developers to use taxable debt for additional financing needs. This approach enables states to stretch their PAB resources and build more affordable rental units. 

Challenges Faced by Private Activity Bonds (PABs) 

Although bipartisanship has favored a LIHTC program expansion, PABs are difficult to accommodate since they present costs to the federal government. PABs are reducing tax revenue by granting the exemptions, and its cost may be controlled in either or both of the two following manners: Provide exemption only for a period of 10 years or link the exemptions to revenue-enhancing reforms, such as requiring states to get rid of zoning barriers to access the state volume cap exemption for affordable housing.

 

For instance, the Affordable Housing Credit Improvement Act is an example of such a challenge. It was deemed that the revenue would be reduced by $12.7 billion over the ten-year period. Nonetheless, such an investment would house 1.9 million low-income people, create over 1.2 million jobs, and bring in over $47 billion in tax revenue. 

 

This is why the housing crisis remains an emergency for millions of Americans, and one way to address such an urgent need is to expand PABs for affordable housing. 

Leveraging PABs for Housing Solutions… 

Private Activity Bonds (PABs) play a crucial role in addressing the affordable housing crisis by providing low-cost financing, especially when combined with 4% Low-Income Housing Tax Credits (LIHTCs).

 

Despite challenges like limited volume caps and complex regulations, PABs remain a vital tool for developing and preserving affordable rental housing.  

 

With strategic reforms, such as better allocation of bond caps and streamlined processes, states can unlock more affordable housing units and maximize the potential of this powerful financing mechanism. 

 

Effective utilization of PABs is key to tackling the nation’s growing housing shortage.