Arranging financing for any property development is challenging. For constructing affordable housing, however, this challenge is even more acute.
The gap between rents that low-income households can afford, and the mortgage repayments property owners must bear is unsustainable.
To fill this gap, many developers rely on a combination of some form of government subsidies. Combining the Low-Income Housing Tax Credit (LIHTC) program and the HOME Investment Partnerships program is popular among developers.
This article will give a high-level overview of financing with LIHTC, the LIHTC financing ecosystem, LIHTC financing stakeholders, other federal government subsidies, and what happens after the construction phase is complete and the developer sells the property.
Financing LIHTC Projects
LIHTC is a central part of government subsidies that fund affordable housing development and is responsible for the construction of more than 3.5 million units for low-income households.
Financing LIHTC projects is a complex process that involves a blend of equity and debt. The LIHTC program engages private and public sectors to develop or maintain affordable housing.
Developers raise capital for each of their housing projects using traditional financing like bank loans, REITS, or individual investors.
However, developers can reserve some part of their multifamily housing project as affordable housing to be eligible for government subsidies in proportion to the affordable housing units they plan to produce. Equity investors and tax credit syndicators play a role in how this system works.
Equity and Debt in LIHTC Financing
Effective LIHTC developers leverage the strategic use of equity and debt to fund affordable housing development.
The Federal Department of Housing and Urban Development (HUD) sets nationwide affordability requirements, and the Internal Revenue Service (IRS) calculates each state’s tax credit allocation.
For each state, its Housing Finance Association (HFA) supplements Federal LIHTC guidelines with state-specific requirements and designs the application processes for government funds.
Private developers, in turn, propose affordable housing projects to these HFAs, seeking LIHTC funding, among other government subsidies. Once a project is approved, the developer monetizes the tax credits to raise additional funds to meet the funding gaps in the development project.
The Role of Equity Investors
Developers secure immediate financing primarily through equity they raise from institutional investors in exchange for tax credits.
These investors provide upfront cash in exchange for the future tax credits the project will generate, allowing the developer to cover the construction costs. The partnership between developers and equity investors usually operates on a contract partnership as an LLC, transforming future tax credits into financial capital to build affordable housing.
Tax Credit Syndicators
Developers also engage with tax credit syndicators to monetize tax credits. Syndicators pool multiple LIHTC projects into a single equity fund, which investors can then invest in as a diversified portfolio.
Developers with limited taxable income or those seeking to mitigate financial risks prefer syndicators over individual investors.
Syndicators also benefit developers by providing access to a broader pool of potential investors. And investors are also able to spread their risk across several projects.
Additional Subsidies for Financing Affordable Housing
Besides the LIHTC program, developers often tap into other federal and state programs to close the financing gap for affordable housing projects. The CDBG, HTF, HOME program, and Multifamily Revenue Bonds are some other programs that developers can leverage.
State-specific funding programs will supplement these subsidy programs and are unique to each state.
Community Development Block Grant (CDBG)
The U.S. Department of Housing and Urban Development (HUD) administers the Community Development Block Grant (CDBG) program.
The CDBG provides affordable housing, anti-poverty programs, and infrastructure development through annual grants to cities, counties, and states.
These grants help improve the living conditions of low- and moderate-income residents by ensuring access to decent housing and expanding economic opportunities.
The National Housing Trust Fund (HTF)
The Housing and Economic Recovery Act (2008) established the National Housing Trust Fund (HTF). It targets constructing, rehabilitating, preserving, and operating rental housing for extremely low-income individuals.
With allocations increasing annually, the HTF is a relatively new resource in the affordable housing finance landscape.
It addresses the needs of the most vulnerable populations. Advocacy efforts continue to expand this funding source. In 2023, the HTF had an allocation of $382 million and has been consistently growing in relevance as an integral part of the national housing strategy.
HOME Funds
The HOME Investment Partnerships Program is a resource for low-income housing developers.
Despite funding fluctuations, HOME funds allow states and localities to address a broad spectrum of affordable housing challenges. The program supports both rental and homeownership developments for low-income households.
Multifamily Revenue Bonds
Multifamily Revenue Bonds finance the acquisition, construction, or rehabilitation of affordable rental housing.
As with LIHTC financing, to raise capital via MRB bonds, developers must reserve a portion of the apartments for families with incomes at or below specific average median income (AMI) thresholds. States frequently combine these bonds with LIHTC and HOME funds to serve lower-income families more effectively for extended periods.
Eligibility for LIHTC
The LIHTC program’s affordability requirements are designed to address the critical need for accessible and sustainable housing.
Compliance standards set in place to cap tenant incomes and rent restrictions help ensure long-term affordability for low-income households.
Target Demographic for LIHTC Housing
LIHTC housing targets individuals and families with incomes below certain thresholds, typically 30% to 60% of the Area Median Income (AMI).
This ensures that the program serves those with the greatest need for affordable housing, including low-income households that struggle to find housing options within their financial reach.
Income Limits and Rent Restrictions
To qualify for LIHTC, property owners must rent out housing units according to specific income limits and rent restrictions.
Income limits vary by location and household size, with eligibility generally based on household income as a percentage of AMI.
Rent for LIHTC units is capped to ensure that no more than 30% of a household’s income is spent on housing costs, including utilities. Rent caps for an area work out to 18% of the AMI.
This approach guarantees that LIHTC housing remains affordable and accessible over time.
Threshold Criteria in LIHTC
The LIHTC program mandates developers to set aside a minimum number of housing units for affordable housing. Developers must also cap rents on these units.
Most developers reserve 20% of a property’s units for households earning 50% or below the AMI or at least 40% of units for households earning 60% or below the AMI.
Reserving affordable housing units and deciding on rent caps is called Minimum Set-Aside Election.
The state agency allocating the tax credit conducts threshold criteria review to validate this Minimum Set-Aside Election. Developers must clear this review to receive tax credits.
Recent amendments via the income averaging rule for LIHTC properties now allow households to earn up to 80% of AMI if the average income across all LIHTC-assisted units does not exceed 60% of AMI. This flexibility accommodates a broader range of income levels while ensuring the program still focuses on those in need.
An Overview of LIHTC Project Compliance
Once a LIHTC project is complete, it must comply with the developer’s affordability commitments when applying for tax credits. Property managers and operators must ensure units are affordable to and occupied by eligible low-income tenants.
Ensuring compliance with affordability commitments in LIHTC projects is critical to monetizing tax credits.
Once the property construction and lease-up phases are finished, the developer hands over the property to the operator, also called the property owner. In many cases, institutional investors or tax credit syndicators delegate responsibility for the day-to-day management and regulatory compliance of the LIHTC project to asset managers.
With the help of LIHTC property management software, asset managers track and ensure project compliance if the low-income affordability restrictions are in force.
Minimum Set-Aside Election
The minimum set-aside election is made at the project’s inception. This election is irrevocable and specifies the percentage of units and their corresponding income limits the developer commits for low-income tenants. Property owners must stick to these minimum elected standards.
The Compliance Period
Developers must adhere to the affordability and occupancy requirements throughout the Compliance Period. The compliance period extends for 15 years initially, after which some states present exit options for investors. There is a subsequent 15-year extended use compliance period, so the compliance period spans 30 years for LIHTC.
Annual Certification
Property owners are required to submit an Annual Owner’s Certification of Continuing Program Compliance (AOC). This certificate verifies adherence to LIHTC compliance standards and, where applicable, other subsidy program regulations.
The AOC includes the submission of tenant data and the payment of an Annual Compliance Monitoring Fee. Failure to verify and submit these certification reports can result in significant penalties, including issuing a Notice of Noncompliance.
Tax Credit Clawbacks
LIHTC property owners’ noncompliance can trigger a clawback of awarded tax credits. Once triggered, the IRS recaptures the financial benefits previously awarded to the project. Since tax credits are claimed yearly, the IRS increases the tax liability of the corporation or investment fund that owns and operates the affordable housing project.
Compliance Monitoring is Critical to LIHTC Financing
States and local agencies monitor LIHTC projects to ensure ongoing compliance with program requirements. This involves regular reviews of tenant eligibility, rent levels, and property standards.
LIHTC projects are complex. Property owners use specialized tools to track and monitor the compliance of their LIHTC projects. It’s up to asset managers to identify and resolve any noncompliance proactively to ensure profitability for the investors.
