California offers a state-level low-income housing tax credit (LIHTC) in addition to a federal program, which can help compensate for a deal’s lack of soft funding by generating additional equity proceeds from investors.
It is used in only about half of the states in the country. In California, Redding and Chico are among the markets that use it, according to Brad Butler, partner in the commercial finance practice group and co-chair of the multifamily housing industry sub-team at law firm Frost Brown Todd LLP.
“These and other tax credits play a crucial role in bridging financing gaps for developers,” Butler told GlobeSt.com. “Developers are encouraged to stack various tax credits, including historic rehabilitation credits, to make affordable housing projects financially viable.
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Butler said that LIHTCs are an effective way to address the housing crisis; however, they tend to be underutilized due to the complexity of the program, as well as the state’s preference for new construction projects over rehabilitation projects, despite replacement costs still exceeding acquisition expenses in the current market. For example, it costs more to build ground-up than buy and rehab, which means that deals don’t pencil as easily. And the lack of soft funding availability to close gaps in development budgets, since interest rates are still prohibitive.
“California generally is experiencing an affordable housing crisis, and Redding and Chino are not exceptions,” Butler said.
“Home prices are increasing at a faster rate than wages, and apartments simply aren’t being built quickly enough to keep up with demand. Consequently, there’s significant upward pressure on rents, which makes available housing even less affordable every day.
“Additionally, there is a skilled labor shortage for many of the trades, which is driving up construction costs and slowing construction schedules for new developments. As such, new deals aren’t penciling under traditional structures, and alternative structures must be considered.”
Specifically, LIHTCs could provide the solution. The federal program provides owners of specific multifamily properties with tax credits over 10 years based on how much they invest into the property in exchange for ensuring the units remain affordable to members of the community based on the applicable income threshold for a specific unit for at least 55 years in California.
“Typically, the units are leased to individuals at or below 60% of the area median income for the county or city in which the property is located,” Butler said.
“Furthermore, the rent payment (including any tenant-paid utilities) may not exceed 30% of the applicable income limit, which is what makes them affordable. So, rent is based on what people in the community earn rather than what typical market rate apartment rates would be.”
In exchange for receiving these tax credits, investors will typically make equity contributions based on the total amount of credits they expect to generate. For example, if a deal is expected to generate $10 million in credits, then an investor would contribute $9 million in equity (assuming a $0.90/credit price).
“In addition to the equity generated by the federal low-income housing tax credits described above, a project could potentially take advantage of other federal credit programs such as the Historic Rehabilitation or Energy Credit program,” Butler said.
“Additionally, under California law, owners could potentially obtain state-level low-income housing tax credits. These additional credits would generate additional equity for the property owner, which could potentially offset the increased construction costs that market-rate developers are currently facing.”
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