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Background and Current State of Market:

Since the inception of the Low Income Housing Tax Credit Program in 1986, LIHTCs have incentivized the flow of private equity into affordable housing development by providing investors with federal income tax credits over a 10-year period. In California, LIHTCs are awarded to developments by the California Tax Credit Allocation Committee (TCAC) through an annual application process. Low income development became so popular in the height of the real estate market that developers were able to sell LIHTCs to credit-hungry investors for more than one dollar for each dollar of LIHTC. Enter the US’ greatest economic crisis in recent history and we find: (i) corporate profits evaporating, which significantly reduces the need for income tax credits, (ii) Fannie Mae and Freddie Mac, two of the largest purchasers of LIHTCs, stop buying LIHTCs in the spring of 2008, (iii) commercial lenders unwilling to lend to affordable housing projects due to the lack of investors, and (iv) developers handing back LIHTCs because they cannot find investors or secure financing. The tax credit market effectively stalled.

Treasury and TCAC Response:

On Feb. 17, 2009, President Barack Obama signed the American Reinvestment and Recovery Act of 2009 into law creating the Section 1602 Program (the so-called “Exchange Program”) whereby eligible state agencies such as TCAC can exchange LIHTCs for cash. TCAC may fund up to $0.85 in federal grant monies for each dollar of LIHTC awarded to developments in 2007, 2008, and 2009. On May 4, 2009, the US Department of Treasury issued guidance relating to the Exchange Program and on July 13, 2009, TCAC adopted regulations to address the whopping $287.4 million in Exchange Program funds that California is expected to receive.

Developers and commercial lenders have begun talks on how to realize the benefits of the Exchange Program and revitalize affordable housing development in California. What we know so far from the new TCAC regulations is that TCAC will disburse Exchange Program funds in the form of a loan not requiring repayment to TCAC provided that the applicable development continues to be in compliance with certain state and federal regulations. Now five months after the enactment of the ARRA, it is unfortunate for the large number of needy developments (30 Exchange Program applications had been submitted to TCAC as of June 4, 2009) that TCAC has yet to document these loans and infuse the Exchange Program funds into the market.

TCAC Exchange Program Funding Issues:

Commercial lenders in this market are not strangers to complicated financing structures including loans from multiple commercial lenders and grants and subsidies from a myriad of governmental agencies; however, the Exchange Program will be TCAC’s first embarkation into this intricate debt regime. While many complex technicalities will eventually need to be addressed, certain critical issues regarding the Exchange Program must be resolved first before commercial lenders can get comfortable with TCAC loans in the debt stack for affordable housing development:

TCAC’s security interest in the development will be subordinate to that of the primary construction lender, but it remains to be seen what the terms of that subordination will be and where the TCAC loan will fit with regard to lien priority with other loans, grants, and subsidies.

TCAC will have a right of first refusal to purchase the development upon any sale of that property, but the terms and conditions of that right of first refusal are not yet established, an issue that all commercial lenders must pay particular attention to, including a careful analysis of potential property valuation impacts and subordination issues.

TCAC will disburse 40% of funds following the construction loan closing, 25% upon the issuance of a certificate of occupancy for the entire project, and the remaining 25% upon 90% occupancy; however, all Exchange Program funds must be disbursed to the applicable developers to reimburse project costs by Dec. 31, 2010. Commercial lenders are unlikely to commit to construction loans to developers with Exchange Program funds (particularly for projects with 2009 LIHTC allocations, for which construction would not begin until late 2009 or 2010) until there are assurances that the Exchange Program funds will in fact be available through the construction period for the applicable developments, taking into account reasonably foreseeable delays.

While everyone engaged in this market is working in concert to enable this crucial liquidity into the market, it may yet be another few months before the low income housing development market receives this needed boost. Please stay tuned to learn how the Exchange Program funds will finally reach this market in California.

The views expressed in this article are those of the author and not GlobeSt.com.

Hilary Metra Gevondyan’s transactional real estate practice focuses in the area of commercial real estate finance, acquisitions and dispositions, and leasing. She can be reached at [email protected] or 415-836-2565.

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