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Rural Housing Finance Programs: An Overview (Part II)

State Agencies Tap IRS Program for Affordable Multifamily Finance Option

Faith Schwartz    |    Housing Policy

In my last blog I wrote about a couple of ways to finance rural housing: through United States Department of Agriculture mortgages and the secondary market efforts of Farmer Mac, the agricultural “mini-me” of Fannie Mae and Freddie Mac. This time I want to look at a complex but effective program that allows state housing agencies to tap a federal tax credit program to bring investor equity into affordable rural housing across the country.

The Low Income Housing Tax Credit (LIHTC) program, at first glance, seems to have every chance to fail because of its many moving parts. Administered by the Internal Revenue Service because of the tax credit part, and operated by state housing finance agencies, the LIHTC mix also includes nonprofit and for-profit developer/operators, lenders, servicers, capital market syndicators and investors.

But the program works, to the tune of about 100,000 affordable multifamily units a year since it got started back in 1986. Though more associated with urban areas, the program often directs sophisticated investor money into remote rural areas. For instance, a recent analysis of the program in the state of Ohio quantified rural projects at 22 percent of the total.

The LIHTC is an affordable multifamily program, but there can be an option to convert the units to market rentals or to homeownership units after 15 years.

The projects are subject to complicated rules that mandate certain percentages of affordability levels, as well as a mandatory number of units that need to remain operational over the term of the project, making a good operator key to the success of the project. Projects can choose between having 20 percent or more of units occupied by renters at or below 50 percent of area median income (AMI), or 40 percent or more of units occupied by those at or below 60 percent of AMI.

Here’s how it works. The IRS allocates tax credits to the states on a per capita basis, about $2.30 apiece in recent years. So if your state has ten million residents, your state housing finance agency (HFA) will get more than $20 million in credits to allocate. Developers, both for-profit and nonprofit, submit proposals to the state HFAs, where they are ranked by a number of criteria. The HFAs decide which projects to fund.

The process isn’t over, though. Not all companies need tax credits. So capital markets firms called syndicators package the credits and sell them to investors that can use the tax write-off. Besides the tax credit itself, there is a second benefit for investors, who are typically structured into partnerships with the developers for the specific projects. That’s the net operating losses from the projects, which can defer taxes. The investors often sell their interest back to the developers at the end of the rental terms, allowing them to convert them into market-rate housing.

Tax credits usually won’t fund a whole project so gap financing is often secured, such as HUD HOME funds or the Affordable Housing Programs of the 12 Federal Home Loan Banks. The financing can be elaborate and beautiful. An example is a 68-unit housing project on the reservation of the Yakama Nation in Washington state. Here LIHTC funding was augmented by two sizeable HUD Title VI loans, 95 percent guaranteed by the federal government, with the result that dozens of new homes were built in a rural part of Washington.

Tax credits have been used extensively on American Indian reservations, which are almost all rural. LIHTC is a workable way to flow capital markets equity funding to some of the most remote areas of the country. And the potential conversion of rental units to homeownership units has some chance of success in areas where people tend to stay in the same places not just for years, but for generations.

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