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Massachusetts should use more volume cap bonds for housing

Lack of affordable rental housing is one of the biggest issues facing the Commonwealth today.  Mayor Walsh has estimated that in Boston alone accommodating growth and stabilizing the housing market will require the creation of 53,000 new units of housing by 2030, a 20 percent increase in the housing stock.  The low rate of housing production, increasing rents, and the loss of affordable housing through the “expiration” of rental subsidy programs have all combined to create a severe housing shortage.

In March, the Special Senate Committee on Housing created by Senate President Stan Rosenberg and chaired by Senator Linda Dorcena Forry issued a report, “Facing Massachusetts’ Housing Crisis” noting “housing production is an economic imperative for the Commonwealth” and putting forward 19 proposals to address this crisis. 

There’s an additional step to substantially increase housing investment: the Commonwealth can maximize benefits from tax exempt bonds by using these bonds exclusively for multifamily housing which garners significant additional federal resources through the federal Low Income Housing Tax Credit (LIHTC).  These tax exempt private activity bonds are issued each year subject to an overall volume cap allocated to each state under the Internal Revenue Code.  Each state decides how to allocate its volume cap. In 2016, Massachusetts has a total volume cap allocation of $675 million for multifamily affordable rental housing, student loans, industrial development, and single family housing.

While all of the permitted uses benefit from lower, tax exempt interest rates, only projects using multi-family housing bonds receive significant additional federal resources through the LIHTC program.  LIHTCs, purchased by investors in affordable multi-family housing, has leveraged, on average, over $51 million in equity for each $100 million in affordable multi-family housing bonds issued in recent years.  While other uses benefit from the lower tax exempt interest rates, only the use of bonds for multifamily housing reaps additional benefits through LIHTC’s substantial infusion of equity.  This leveraging mechanism can finance new construction, rehabilitation, and preserve affordable rental housing while also generating business activity and local employment.

The numbers supporting the use of volume cap for multifamily affordable housing are compelling: by allocating all of the volume cap to multifamily housing, the Commonwealth would receive $168 million in additional federal financial benefits every year. 

We welcome the opportunity to work with the legislative leadership and the Baker Administration to explore creative approaches to maximize the use of private activity volume cap for multi-family housing that qualifies for LIHTC while protecting the other important uses.  Legislative appropriations directly supporting the other uses of volume cap should be considered.  Alternatively, a fee on multi-family housing bonds could be charged with the fee being used to provide a subsidy of student loans, industrial development bonds and single family loans.  The current case for a smarter use of tax exempt volume cap is clear.  We are excited about the possibility to preserve and increase affordable rental housing in Massachusetts through  maximizing the benefits from tax exempt bonds.

First published in the Boston Business Journal's "ViewPoint" column entitled, "New Housing Resources Generated Through Bonds" on April 29, 2016.  (Subscription required)

New York State releases RFP

New York State Homes & Community Renewal (HCR) released the 2016 Multifamily Open Window RFP today, an offering of $70 million in funding for projects ready to close by July 2016 in five areas (New Construction Capital Program, Supportive Housing Opportunity Program, Public Housing Preservation Program, Multifamily Preservation Program and Middle Income Housing Program). In addition, $117.2 million of Fiscal Year 2016-17 funding for other continuing HCR programs (such as Homes for Working Families and Mitchell-Lama Loan Program funds) is available via the Open Window application process.

The RFP notes that HCR expects to make additional housing funds available once an MOU is finalized between the Governor, the NY Assembly and the NY Senate.

For now, here are the details of this great news from New York State:

New Massachusetts Statute on Retainage and Substantial Completion Will Affect All Affordable Housing Developers

On August 8, 2014, Governor Patrick signed into law Chapter 276 of the Acts of 2014 which limits the amount of retainage that can be held on private construction projects to 5% of each progress payment. The law also provides detailed requirements for how and when the reduced retainage amount must be released, establishes procedures for monetizing and addressing punch list items, and mandates a "one-size-fits-all" substantial completion definition that the law expressly provides cannot be altered, expanded, or eliminated. The new law does not apply to construction contracts with a value of less than $3,000,000, contracts for the construction of 1-4 family residences or contracts that are entered prior to November 8, 2014.

Developers, lenders and public agencies all have significant planning to do before the law becomes effective in November. Typical HUD projects and most projects involving institutional lenders currently require 10% retainage. Without that security, owners may be required to provide other types of protection to HUD, lenders and investors. Such revised collateral requirements will have financial implications for projects and developers.

Construction contracts and loan agreements  on most projects have  expansive definitions of "substantial completion" because that date triggers a number of obligations under most construction contracts. Owners, lenders and investors will need to carefully study these new legal requirements to assure that construction contract provisions under the Chapter 276 continue to meet their underwriting needs.

Nixon Peabody is assessing the impact of this new law and will issue additional updates as more details regarding the practical implementation of the law become clearer.

HUD and Treasury Team Up on Financing Affordable Housing

An interagency partnership between HUD and the Department of Treasury will expand opportunities for state and local housing finance agencies (HFAs) to finance affordable housing through a new risk sharing initiative. On June 26, Treasury Secretary Jacob Lew announced that the Treasury’s Federal Financing Bank (FFB) would use its authority to finance mortgages insured by HUD’s Federal Housing Administration (FHA) under its Multifamily Mortgage Risk-Sharing Program.

Under the new arrangement, FHA will insure the loans through its Risk-Sharing Program, and FFB will purchase certificates or securities evidencing undivided beneficial ownership interests in the mortgages. While the FHA Risk-Sharing program has been historically successful in keeping financing costs low for HFAs since its establishment in 1992, the economic downturn has required housing finance reform to maintain the availability of low-cost capital. The Obama Administration has called on Congress to authorize Ginnie Mae to securitize loans through the FHA Risk-Sharing program as one option. The Treasury and HUD released an FAQ on June 26 (available here), clarifying that the Administration is not abandoning the Ginnie Mae legislation in favor of the FFB partnership. Instead, the HUD-Treasury collaboration is an interim strategy to reduce HFA borrowing costs while legislation is pending.

The New York City Housing Development Corporation will originate and service the first loans under this new initiative. The first project will be an affordable housing rental property in Far Rockaway, Queens that suffered damage due to Hurricane Sandy.

Chairman Camp's Tax Reform Proposal Raises Issues for Housing

The draft proposal would dramatically change parts of the tax code.  It would eliminate the rehabilitation tax credit (also known as the historic tax credit), and the renewable energy investment tax credit.  The new markets tax credit is not a permanent program, but by implication it would not be renewed under this bill. 


On the plus side, the low income housing tax credit made the first cut and remains, but in a substantially remade format, which likely will make it much less effective.  Also, congressional sources are already predicting that tax reform will require serious study and not be enacted this year.  Still, the discussion draft provides a working template for further tax reform discussion. 

As to the low income housing tax credit, the fundamental changes include:

  • eliminating the 4 percent acquisition credit;
  • credit period of 15 years;
  • housing finance agencies would allocate qualified basis rather than credit amounts, at a rate of $31.20 multiplied by the state’s population, with a minimum of $36.3 million; and
  • repeal the 130% basis boost for "high-cost and difficult development areas”.
The draft, and the accompanying statement by the Joint Committee on Taxation, provide that the changes will both be less expensive program (increasing revenues by $10.7 billion over 10 years) and would increase the amount of Housing Credit-financed projects by more than 5%.  The two points would seem to be inconsistent.
At the same time, the draft eliminates entirely tax-exempt private activity bonds. That means no 4% low income housing tax credit transactions at all.
Why can’t bond issuance costs go into LIHTC eligible basis?

Development costs ultimately determine the amount of LIHTC credits available to a project, so it is important to analyze these costs to maximize eligible basis.  While third party construction loan costs are not “brick and mortar,” the IRS treats construction loan costs as indirect costs sufficiently related to the residential rental property to be capitalized and included in eligible basis.


On the other hand, the IRS does not apply the capitalization rules in the case of bond issuance costs for tax-exempt bond deals.  IRS technical advice, TAM 200043015, addressed this issue and explained that the tax-exempt bond legislative history concludes that bond issuance costs are not sufficiently associated with providing residential rental housing to satisfy the exempt purpose of the offering. Both the bond rules and the LIHTC rules use the same definition of residential rental property.


Characterizing a certain portion of bond issuance costs under the capitalization rules as satisfying the exempt purpose to provide residential rental housing is directly contrary to this specific congressional determination. Consequently, permitting capitalization of bond issuance costs for eligible basis purposes would result in the disparate treatment of the term “residential rental property” between the LIHTC and Bond rules.  This position was recently reaffirmed in IRS informal guidance LIHTC Newsletter #52, written by IRS Program Analyst, Grace Robertson.


It may be time for the IRS to revisit this issue with more formal IRS guidance so that developers and investors can be certain in the computation of eligible basis.

Rep. Camp Will Not Run For Senate
On Friday, Rep. Dave Camp (MI) announced he will not run for Michigan’s open Senate seat. In July, Rep. Camp stated he was considering running for the Senate. Camp is the Chairman of the House Ways and Means Committee, though he is term-limited and must step down after the 2014 election. He and Senator Baucus continue to work on tax reform. Had Rep. Camp run for the Senate, the conventional wisdom was that tax reform efforts would be greatly diminished. While this does not necessarily improve the chances the House and Senate will act on tax reform legislation, it suggests that Rep. Camp will continue to work with his Senate counterpart to attempt to move legislation.
Read more about the announcement here.
Chairmen Seek to Turn Tables on Tax Issues
Chairman Max Baucus (D MT) and Ranking Member Orrin Hatch (R UT) last week asked members of the Senate Finance Committee to adopt a "blank slate" approach.  The upshot is that instead of debating what programs to get rid of, the Senators should presume that all benefits, deductions, credits, etc., will be removed and to argue for inclusion of any such provisions.  These sorts of provisions are referred to as "tax expenditures."  The Dear Colleague letter that Senators Baucus and Hatch sent provides that it expects that some tax expenditures will remain, but seeks support for any specified provisions.  Also, members are asked to provide clear evidence that any requested provision helps grow the economy, makes the tax code fairer, or effectively promotes other important policy objectives.  The Dear Colleague letter asks Senators to formally submit legislative language or detailed proposals by Julty 26th.
Congress Gears Up To Review Residential Real Estate Tax Breaks

The House Committee on Ways and Means has scheduled a public hearing this Thursday, April 25, 2013, on “Tax Reform and Residential Real Estate.” In preparation for this hearing, the staff of the Joint Committee on Taxation (“Joint Committee staff”) has issued a report (JCX-10-13) summarizing the various tax code breaks for residential real estate.


The report discusses the homeownership tax incentives including the home mortgage interest deduction, the real property tax deduction, the exclusion of gain from sales of a principal residence, tax-exempt bonds for owner-occupied housing, first-time home buyer distributions from individual retirement plans, the exclusion from income of housing allowances, the exclusion from income of the discharge of principal residence indebtedness, and the tax treatment of a tenant-stockholder of a cooperative housing corporation.


The report also describes the tax provisions that offer incentives for rental housing such as the  low-income housing credit, the rehabilitation credit, tax-exempt bond financing for rental housing, accelerated depreciation for rental housing, passive activity loss rules and

special rental real estate rules.


While economists generally reason that subsidies may lead to inefficient outcomes, the report suggests a way to rationale home ownership tax incentives are the “externalities” or spillover benefits that accrue to someone other than the homeowner.  For example, if homeowners maintain their homes better than renters, this may benefit others in the form of aesthetics or in fostering other desirable neighborhood characteristics such as lower crime.


Similarly, the rental real estate subsidies increase the rate of return to investment in the residential rental housing sector and may increase the supply of rental housing. Also, the rental real estate tax incentives may reduce the cost of renting relative to owning.



Financing 4% LIHTC With Taxable GNMA Securities

 Historically, tax-exempt bonds have generally provided a better return on investment than treasury notes and bonds, due to their low, tax-exempt interest rates.  In fall 2008, however, the tables were turned, as many AAA-rated debt securities became worthless or worth only pennies on the dollar.  Consequently, tax-exempt municipal bond rates soared, due to concerns about credit quality and liquidity, actually surpassing federally taxable U.S. Treasury bond rates, a reversal that was almost unprecedented.  As a result, many long-term debt investors fled to the safety of U.S. Treasury bonds.

Years later, the situation has not changed much, as continuing uncertainties surrounding the United States and European economies and financial systems are joined by growing concerns about the tax-exempt status of municipal bonds.  Therefore, investors may be thinking, why not just borrow in the taxable markets through the sale of taxable GNMA securities?  The problem is that to take advantage of the 4% LIHTC, a project’s owner is required to finance 50% of the project’s land and depreciable basis with tax-exempt bonds, and to keep these tax-exempt bonds outstanding until the project’s placed-in-service date.

To make the most of your investment, one solution is a short-term escrow structure combining taxable GNMA sales with tax-exempt bonds and the 4% LIHTC.  As further described below, the structure involves issuing short-term, cash-backed tax-exempt bonds, selling GNMAs into the taxable market, and using the proceeds to pay off the bonds on the project’s placed-in-service date.  This structure dramatically reduces the long-term borrowing rate and negative arbitrage currently associated with projects financed with FHA-insured mortgage loans, by pricing the permanent loan rate in the huge, highly efficient forward delivery market for taxable GNMA securities, rather than the much smaller, less efficient “fully funded” long-term tax-exempt multifamily housing bond market.

To use the short-term escrow structure, the bond underwriter begins by selling tax-exempt bonds to purchasers, and investing the bond proceeds in an AA- to AAA-rated guaranteed investment contract (GIC 1).  At the same time, the underwriter bids on a second GIC account with the same provider (GIC 2), but no deposits are initially made into GIC 2.  Next, the FHA lender for the project sells GNMA securities to institutional GNMA purchasers on a forward delivery basis.  These GNMA securities are issued in the form of construction loan certificates (CLCs) with respect to each loan advance, and the purchase price of each CLC is deposited into GIC 2.  Concurrently, an equal amount is withdrawn from GIC 1 and delivered to the FHA lender to repay it for the corresponding loan advance.  Upon delivery of each CLC, the amount in GIC 1 decreases and the amount in GIC 2 increases by an equal amount, and thus the tax-exempt bonds remain fully cash collateralized.

Upon final FHA endorsement of its loan, the FHA lender issues GNMA securities to the GNMA purchaser in exchange for the previously issued CLCs, plus any cash necessary to add up to the amount of the FHA loan advance.  Finally, the replacement proceeds in GIC 2 are withdrawn and used to redeem the bonds after the project’s placed in service date.  The result is that the tax-exempt bonds have remained outstanding for just long enough to qualify the project for the 4% LIHTC, and the short-term bonds essentially have an AA to AAA investment grade rating, with no separate credit enhancement.

This structure, as opposed to a traditional long-term tax exempt FHA-backed bond financing; allows for all-in long-term borrowing rates that are significantly lower than other financing programs; and reduces negative arbitrage from around 10% to roughly 2% or less.  Best of all, this structure can be used with various types of HUD loans, including HUD 223(f) Pilot Program loans, allowing for the benefits described above, in addition to the advantages of the Pilot Program.  Therefore, this structure has basically supplanted the traditional structure in the current market, and it will likely remain a factor until tax-exempt bond rates fall back below taxable rates, or until other changes are made to the LIHTC program.

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