New apartment construction / What is the real score?

The Inland Northwest is currently experiencing an unprecedented volume of new apartment construction. While many of the projects are market-rate projects, many of them are below market rate and are commonly referred to as “Low Income”, “Affordable” or “Subsidized Housing”. More accurately, however, the majority are Internal Revenue Code:  Section 42, Low Income Housing Tax Credit (LIHTC) projects.

Having said that; consider the following and you decide what the real score is on IRC Sec 42 (LIHTC) vs the more familiar IRC Sec 8 housing and why it matters.

Every state in the US is allotted Tax Credits annually from the Federal Government (HUD) based upon census tract data.  One dollar of tax credit is good for one dollar off one’s Federal Tax liability in a given year. Each state then makes these tax credits available, through a very rigorous bidding process, to qualified developers who present proposals for projects in their respective states. Prevailing developers are awarded TC’s (EX: 1M … really meaning 1M for 10 years = 10M) which they can then sell to investors for cash.

So now, say our prevailing developer sells 10M of TC’s for 10M cash (market value of TC’s vary) and builds a 20M apartment project at 50% loan to value.

Upon completion of the project, the developer is bound by the terms of the TC grant to lease his apartment units to residents who earn 40, 60, or 80% of the area median income (AMI). Current family AMI is $58,966 in Kootenai County** and $63,402 in Spokane County**. Qualifying tenants are required to pay their prorated share of market rent for that unit. That is; a 40% resident would pay 40% of market rent while an 80% resident would pay 80% of market rent.

The developer is required to maintain that structure with oversight from the state for a minimum of 15 years after which he can sell the project or convert to a market-rate project during a mandatory 3 year conversion period.

The above, however, begs the question; how can the developer afford to rent his apartment units at below-market rates? The answer is that the cash – flow model anticipates below-market rents and that is why these projects always have a low loan to value (LTV). Recall the developer only borrowed 50% of what it cost to build the project.

So, with that background; you decide what the real score is on Section 42 (vs) Section 8 housing & who wins?

Until next time,

Glenn

** Spokane – Kootenai Real Estate Research Committee Fall 2018 report/US Census data