Affordable Housing Market

I worked for 2 years in the multifamily affordable housing group of a GSE. Generally speaking, those who develop, own and manage LIHTC properties specialize in it--it's not something they do as a small portion of their portfolio. It's basically what they do and are known for. The reason? Affordable housing is incredibly complicated and winning LIHTCs for developments can be very political since they are awarded by each state. They don't award them to guys who don't know what they're doing. And the regulatory oversight of LIHTC properties can be overwhelming for those who don't know what they're doing.

Here is a ridiculously basic breakdown of how low-income housing tax credits work:

• A state awards a proposed multifamily development and developer tax credits that have been allocated to the state more or less proportionately by the federal government. The state undertakes a lengthy review process.

• The tax credits are then purchased by an equity investor, which is usually a commercial bank. For the top developers in the best locations, they often get $1 per $1 in tax credit. Depending on the market, investors might even pay more than $1 for $1 in tax credits. Then you have markets (ahem--Memphis...) where equity investors might pay substantially less than $1 for the tax credit. I've seen some tax credits sell for under 70 cents on the dollar.

• Let's say an investor purchases $1 million in tax credits for $1 million. At least when I was there, the usage schedule was 10 years, which means that the investor could deduct $100,000 directly from its taxes each year for 10 years. Banks love these investments because the large, stable ones have pretty predictable projected net taxable income. It can be a great way to basically get free money and advertising in the community.

• Now, let's say that $1 million is used for a $5 million project. You've now got $1 million in cash equity put up. The other $4 million might be debt. The developer often times puts up $0 and then pays itself a healthy developer fee, which is financed by the debt instrument. Definitely lower returns, but getting any return on zero dollars invested is as good as it gets in real estate.

• Now, the primary risk to the equity investor is technical default. If the property is not managed in accordance with the tax credit rules, the equity investor could lose all of its tax credits. The rules can be pretty intricate, but the big ones require renting units to persons make X% (80%, 70%, even 50%) of the area median income. Because the consequences can be pretty big for not properly managing a LIHTC property, the typical equity investors are banks who have qualified tax credit personnel who analyze the deals and then service them afterward. Few equity investors do one-off deals--they are mostly expert professionals.

Section 8 (Housing Choice) voucher program is an entirely separate program through the FHA. A lot of times a single property will have both LIHTC and Section 8, but they are fundamentally different programs.

Here is a brief low down on Section 8:

• It's a federal rent subsidy program usually run by county housing authorities.

• You can have project-based Section 8 housing which is basically a property that is entirely Section 8. This is actually how we get the term "the projects" in the ghetto--it's short/slang for project-based Section 8.

• You have properties that accept Section 8 vouchers but aren't project-based. Anyone can accept Section 8 vouchers, even people on Craigslist.

• To qualify for a Section 8 voucher, you have to go through the local housing authority. Most people earn less than 30% of the area median income. There are usually enormous waiting lists for these vouchers.

• If you get a voucher you can use it anywhere that accepts them (no one is required to accept them). The housing authority determines what a proper "market rate" is for certain types of housing and issues a voucher in that dollar amount. The tenant pays no more than 30% of his/her income and then the voucher subsidizes the rest.

Example: market rent is $1,000. The tenant earns $1,000/month. The tenant pays $300 and the voucher subsidizes $700.

Arbitrage: often times the housing authority will issue a voucher for more than the real market rent at a unit. Let's say a landlord could only get $800/month out of his unit. Well, if the housing authority has said units in that county should go for $1,000, the landlord will take the voucher and get $1,000 in rent, making $200 above market. In turn, they get a marginal tenant.