Thursday, February 21, 2013

Rethink Real Estate: The Housing Credit

Trumbull Park Homes, a low-income housing development in Chicago, Illinois. Photo by Robert R. Gigliotti via Flickr.

Congress began the Low-Income Housing Tax Credit (Housing Credit) program in 1986 to incentivize the private sector to develop more affordable rental units for low-income households. Since its creation, the credit has created or preserved nearly two million affordable rental units across the country.
The program offsets investors’ federal income tax liabilities, but the responsibility for administering the program is delegated to the states. States designate housing credit agencies to distribute a pool of tax credits from the U.S. Department of Treasury based on their population. In 2010, the amount of credits agencies received was equal to the greater of $2.10 per capita or $2,430,000. For example, the population of Oklahoma in 2010 was about 3.6 million people, so the state received about $7.7 million in tax credits, or 3.6 million multiplied by $2.10.
Housing credit agencies allocate credits to projects that also meet certain criteria set forth in state qualified allocation plans and Section 42 of the Internal Revenue Service code. Both guidelines specify rules and scoring priorities for the competitive allocation process. Eligible projects must be a residential rental property and restrict rent to low-income tenants. A LIHTC property must also remain affordable for at least 30 years. Some states may require a longer affordability period for certain projects.
Developers are also required to choose between the 20-50 rule – which requires at least 20 percent of the units to be rent restricted and occupied by households with incomes at or below 50 percent of an area’s median income – or the 40-60 rule, which requires at least 40 percent of the units to be rent restricted and occupied by households with incomes at or below 60 percent of an area’s median income.
Developers may sell the credits they receive to investors or a syndicator, who assembles a group of investors and acts as their representative. Through a limited partnership, an investor acquires a 99.9% or 99.99% limited partner share, while the developer sponsor set up one or more general partners with a .1% or .01% share. Typically, a real estate developer can cover construction costs with investor equity. The sale of the credits further reduces the amount of debt a developer incurs when constructing a project. In return, the investor receives a dollar-for-dollar tax credit and other benefits for ten years. If the project were to stall or run into any difficulties, the most the limited partner can lose is the amount invested; however, the general partner can lose more than the amount invested.
However, partnerships are structured most often as limited liability companies (LLCs). A typical LLC consists of the developer managing the day-to-day operations of the project, and the credit purchaser as having a passive investor role. The developer still has a small percentage ownership interest (.1%), and the investor still has a large ownership interest (99.9%). All members of an LLC have liability that is limited to the amount invested. That is, if the project faces a setback, the most they can lose is the amount invested.
The housing credit provides many benefits for the federal government because the private sector takes most of the risk associated with building the projects. Investors may not reap the benefits from the credit unless the housing is built, maintained at a certain standard, and remains affordable throughout the compliance period. This model ensures that the program continues to fulfill its intended purpose of providing stable housing to low-income households, while developers and investors benefit from the return on their investments.
As members of Congress debate tax reform, they should consider protecting and preserving the housing credit.

Thursday, February 7, 2013

Rethink Real Estate: Qualified Energy Conservation Bonds

The Parker Ranch installation in Hawaii. Photo by the U.S. Department of Energy.
Qualified Energy Conservation Bonds (QECBs) give state and local governments a low-cost financing option to encourage energy conservation.
Funding from the program has been used to retrofit public buildings, to power buildings with renewable energy, and to improve public transit infrastructure. Authorized by Congress as part of the 2008 Energy Improvement and Extension Act, the original legislation allocated $800 million in federal funding to the effort and has since been increased to $3.2 billion as a result of the 2009 American Recovery and Reinvestment Act. As of July 2012, about $760 million in allocated funding had been spent. Because QECBs do not have to be spent within a certain time period, a great deal remains untapped.
QECBs were originally structured solely as a tax credit bond, in which the bond purchaser received a federal tax credit equal to 70 percent of the interest rate multiplied by the principle amount of the QECB. However, the Hiring Incentives to Restore Employment Act of 2010 (HIRE) allowed for a direct subsidy bond option due to a lack of investor interest in using the tax credit structure. Under the direct subsidy option, QECBs are among the lowest-cost public financing tools because the U.S. Department of Treasury subsidizes the issuer’s borrowing costs by offering a direct cash subsidy to the bond issuer.
The Treasury allocates QECBs to states based on population, and then states sub-allocate the bonds to municipalities with populations of 100,000 or more. The Treasury also sets the bond’s interest rate and maximum term. Though states choose which municipalities receive the bonds, they are required to formally accept the allocation through an agreed upon process or else the funding is returned to the state. Municipalities sell taxable QECBs to investors as a term-limited bullet bond. Because of the structure of the direct subsidy bond option, the municipality pays a taxable coupon to the investor and also repays the principle when the bond matures. The Treasury then pays the municipality the lesser of the taxable coupon rate or 70% of the tax credit rate as a rebate. Proceeds from the sale of the bonds are used to fund qualified projects and must be spent within three years of issuance.
Qualified projects must be used to either reduce energy consumption in publicly owned buildings by at least 20%; for rural development (including the production of renewable energy); for certain renewable energy facilities (such as wind, solar, and biomass); and to implement green community programs (including the use of grants, loans, or other repayment mechanisms to implement such programs). The Treasury also requires that at least 70% of a state’s allocation must be used for governmental purposes, but the other 30% can be used to improve privately owned buildings.
In 2012, the IRS issued additional guidance (Internal Revenue Code § 54D) to address questions surrounding the types of activities that can be financed with QECBs including what constitutes a “green community program.” The clarifying guidance is meant to allow municipalities and states to use a variety of energy-saving methods to lower fiscal cost and improve sustainability. For instance, transportation initiatives that conserve energy or support alternative infrastructure, such as improvements to bike paths or mass transit infrastructure, can use QECBs as a funding source.
By providing a needed financing mechanism for energy-efficiency projects, the QECB program can be a useful resource for municipalities that want to promote sustainability best practices by reducing energy consumption in public buildings or improved infrastructure.