Appraising affordable multifamily housing.
The demand for affordable housing in the United States has increased during recent years, and as a result appraisers need to understand and apply specialized assumptions and techniques when valuing these property types. Appraisers must recognize the differences between an affordable housing development and a standard market-rate project and account for these differences when preparing an appraisal. (Reprinted by permission of the publisher.)

Apartment houses (Valuation)
Valuation (Methods)
Real property (Valuation)
Real estate appraisers (Vocational guidance)
Nahas, David C.
Pub Date:
Name: Appraisal Journal Publisher: The Appraisal Institute Audience: Trade Format: Magazine/Journal Subject: Business; Real estate industry Copyright: COPYRIGHT 1994 The Appraisal Institute ISSN: 0003-7087
Date: July, 1994 Source Volume: v62 Source Issue: n3
Product Code: 6531200 Real Estate Appraisers; 1523000 Multifamily Housing NAICS Code: 53132 Offices of Real Estate Appraisers; 23322 Multifamily Housing Construction SIC Code: 6531 Real estate agents and managers; 1522 Residential construction, not elsewhere classified
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During recent years, significant economic changes have occurred in many parts of the United States. Multifamily housing starts, once a common sight throughout the country, have slowed dramatically due to changes in tax treatment, overbuilding, and scarcity of financing. At the same time, the demand for more affordable housing continues to increase as job losses and slowing economic growth lead to stagnating incomes for many Americans. The combination of these factors has created an environment where affordable housing is not only in high demand but also the only feasible project type for many developers to undertake.

Many appraisers are familiar with the valuation of affordable multifamily developments constructed with the assistance of the U.S. Department of Housing and Urban Development (HUD). Recent reductions in HUD programs, however, have created the need for a variety of new financing structures. As a result of these changes, project characteristics different from those used in traditional real estate development are becoming prevalent. To meet the needs of developers and lenders engaged in the production and financing of this new breed of property, appraisers must recognize the differences between an affordable housing development and a standard market-rate project, and they must account for these differences when preparing an appraisal.

The goal of this article is to explore the differences and similarities of affordable housing in comparison with market-rate projects, and to discuss the specialized assumptions and appraisal techniques that should be applied when preparing an appraisal. For those unfamiliar with the variety of current financing programs, descriptions of past and current project financing sources are provided in the Appendix.


The development of affordable housing differs in several respects from traditional market-rate development. These differences must be recognized by an appraiser since they directly affect the feasibility of the completed project as well as many underlying assumptions.


Most affordable housing is owned by limited partnerships, nonprofit organizations, or public agencies. Limited partnerships are used to insulate a tax-credit investor from unlimited personal liability on a loan whenever low-income housing tax credits are part of the financing structure. The primary objective of a limited partner is to maximize losses and tax credits rather than obtain cash flow or long-term appreciation.

Resales of viable and functioning affordable projects are quite infrequent for several reasons. First, public agencies and nonprofit housing development organizations typically seek to establish a stable portfolio of properties and primarily build to hold. Second, provision of low-cost housing is central to their organizational purposes while profit generation usually is not. Third, most of the public financing approvals that facilitate the development of these properties also severely restrict ownership transfers and changes in use.

One exception to this condition is that of expiring use. Many projects developed during the 1970s with financing insured by the Federal Housing Administration (FHA) required affordability for a 20-year period. As these use restrictions expire, a substantial stock of inexpensive rental units is threatening to disappear. In an effort to save these units from conversion to market rents, Congress has enacted legislation allowing owners to obtain insured cash-out refinancing and transfer ownership to nonprofit organizations that will maintain the units as affordable housing.

Operating revenue

In a market-rate project, revenue is a result of the prevailing market rental rates and vacancy and collection losses, the suitability of a property for the local marketplace, and the resulting level of market acceptance. For an affordable project, however, revenues are largely driven by financing, tax credits, and other regulatory requirements. These requirements limit the property's revenue in two ways.

First, rents normally must be "affordable," that is they may not exceed 30% of the monthly gross income for the target household's income group. Second, no household occupying a low-income unit may earn more than the target income for that unit. For example, if the median annual income for a family of four is $36,000 in the project's geographic area, and the rent for a unit is restricted to 50% of median income, then the resident household cannot earn more than $18,000 per year, and the monthly rent cannot exceed $450 ([0.3 x 18,000]/12), less an allowance for utility expenses.

Clearly, this will not have a significant impact in areas where prevailing market rents are comparable to the restricted rent. In many markets, however, the restrictions severely curtail a property's revenue. Further, depending on the income restrictions, locating qualified credit-worthy tenants may also be a challenge.

Operating expense

Operating expenses in affordable housing projects can be much the same as expenses for a market-rate development when considered on a line-item or a dollars-per-unit basis. As a result of below-market rents, however, the expenses will be a different percentage of gross income than those of a market-rate project. There are several expense categories that should be carefully considered by an appraiser.

Maintenance and repairs

Due to the prevalence of large families with children, greater project density, and, frequently, a lower-income market location, maintenance and repair expenses in affordable projects are likely to be higher than those in a typical suburban market-rate apartment complex. Further, a high level of maintenance must be maintained to achieve community and political acceptance of the project and to avoid being labeled with the "low-income housing" stereotype.

Operating and replacement reserves

Unlike market-rate property, whose appropriate reserves are optional and are calculated by useful-life calculations for property components, many project approval and financing covenants set forth specific percentages of construction cost or adjusted gross income that determine annual reserve requirements.

Partnership management fees

The limited partnership structure used by tax-credit projects and many financing covenants normally requires the general partner to prepare special operating audits and budgets each year. Further, a partnership management fee may be payable to the syndicator responsible for structuring the limited partnership. These costs can amount to an additional $10,000 to $15,000 per year.

Property taxes

Depending on state law, properties owned directly by nonprofit organizations or partnerships with a nonprofit general partner may be exempt from ad-valorem property taxes if dedicated to affordable housing. This is a significant cash flow benefit in high-tax states. Property taxes for any commercial space and special-district assessment charges are still assessed.

Management fees and overhead

Because many affordable housing projects are managed by nonprofit sponsors or local developers who lack a large portfolio of properties, economies of scale frequently obtained by large property management firms in the area may not be available. This results in higher administrative costs than might typically be expected.

A special note on expenses: In most affordable housing developments, particularly those with nonprofit sponsors, debt service covenants prevent the owners from ever receiving substantial cash flow from the property operations. Thus, it is common to see expenses much higher than normal, as they reflect loading for general sponsor overhead and an above-average level of maintenance. It is best not to consider expenses on a percentage-of-gross-income basis for comparison. Because gross income is artificially low due to restrictions and because expenses may be unusually high, it is not uncommon to see operating expenses and reserves totaling 45% to 70% of gross income.

Escalation assumptions

Financing and low-income housing tax credits cap the permitted increase in revenue for the affordable project. This is an important factor when considering the long-term return on investment and cash flow available to an owner of these properties, and should be considered in any discounted cash flow (DCF) analysis. In the market-rate property, escalation assumptions are driven largely by reasonable anticipation of revenue changes as a result of supply, demand, and prevailing economic conditions. Because low-income rents are a fixed percentage of area median income, however, they may change only in response to median income changes and may be forced upward or downward at rates different from overall market trends. On the other hand, this offers some income stability even in a declining rental market if the affordable rents are initially established at a comfortable margin below market.

Construction costs

Construction costs for affordable housing tend to be higher than the cost of constructing comparable market-rate product for several reasons.

Land costs

Sites selected for affordable housing often have been passed over by other developers because of excessive development, on- or off-site preparation requirements, or environmental issues. Land may have been acquired at premium prices by public agencies through the eminent domain process, or an above-market price may have been exacted by the seller in return for agreeing to an unusually long escrow period. Extended escrows are often required to permit adequate time to arrange the complex financing and approvals relating to low-income development.

Hard costs

To avoid the stigma associated with low-income housing and assure community and political support for a proposed project, public agencies and developers often propose architecturally significant designs and specify materials and construction methods appropriate for high-grade residential development. As mentioned, payment of prevailing wages is often required as well, resulting in total hard costs that routinely exceed standard industry guidelines.

Soft costs

The area of greatest diversity between affordable and market-rate developments is that of soft costs, which include fees, legal expenses, developer profit, and general overhead. Many of these added costs are necessitated by the forms of financing, tax credits, and public agency assistance employed. All of these require extensive applications, design review, public hearings, legal structuring, and direct fees. In the case of the nonprofit developers, they often lack significant development and construction expertise on staff and rely heavily on outside consultants. This significantly increases soft costs when compared with large commercial developers who maintain development expertise in house. Because distribution of operating cash flow is limited, developer fees for both nonprofit and for-profit developers are usually substantial, ranging from 10% to 15% of total project cost.


Many of the loan programs, and particularly syndication agreements common to tax-credit projects, require that substantial operating reserves be established. These reserves protect against not only operating cash flow deficiencies but also construction defects and unexpected maintenance problems that may arise during the term of affordability restrictions, when rents cannot be increased significantly. The typical source for these funds is either project financing or syndication proceeds.

Vacancy and collection losses

One area where affordable projects enjoy a decided advantage is vacancy and collection losses. With rents well below market, these properties usually maintain substantial waiting lists of qualified prospective residents. Often lotteries are required to select the initial tenants from a large pool of applicants. As a result, vacancies in most truly affordable properties range from 2% to 4%, and turnover is minimal. And contrary to what might be expected, collection losses usually are very minor due to affordable rents, careful tenant selection, and the scarcity of units. Residents who are fortunate enough to obtain a high-quality affordable apartment typically protect the right aggressively.


Preparation of an affordable housing appraisal does not differ significantly from preparation of a market-rate appraisal, as long as the unique characteristics of affordable housing are not overlooked. By practicing the following steps as a matter of course, appraisers can be assured of providing their clients with accurate and useful analyses of prospective affordable housing developments.

Determining the definition of value

As with any appraisal project, the first priority of an appraiser should be to determine the purpose of the appraisal and the appropriate value definitions to be applied. Now that the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) requires lenders to obtain their own appraisals, conflicts of purpose between lenders, borrowers, and public agencies should be minimized. It is worthwhile, however, to review the purposes for which appraisals may be required.

Market value

This definition, as established by the appropriate governmental agencies and regulators, is commonly required by private lenders. These lenders usually seek a valuation of the property as if unencumbered by any restrictions and without the benefits of any concessionary financing, property tax exemption, or tax credits. This value represents a worst-case scenario for the lender and is intended to represent the value of the property in the open market following a foreclosure. Implicit in the request is the requirement imposed by most lenders that all affordability and occupancy restrictions imposed by public agencies, junior lenders, or the tax-credit program be unconditionally subordinated to their Hens. By so doing, the lenders may then evaluate the property as if it were a market-rate project competing with other projects in the local marketplace. For this type of report, an appraiser may ignore all restrictions and evaluate the project using prevailing market conditions.

Restricted value

Lenders may also request estimation of a property's restricted value, defined as the market value assuming the property to be 1) encumbered by a governmental or private restriction governing rents and tenant income levels for a term; and 2) if applicable to the jurisdiction in question, benefitted by a reduction in, or exemption from, property taxes in the event that it will be owned by a nonprofit entity. This value, while not normally considered for determining the maximum loan-to-value ratio of the requested financing, offers some insight into the effect of affordability restrictions on value and gives the lender valuable information regarding the operating expenses an owner will incur while using the property for its proposed affordable housing purpose. Lenders may also want to evaluate the feasibility of the project following foreclosure if the lender were to allow affordability restrictions to remain in effect.

Investment value

As a component of restricted value, a lender may request that the value contribution of concessionary financing and tax credits be considered. This is normally accomplished as follows.

* Concessionary financing. If an appraiser is fortunate enough to find comparable sales of properties with concessionary financing in place, the task of estimating value for concessions is vastly simplified. This is not usually the case, however, and an appraiser must resort to the use of the DCF model to evaluate the savings achieved by an investor as a result of below-market interest rates or unusual repayment terms. To employ this model, the difference in debt service requirements between an open market and restricted transaction is determined, and the savings are discounted to a present value using a market rate of return as the discount factor. This present value can then be added to the intrinsic real estate as the value specifically attributable to concessionary financing.

* Tax credits. The value of tax credits exists for the first 10 years of a project's life and can be estimated with one of two methods. Using the first method, an appraiser surveys a variety of tax-credit investors active in a local market to determine the going investment rate. Such rates are normally expressed in cents per dollar of tax credit, and usually range from .40 to .50 (e.g., a project allocated a total of $4 million of tax credits over the 10-year term would generate $2 million of equity investment if the investor paid 50 cents per dollar). The amount of tax credits available annually can be estimated prior to completion by reviewing anticipated project costs and the tax-credit reservation issued by the state allocation committee. Under the second method, an appraiser again utilizes a DCF model to simulate an investor's analysis and evaluate the present value of annual tax benefits. These benefits include the tax-credit deduction, the applicable annual depreciation for the improvements and related property, and any operating losses arising from operations or resulting from accrued but unpaid debt service on subordinate public financing and ground leases.

Investors typically develop such a model in order to evaluate their overall return during the anticipated holding period, which for most tax-oriented investors is the 15-year statutory holding period established by the Internal Revenue Code. The investor then matches the anticipated tax benefit for each period with the corresponding cash inflow or outflow to estimate the internal rate of return (IRR). To maximize IRRs, many investors pay syndication investments over a multiyear period rather than make a lump sum investment at project inception.

In the author's experience with more than 100 recent transactions in California, the market generally places a high discount rate on such credits, with IRRs often ranging from 20% to 25%. While this IRR may appear excessive in light of current interest rates, it is the result of the learning curve unfolding for many large corporate investors who perceive a high degree of real estate risk associated with low-income housing, a generally inadequate supply of investors, and the syndication load charged by commercial syndication.

Other values

As is the case with any project, an appraiser may need to evaluate the "as is" value or a value prior to stabilized occupancy. These analyses are performed in the same manner required for market-rate development. However, there is commonly very little, if any, discount required for a restricted value approach because units below market rate are normally absorbed immediately upon completion.

Preparing the cost approach

The cost approach to value for an affordable development is prepared in much the same manner as for a market-rate project. This approach rarely has much significance aside from occasional use by lenders to cross-check the proposed development budget against an independent estimate. Most affordable housing projects are not economical from a traditional perspective in that the development costs regularly exceed the market value upon completion. This can be explained by the restricted project revenues, high soft costs, and market economics in locations frequently selected. Further, because of the presence of discretionary approvals, the principle of substitution is not valid in many instances.

The following characteristics warrant special attention.

Land sale comparables

Comparables may be difficult to find and adjust because of atypical discretionary approvals received by the subject project. These approvals often add significant value to the site, value that may not be applicable to other land sales found in the subject's market area. For this reason, it is important that an appraiser consider not only the size and similarity of comparable parcels, but also their suitability for development in a manner comparable to the subject.

Hard construction costs

Hard costs can be readily estimated by reference to a standard construction cost estimating guide for the market area. Costs that may require special attention include the cost of above-average construction specifications, the cost of unusual site preparation and off-site improvements, and the cost of constructing nonresidential facilities such as child care centers and commercial spaces in mixed-use projects. Although the differential is difficult to estimate, an appraiser may wish to cross-check indicated costs against a developer's construction contract of preliminary bid responses if payment of prevailing wages is required by public financing sources.

Soft costs

An appraiser must rely significantly on a developer's budget for unusual soft costs unique to affordable housing. These include special development or mitigation fees, the cost of obtaining and syndicating tax-credit allocations, financing commitment fees, and special legal, consulting, and accounting fees.

There are two primary methods for adjusting these costs to market conditions. Many appraisers ignore these items in preparation of the cost approach, resulting in a replacement cost estimate far lower than a developer's proposed budget. The other approach commonly used is to account for economic obsolescence to adjust the costs downward to the level indicated by the open market. While either approach results in basically the same conclusion, the second method is preferable because it acknowledges the extra costs implicit in an affordable project. As such, it can be a useful reference for lenders and public agencies evaluating the overall merit of a development proposal.

Preparing the market approach

The market, or sales comparison, approach to value is often the most challenging approach to prepare because appropriate sales comparables are difficult to locate. The first step in this approach is to evaluate the suitability of the proposed project for affordable housing. This analysis will assist an appraiser in later selecting comparable sales that provide utility similar to the subject, even if by necessity they are located outside the subject's market area. In order to effectively serve a low-income resident population, affordable housing projects must be sensibly located in markets with sufficient rental demand. Further, because many residents will not have a personal means of transportation available, proximity to public transportation, employment, schools, shopping, hospitals, and other services are important considerations.

Market sales comparables may then be selected from within the subject's immediate neighborhood or from another neighborhood that displays similar economic characteristics and property acceptance by investors. It is not necessary to limit the selection of comparables to properties with restricted rents or low-in-come targeting as long as reasonable location adjustments are performed to adjust for neighborhood characteristics. Under the market value definition most often sought by lenders, it is explicitly stated that the evaluation should assume that no affordability restrictions are present because these will be subordinate to the senior lien and cease after a foreclosure. An appraiser can adequately assess the value impact of affordability restrictions through a restricted-rent version of the income approach, which will then be considered in the final reconciliation of value.

Sales comparables should be of similar construction quality, design, and market appeal (if the subject were not guided by affordability restrictions), should target a similar tenant population (e.g., seniors, large families), and should provide a similar unit mix in order to provide useful comparisons for gross income multipliers (GIMs), dollars per room, dollars per unit, operating expenses, and indicated overall capitalization rates ([R.sub.0]s).

Preparing the income approach

For purposes of estimating the market value of a subject property, the income approach to value is prepared in the normal manner with appropriate assumptions for revenue, expenses, and capitalization (cap) rates derived from open-market comparisons. Intricacies arise, however, when preparing an income approach under the restricted value definition. Naturally, the key to accurately preparing the income approach is to thoroughly understand the impact and requirements of all relevant regulatory and financing covenants. Each of the two typical methods of evaluating the income approach--the capitalization rate method and the DCF method--requires special consideration.

Capitalization rate method

Selection of a cap rate is complicated by the fact that open-market cap rates presume the risk and return profile of property ownership as defined by the typical investor in a specific market. Such profiles are predicated on current market growth expectations and inflationary conditions, rates of return available on alternative investments, and a risk adjustment premium based on the potential variability of these estimates.

In selecting a cap rate for an afford-ability-restricted property, an appraiser should consider the greater stability of the revenue stream over time, presence of concessionary financing terms, and the ability of the property to withstand fluctuations in market demand. While restrictions do not permit rapid upward adjustment of rents in response to changing market conditions, over time inflation protection is provided to investors because rents are defined by a percentage of area median incomes, which presumably are positively correlated with market inflation rates.

Sufficient sales of rent-restricted properties do not exist in most markets to provide definitive guidance to an appraiser; however, these considerations lead many appraisers to select a cap rate for restricted valuation that is slightly lower than the indicated open-market cap rate.

Once an appropriate cap rate has been estimated, it is applied to the first-year estimated net operating income (NOI). This NOI should account for revenues in accordance with maximum regulatory guidelines, potentially reduced vacancy and collection losses, and expenses and reserves that may be higher than normal. Caution should be used to ensure that restricted-unit rents do not exceed comparable levels in the open market, a condition that occurs regularly in many areas. If rents do exceed comparable open-market levels, then the concept of a restricted value is not relevant to the property, and market rents should be used in every valuation approach.

There is one exception to this rule. When valuing a property that is guaranteed above-market rents for a long period of time as a result of HUD's Section 8 project-based assistance contract, an appraiser should note the higher contract rents in the restricted income approach and will likely conclude a value greater than the open-market value. Most lenders accept Section 8 rent schedules only for project-based assistance because tenant-based assistance is not tied to the property and can expire or move to competing developments.

DCF method

This method relies on the premise that a property's value is equal to the present value of all income derived from ownership during a reasonable holding period. Typically, DCF analyses are not a preferred appraisal method for market-rate projects because of the number of subjective estimates required for growth and reversion rates.

The DCF analysis can be useful when applied to affordable housing's restricted value because it permits an appraiser to evaluate directly the impact of certain investment characteristics. Regulatory agreements regarding ownership and holding periods, equity sharing upon disposition, guaranteed priority returns based on developer equity, debt service deferrals, and revenue and expense. trending assumptions--all affect restricted value and may be readily modeled using a DCF analysis.

Preparing the final reconciliation of value

Under the market value definition, a reconciliation is straightforward. It presents a challenge only when a subject's restricted value is considered. Under a restricted-value analysis, the cost approach has limited utility because unique property characteristics and development expenses result in an indicated value substantially greater than that of the market approach or income approach. Further, because of the scarcity of land and the inability to obtain the required zoning, discretionary approvals, and special financing or tax credits necessary to create a feasible affordable project, the principle of substitution is usually meaningless.

The question then becomes an evaluation of the market and income approaches. In most cases, these values will fall within a reasonably dose range of each other as the result of carefully determined cap rates and NOI projections and prevailing relationships between the GIM and other measures of investors' required rates of return. Unless resales of affordability-restricted properties are evident in the marketplace, however, the value of the market approach is somewhat reduced, and an appraiser will rely most heavily on the income approach to value as the best method to assess the restrictions' impact on value.


The primary task of an appraiser is to correctly define and evaluate the various components of value. In a market-rate project, these generally are limited to cash flow obtained during ownership and terminal flows from property disposition, offset by the costs of acquisition, disposition, and ownership. When considering a market value definition absent affordability restrictions, the appraisal process does not vary significantly between market-rate and affordable housing development.

For an affordable housing project operating under restricted conditions, this process is made significantly more complicated. In the first place, costs of construction or acquisition are usually much higher than "normal." Further, cash flow may be limited and disposition value may be nonexistent as a result of the excessive financing used in property construction and interest payments commonly deferred during a project's lifetime. These negatives, however, are offset by benefits received in the form of concessionary financing, preferential return on investment, and low-income housing tax credit allocations.

As we have seen, many features of affordable housing work together to simulate an investment environment comparable to that of market-rate development. Through careful evaluation of the economic impacts of these factors, appraisers can successfully estimate the value of affordable housing developments and consistently produce accurate and useful appraisal reports for their clients.


Traditionally, low-income housing, or "affordable" housing as it is now known, fell into two broad categories. Properties in which 100% of the units were reserved for low-income households were most often constructed, owned, and managed by public housing authorities (PHAs) under the general supervision of the U.S. Department of Housing and Urban Development (HUD). PHAs receive annual funding directly from HUD and are charged with providing shelter for the lowest income tier of households in their communities. Rental rates and annual increases are determined by HUD guidelines, and as a result of mismanagement and federal funding restrictions many PHAs are now struggling to maintain safe and decent housing for residents. Due to design and construction issues, occupancy restrictions, and generally poor cash flow, these properties are normally not comparable to newly developed affordable housing.

Of course, HUD programs hove not been restricted to properties developed by PHAs. Until the HUD program scandals of the early 1980s, a variety of HUD-assisted financing was available for private developers. These programs generally took the form of mortgage insurance that was provided through the Federal Housing Administration (FHA) to induce private lenders to finance perceived "high-risk" properties. In return for the FHA insurance, which generally resulted in below-market interest rates, developers were required to reserve at least 20% of a projects units for occupancy by low-income households. The balance of the units were available for market-rate residents, thus providing the owner with appreciation potential in addition to the initial profits obtained through construction and development fees.

The two primary development structures of the past have given way to new initiatives for affordable housing development. These initiatives are a result of social and fiscal concerns arising from the poor reputation of public housing projects and the abuses common in many FHA-insured developments. New programs have been devised to assist developers in creating affordable housing for local communities, emphasizing a partnership between public and private financing sources and local communities instead of the federal government. It is this spectrum of programs that appraisers encounter today, programs that hove varied impacts on property ownership structures, marketability, and creation of value through the development process.

Low-income housing tax credit

This credit, first authorized by the Tax Reform Act of 1986 and made permanent by the August 1993 tax legislation, is contained in Internal Revenue Code Section 42. Under the section, an annual tax credit is available for 10 years to developers of residential properties that meet the program criteria. The guidelines require that at least 51% of a property's units be occupied by households whose annual earnings do not exceed 60% of the area median income, as determined by HUD. Once this threshold is met, the credit is prorated based on the portion of a project's units that meet program requirements. Although the exact credit percentage is determined by a technical formula and changes monthly, the credit is approximately equal to 9% of qualified basis (hard construction costs plus certain soft costs) for new construction, and 4% of qualified basis for the acquisition of existing properties requiring substantial rehabilitation or for properties financed with housing revenue bonds.

To utilize the credit, property developers must obtain a specific allocation of credit from the state's allocating agency and agree to maintain occupancy and rent affordability restrictions for at least 15 years. In same states the credit is readily available; however, in many others the credit allocation process is very competitive. It often requires developers to agree to affordability terms as long as 50 years and to household income restrictions well below 60% of the median.

Because use of the tax credit by individuals is limited to an annual maximum, and the alternative minimum tax (pursuant to Internal Revenue Code provisions) remains a consideration, credits tend to be sold either in private placements to large corporations or through public syndications to groups of corporate or individual investors. Rarely are the credits of direct use to a property developer. Through the syndication process, tax-credit investors participate in properly ownership as 99% limited partners. Normally the property developer or an affiliate retains a 1% partnership interest as the managing general partner. In this way, the majority of depreciation, operating loss, and tax-credit benefits are distributed to the tax-credit investors.


Two federal programs currently provide funds to local communities for use in developing affordable housing. The Community Development Block Grant (CDBG) program has been in place for many years. Under this program, funds are provided to states and local governments who then lend the funds to property developers. Loan terms and repayment schedules are determined by the local agency; however, long-term affordability and rental restrictions are normally exacted in exchange for fixed interest rates in the 3% to 6% range. If CDBG funds are used directly to fund construction, the Davis-Beacon Act applies, requiring that construction workers be paid prevailing [or union-equivalent] wages. This significantly increases the cost of construction in communities where union labor is not the norm. The Davis-Beacon Act can be avoided if funds are used only for predevelopment costs, land acquisition, or permanent financing.

The Cranston-Gonzalez National Affordable Housing Act of 1990 established several new programs for affordable housing, including the HOME program for multifamily housing development. Like CDBG funds, HOME funds are disbursed through local agencies. However, these funds generally must be matched by local agencies and trigger prevailing wages whenever they are used for improvements. Nonprofit organizations receive priority for HOME funds.

Redevelopment agency tax-increment funds

In many states, local communities are permitted to establish redevelopment agencies and identity local redevelopment plan areas. When a plan area is formed, properly tax revenues to local government agencies are frozen at their current levels for a long period of time, generally at least 15 years. Using funds borrowed through the issuance of municipal bonds, the redevelopment agencies make loans or grants available under advantageous terms to encourage redevelopment of the plan area. As properly values in the area increase as a result of redevelopment, rising assessments lead to additional property tax revenue, or "tax increment," which is used to repay the bonds and generate additional operating funds for the agency. Although most redevelopment agency activity focuses on commercial properly, some states require that a percentage of the tax-increment funds be used only for housing. Thus, redevelopment agencies in larger cities can be a solid source of funding for affordable housing development.

State and local housing finance programs

Under federal law, public agencies are permitted to issue tax-exempt revenue bonds to finance the development of housing. Generally, at least 20% of the housing units must be affordable to households earning not more than 50% of area median income, or 40% of the units must be affordable at the 60% level. The bond program requires that affordability restrictions be imposed for the term of the bonds. Properties financed by bonds receive an automatic 4% low-income housing tax credit but are ineligible for the 9% tax credit.

To obtain the investment-grade credit ratings that result in very attractive long-term financing rates, bonds are normally rated by an organization such as Standard & Poor's or Moody's. Because revenue bonds are not guaranteed by the issuing agency and rely solely on project cash flow for payment to bondholders, the rating agencies generally require that a financial institution provide a guarantee, or "credit enhancement." Revenue bonds are currently difficult to issue because financial institutions are unwilling to provide such a guarantee.

Private financing sources

The final common source of project financing is private lenders. These include private foundations, charitable organizations, and traditional institutional investors, banks, and savings institutions. Often, the private foundations and charities will provide grants to nonprofit developers with the understanding that certain affordability guidelines be enforced. Commercial banks and savings institutions are encouraged to provide financing for affordable housing by the Community Reinvestment Act, but they offer a traditional loan product and are likely to seek a market rate of return on loans. With the restricted income of an affordable project, though, private financing alone is rarely sufficient to cover construction costs and create project feasibility.

Section 8 rental assistance

Some properties may receive rent subsidies through the HUD Section 8 Rental Assistance program, under which PHAs enter into contracts with property owners that guarantee payment of a fair market rent (FMR) for a specific unit, FMRs are published annually by HUD for each market area but may also be adjusted downward by the PHA based on an actual survey of competing units in the open market. The PHA then supplies the unit resident to the project, and the resident pays 30% of gross monthly income toward the FMR while the PHA pays the difference directly to the landlord. In order to participate, individuals apply to the PHA and establish eligibility as a very low-income person whose earnings do not exceed 50% of the area median.

The subsidies fall into two categories, tenant-based and project-based assistance. Under tenant-based assistance, known as certificates or vouchers, program assistance is committed to the tenant who then locates a unit and assigns the assistance payments to the landlord. This generally guarantees the landlord consistent income for a one-year term. However, the tenant may relocate at lease expiration, taking the assistance elsewhere. Under project-based assistance, the property qualifies with the PHA and a long-term contract (5, 10, or 15 years) for all or most of the units is executed with the PHA. This type of contract provides incremental value to the real estate by guaranteeing a scheduled income stream and zero vacancy for a long period of time.

Discretionary approvals

Although not specifically financing sources, discretionary approvals often benefit affordable housing developments. Such projects are eligible for approval due to the public and social benefits they provide, and the approvals often have the effect of creating project viability. The most common of these approvals include conditional-use permits, zoning variances for design and parking requirements, and density bonuses permitting an unusually high number of units to be constructed, thus lowering the per-unit land cost. Other discretionary approvals may result in fee waivers for plan checks, utility fees, school fees, and traffic- and development-mitigation fees.

David C. Nahas is the chief lending officer of Savings Associations Mortgage Company, Inc., a consortium of more than 80 California-based financial institutions that provides permanent financing for affordable multifamily housing developments. Mr. Nahas manages the loan origination, underwriting, and secondary marketing functions for the firm, and works with the appraises responsible for evaluating prospective affordable housing projects.
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Copyright 1994 Gale, Cengage Learning. All rights reserved.