Freddie Mac (the Federal Home Loan Mortgage Corporation) has released a study titled “Risk and Impact of LIHTC Properties Exiting the Program: Examining the Risks of Expiring LIHTC Restrictions and the Outcomes of Properties that Exit.”
As market rents continue to rise, rental affordability is becoming increasingly important – especially in preserving existing affordable housing. Some in the industry are concerned that units supported by Low-Income Housing Tax Credits (LIHTC) may transition from having restricted, affordable rents to levels that are too expensive for low and even moderate-income households to afford.
The goal of this Freddie Mac study is to provide an overview of the general risk that currently exists in the market and the potential for a high level of lost affordable units.
A key finding from the research is that LIHTC properties that exit the program often remain more affordable than conventional market rate properties that were never subsidized, even if they are not resyndicated. Former LIHTC properties are often transitioning to workforce housing, remaining affordable to tenants that earn below the area median income (AMI).
Here are some of the key findings outlined in the report:
- 86.8% of LIHTC properties are programmatic, meaning that they are still in the program and remain subject to rent restrictions. However, a growing number of properties will be able to exit the program in the coming years.
- High opportunity areas have a relatively high share of programmatic LIHTC properties, which, given the elevated rental costs, can be particularly beneficial for these areas.
- LIHTC properties that have left the program (referred to as non-programmatic) generally have higher rents compared with LIHTC-restricted units, but lower rents compared with conventional market-rate units.
- Some non-programmatic LIHTC properties increase rents substantially above 60% of the AMI affordable rents, but the majority are still affordable at this income level. The most common path for non-programmatic LIHTC properties is to remain affordable at 60% of AMI, which happens roughly 61% of the time.
Explanation of Risk
Housing researchers generally agree that the U.S. suffers from a lack of affordable housing. The National Low Income Housing Coalition (NLIHC) estimates that for every 100 renters earning 30% of AMI there are only 36 units available.
The LIHTC program is the federal government’s primary vehicle for providing affordable housing nationwide. The study found that based on the equity financing for LIHTC properties in 2021, most units (84.5%) are priced at 60% of AMI, with the remaining 15.5% targeting either 30%, 40%, or 50% of AMI. This validates what we in the industry have known anecdotally for years – most LIHTC properties operate under the 40/60 minimum set-aside.
Identifying Types of Risk of Properties Exiting the LIHTC Program
Between years 1-15 of the initial LIHTC compliance period, the risk of affordability loss is low since there is typically no legal way to raise rents above what is permitted at the time of LIHTC allocation. However, after year 15, several risks emerge that could lead to LIHTC properties leaving the program.
The Qualified Contract (QC)
Beginning as early as the end of year 14, LIHTC property owners typically may inform the applicable state Housing Finance Agency (HFA) of their intent to sell the property pursuant to the QC process.8
• If a buyer is not found by the HFA within one year, the owner can convert the property to market rate rents after a three-year “decontrol” period.
It should be noted that this option is very unpopular with the states and Congress is considering doing away with the option.
Expiration of Affordability Restrictions
Depending on the year a property is placed in service, affordability restrictions will generally lapse after 30 years. After this period, property owners can raise rents without the risk of credit recapture by the IRS or, in some cases, legal action by the HFA.
• Some states require a longer extended use period, and some property owners agree to more stringent restrictions in order to be more competitive in the allocation process. In this way, the 30-year rule is not universal.
Historically, LIHTC properties have very low delinquency and default rates. However, a LIHTC property could still suffer from financial and operational problems that give a lender the right to foreclose. This can happen even before year 15.
Upon foreclosure and transfer of ownership, the Land Use Restriction Agreement that includes rent restrictions typically will terminate, permitting the new owner to convert the property to market rent after a three-year decontrol period.
The study notes that leaving the LIHTC program via foreclosure is very rare.
If LIHTC properties leave the program, the degree of affordability loss can only truly be measured on a case-by-case basis since property owners will not necessarily raise rents, especially if property or local market conditions can’t support the increase.
Snapshot of Current Non-Programmatic LIHTC Properties
The study identified 40,296 multifamily properties in the entire history of the LIHTC program. Of these, 34,975 are programmatic, which means they currently restrict rents based on local income in accordance with LIHTC requirements. The remaining 5,321 properties have exited the LIHTC program and are no longer believed to have LIHTC restricted rents.
What Factors Increase or Decrease the Propensity of a Property to Exit the LIHTC Program?
- Ownership Type: LIHTC properties with nonprofit owners are less likely to leave the program.
- Year Placed-in-Service: Older LIHTC properties are substantially more likely to exit the program. Over 90% of properties placed in service prior to 1990 are believed to be non-programmatic. In 1990, the program length switched from 15 years to 30 years. However, beginning in 2020, the 30-year extended use period is expiring for a number of LIHTC properties, and this is a concern.
- Property Size: Smaller properties are more likely to have exited the program. The average property size of a non-programmatic property that was placed in service prior to 1990 is 43 units, compared with 73 units for programmatic properties. The trend changes for properties in service after 1990, where programmatic properties tend to be smaller than non-programmatic properties.
- Resyndication History: The rate for resyndicated programmatic properties is high — 96.2% of properties that have resyndicated (i.e., obtained a new allocation of credits) remain programmatic.
- The State: Some states will mandate or incentivize extended use periods longer than the 15-year federal minimum. The study has identified 11 states for which this is true, with extended use periods ranging from 18 years to 99 years. These increased restrictions appear to decrease the rate of non-programmatic properties. Therefore, LIHTC properties in states with longer extended use periods will generally correlate with a lower risk of near-term exit. Following are the states the study identified with extended use periods longer than 15 years:
- Alabama – 20 years
- California – 40 years
- Connecticut – 25 years
- Hawaii – 30 years
- Kentucky – 18 years
- Maine – 30 years (was 75 years until 2013)
- New Hampshire- 45 years (was 84 years prior to 2020)
- Oregon – 45 years
- Pennsylvania- 25 years (was 20 years prior to 2021)
- Utah – 35 years (was 84 years prior to 2013)
- Vermont – 84 years
- Local Housing Market: There is the concern of an increased risk of losing LIHTC restricted properties that may be able to receive a premium due to local housing conditions. This is especially the case in highly sought-after neighborhoods. Interestingly, non-programmatic properties are in lower-income areas compared with programmatic properties. Given the elevated rental costs, high opportunity areas especially benefit from affordable housing, so it’s encouraging that an outsized portion of LIHTC units are still in the program.
- Rent Level – Market vs. Max LIHTC: As market rate rents increased, fewer conventional market rate properties remain affordable at 60% of AMI and below, creating a gap between maximum restricted LIHTC rents and conventional rents. If market rent is substantially higher than maximum LIHTC rent, this could entice property owners to reposition a LIHTC property as market rate either at the expiration of affordability restrictions or before expiration via a QC.
What Happens to LIHTC Properties that Become Market Rate?
Once a LIHTC property exits the program, rents at the property are no longer subject to restrictions, provided the property does not receive other subsidies and is not subject to other restrictive covenants. The Study uses seven metro areas to determine the answer to what is happening to exiting LIHTC properties. These are Dallas, Indianapolis, Los Angeles, Orlando, Phoenix, Seattle, and Washington, D.C. These locations were chosen because they are geographically and culturally diverse and had relatively large non-programmatic populations. Non-programmatic properties with fewer than 50 units were not considered.
Here are the major findings:
- Non-programmatic LIHTC properties are considerably older than other market-rate properties.
- Non-programmatic LIHTC properties generally have lower property ratings and lower location ratings compared with conventional market rate properties.
- Rents in non-programmatic LIHTC properties tend to be lower than market-rate units that were never in the LIHTC program. This is true for all seven metro areas studied. The largest rent gap was in Dallas, where non-programmatic LIHTC rents are 26.5% lower than market rate, while the smallest gap was in Phoenix, where non-programmatic rents are only 3.0% lower.
- The analysis shows that non-programmatic LIHTC rents are still materially below the rest of the market.
- In general, many non-programmatic LIHTC properties continue to provide affordable housing. Rent levels across these metro areas for non-programmatic properties are affordable, on average, to tenants making 61% of AMI.
Opportunity for Workforce Housing
Non-programmatic LIHTC represents a loss of the strictly affordable stock, which is the segment of the market with the most need, but it benefits another market segment: workforce housing.
Workforce housing typically serves renters who make below the median income for the area but are not eligible for subsidies.
Overall, programmatic LIHTC units are generally the most affordable and guarantee they will remain affordable, followed by non-programmatic LIHTC.
Loss of Deeply Affordable Units
The loss of affordable LIHTC units can still be very problematic. This is especially true for deeply affordable units at 30% AMI. There are no units in the non-programmatic dataset that are affordable at 30% AMI, while only 0.1% of conventional market-rate units are affordable at this level. Since market rents can almost never support rents at this level, the conversion of a LIHTC property to market rate typically means the loss of deeply affordable units at 30% AMI.
Conclusion of the Study
Rent and income restrictions for LIHTC properties generally persist for at least 30 years, but as the program ages and more properties near the end of their compliance periods, the risk of affordability loss increases. Certain factors are correlated with the risk of ending LIHTC rent restrictions such as ownership type, property characteristics, and local housing market. The decision to convert properties to market rate, however, ultimately lies with the property owner who is motivated by a variety of factors.
Fortunately, the propensity for LIHTC properties to move to a rent level on par with market rate is low. Although rent for units among non-programmatic LIHTC properties is typically higher than programmatic LIHTC rents, they are still materially below conventional market-rate rent levels. In this way, LIHTC properties leaving the program play a role in a community’s overall rental housing strategy by adding to the workforce housing stock, thus increasing affordable access to households that may not qualify for subsidized housing.
However, several risks remain, particularly around the loss of deeply affordable units and the risk of rents increasing due to market conditions or rehabilitation of the property. Available public subsidies can best benefit those properties that provide deeply affordable housing as well as affordable housing in areas without a lot of access to similar-priced housing. Understanding the risks associated with the loss of affordable units from LIHTC properties can help inform what may happen as more properties exit the program and provide strategies to help preserve affordable housing to help those tenants most at risk of losing affordable housing.