Policy Corner: Saving the 4% Tax Credit
The lack of affordable housing, a problem impacting urban, suburban and rural areas for decades, has been exacerbated by the wave of unemployment and underemployment related to the pandemic. The “America’s Rental Housing 2020” report by the Joint Center for Housing Studies of Harvard University revealed that burdened renters, which is defined as having to pay more than 30% of income on housing, totals 20.8 million people, representing nearly half (47.5%) of all renters in the U.S. Nearly 10.9 million renters—or one in four—spent more than half their incomes on housing in 2018.
The Low-Income Housing Tax Credit (Housing Credit) program, created by the Tax Reform Act in 1986, is our nation’s primary tool for providing indirect federal subsidies to construct, renovate and/or preserve affordable rental housing.
“The housing credit and the equity investment it generates has been responsible for the development and preservation of approximately 3.5 million units of affordable housing across the U.S. since the program was signed into law by President Reagan,” said Will Eckstein, senior vice president for Greystone Affordable Development. “About one-third of that development, around 1.2 million units, has utilized tax-exempt bond financing in conjunction with the 4% tax credit.”
4% vs. 9% tax credits
There are two types of tax credits available to support the production of affordable housing. The non-competitive 4% tax credit, which can be used for preservation of existing rental communities or new construction, is as-of-right with developments that are financed with private-activity bonds and meet one of two standards for rentals. Either 40% of the units must be rented at an affordable rate for households earning 60% or less of area median income, or 20% of the units must be rented to households earning 50% or less of area median income.
Traditionally, the 9% tax credit is awarded at the state level through state housing finance agencies.
“Bond volume cap and the ability to secure 4% tax credits has grown to be an increasingly competitive process as it has risen in popularity over the last decade; however, applications for 9% tax credits are still much more competitive,” said Eckstein. “Developers can make multiple attempts over several years to secure 9% credits without ever succeeding.”
What’s at risk for tax credits
While extremely low mortgage rates have been one of the few bright spots in the 2020 economy, those low rates ultimately reduce the value of the 4% tax credit.
“The interest rate for the 4% tax credit is variable and is at historic lows due to the low interest rate environment which has been impacted by the global pandemic,” said Eckstein. “Ultimately, this means there are less dollars available for funding and supporting affordable housing development and preservation while at the same time we are seeing a substantial increase in construction costs as well as a disruption in our supply chain.”
Developers are in the hot seat, said Eckstein.
“The need for affordable housing is greater than ever, while the source of funding is being reduced,” he said.
One way to help offset the current challenges within the industry is for Congress to establish a floor for the 4% credit like they did in 2015 for the 9% tax credit, said Eckstein.
“If the tax credit rate is fixed at 4%, some estimates indicate we could see an additional 120,000 units of affordable rental housing built or preserved,” Eckstein added.
While there wasn’t a specific housing tax credit provision in the CARES Act of 2020, Congress is discussing specific legislation that could establish a floor for 4% tax credits, which has received significant bipartisan support thus far.
Another proposal would amend what is commonly referred to as “the 50% test,” the requirement that at least 50% of funds come from private activity bonds.
“If Congress reduced that requirement to 25%, developers would benefit from more readily available funds for affordable housing development and preservation,” said Eckstein.
He continued, “The potential impact of a fixed 4% rate is highlighted by this real-world example in our development pipeline. As proposed, it’s a 132-unit new construction affordable housing community in a large metro in the Southeast that currently has a $2.4 million funding gap. However, if Congress passed a fixed 4% rate, the funding gap would be eliminated as the amount of equity generated by the syndication of the housing credits would increase from approximately $8 million to more than $10 million. Closing the funding gap would ensure the financial feasibility of the project and the likelihood of this proposed urban infill affordable community becoming a reality.”
Why tax credits matter
The LIHTC program has a broad impact on the supply and availability of affordable housing in a wide range of housing markets, which in turn impacts renters and local communities.
“Building and preserving affordable housing communities supports a variety of jobs and industries and encourages investments within a community,” said Eckstein. “Not only do developers hire people to work directly on affordable housing, but local businesses benefit during construction and renovation and because of the additional jobs created and households established in the neighborhood when it’s complete.”
The tax credit program and public private partnerships for affordable housing are one of the few solutions available in the country with strong bipartisan support.
“Our country was already in an affordable housing crisis before COVID-19, and the impact of the virus has only exacerbated the problem,” said Eckstein. “Setting a floor for the 4% tax credit rate in an effort to support and encourage the development of affordable housing across the country is an easy unifying force in an otherwise divided world.”