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FEDERAL PROJECT-BASED and DEVELOPMENT FINANCE PROGRAMS "Section 8 can’t help if there’s no housing." Roundtable participants discussed the many challenges to developing affordable rental housing in rural areas. Remote locations and dispersed populations make it much more difficult to develop affordable rental housing for low-income households. It is also often difficult to find bankers who are willing to meet with developers in remote locations. When and if financing can be obtained, smaller projects often cannot benefit from economies of scale, and therefore have higher costs per unit. Roundtable participants also agreed that Not-In-My-Back-Yard (NIMBY) sentiments hinder development of affordable rental housing in many rural towns. Project proposals for groups with special housing needs, especially migrant and seasonal farmworkers and people experiencing homelessness, regularly encounter strong opposition from local residents. Battling local fears and prejudice, it was noted, adds substantially to the cost of developing affordable rental housing, and in many cases derails very good projects that would have filled an important housing gap. Federal programs have been used to provide incentives for developers to overcome some of the difficulties associated with rental housing development in rural areas. Section 515, Section 538, and Low Income Housing Tax Credits (LIHTC) are programs that have been used by affordable housing developers to increase the stock of affordable rural rental housing units. 26 Utilizing these resources has become more difficult, however, given recent budget cuts and the increased complexity of administering these programs. Section 515 Program Description The Section 515 Rural Rental Housing program of the Rural Housing Service (RHS) is a direct mortgage loan program that provides capital financing to develop rental housing for very low-, low-, and moderate-income tenants. Under this program, RHS makes loans to nonprofit (for 100 percent of the total costs) and for-profit (for up to 95 percent of costs) developers to build rural rental housing. Section 515 financed housing is affordable to the lowest income households because these loans are for long terms (30 years, amortized for 50 years), carry a basic interest rate of only 1 percent, and can be combined with deep subsidy rental assistance. The 1 percent loan enables the debt service on the property to be sufficiently low to support below-market rents affordable to low-income tenants. Section 515 funds are allocated to each state using a formula to determine need. RHS publishes a Notice of Fund Availability (NOFA) in the Federal Register and individual loan requests are ranked competitively. Section 515 can be used to finance several different types of housing, including:
The Section 515 program, when combined with Rental Assistance, is structured to serve the lowest income rural households with RA. Over 87 percent of those living in Section 515 housing have very low incomes, 10 percent are low-income, and less than 1 percent have moderate incomes. The average Section 515 tenant has an adjusted income of less than $7,300. 27 In its 30-year history, Section 515 has produced over 514,000 housing units. There is still, however, a tremendous unmet need for Section 515 program funds. According to National Rural Housing Foundation assessments, there had been a backlog of more than $1 billion in loan requests that were determined to be both eligible and feasible. Also, over 200,000 families were on the waiting lists for the 20,000 units that will become available through tenant turnover in existing Section 515 complexes. 28 Issues and Concerns The most troubling concern for affordable housing providers and developers has been the unabated cut in funding to the Section 515 program. In its effort to balance the federal budget, Congress began cutting the RHS budget in 1993. The federal allocation to Section 515 was dramatically slashed in the following years: from $540 million in FY 94 to $220 million in FY 95, a 60 percent cut. In FY 98, the program was appropriated $125 million (one-ninth of the amount it received in 1983 when the budget was $950 million). These reductions obviously result in fewer units produced, and consequently a greater number of rural people without access to decent, affordable rental housing (Figures 10 and 11).
Section 515 funding cuts have been felt by rural affordable housing providers in many ways. Housing developers participating in the roundtables recalled a time when the subsidized loans and rental assistance would allow them to build rental projects affordable for people with extremely and very low incomes without having to seek other subsidy sources. As the program budget has shrunk, RHS has encouraged applicants to leverage additional sources of financing in order to stretch program dollars further. This has added to the cost of putting financing packages together, especially for nonprofit organizations already challenged to find operating funds (see Leveraging section below). One San Francisco participant felt that the limited funding available for new Section 515 construction discourages applicants from seeking program funds. In California, only three or four new construction project applications were submitted for 1999. Other San Francisco panelists agreed that many developers, particularly nonprofit housing sponsors, will not commit the substantial time and resources necessary to produce a good application for funding that is just not there. A lack of applications from a specific state, participants agreed, is not a reflection of a lack of program demand. Rural Development staff at each of the roundtable sessions expressed their concern that the agency is not able to fund all of the worthy project proposals submitted each year. A few years ago, Section 515 was an $800 million program, whereas in FY 99 it had $120 million. Agency staff observed that it is not likely that demand for affordable rental units dropped off that quickly. At least one person at each roundtable observed the Section 515 program’s shift away from new construction to portfolio maintenance needs. Each panel agreed that there is not enough funding to meet all the needs for upgrade and rehabilitation of older properties. The Section 515 portfolio is aging and as a result, rehabilitation and servicing problems are increasing. One Kansas City participant observed that demand for rehabilitation assistance in some Midwestern states has exceeded RHS’s ability to fund more than a few applications for any given state. In Missouri, only three out of eight rehabilitation applications were funded in FY 99, according to a roundtable participant. Other panelists also observed that program funds not only pay for the new rental housing construction in rural communities, they are also used to maintain and repair older projects and provide incentives to keep private Section 515 owners participating in the program (see Prepayment and Preservation section below). Lower funding levels are just not able to adequately meet any one of these needs, let alone all of them. Section 538 Program Description The Multifamily Rural Rental Guarantee Loan program, Section 538, was designed to meet the needs of low- and moderate-income rural residents not being served by the Section 515 program. Section 538 guarantees loans made by certified private lenders for affordable multifamily rental housing. RHS guarantees the lender’s loan up to 90 percent of the total development cost and commits to pay up to 90 percent of the outstanding principal and interest in the event of a default on the loan. Demand for Section 538 financing has been strong in the program’s three-year history. Since the program’s inception, $148 million in loans have been guaranteed to develop new rental housing. In 1997, Section 538 guaranteed $28.1 million for 16 loans in 12 states to build a total of 813 new affordable rental units. 29 An additional $51.8 million in outside funds has been leveraged by these RHS loans. Rents for Section 538 units range from $347 to $660, with $447 as the average. 30 Section 521 Rental Assistance is not used in conjunction with the Section 538 program. Issues and Concerns All three roundtable panels noted the growing federal emphasis on guaranteed loans in lieu of more funding for the direct loan programs. As Table 6 shows, the Section 515 program was cut by 24 percent from FY 98 to FY 99. At the same time, the Section 538 allocation is five times higher in FY 99 than the FY 98 allocation. This emphasis on Section 538 is significant as this program is not structured to serve households with the lowest incomes. Given the rental costs of Section 538 units and the lack of rental assistance, it is evident that Section 538 rental units will not be affordable for extremely low- and very low-income households. Each panel agreed that guaranteed loan programs are attractive from a budgeting standpoint, but that without some additional form of deep subsidy, such as rental assistance, these programs do not have the financing mechanisms that allow rental housing development affordable to rural households with extremely low and very low incomes. Section 515 and Section 538 Federal Allocation (in millions) FY 98-99
Source: RHS Data
Low Income Housing Tax Credit Program Description The Low Income Housing Tax Credit (LIHTC) program was established by the 1986 Tax Reform Act to encourage private investment in the development of affordable rental housing. Under this program, each state is currently allocated a tax credit of $1.25 per state resident by the Internal Revenue Service (IRS). The state Housing Finance Agencies (HFAs) and the IRS jointly administer the credits, which are awarded to developers of affordable housing projects who in turn offer these credits to investors. The owners of the credits obtain a dollar for dollar reduction in their federal tax liability in exchange for their investment in affordable housing projects. The tax credits are written off in equal installments over a 10-year period. In order to receive tax credits, a development must adhere to the following minimum requirements:
Between 1986 and 1996, approximately 600,000 rental units for low-income households were produced using LIHTC-backed dollars. 32 As of 1996, a total of 827,000 affordable rental units had been developed and over $12 billion in private investments had been made as a result of the tax credit program. LIHTC can be used to fund new construction, rehabilitation, or acquisition projects. The majority of projects developed with LIHTC-backed dollars have been new construction, multifamily developments. A recent Government Accounting Office (GAO) report found that the average LIHTC project developed between 1992 and 1994 had 43 units, and 73 percent were new construction. 33 LIHTC has been an extremely popular program and demand for the limited credits available has been overwhelming. The total amount of available tax credits has risen each year since the program’s inception. In each of the last four years, 95 percent or more of the total credits allocated have been used. For example, in 1997, of the $387.3 million available in credit, $382.9 million, approximately 99 percent of the allocated credits, were used to finance the development of affordable rental housing. In this same year, total demand for LIHTC far exceeded the available supply. Requests for LIHTC totaled $1.09 billion, almost three times the $387 million in credit that was available. 34 Although most LIHTC projects are developed in central cities, rural areas have been able to access this resource. From 1992 to 1994, almost 30 percent of all LIHTC projects and 20 percent of all affordable units developed using the credits were in nonmetro areas. In 1996, approximately 24 percent of all LIHTCs went to nonmetro areas. 35 Issues and Concerns LIHTC is a popular and successful program by most accounts. However, the value of the credit has not been adjusted since the program’s inception to match the rate of inflation. While the credit cap has remained fixed since 1986, the cost of developing affordable rental housing has increased enormously. Thus, the purchasing power of $1.25 credit per person simply does not go as far in 1999 as it did in 1986. There are proposals in Congress to increase the credit cap to $1.75 per state resident in order to restore the value of the tax credit. Panelists in each of the roundtables mentioned LIHTC as the most substantial source of affordable housing development funds. Each group also agreed that without additional subsidy from such sources as rental assistance, tax credits cannot produce units with rents low enough to be affordable to extremely low-income households. A 1997 GAO report estimates that almost two-fifths of LIHTC households receive some form of additional rental assistance that allows them to afford their units. The average income of these households is 25 percent of the area median, compared with 45 percent of the median for renters of tax credit units that do not also receive a rental subsidy. 36 Panelists also noted that in order to be successful, LIHTC projects require deep subsidies from other development sources. According to one roundtable panelist, “Because rural areas have lower median incomes, the Housing Finance Agency has to provide [a] larger deferred loan to make tax credits work there. [They] have to provide special incentives to make [the credits] work in rural areas.” This need to offer incentives to leverage additional resources to build affordable rental housing is a defining component of the rural development process. Leveraging As development projects have become increasingly expensive, the need to leverage additional dollars to build affordable housing projects is vital. It was noted by panelists that in 1998, 73 cents was leveraged for every Section 515 dollar committed to projects. For example, every Section 515 dollar in Iowa projects leveraged eight dollars from other funding sources. Potential funders view Section 515 financing as an important investment in low-income housing, and therefore are more comfortable making investments themselves. The benefits of leveraging were discussed during the roundtables. A number of panelists observed that leveraging allows federal programs with deep subsidy, like Section 515, to support more projects. Rural Development staff added that leveraging facilitated the development of 1,300 more units than would have been possible using Section 515 alone. If local lenders are involved in project financing, it also increases the community’s “investment” in a project, potentially reducing NIMBY sentiments that often mar the development process. Additional funders also help to spread the risk in cases where projects cannot be completed or if a project sponsor has mortgage difficulties. While it is a necessary function, leveraging also makes the development process more complex for rural developers. Each group reached consensus that every layer of financing adds different requirements and monitoring criteria. Each layer of financing also increases development and operating costs. Panelists of all three groups also agreed that many rural nonprofit housing organizations need to increase their development capacity in order to effectively leverage funds. The groups agreed that the need for leveraging is forcing less sophisticated developers to use some of the most sophisticated financing mechanisms. This was particularly noted in regard to using LIHTC or state tax credit programs. Tax credits require more use of consultants and attorneys, and nonprofit inexperience using tax credits can mean that the project sponsors are not able to evaluate the soundness of consultant recommendations. It was also generally agreed that one of leveraging’s complications is having to work with different program funding cycles. Since every funder wants to see other sources already committed to a project, sponsors often have difficulty obtaining early funding commitments. As one panelist remarked, “No one wants to be the first in on a deal.” Preservation and Prepayment “[The] easy part is building. [The] hard part is once it’s built making sure it lives for the long haul.” Affordable units that have been developed using Section 515 funds are being lost at an alarming rate. Section 515 project owners are taking advantage of their ability to prepay their Section 515 loans and free the subsidized projects from the rent restrictions imposed by the program. Once an owner prepays the subsidized mortgage the rents can be raised. According to RHS data, the agency had received 1,274 prepayment applications by November 1998; 631 projects were eventually prepaid and 5,694 affordable housing units were lost. 32 RHS staff and housing providers are working to develop strategies to preserve these affordable housing units. Panelists discussed the reasons that project owners have given for trying to opt out of Section 515 and other subsidized rental programs. Many of the prepayment requests are coming from aging owners of smaller Section 515 projects. These “mom and pop” owners are looking towards retirement, and many are tired of managing their Section 515 projects. Other reasons for prepayment requests include favorable interest rates and “hot” real estate markets, making it possible to get a good return on the properties. Some owners have cited frustration in dealing with government agencies as a reason for removing their units from the affordable housing stock. A few panelists felt that subsidized rental projects in active real estate markets were at a high risk of prepayment, since owners would be able to get a higher rent for the property, if the subsidized loan is prepaid. These kinds of markets are characteristic of rural tourist destinations like ski areas or coastal towns, or retirement communities that attract more affluent retirees, or “snow birds.” Several roundtable participants said they had noticed that when prepayment programs were announced in particular states, there often followed a wave of requests to opt out of the program. Panelists from the San Francisco roundtable reported that Colorado and Washington were two states noted for a great deal of prepayment activity, with 3,000 prepayment requests per month in Colorado alone in 1998. The year before, there were only about 1,000 requests per month in Colorado. 32 In California, state agencies have identified over 7,000 affordable housing units at risk of prepayment. Other states, like Missouri, have experienced only a few requests to prepay HUD Section 8 new construction projects, and even fewer Section 515 prepayment requests. Panelists at each of the roundtables told stories about tenants reacting poorly to notices of an owner’s intent to prepay a project. In each panel, it was agreed that elderly tenants are most vulnerable to prepayment, and tend to react the most strongly to notices sent by owners. Although stories were shared about owners who made special efforts to inform their tenants through meetings and question and answer sessions, many other panelists shared stories of elderly residents reacting in panic to legal notices they did not understand.
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