(c) Housing Assistance Council, 1998

ISBN 1-58064-084-2

Permission is granted ONLY to nonprofit community-based organizations to reproduce and/or adapt this document, and only for their own use.

V. CREATIVE FINANCING SCHEMES: AZTECA ECONOMIC DEVELOPMENT AND PRESERVATION CORPORATION'S LOW INCOME HOUSING TAX CREDIT PROJECT

Introduction

Azteca Economic Development and Preservation Corporation (AED&PC) is a small nonprofit organized in 1982 to promote the revitalization of the Azteca neighborhood, one of the oldest residential neighborhoods in Laredo, Texas. AED&PC has been intensely involved in grassroots community organizing work along the border since 1986. In fact, Rafael Torres, the Executive Director, is Co-Chair of the Border Low Income Housing Coalition.²² While the city of Laredo had one of the highest growth rates of any city in the nation from 1990 to 1994, there has been a critical shortage of affordable housing for low-income residents. In addition, land is extremely expensive, making the production of affordable housing very difficult. For example, in Laredo, lot costs start between $10,000 and $20,000. One of the primary reasons that people choose to live in the colonias is this desperate lack of affordable housing within the cities.²³ Consequently, much of Laredo's low-income work force lives in colonias and commutes to the city for employment. AED&PC has put together a project in this climate, in order to create a supply of affordable housing within the city of Laredo. This project creates 50 units of housing within the city, with 100 percent Section 8 project-based assistance for 15 years. The El Azteca project is located in the historically important Azteca neighborhood, near the Rio Grande River. AED&PC expects this project to serve as a catalyst to encourage the private and public sectors to participate in the physical and economic revitalization of this neighborhood.

This project is an example of how a small local nonprofit can garner support from a range of public and private partners and creatively put together multiple layers of financing to create affordable housing options for colonia residents within the city. The El Azteca project has received support from the City of Laredo, the county, and the state. It has brought together several layers of financing including Low Income Housing Tax Credits, HUD HOME and CDBG funds, and project-based Section 8 subsidy, equity investment from the Texas Housing Finance Corporation and Fannie Mae, construction financing through Bank of America, and permanent mortgage financing through AFL-CIO pension funds. Additional partners in this venture include the National Rural Development and Finance Corporation (now known as the Rural Development and Finance Corporation) and Intrust, an investment banking firm, who have both provided pro bono consulting services to AED&PC in order to assist it in putting together this complex project.

Overview of Housing Needs in the Laredo Region

Laredo, located in Webb County, is separated from its Mexican counterpart, Nuevo Laredo, by the winding Rio Grande River, which is the main source of water for thousands of people living on both sides of it. Population growth on both sides of the border has put mounting pressure on this water supply. In fact, the World Environment Center reports that the population of Webb County has increased more than 30 percent since 1980.²⁴  The growth in population has meant that demand for housing and utilities has outpaced housing supply and the provision of utility services. A study by students and faculty at Colegio de la Frontera Norte of maquiladora workers in Nuevo Laredo found housing to be in extremely short supply with many homes occupied by two or more families.²⁵ Nearly 67 percent of the workers surveyed indicated the need and desire to buy housing of their own, while only 11 percent of these stated they had access to any sort of land within the city.

Across the river, conditions do not differ much in Laredo. High cost of land and housing has resulted in a critical shortage of affordable housing within the city. In Webb County, approximately 10,000 people live in dozens of colonias. All but six colonias lack water, and all but one lack sewer service. Of the six colonias with water, four have had problems complying with Texas Department of Health (TDH) standards. One colonia had such elevated levels of arsenic in the water that TDH ordered the residents to unhook from the private water system.

Also threatening the drinking water quality is the increasing contamination of the river by municipal and industrial sources. According to the World Environment Center, approximately 30 million gallons of raw municipal and industrial sewage pours into the Rio Grande each day from more than two dozen discharge points in Nuevo Laredo, some of them clandestine. Residents of the colonias without water service obtain water from spigots in Laredo and haul it home in barrels and jugs, some of which were previously used to store chemicals. Some residents even travel up to 30 miles to get water. This is illustrative of the relationship Laredo has to the residents of the surrounding colonias situated in Webb County. As indicated, the housing situation in Laredo is profoundly impacted by both development pressures in Nuevo Laredo and the conditions prevalent in the colonia communities of Webb County. This makes the creation of affordable housing within Laredo an even greater challenge.

The Idea

The Azteca Economic Development and Preservation Corporation had been working in the Azteca neighborhood since 1982, trying to revitalize this community of over 750 working class families. El Azteca, the oldest residential neighborhood in Laredo, was suffering from many of the same problems as any inner-city neighborhood in the country. Economic disinvestment, substandard housing and the prevalence of low-income residents dominated the neighborhood. In addition, with a rapid growth in the population, an increasing number of families were being forced to turn to the colonias in search of affordable housing.

AED&PC decided to tackle both these problems simultaneously. AED&PC was determined to create a modest supply of affordable housing for residents of the community, and provide them with an option other than moving to the colonias. At the same time, it would use this creation of affordable housing as a catalyst to spur revitalization of the aging neighborhood. Armed with not much more than grim determination, AED&PC acquired two city blocks of land on the banks of the Rio Grande River. One of the blocks would be developed into affordable housing units to serve a range of residents from the elderly, to single mothers with children, to the typically large families in the area. The other block would later be developed into commercial space to meet the day-to-day needs of the neighborhood. It would include a laundromat, day care facilities, a youth center and a restaurant. Once the land was purchased, the commitment was made. AED&PC set about weaving together a complex tapestry of public and private partners, and financing sources that would help make its dreams a reality.

The El Azteca project was one of three projects selected along the border for funding through a combined AFL-CIO/HUD Section 8 competition. AFL-CIO provided permanent financing, and encouraged its applicants to acquire tax credits. Several additional financial partners also participated in this venture by contributing construction and other funding.

The AFL-CIO Housing Investment Trust Fund has a long history of using workers. pension funds to invest in affordable housing development. Founded in 1965, the AFL-CIO Housing Investment Program is the first labor-sponsored vehicle for pension fund investment in real estate. The AFL-CIO Investment Trusts (Housing and Building) hold pension fund assets valued at over $1.5 billion according to staff interviewed.²⁶ This program has provided retirement security for union members through the prudent investment of union pension funds in housing and commercial real estate. In an effort to expand this mission, the AFL-CIO Housing Investment Trust began to search for new partners to join it in creating affordable housing along the border. In 1993, the Trust created a new initiative called the National Partnership for Community Investment. Through this National Partnership for Community Investment, the Housing Investment Trust worked in conjunction with HUD, Fannie Mae, Freddie Mac, and numerous local and state governments and organizations to facilitate the creation of affordable housing. One of the regions targeted was the Texas-Mexico border area.

Simultaneously, the U.S. Department of Housing and Urban Development (HUD) was searching for new ways to leverage public dollars with private investments to create affordable housing in America's distressed areas. Secretary Cisneros committed $100 million in project-based Section 8 subsidies to this effort, inviting private partners to join HUD in spurring the development of affordable housing by utilizing Low Income Housing Tax Credits. Subsequently, $50 million of the subsidy was awarded to projects supported by the AFL-CIO Housing Investment Trust, while the rest was divided among other private lenders that expressed an interest in partnering in this venture with HUD. The AFL-CIO Housing Trust Fund was given the authority to allocate the Section 8 subsidies as needed to the different projects they were funding.

Equipped with the Section 8 budget authority, AFL-CIO organized a competition in 1994, inviting proposals for developing affordable housing from local nonprofit groups throughout the country. Of all the responses received, three were for projects along the Texas-Mexico border. AFL-CIO determined that it would fund all three. The El Azteca project in Laredo was one of the projects selected. The AFL-CIO Trust also encouraged each of these applicants to acquire tax credits. The Section 8 subsidy it could provide would help make the tax credit project feasible. (The Laredo project was initially slated to receive a 50 percent allocation of Section 8 subsidies. It soon became apparent that the Laredo population earned extremely low incomes, and could not afford to rent units in the new development. The El Azteca project would need a 100 percent Section 8 subsidy in order to serve the housing needs of the city. s low-income population.)

Independently of these activities, a group of corporate investors came together to pool their resources and create a mechanism for developing affordable housing along the Texas-Mexico border. Intrust USA, Ltd., an investment banking firm headquartered in Delaware, set up a nonprofit called the Texas Housing Finance Corporation. It then raised the capital to create a fund called the Texas Housing Opportunity Fund II (THOF II).²⁷  The five corporate investors in THOF II are Bank of America FSB, Banc One Community Development Corporation, Freddie Mac, Fannie Mae, and Comerica Community Development Corporation. The pooled investments of these corporate investors total $10,250,000. These funds could now be used as an integral link in financing the development of affordable housing projects located in the various regions of Texas.

The nonprofit Texas Housing Finance Corporation manages the THOF II fund and serves as the fund's general partner, while the corporate investors constitute limited partners. One of Intrust's subsidiaries, Intrust of Texas, Inc., serves as a special limited partner. In this capacity, Intrust reviews all due diligence work with respect to properties considered for funding, and oversees the asset management and acquisition process. These activities are supported by a team of housing professionals and consultants.²⁸ This structure enables the fund, THOF II, to invest as a limited partner in multifamily rental housing projects that qualify for Low Income Housing Tax Credits. Participation in this fund enables corporate investors to earn a competitive rate of return while providing needed capital for the development of affordable housing.

The investment partnership structure offers investors the advantages associated with pooling their capital while dividing their risks. In return for their investment, the limited partners are provided Low Income Housing Tax Credits that they may use to offset their federal income tax liability. In addition, the general partner allocates any losses to qualifying business partners to offset business income, and preserves and protects the partnership's investment for 15 years. The investor limited partners in the THOF II partnership are projected to achieve an after-tax internal rate of return of 17 percent, with a minimum expected return of 15 percent.²⁹  The partnership clearly demonstrates how investing in affordable housing can be a profitable business venture for corporate investors.

Spurred by the success of its initial tax credit equity fund, the Texas Housing Finance Corporation made a seed loan to AED&PC to assist it with preliminary design activities, and putting together its tax credit application and other loan applications. In addition, Intrust, USA, offered to provide pro bono investment banking services and technical assistance to AED&PC, to help the group negotiate the complex requirements of putting together a tax credit project.

As mentioned earlier, AED&PC has a history of commitment to the revitalization of the El Azteca neighborhood in Laredo. It is also a qualified Community Housing Development Organization (CHDO) and has prior experience in rehabilitating primarily single-family rental housing. It has no prior experience with multifamily housing development or tax credits. Supported by seed money from the Texas Housing Finance Corporation, AED&PC moved to simultaneously secure permanent mortgage, tax credit equity, and local grant sources in order to develop the El Azteca multifamily housing project.

AED&PC was one of the first groups to secure HUD Section 8 support via competition in the AFL-CIO Housing Trust Fund Program. This initial success was the result of the combined efforts of a number of concerned parties. AED&PC was assisted in putting together this application by the Rural Development and Finance Corporation (RDFC) at no charge. Rafael Torres, Executive Director of AED&PC, asserts that this assistance proved extremely valuable in meeting all the requirements set forth by AFL-CIO. With critical support from NRDFC, the El Azteca project was eventually awarded 100 percent Section 8 subsidy.

Another prerequisite for participating in the AFL-CIO program was that the developer had to use unionized labor for construction of the project. This posed a major obstacle, since there were no union contractors available in the area. AED&PC negotiated a special arrangement with AFL-CIO to meet this requirement. Together they selected a local contractor that would be willing to work on the project under stipulated terms and conditions for labor. AED&PC helped negotiate a relationship between the local contractor and the San Antonio Building Trades Union in order to meet AFL-CIO requirements. The local contractor agreed to provide salaries and benefits commensurate with standard union practice. This was the first time that this contractor would provide fringe benefits to the employees, perhaps setting a precedent for the future.

With the HUD Section 8 award in hand, AED&PC was able to secure a $1,110,000 first mortgage at a favorable rate through the Fannie Mae Mortgage Backed Securities (MBS) program. PW Funding Inc.(PWF), a full service mortgage firm specializing in originating, funding and servicing mortgage loans for multifamily housing properties, also participated in this venture. PWF is one of the nation's largest mortgage bankers in the Delegated Underwriting and Servicing Program (DUS) sponsored by Fannie Mae.³⁰  PWF made a forward commitment to provide the permanent financing on the El Azteca housing development project. When funded, the loan will be sold to Fannie Mae under the DUS program. Fannie Mae will, in turn, issue a Mortgage Backed Security. Fannie Mae's loan is a $1,078,000, 9.1 percent interest, fifteen year fully amortizing loan. The Fannie Mae MBS will then be purchased by the AFL-CIO Housing Investment Trust. This transaction brings down the interest rate for AED&PC. The nonprofit developer has this permanent financing at an interest rate of approximately 8.75 percent.

In addition to securing permanent financing, the nonprofit developer, AED&PC, needed to raise equity for the project. AED&PC decided to compete for tax credits, as recommended by the AFL-CIO Housing Investment Trust program stipulations. AED&PC received the highest score in Texas in the 1994 tax credit application, and was approved by the Texas Department of Housing and Community Affairs for $2,710,000 million (9 percent) tax credits in the 1994 state competition. These tax credits were sold to the Texas Housing Opportunity Fund II (THOF II) for $1,640,000. In other words, each tax credit dollar was purchased for about 60 cents.

AED&PC was assisted by Intrust in its efforts at preparing a successful tax credit application. In fact, Intrust's involvement in the Azteca project began at the conceptual stage and at the time of this research was expected to span the entire development process, according to both Rafael Torres and Jim Mingey. In addition to providing critical support in preparing what proved to be the highest ranking tax credit application of the cycle, Intrust has provided ongoing financial advice and development consulting to AED&PC. The major obstacle Intrust faces is the inordinate amount of attention to detail that this business requires, combined with the geographic distance between Intrust and the nonprofit client. Putting together a tax credit deal requires timely advice and daily consultation. Intrust and AED&PC overcame this hurdle through the use of leading edge communication technology. For instance, they installed video conferencing capabilities at AED&PC to facilitate Intrust's development consultant role in the El Azteca project. This enabled AED&PC and Intrust to work on and simultaneously view the same financial spreadsheets.

In order to meet tax credit application requirements, AED&PC created a limited partnership called the Riverfront Housing Limited Partnership and sold the land for the El Azteca project to this partnership. This Partnership will be the ownership entity of the El Azteca project. In addition, the El Azteca project is governed by a two-tiered limited partnership. The Riverfront Housing Limited Partnership forms the lower tier of this partnership. The upper tier partnership involves the Texas Housing Finance Corporation as the general partner and the five corporate investors in THOF II as the limited partners, with Intrust as a special limited partner, as described earlier. The lower tier partnership involves AED&PC as the general partner and THOF II as the limited partner. The limited partner, THOF II, contributes equity to the project by purchasing the $2.7 million tax credits for $1.6 million. In return, it obtains 99 percent of the ownership in the project in addition to the benefits obtained through the tax credits. The general partner, AED&PC, applies for tax credits and is awarded credits based on the estimated construction cost of the project. It is then responsible for the actual development of the project from construction to lease-up, and for ensuring compliance with IRS requirements for tax credit projects. In return, the general partner gets a developer's fee and retains a mere 1 percent ownership in the project. In this instance, AED&PC has also contributed $171,050 of equity in the project. The developer's fee has been calculated at $175,000, which is approximately 5 percent of the total cost. This would have served to pay back the equity invested in the project by AED&PC. However, this fee is already obligated to be put back in the project. In addition, the cash flow from operating the multifamily rental property is expected to be utilized towards the mortgage from AFL-CIO and the State of Texas.

Through Intrust's assistance, AED&PC was able to keep syndication costs down to $15,000. This low syndication cost was achieved through careful negotiation, driven by the fact that the nonprofit did not have open-ended funding available for this purpose. AED&PC stresses the importance of having competent technical counsel at this juncture. There are additional expenses involved in putting together this deal. For instance, some money has to be put aside to account for contingencies. In this instance, AED&PC has set aside approximately 3.2 percent of total costs as reserves. In addition, the developer has to pay lawyer's fees. In this instance, THOF II required a tax opinion prior to investing in the El Azteca project. The law firm of Peabody and Brown provided this opinion at a cost of approximately $16,000. AED&PC had to cover this cost, though it will be reimbursed to the group at closing through the construction budget. The tax credit application itself requires that the nonprofit show site control for the proposed project. It also requires that the nonprofit prepare a development plan supplemented by an architectural study, a market study and an environmental audit. AED&PC was able to meet this requirement with the assistance of the seed money loan from the Texas Housing Finance Corporation.

In addition to setting up a partnership in order to implement the tax credit project, AED&PC had to seek and obtain other pieces of financing and support as well. Finding construction financing for the project was one of the most crucial elements of this deal. AED&PC secured two loans from the City of Laredo for $367,750 (1992 HOME loan and 1994 HOME loan) to support construction costs. These loans will bear an interest rate of 10 percent and will be repaid utilizing 50 percent of the cash flow from the property. Bank of America, FSB agreed to provide interim financing in the amount of $2,120,000 during the construction period. This loan is provided at an interest rate of one point above prime, which is between 8 and 9 percent. AED&PC is also approved to receive a $225,000 loan from the State of Texas through their Border Housing Initiative Program. This loan has a 15-year term, is fully amortizing and bears an interest rate of 3 percent. Finally, the County of Webb agreed to provide a 20-year tax abatement to the multifamily property and improvements upon completion of construction. This means the property is fully protected from taxes for the time period of tax credit compliance.

Putting the finances together for the El Azteca project required careful negotiation and organization. However, more pieces needed to be in place to complete the puzzle. Since AED&PC was awarded 1994 tax credits, it needed to expend approximately 10 percent of the dollars by the end of the first year in order to maintain compliance with tax credit regulations. The nonprofit was able to make this carry over.

Finally, at the time of this research the project was required to be completed by the end of 1996 in order to remain eligible for 1994 tax credits. AED&PC was working hard to meet this deadline.

According to conversations with Rafael Torres while conducting this study, meeting the construction deadline was not the last hurdle AED&PC had to jump. The project has to remain in compliance for a period of 15 years in order to continue receiving tax credits. The credits themselves are paid out over this time period in four installments, with $656,000 being paid out at closing. Maintaining compliance over 15 years requires the careful management of the multifamily project by an experienced property manager, who is able to meet all of the IRS's reporting requirements to their satisfaction. For instance, the IRS sets requirements for determining income levels of residents that are eligible to rent units in the tax credit multifamily property. The property manager has to maintain tax forms that certify that all renters are income-eligible, as well as backup documentation for each unit throughout the compliance period. AED&PC has retained ADV Housing Management Services Corporation as the property manager for the El Azteca project. This company is a for-profit subsidiary of Amigos Del Valle (ADV), a nonprofit with many years of experience working in the colonias, in particular with housing for seniors. ADV currently manages about 519 affordable housing units in 10 different projects throughout the Rio Grande Valley including Harlingen, Brownsville and McAllen. However, this is the first tax credit project ADV will manage. Once again, Intrusts involvement with the project will prove valuable. It will provide training and consulting support to the property manager, and help the manager meet IRS reporting and compliance requirements.

At the time of this study, AED&PC was working with Andrew Perez-Frank Associates as the architect responsible for designing the development. The development was to be constructed by Modern Construction of Laredo. Modern did not have the capacity to bond its construction. However, Modern was able to overcome this obstacle by putting up a letter of credit to guarantee a portion of its work. The other obstacle faced with respect to the contractor was the lack of unionized labor. The resolution of this has already been discussed.

The development site is located in the south-central sector of the city, where the Rio Grande River/Mexican border serves as the neighborhood's southern boundary, within easy walking distance of the downtown area. At the time of this study, most of the apartments were to be two-story, town home style units with the exception of a few one-bedroom units and five accessible units. These unit types would range in size from 518 square feet to 1,202 square feet. The development would consist of four separate apartment buildings, a large courtyard/playground area, and concrete and asphalt paved parking spaces. Also included in the development is an office space/laundry facility. The development's gross building area is approximately 50,150 square feet, with 41,264 square feet of rentable area. The actual construction would feature concrete slab foundations, wood frame wall construction with stucco on the exterior walls, and standing seam roof panels. Entries at the second and third floor areas would have balconies with metal balcony railings. All the units would have wall to wall carpeting, with vinyl floor coverings in the kitchen and bath areas. The development was designed with consideration to its location in the historic neighborhood. In summary, the El Azteca development can be characterized as good quality subsidized multifamily housing development. [Refer to Figure 3 below for elevations of El Azteca.]

Lessons Learned and Replicability

This project has a number of lessons to offer other groups interested in putting together similar housing deals. Each of the players involved in this project has its own perspective to offer on the key ingredients responsible for its success.

According to Jim Mingey, President of Intrust, the strength of the nonprofit developer is its integrity, commitment to the cause and the support it has in its community. Without this commitment, the El Azteca project would have not been a success. The reputation of the nonprofit developer within the community facilitated the project obtaining critical financial support at the state and local level. For instance, the project was able to obtain a 20-year tax abatement from the county. This will help the project maintain tax credit compliance over the required 15-year period. In addition, Eric Price, AFL-CIO, and the other members involved in this project, all concur that Rafael Torres. personal history of community organizing work along the border and grassroots support he commands contributed to the investors. level of confidence in the feasibility of this project. Other groups interested in pursuing tax credit projects should bear in mind that they bring this valuable benefit to the table. The relationships they develop with local government through ongoing community development activities can facilitate the receipt of critically needed support. In addition, community support for the nonprofit's affordable housing project circumvents problems that may arise as a result of the NIMBY (Not In My Backyard) syndrome. Corporate investors cannot succeed without the nonprofit's assistance in this regard.

The benefits of putting together a successful tax credit project accrue in varying proportions to the different players involved. In this instance, the project description enumerates the benefits to the corporate investors. For example, by providing pro bono consulting support to the nonprofit, and compromising on the extent of profit collected, the equity fund is building a base for future deals.³¹  In some ways, this is an investment in the future for the fund. It builds credibility and creates the potential for other successful investments. It also generates more business. For instance, Fannie Mae has already committed $10 million to creating a Border Housing Opportunity Fund, which will be managed by the Texas Housing Finance Corporation.

The various government sources also benefit from partnering in this project. They are able to leverage private dollars to add to the effectiveness of their program funds.

Unfortunately, in this instance, the nonprofit developer does not benefit monetarily by obtaining the appropriate developer's fee. The nonprofit does, however, benefit by developing the capacity and skills necessary to pursue future projects. It also benefits from the relationship developed with the various corporate investors, who have all expressed an interest in partnering with AED&PC on future projects.

Rafael Torres argues that the ultimate, and most important, beneficiary of this complex deal-making and financial circus is the community. The community gets the affordable housing and, if AED&PC proceeds equally successfully with the rest of its plans, the community will finally begin to reap the benefits of overall revitalization.

Figure 3: Elevations of the El Azteca Multifamily Housing Development

It is extremely difficult to assess the replicability of this project. El Azteca has many unique advantages that contribute to its success. The 100 percent project-based Section 8 subsidy, HOME and CDBG dollars, and a 20-year tax abatement head this list of distinctive ingredients. Most developers of affordable housing stress the need for governmental subsidies to buy down the cost of a project, especially in expensive housing markets. Soft money is crucial for actually making the housing affordable to low-income renters, owing to the mismatch between construction costs and what the renters can pay. However, the lesson here for other groups is to recognize the opportunities offered by a lot of parties staking their reputations on being able to do something positive along the U.S.-Mexico border. The players involved in the El Azteca project urge local groups to take the plunge, and capitalize on this environment.

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