Building Blocks

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It’s everybody’s favorite housing subsidy–in part, because it’s just about the only one left. If you want to build cheap housing these days, you build tax credit housing. If you want to rehab buildings, you do it with the help of tax credits. Supportive housing, homes for the homeless, and nearly all the rehab done on city-owned buildings: all of it is driven by the market forces of tax credit financing.

Invisibly, tax credits have backed almost every affordable housing development project in the last decade. The city’s two huge new single-room occupancy residences, the Times Square and the Prince George, were built with tax credits. All the tens of thousands of apartments renovated under the city’s two major rehab programs, the Neighborhood Entrepreneurs Program and the Neighborhood Redevelopment Program, are supported by tax credit money. Even redevelopment in Union Square is being underwritten this way. All in all, tax credits in New York City add up to more than $100 million in investments each year–a substantial amount of money, considering that the city’s entire housing development budget is $219 million.

The program, created by the 1986 federal tax reforms, has built between 750,000 and a million cheap apartments and houses nationwide, and adds about 62,500 more units annually. Investors who were initially reluctant to put their money into housing for the poor are now fighting over the chance to invest in these projects, and competition means that more money goes into housing and less into investors’ pockets. A decade ago, real estate investors would expect profits between 20 and 40 percent; now, returns sometimes slip into the single digits. In an era when housing subsidies have been political deadweight, this thriving program proves that private money can work for the public good.

But in the opinion of some of the city’s nonprofit housing developers, it’s just not capitalist enough.

About five years ago, New York City’s housing agency decided that it would deal almost exclusively with the New York Equity Fund, a tax credit syndicator founded by the nation’s two big nonprofit housing intermediaries, the Enterprise Foundation and the Local Initiatives Support Corporation (LISC). Since then, if your nonprofit housing development group wants to rehab city buildings, you must work with the New York Equity Fund, and you must accept their terms.

In effect, it’s a monopoly, and it offers one-size-fits-all monopoly pricing. Even though a big nonprofit with a precious piece of Lower East Side real estate could get much more money for its tax credits on the open market, the New York Equity Fund will offer it the same kind of deal as an unsophisticated new community group trying to develop part of East New York. Since that rate can be as much as 10 points below what the market might offer, the developer obliged to work with the Equity Fund rather than play the market might be missing out on between $30,000 and $50,000 for each project, money that could be plowed back into the development or reallocated to another one. It adds up: with tax credits accounting for about $600 million in city-controlled development during the last decade, the missed opportunity is in the millions.

“It’s a huge amount of money, and it’s either going into their pockets or into their investors’ pockets,” says one developer who asked not to be named, for fear of jeopardizing his projects. “The reason they can do it is because [the city housing agency] gives them a monopoly, and they don’t have to compete with anybody. The Equity Fund simply has not adapted to the market.”

LISC and Enterprise were instrumental in making tax credit investments legitimate, in convincing investors to pony up money for these projects, and in coaching nonprofits on how to handle baffling tax and real estate paperwork. But a handful of New York City community developers now want to leave them behind. They want to dive into the sizzling private tax credit market, with its promises of more money, faster development, and chummier relationships with big banks. They want to take off the training wheels, but the city’s Department of Housing Preservation and Development won’t let them.

That’s because the New York Equity Fund helps HPD as much as it helps community groups. The fund has a perfect track record–never has one of its projects failed. It is highly reputable, offering instant credibility with investors, technical expertise, and a deep commitment to affordable housing. The one thing it doesn’t provide is access to the big bucks in today’s hot tax credit market.


In the early days, investors were terrified of low-income housing tax credits. “You’d tell investors: we’re working on homeless housing in the South Bronx with HIV-positive residents, and you’ll need to commit to 15 years investment,” laughs William Frey, Senior Vice President of the Enterprise Foundation. “The reaction was, ‘Give me a break.'” Nonprofit developers agree that the reputation and technical skill of the intermediaries were instrumental in getting the programs running in New York State, which was an early leader in tax credit development.

And these projects needed lots of help in the beginning. Arranging tax credit deals is an arcane process that can scare off sensible investors and bewilder even sophisticated developers. The arrangements include strict compliance paperwork and menacing clauses, like provisions that hold nonprofits fully liable if projects fail.

This powerful subisdy is driven by the fact that corporations want to find a way to escape the 35 percent federal tax rate. Investing in these low-income housing projects allows them to reduce their tax liability: for each credit that it buys for 50 to 80 cents, a corporation can take a full dollar off its federal tax bill. Loosely speaking, that means that when a company invests $500,000 into a development project, it can take $625,000 to $1 million off its taxes. For banks, it’s an even better deal–because they are putting money into housing for poor people, they also get brownie points from regulators under the Community Reinvestment Act.

In the open market, a developer interested in doing a major rehab project begins by applying to the state for tax credits. For example, a builder planning a project budgeted at about $2 million would apply for $2 million worth of tax credits from the state. There are complex formulas that govern which projects can get the credits, but in general, 20 to 50 percent of a development’s future tenants will have to make roughly half of their area’s median income.

Then the developer shops these credits around trying to get the best possible deal, either directly from corporations and investors or through a syndicator that specializes in brokering these deals. The New York Equity Fund is one of these syndicators; others include nonprofits like the Enterprise Social Investment Corporation and LISC’s National Equity Fund, and for-profits like Related Capital. These days, a developer could get around $1.5 million in exchange for that $2 million in tax credits. The investor then would be able to take about $300,000 off his or her IRS bill in tax credits and depreciation for each of the next 15 years, for a total tax benefit of around $3.5 million. In exchange, the developer gets regular infusions of cash.

When the program was new, wary investors wouldn’t pay much more than 40 cents for each dollar in tax credits, and as buildings aged they could take depreciation losses each year. Together, those two tax breaks added up to a sweet deal. But from a policy standpoint, it was inefficient in those early years, costing the U.S. government $6 billion in foregone tax revenue for the approximately $3 billion it put into housing development between 1992 and 1994, according to a General Accounting Office estimate.

But in the long run, tax credits have paid off. First, they have pushed corporations to invest in inner-city neighborhoods. And because they’re funded with money the government forfeits rather than money that it must appropriate every year, Congress can’t tinker with tax credits the way it does with other housing subsidies. By law, each state is guaranteed $1.25 per capita in new funding every year, which adds up to a total of $300 million annually in New York State.

And although that rate hasn’t been increased since 1986, the money now goes further than it used to. Since those early days, the market price for a tax credit has nearly doubled, as investors have come to realize that the projects are both lucrative and reliable. Some developers are now getting as much as 85 cents on the dollar, says Richard Barnett of the National Land Advisory Group, a housing market analysis firm.

“It’s become very aggressive, especially in the Northeast,” agrees Paul Woollard, a managing director in First Union Bank’s affordable housing group, which has about $900 million invested in tax credit projects. “It’s a good example of a maturing industry–the margins have compressed, and the pricing has come down.” Woollard believes that for investors, prices have reached their natural limit. “Much beyond this,” he observes, “it doesn’t make economic sense.”


But in New York City, tax credits are anything but high-flying–instead, they’ve become the backbone of a remarkably reliable funding pool for affordable housing. At the end of the 1980s, back in the early days of tax credits, the city government, together with LISC and Enterprise, pioneered a successful and prolific program that allowed nonprofit developers to fix up city-owned vacant buildings for formerly homeless tenants. Under this program, tens of thousands of apartments were fixed up with tax credits, HPD loans and technical help from the New York Equity Fund.

It was successful in part because no matter who was doing the work or where the buildings were, the terms and the structures of the deals were the same, explains William Traylor, the managing director of the Equity Fund. From the city’s point of view, that made it simpler, safer and easier to administer.

The formula worked so well that the administration’s two major rehab programs–NRP and NEP–were set up much the same way. The New York Equity Fund would structure the deals, supply up to half the money, provide technical support, and, in the case of NRP, help run the program. For a housing department that was losing much of its experienced staff to budget cuts, it was like a dream come true–reliable, free outsourcing. Traylor says that “about 99 percent” of the New York Equity Fund’s business has been through HPD.

But the trade-off was that LISC and Enterprise dictated the details of the deals, and they still do. That is what now frustrates some nonprofit developers, who say the New York Equity Fund hasn’t kept up with the market.

For one thing, the Equity Fund has a lock on how reserves are invested. In each tax credit project, a substantial chunk of money is set aside in reserve for 15 years–for city-owned buildings, roughly $300,000 to $500,000, and for big supportive housing projects, up to $4 or $5 million. That adds up to hundreds of millions of dollars in reserve funds, and on HPD’s direction, virtually all of it has been socked away in basic interest-bearing accounts at Banker’s Trust. Community groups assert that if they could invest their own reserves with banks of their choosing, they could leverage the money to get better deals, more grants or cheaper loans.

“It robs us of the opportunity to develop larger and more meaningful relationships of our own with those financial institutions,” says Mark Alexander, executive director of Hope Community, a large Harlem housing nonprofit. (Several prominent nonprofit developers privately agree with Alexander, but he is the only one willing to go on the record with criticisms of LISC and Enterprise.) “In some cases we’re talking well over a million dollars. If the bank is earning $50,000 a year off my accounts, they’ll work the account. That’s the capitalist way: Green pastures get tended.” If they could also sink the money into other kinds of investments, say other developers, they could wind up with more money–cash that could ultimately be plowed back into affordable housing.

In late 1999, LISC did launch a $36 million mutual fund with Neuberger Berman that allows groups some flexibility to distribute their reserves between equities, corporate bonds and a money market account. “Our response grew out of what we heard from groups,” says Traylor. Frey says that Enterprise may consider doing the same thing with its projects. But for a community group to shift its projects’ reserves from this investment firm to Chase or Citibank, for example, is still out of the question.

And the amount of money developers can get for their credits is still a contentious issue. According to nonprofits who have worked with the New York Equity Fund, it pays builders rates from the upper 60s to the low 70s for every dollar it sells in tax credits. By comparison, the state housing agency, which also administers some tax credits, now has set a floor of 70 cents on the dollar for groups applying for tax credits. Their top rating is reserved for groups that have found investors that will pay more than 78 cents on the dollar.

“It’s like the Mafia: they have to take their vigorish off the top,” says another longtime nonprofit developer. Undoubtedly, much of that money funds LISC and Enterprise’s community development work. But investors are getting their share too–companies like Brooklyn Union Gas, Capital Cities/ABC and just about every major bank in the city. The New York Equity Fund, however, refuses to share information on the returns it offers to investors, and some developers charge that they are projecting returns well above market rate. Unlike a government program, the fund doesn’t have to reveal how it allocates its money, leaving nonprofit builders to wonder how much of the money that could be put into housing is going to investors instead.


LISC and Enterprise respond that they are merely shielding nonprofit developers from the harsher winds of the free market. By offering the same kind of deal across the board, the New York Equity Fund’s Traylor says, it is able to effectively subsidize newer groups while giving experienced developers a reliable if inflexible source of funding.

Leveling the playing field also means asking developers who have valuable real estate to forego any windfalls they could have won from private investors. “A deal in Harlem,” Traylor points out, “would get a hell of a lot more, because it’s great real estate, and that’s what [the investor] is buying. It’s very different from a deal that is spread across 30 buildings in central Brooklyn, which might be wood-frame buildings in a badly deteriorated neighborhood with lots of crime. We buy everything, regardless of the community organization, their skill set, and the real estate. The price is based on that–it averages out.”

And the two groups, through the New York Equity Fund, offer more than just cash. They provide services that no private syndicator does, training accountants and developers in complex annual recertification procedures, and investing time and hand-holding to make sure difficult projects don’t fail. The fund is also still recruiting new groups into tax credit funding–and some of these are working in neighborhoods like Bedford-Stuyvesant, where the projects are harder and the problems bigger.

Similarly, the Equity Fund takes many responsibilities off of HPD. The Fund doesn’t just manage reserves–it also reviews budgets and makes sure that the developments have good cash flow and healthy underwriting. “We’re quasi-governmental,” is how Traylor puts it. “HPD gets more from [LISC and Enterprise] than a good financial return,” says Carol Abrams, the department’s spokesperson. “We value the technical assistance to ensure project success, front-end seed loans, asset management and the willingness to help the [developer] if the project faces setbacks.”

For their part, nonprofit executive directors like Alexander resent that they are paying for this free ride when they could be getting better deals elsewhere. “For HPD, it’s been easy,” grumbles Alexander. “They have a partner who knows this stuff, who has worked out deals on how the documents should look. It makes production easier when you’re only dealing with one partner. It’s still wrong.”

But the security that the New York Equity Fund offers is something that Alexander and other free-marketeer community developers must take seriously. In the next few years, some of the first tax credit projects will be expiring, and many community groups will want to buy out their investors. Just how much that will cost–or how nonprofits will round up the cash–is still unclear. Some investors will undoubtedly be happy to walk away from projects with their tax break in hand, while others may try to convert the buildings to market-rate housing, or sell them, if their deals allow it. But in any case, nonprofit developers that stay with their projects will have to find a new source of money to keep the developments functioning.

That’s exactly where LISC and Enterprise may be able to prove their value again, hooking up community groups big and small with cash, credit, legal expertise and other resources. “Our intent is to not harm the project,” promises Traylor. “The ultimate goal is to keep projects in good condition, and financially sound. I think everyone can rest assured that will be the outcome.”

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