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Tax credit financing, explained
September 22, 2016

by Chris Dettling  |  The typical affordable housing deal often requires more than 10 different sources of financing. It’s complicated, to say the least. Each source has its priorities and requirements, which occasionally conflict. (In other words, successfully financing a project is like herding cats with each cat having its own lawyer, as Lee Blons likes to joke.)

Let’s look at the most important source of financing for affordable housing – the federal Low-Income Housing Tax Credit (LIHTC or Section 42). Created in 1986, tax credit financing is an important tool for developers of affordable housing such as Beacon because it provides private equity to projects, reducing the need for amortizing debt, allowing the owner to keep rents low.

There are two types of tax credits: the 30 percent credit and the 70 percent credit (also known as the 4% and 9% credits, respectively). 4% credits typically finance about 30 percent of the cost to develop a project while 9% credits finance about 70 percent. The 4% credits are more plentiful; the 9% credits are more desirable – and extremely competitive. Minnesota Housing typically receives between 3 and 5 times more proposals each year than can be funded.

4% credits are available to projects financed with tax-exempt bonds. Minnesota Housing’s capacity to issue tax-exempt bonds varies from year to year but recently has been as low as $145 million and as high as $300 million. The debt service on the bonds is paid directly by the project and not by the state. 9% tax credits are allocated to states based on population. In 2016, each state received $2.35 per capita in 9% tax credits and Minnesota’s allocation was $12,824,356. The state sub-allocates a portion of these credits to Duluth, Minneapolis, Rochester, Saint Cloud, and Saint Paul and the Dakota and Washington counties.       

9% tax credits are awarded to affordable housing developers through a competitive process guided by state- or locally-determined scoring criteria, called a Qualified Action Plan (QAP). The criteria may vary depending on the particular QAP. Points may be awarded to projects in communities with good access to transit, low percentage of minority populations, or in economically integrated communities, or with features as multiple bedrooms to serve large households, set-aside units for people with disabilities, or for those with histories of homelessness or very low incomes, to name a few.

Here’s how tax credits work:

Let’s say a Beacon project receives an award of $1,000,000 in credits. We sell the credits to an institutional investor with tax liability (banks, insurance funds, etc.) in exchange for equity. The investor benefit is $1,000,000 in tax credits annually for 10 years, for a total of $10MM. The benefit to Beacon is around $8.5 to 11 million (depending on the credit price which fluctuates based on market conditions) in cash from the investor up front to fund construction.

While the tax credit is the largest affordable housing program available to developers it, by design, doesn’t pay for 100 percent of the building cost. Other private and public capital sources are always necessary to complete the affordable housing funding puzzle – advocates such as Beacon Citizens play a crucial role in keeping this issue in front of public officials who shape our state and local budgets.

One new innovative (albeit temporary) source in Minnesota is the Housing Infrastructure Bond (HIB) program whereby the state pairs 4% credits with tax-exempt bonds to help finance supportive housing for households experiencing homelessness, among other types of projects.

The state pays the debt service on the bonds and provides a deferred loan to create or preserve affordable housing. This loan, along with the equity generated by the 4% credits—a source which is often undersubscribed in Minnesota—helps fill a large part of the gap. Both Prior Crossing and 66 West benefited from the HIB program.

Chris Dettling
Chris is Beacon's associate director of housing development.