The Trump administration’s proposal to slash the corporate tax rate from 35 to 15 percent is a bittersweet blessing for one class of investors. Lower taxes are appealing to almost everyone, regardless of their political views, but for investors in the affordable housing market, which are mainly commercial banks, they are downright scary. These investors have traditionally relied on tax deductions, including depreciation and interest payments, to make their investments financially viable — but the simple math is deductions from a 35 percent tax rate are far more valuable than those taken from a 15 percent rate.
Even investors in projects built years ago would be hit hard by lower corporate taxes. Investors in these projects are required to retain their positions for 10 to 15 years, so investments made four or five years ago would suddenly become problematic and the pain could go on for years.
Given this uncertainty, the market for new affordable housing projects is at a standstill. Investors are demanding protection against potential tax cuts, either by offering lower initial bids or by asking for language in project agreements that would allow them to claw back some of their investment if tax rates go down. So far, we have not heard of any deals that have closed with these new terms.
The Tax Reform Act signed into law by President Ronald Reagan in 1986 helped spur the affordable housing market. The Act gives investors a one-for-one tax credit for every dollar they invest in affordable housing. Critically, it also gives them an avenue to take deductions against their corporate tax bills. This last benefit has been key to making affordable housing projects attractive to investors.
The program has enjoyed bipartisan support over the years because it has delivered millions of housing units to lower-income people, while creating hundreds of thousands of jobs and improving neighborhoods in nearly every state in the nation. Almost 100,000 units were built or renovated under the program in 2014 alone, according to the National Multifamily Housing Council.
There is also no slowdown in demand for affordable housing. A record 21.3 million households were identified as “cost burdened” in 2014 by Harvard University’s Joint Center for Housing Studies, which means they paid more than 30 percent of their income in rent. More than half of these households faced even more difficult circumstances, paying more than 50 percent of their income in rent.
The affordable housing program helps meet this challenge by granting tax credits to projects in which developers agree to lease units only to households earning 60 percent or less than the median income in a local metropolitan area. Developers are also required to charge affordable rent, as determined by the government, for an extended period of time.
Under these rent-restricted conditions, project financial margins are almost always extremely tight. For example, in projects that receive the most generous tax credits, developers are allowed to rent only to households earning 50 percent or less than the area median income. So, if the median is $50,000, the project can only serve people making $25,000 or less. The rent is also capped at 30 percent, which means a family of four making $25,000 pays only $625 a month in rent with a portion of that amount earmarked as a utility allowance. If the allowance is $100, the developer receives only $525 a month, barely enough to cover operating expenses.
Developers almost always face funding gaps when they are putting together projects, and tax reform threatens to make the gaps even wider. In recent negotiations, investors are taking a tough line. If they think tax cuts will be modest, they have offered to pay $0.95 a credit, down from $1.06 six months ago. If they think the corporate tax rate will really be cut to 15 percent, investors are further lowering their offers or are demanding “adjusters,” including putting some of their investment dollars into escrow, which could be taken back if rates are cut deeply.
Investors need a reasonable return on investment to continue participating in the market. Typically, they have earned a 5 to 6 percent annual return. Given all of the benefits of the affordable housing program, including millions of affordable homes and hundreds of thousands of jobs, this is a something well worth saving. We strongly urge Congress to make the tax credits worth more, if they cut corporate taxes. We would also strongly encourage local governments to consider property tax abatements that would ease the biggest expense in any affordable housing project. Government programs are not always successful but this one is well worth keeping.
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