Preserving Affordable Housing While Preserving History

8 min read

How historic tax credits can be used in acquisition rehabilitation projects

The acquisition and rehabilitation of affordable housing (acquisition/rehab) may appear like a recent concept as many of these projects are nearing the end of their affordable compliance period, but it is a well-used development strategy. Likewise, utilizing State and Federal Historic Tax Credits (HTC) as a component of the capital stack of these projects may seem like a more contemporary occurrence as discussions about this strategy have become more frequent, but as early as 2006, HUD entered into a cooperative agreement with the National Trust for Historic Preservation (NTHP) as part of America’s Affordable Communities Initiative to “document workable solutions to major barriers to urban rehabilitation.”

In 2006, the housing market was turning white hot and affordable housing developers and advocates, as well as preservationists realized there was an important nexus between the preservation of affordable housing for America’s lower-income residents and the preservation of historic neighborhoods and buildings. Many affordable units coming out of compliance were lost to gentrification and historic buildings were in some cases demolished as developers combined lots in order to build larger market-rate multifamily projects. The partnership between the two preservation efforts was a natural one: utilize Historic Tax Credits to help finance the rehabilitation of affordable units.

There are a number of reasons acq/rehab projects present themselves. Typically, the end of a building’s affordable housing compliance period means the owner is undertaking a capital needs assessment (CNA) or physical needs assessment (PNA) to understand the level of investment required to recapitalize. If, after the assessment, the original developer chooses to divest its portfolio or a managing partner wants to exit, a new partnership is necessary to keep the units affordable and to reinvest. This type of transaction often occurs in areas that are experiencing rising property values, such as long-standing affordable housing projects found in core urban neighborhoods. These are often located in older neighborhoods that were settled by middle-class families early in the 20th century and where income-controlled units became commonplace towards the end of the century. As a result, HUD has developed a number of programs over the years to encourage the retention of affordable units, including Rental Assistance Demonstration (RAD), Market-to-Market, Mark Up to Market and Project-Based Vouchers. These programs have proven that they are capable of incentivizing the retention of affordable units, but it is only a part of acq/rehab success. Other tools for financing reinvestment are necessary.

Despite a long history of twinning the HTC and Low Income Housing Tax Credits (LIHTC), the strategy for affordable units coming out of compliance in the early 2000s did not usually utilize the HTC in their original rehabilitation. Therse may be several reasons for this: the HTC was perhaps not well known; there was a perception that historic preservation would increase costs; or maybe developers did not view the properties as “historic” or eligible to be listed on the National Register of Historic Places, one of the requirements of utilizing the federal HTC. The other requirement is that the project’s qualified rehabilitation expenditures (QREs) must exceed the owners’ adjusted basis in the building.

The Federal HTC is 20 percent of QREs, but in combining the credits, the LIHTC’s basis is adjusted by the amount of historic credit received, something developers may perceive as negative. Both basis calculations are done over a 24-month period and other aspects of the programs work well together.

Despite the impact the use of the HTC might have on the LIHTC, the credit amount is a significant gap filler on projects that can typically have six or seven forms of financing in their capital stack. Another positive of twinning the credits is that the same investors will typically have an appetite for both, somewhat reducing the complexity of the transaction. Currently, pricing for twinned deals is around 90 cents on the dollar.

State HTCs
In addition to the Federal HTC, many states have historic credits that follow the same guidelines from a design perspective but can often be easier to monetize. The amount of credit available in state programs can sometimes be greater than the 20 percent of QREs in the federal program and some state programs have a set aside for affordable housing. Although some states have per project caps that may limit the funds available for a single building, scattered site developments for larger acquisition/rehab projects may benefit from having each building being treated as a separate project therefore receiving a separate allotment of tax credits for each. State credit programs have made utilizing HTCs on acq/rehab projects much more appealing.

The Secretary of the Interior’s Standards for Rehabilitation are the guiding requirements for HTC projects. Typically, what makes acq/rehab projects a good fit for the HTC program is they are “paint and paper” rehabs where the focus might be on kitchens, baths and systems or things that will not heavily impact a building’s historic character, a central tenant of the Standards. For instance, there are usually no changes to floor plans to increase units so demolition is not a concern. Code upgrades are often an integral part of these projects, and with most HTC projects, therefore, treatment plans have been developed and widely accepted over the years to address code-related issues.

Energy Issues
Energy-related requirements from housing agencies can present more complicated issues for acq/rehab projects that are eligible for HTCs. Early LIHTC projects may have non-historic windows that are at the end of their useable life and must be replaced. Even though the aged replacement windows are not original, any new windows would still need to match the historic profiles of the original windows, either based on photographic evidence or looking at other buildings of the same period in the neighborhood. Replica windows for HTC projects have come a long way and are usually all aluminum with insulated glass. From an energy perspective, these windows can match many of the high-performance windows available today. High-performance building envelope requirements, however, present challenges as finding ways to introduce additional insulation into the walls can be problematic.

Approval Process
If HTC and LIHTC objectives align, timing of the historic credit approval process—the three-part historic preservation certification application (HPCA)—works well with acq/rehab. Parts 1 and 2 of the application are typically filed together: Part 1 is a determination that the building is historic. Part 2 is a description of the proposed work, addressing how the work meets the standards mentioned above, combined with design development drawings and photographs of the buildings’ existing conditions. Part 3 is the final certification that the work was executed as approved and is a one-page form combined with photographs showing the completed project. These applications are submitted to the State Historic Preservation Office (SHPO) first for review and comment then forwarded to the National Park Service (NPS) for review and approval.

The requirement to list the building on the National Register can run on a parallel track with the HPCA once the Part 1 has been approved. In order for a building to be considered historic, it must be 50 years old or older. The perception of what is “historic” is fairly narrow in the affordable housing industry, but typically many of the buildings involved in acq/rehab meet the requirements. Beyond the 50 years, they must have an architectural or cultural reason for listing, which are very broad categories that allow for a broad range of buildings to be eligible from garden apartments to 1960s towers originally placed in service for affordable housing. Other projects, such as a scattered site of six- to 12-unit apartment buildings in an early 20th century neighborhood, can be listed in association with the street-car suburb movement that was taking place at that time. National Register listing typically does not have any long-term impact on a property.

In Conclusion
Acq/rehab projects can be challenging to finance depending on a state’s Qualified Allocation Plan (QAP) and the emphasis they put on housing preservation versus housing creation. If the QAP supports housing preservation then HTCs, both federal and state, can be key sources of funding and alleviate some of the financing challenges on these critical projects. The timing of the credits align well and the investor community is typically the same. The real key to this opportunity is recognizing the historic significance of existing affordable housing properties and the inherent financial benefits that come along with that distinction.

Bill MacRostie is based in the MHA DC office where he advises clients on historic rehabilitation tax credit design and regulatory issues. From 2000 to 2003, Bill was the Washington, DC principal of a national historic consulting firm. From 1997 to 2000, he was National Director of Historic Property Services for Ernst & Young LLP where he advised developers, institutional investors, and equity syndicators on historic certification matters. While at E&Y, Bill originated historic credit investments for the firm’s corporate and institutional clients. Bill has also worked for Langelier Historic Properties, Inc., an equity syndication firm specializing in rehabilitation development, and served as an architectural historian on the staff of the Technical Preservation Services Division of the National Park Service in Washington, DC where he performed historic tax credit project review. In private practice for more than 30 years, Bill has advised clients nationwide on projects ranging in size and type from the multi-phased $175 million mixed-use Stroh’s Riverplace project in Detroit, Michigan to a $1.5 million hotel rehabilitation in Santa Rosa, California. He has represented clients in over two dozen tax certification administrative appeals in Washington, DC. For the 14 years that NPS certification project review was conducted in regional offices, Bill worked extensively in every regional office and most major states around the country. Bill has lectured widely on the subjects of historic rehabilitation and real estate development. His speaking credits include the nationwide, 21-city “Rehab for Profit” seminar series on historic rehabilitation development co-sponsored by the National Association of Realtors and the National Trust for Historic Preservation, as well as testimony before the Committee on Ways and Means of the US House of Representatives. Bill’s recent publications include articles in Urban Land Magazine, Multi-Housing News, Affordable Housing Finance Magazine, and the Section 42 Report. Bill serves on the board of directors of the National Housing & Rehabilitation Association and is a past treasurer of the board of directors of Preservation Action, the national lobby for preservation and rehabilitation. Bill holds a Bachelor’s degree in History from Lewis and Clark College in Portland, Oregon and a Master’s degree in Historic Preservation Studies from Boston University.