Nonprofit and private developers can take advantage of tax-exempt bonds.
With the ever-increasing
need for more affordable housing, both nonprofit and for-profit
developers must consider every available below-market-rate financing
program to make such projects economically feasible. Viable
sources may be 501(c)(3) bonds for nonprofit developers and
private-activity bonds, which are available to for-profit developers.
State and local governments issue these bonds as a way to finance
these tax-exempt bonds requires a high level of sophistication, and
their transaction costs may be steep, often 3 percent to 5 percent of
bond proceeds. Tax-exempt bonds generally require loans of at least $5
million to be worth the effort, which may make them impractical for
small deals. However, multiple properties can be bundled together in a
single bond issue to take advantage of economies of scale.
these limitations, both 501(c)(3) and private-activity bonds provide
wonderful flexibility. They generally are always available, whereas
low-income housing tax credits usually are allocated only once or twice
a year. They offer extremely attractive interest rates, often over a
30-year term. While the rates fluctuate with the bond market, they
recently hovered around 6 percent. Also, the time frame is relatively
short: A bond transaction can close within a three-month time period.
The Bonds Explained
and local government agencies issue 501(c)(3) bonds on behalf of
nonprofit organizations exempt from federal taxation under Internal
Revenue Code Section 501(c)(3).
bond debt amount states can issue in a given year is flexible, so
competition generally is less than the tax-credit program. However,
nonprofits cannot have more than $150 million in bond proceeds
outstanding at any one time on all their multifamily developments.
issuers such as state housing finance agencies, local redevelopment
agencies, and public housing authorities also allocate private-activity
bonds to for-profit developers through annual funding cycles. There is
a cap on how much private-activity debt states can issue, so
competition may be fierce. For-profit developers can couple
private-activity bonds with low-income housing tax credits -— either
the noncompetitive 4 percent program or the highly competitive 9
Typical Underwriting Standards
entities such as the Federal Home Mortgage Association purchase many
501(c)(3) and private-activity bonds after they are rated investment
grade by agencies such as Standard & Poor's and Moody's.
Underwriting standards for these bonds tend to be quite strict because
a higher grade directly corresponds with a lower interest rate.
For a bond to achieve a high
investment grade, the project must have considerable debt service
generally 1.50 or more. The ratings agencies often require high
operating, replacement, and debt service reserves. Credit enhancement,
such as a letter of credit or insurance that reduces the bond
purchaser's risk of loss should the property fail to pay its debts,
also may be required to mitigate risk. High ratings such as AA or AAA
mandate credit enhancement.
addition to the grading of each bond deal, the borrower's financial and
management strengths are critically important. Issuers review the
developer's property management ability and experience carefully.
Typically only developers with fairly substantial balance sheets and
established track records can attract tax-exempt bond financing.
programs work extremely well with large mixed-income properties and in
some markets can be the only form of financing required if the project
is not in a redevelopment area or special district where other
financing tools are available. In many cases, subordinate debt is
permitted. Given the 1.50 debt service coverage typically required for
the bonds, ample room for a second loan generally exists, but lenders
may have to forego some of their traditional rights such as the ability
Using Tax-Exempt Bonds
The first step in using either 501(c)(3) or private-activity bonds is
to assemble your own team: knowledgeable real estate brokers,
consultants, financial experts, and counsel. Consult with other
affordable-housing developers who have used these bonds. Make sure your
advisers have specific experience with the property type you are
seeking to finance. More important, make sure they have a good working
relationship with the issuer you are considering. You also must make
sure that your project meets the issuer's social goals; otherwise, it
will show little interest.
vary considerably in their levels of expertise in multifamily bond
financing. Some states have excellent housing finance agencies with
extensive multifamily experience. In other communities, a local
jurisdiction such as a county or city housing finance agency may be a
better bet. The transaction costs often are lower than with state
agencies, but the trade-off may be a less-experienced issuer.
Internal Revenue Service requires that nonprofit and for-profit owners
of multifamily projects developed with bond financing set aside either
20 percent of the units for households earning less than 50 percent of
the area's median income or 40 percent of the units for households
earning less than 60 percent of the area median income. In addition to
choosing one of these two set-asides, developers must hold rents at a
reasonably affordable level, which generally is interpreted to assume
rents of no more than 30 percent of the selected income thresholds.
Local inclusionary housing laws and state housing policies also may
apply. Furthermore, developers either must indicate their intent to
finance with tax-exempt bonds in their IRS exemption applications or
request bond financing authority from the IRS.
Tax-exempt bonds are not
for the faint of heart. Like any other financing type, think of them as
other valuable pieces of your commercial real estate financial toolbox.
Surround yourself with knowledgeable financing experts to successfully
obtain tax-exempt bond financing for your affordable-housing projects.