It is not unusual to see Extended Use Agreements (EUAs) for Low-Income Housing Tax Credit (LIHTC) properties with a provision requiring a homeownership option for residents at the end of the 15-year tax credit compliance period. In many cases, developers make commitments for homeownership at the end of the compliance period in order to obtain additional points on the LIHTC application. I have worked with clients on a number of such projects at the end of the compliance period, when it has become obvious that the homeownership component simply is not workable. While the push for points during the application period is understandable, it is in the interest of both developers and Housing Finance Agencies (HFAs) to recognize that creating a workable homeownership option for LIHTC developments is difficult, and those that do work have some common features that are worth taking a look at.
While many states have dabbled in the LIHTC/Homeownership arena, in many cases the efforts have proven unworkable. However, some states have had more success than others. Perhaps the most successful state relative to converting LIHTC rental units to owner units is Ohio. A number of Ohio developers have been very successful in developing the ownership option for tax credit properties. An examination of their formula for success is instructive.
First, and perhaps most importantly, all the homes are single-family homes. Homeport out of Columbus, OH has sold 26 LIHTC units to former tenants with 500 units in the pipeline. CNH Housing Partners (Cleveland) has converted 1,200 single family LIHTC homes to ownership.
Before reviewing the components of a successful LIHTC ownership model, a review of “Lease to Own” basics is called for.
1. Single family homes are built with LIHTC equity and rented for 15 years – just like any other LIHTC units.
2. In year 16, tenants have the option to purchase the home at a reduced price.
> One of the most workable formulas is to base the price on remaining debt, taxes, and cost of repairs made prior to the sale.
> Before the sale, the property owner upgrades the properties with new roofs, furnaces, and hot water heaters.
> The mortgage payment is typically less than the rent (having low mortgage rates makes this possible).
> It is critical that there be financial counselors available to the tenants. These counselors should not be part of the sales team.
> A key to success is that the gap between the sales price and market value must be covered, which can be done in a number of ways:
– Zero interest second mortgage, which goes away in five years (this five-year requirement will discourage “flipping” of the homes).
– Soft money contributed by a locality, such as HOME funds.
Classes and financial education of the residents is crucial.
Targeted outreach to the tenants should begin in year 11 or 12 of the compliance period, with letters, calls, and invitations to classes and counseling. This is especially important since for many residents, the main impediment to ownership is credit. Beginning the counseling and education early in the process may enable tenants to improve credit scores to the point where a mortgage if feasible.
So, under what conditions does the lease-purchase option work best? First, it only works where land is readily available and cheap. It will not work in high cost areas of the country. This is why the program works so well in the “rust-belt” part of the country. Land prices are generally much lower than on either of the coasts.
Urban infill also can work well and will almost always be more successful than suburban development, where land costs tend to be higher.
Developers interested in pursuing the lease-purchase option as part of their LIHTC strategy should recognize the hurdles they will fact up front.
1. Since these are virtually all single-family properties, more credits will be required due to higher development costs.
2. LIHTC managers often lack the skills required for management of single-family properties. Managing a 150-unit single family subdivision is a whole different world when compared to managing a 150-unit building.
3. The lease-purchase option may result in a reduction of affordable rentals, and this may go against the HFAs Qualified Allocation Plan (QAP).
4. Single family homes have higher operating costs than multifamily units. The costs of water and sewer alone can be significantly higher.
5. The sales process can be complicated. What if not all the homes sell? What happens to the rest of the home? These questions all have to be addressed in the planning stage.
6. Many HFAs have no interest in the ownership option due to a lack of resources and the increased cost (there will be about a 30% increase in development cost due to the single-family nature of the development).
Ultimately, the decision as to whether to pursue a homeownership component with a LIHTC project will depend on a number of factors, some of which I have outlined here. Even in cases where an HFA will permit an ownership component as part of an EUA, developers should go into the process with eyes wide-open, understanding that in many ways the lease-purchase option is a niche part of the tax credit world.