Tax-Exempt Bonds and 4% Tax Credits

Tax-Exempt Bonds and 4% Tax Credits Mary Nash K. Rusher Hunton & Williams LLP (919) 899-3066 [email protected] Mark Shelburne Novogradac & Company ...
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Tax-Exempt Bonds and 4% Tax Credits Mary Nash K. Rusher Hunton & Williams LLP (919) 899-3066 [email protected]

Mark Shelburne Novogradac & Company LLP (919) 889-2596 [email protected]

Satana Deberry, Executive Director North Carolina Housing Coalition (919) 881-0707 [email protected]

Tax-exempt bonds issued under Section 142 of the Internal Revenue Code combined with the 4% tax credits under Section 42 of the Code are an alternative to traditional 9% tax credits • Section 42 of the Code provides an automatic 4% tax credit over fifteen years for projects financed with tax-exempt bonds

• 50% or more of the project’s eligible costs must be financed with tax-exempt private activity bonds • Developer must submit an application to NCHFA for allocation of “volume cap” (i.e. permission to issue tax-exempt bonds) • If NCHFA approves the issuance of the bonds, the project sponsor/developer is not required to compete separately for a tax credit allocation

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Benefits of tax-exempt bonds & 4% LIHTCs • No competition; resource goes largely unused • Tremendous need across the state • N.C. has extensive developer capacity – more than 60 groups involved in the 9% process annually • Difficult but certainly not impossible to make the numbers work • Developers all understand LIHTCs, which is the most difficult part • Fewer than 40 stand-alone projects completed since 2000 (excluding portfolio projects) • A little over 5,000 units 3

Tax Exempt Bonds require volume cap • Under the Code, each state is permitted to issue a limited amount of private activity bonds in each calendar year (“volume cap”) • Volume cap is divided among industrial development, student loan, single family, waste disposal and multifamily housing bonds based upon demand; currently far more supply than demand • In North Carolina, 2015 volume cap is more than $944 million • Volume cap for housing allocated by the North Carolina Federal Tax Reform Allocation Committee (“TRAC”), based on recommendation of the NCHFA • Therefore, application to NCHFA is technically application for volume cap, which comes with automatic 4% tax credits

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What are multifamily housing revenue bonds? • Bond (debt) issued by a governmental entity (state, regional or local housing authority, county or city - the “Issuer”)

• Proceeds are loaned to private entity (typically a partnership or LLC - the “Borrower”) • Borrower uses those dollars to acquire, construct and/or rehab and equip “multifamily residential rental housing” • Bonds are “private activity bonds” or “exempt facility bonds” under Section 142 of the Code

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What are the tax rules? • Rules focus on the use of the proceeds of the bonds and use of project constructed with those proceeds

• 95% of proceeds must be used for capitalizable costs • Acquisition of existing property permitted only if an amount equal to 15% of purchase price is used for rehabilitation (structural upgrade or replacement of equipment, renovation of kitchens, etc.)

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Projects must meet the following criteria: • • • • • • • •

one or more buildings or structures located on a single tract of land owned by same person/financed pursuant to common plan occupied on other than transient basis (6 month leases) containing one or more similarly constructed units unit must contain separate and complete facilities for living, sleeping, cooking, and sanitation (no dorms, hotels) functionally related and subordinate facilities can be included (e.g. club house, parking, pool, playground) leased to general public, although it can be limited to just the elderly if owner so designates 7

Breakdown of bond/4% tax credit transactions in North Carolina New construction Stand alone

Portfolio

Smallest has been approximately 90 units, maximum of 200 units under the QAP Note scattered site policies of various cities (Charlotte and Raleigh) may apply Theoretically possible but has not happened in NC

Rehabilitation Smallest has been approximately 90 units (except one historic rehab deal, which is only 48 units); no maximum under the QAP Approximately six to twelve properties transferred together

Only five bond volume awards were less than $5 million (other than unusual circumstances) Cities that have at least one Bond/4% Project: Asheville Cary Charlotte Concord

Durham Elizabeth City Fayetteville High Point

Lexington Raleigh Rocky Mount Wake Forest Wilson Projects underway in Burlington, New Bern, Winston-Salem, Greensboro

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Portfolio Transactions • Portfolio transactions are a very specialized activity • Involve combining several properties in different locations under one owner • Challenging, lots of moving parts • Very efficient outcome as compared to submitting many 9% applications • NCHFA rather than a local authority is the issuer since it has statewide jurisdiction

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Bond/4% Affordability Requirements Bonds and tax credit rules require that at least 40% of the units be rented to families whose income is not more than 60% of area median income; remaining units can be market rent (but no tax credits on those units) •

As a practical matter, in most deals, 100% of the units are income restricted (almost 90% have been done that way)



Tax rules permit as few as 20% to be leased to families whose income is 50% or less of area median, with the remaining at 80% at market rent



Only one such project in N.C. (Charlotte)



An 80/20 project could be an option anywhere a market rate complex works 10

Volume Cap Calendar for 2015 (Round 2) • July 17

• September 4

• October 2 • January, 2016 • December 31, 2016

Deadline for submission of preliminary applications (noon) (will be on-line in late June) Notification of final site scores and initial evaluation of rehab projects Deadline for full application (12:00 noon) Notification of tax credit awards Deadline for closing transaction

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NCHFA Review Criteria for Bond/4% Deals Requirements essentially the same as the 9% pre-app – site scoring, although the score is not important since not competitive – site thresholds still apply – market study is the same – need an option or contract on the real property – other than the last item, a fairly small investment

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Minimum Requirements for NCHFA Approval Must Meet QAP requirements (with a few exceptions) All projects must have either: • 10% affordable to and occupied by households at 50% AMI • 5% affordable to and occupied by households at 40% AMI • DHHS targeting not required Rehabilitation applications must: • Be placed in service date or before December 31, 1998 • Require at least $10,000 per unit of rehabilitation • Not have an acquisition cost >60% of the total cost

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Other NCHFA Requirements • Inducement resolution must be submitted with the full application • • • •

Can qualify for experience with an out-of-state bond deal Since not competitive, in-state points do not matter Do not have to fund a rent-up reserve Operating reserve must be the greater of $1,500/unit or four months’ debt service and operating expenses • Per-unit developer fee is the same, but max is $1,700,000

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Summary of steps required to get approval of volume cap to issue Bond • • • • •

Apply to NCHFA for approval of volume cap for bonds Identify an issuer – local housing authority (best choice), regional housing authority, city or county Issuer adopts preliminary (also called “inducement” or “reimbursement”) resolution Issuer agrees that it will issue bonds if all approvals are obtained Receive approval from NCHFA and allocation of volume cap

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Summary of remaining steps to issue bonds •



• •



Public hearing (also called “TEFRA” hearing) after 14 days’ published notice before Issuer or city/county - depends on jurisdiction--followed by approval resolution from city/county in which project is located Issuer adopts findings resolution to satisfy LGC, if LGC approval required Approval by town/city if a county or regional housing authority exercising jurisdiction within town/city Approval by Local Government Commission (Department of State Treasurer) if term of bonds is longer than 5 years Final approval by Issuer 16

Two Primary Structures for Bond issues Long-term bonds: • Remain in place at least for the full tax credit period • Rents must cover the debt service • Often require some sort of credit enhancement (i.e. Fannie Mae, HUD guaranty)

• Difficult in today’s market because taxable rates often less than tax-exempt rates for enhanced loans

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STRUCTURE – LONG-TERM TAX-EXEMPT MULTIFAMILY HOUSING BONDS BOND HOLDERS OR PURCHASER

Sells Bonds

UNDERWRITER

Purchase Price ($$)

Bonds

($$)

[INDENTURE TRUSTEE]

CONSTRUCTION FUND

Note Assigned

AUTHORITY Loan Agreement & Note

TAX CREDIT INVESTOR

($$)

Upfront Issuance Fee

$$

DEVELOPER/BORROWER Limited Partnership Interest Tax Credits

$$

Revenues

PROJECT

RESTRICTIVE COVENANTS FILED AT CLOSING 18

FHA Multifamily Mortgage Insurance Section 223(f): • Refinance or acquisition • Minor/moderate repairs ($6,500/unit*high cost factor) • Permanent debt with repair escrow – up to 35 years

Section 221(d)(4): • Substantial rehab: 2 major building systems • Construction/permanent debt all in one – initial/final closing • 40-year financing

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Why does someone want to buy these bonds? •





Interest received on the bonds is exempt from federal and state income tax In North Carolina the Local Government Commission requires that bonds must either have credit enhancement, be sold to a bank or similar financial institution or have an investment grade rating • HUD insured mortgage with Ginnie Mae Certificates • Can be privately placed • May be purchased by a single institutional investor such as Bank of America, which may also be the tax credit investor Banks get community reinvestment credit

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Short Bonds • Bonds are outstanding only during the construction period • Bonds and HUD 221(d)(4)/223(f)/Fannie Mae loan are outstanding simultaneously • Construction draws on HUD or Fannie Mae loan deposited to a cash collateral account; corresponding amount of bonds advanced or withdrawn from construction fund to pay actual costs of the Project • Result is that 50% of the basis of the building is constructed with bond proceeds • Bondholders have no interest in the Project but are 100% cash secured; result is lower rate for short-term debt • Bondholders have cash collateral; almost no risk 21

STRUCTURE – SHORT-TERM TAX-EXEMPT MULTIFAMILY HOUSING BONDS At end of construction, cash pays off bonds

BOND HOLDERS OR PURCHASER

CASH

INDENTURE TRUSTEE ESCROW AGENT

Advance Funds

MORTGAGE SERVICER FOR HUD/FANNIE MAE

OR

BOND PROCEEDS

CONSTRUCTION FUND

Note Assigned Release corresponding amount of bond proceeds

AUTHORITY Loan Agreement & Note

TAX CREDIT INVESTOR

UNDERWRITER

Purchase Price ($$)

Bonds

COLLATERAL FUND

Sells Bonds

Upfront Issuance Fee

$$

DEVELOPER/BORROWER Limited Partnership Interest Tax Credits

$$

Revenues

PROJECT

RESTRICTIVE COVENANTS FILED AT CLOSING 22

What about tax credits? • Under Section 42 of the Code, if at least 50% of the basis of • • •



the project is financed with Section 142 tax-exempt bonds, 4% tax credits automatically apply No allocation of 4% tax credits, except in the sense that NCHFA allocates volume cap (4% tax credits come with it) Rules are similar but not exactly the same Short-term financing still produces tax credits; most bond counsel require bonds to stay outstanding until facility placed in service and tax credit equity comes into the deal Note that tax credits are actual, based on qualified basis; not limited to the amount in the NCHFA letter 23

Who are the players in a bond deal? • Issuer – governmental unit that issues bonds • Very important to identify issuer early in the process • In N.C. – local housing authority is the first choice; cities and counties can also act as housing authorities • Purchaser – institution that purchases bonds (in a private placement with a Purchaser may not need an underwriter) • Underwriter – for publicly offered bonds, the investment banking firm that structures the deal and finds buyers • Trustee – bonds are issued under a trust indenture; the trustee holds proceeds pending disbursement for construction costs and collects principal and interest to pass on to bondholders • Credit enhancer – provides financial guarantee for bonds/project; makes bonds ratable/marketable

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Who are the players in a bond deal? (cont’d) • • •

• • •



Bond counsel – oversees entire process and issues opinion that bonds are tax-exempt Underwriter’s counsel – prepares disclosure document to sell bonds to the market place – “Official Statement” Purchaser’s counsel – represents the bank purchasing the bonds in a private placement Borrower’s counsel – looks out for Borrower’s interest; generally does real estate work, tax credit work and opinion (sometimes roles split between more than one firm) Issuer’s counsel – represents the issuer of the bonds Rating Agency – will issue ratings for the Bonds based on credit enhancement; makes bonds more marketable “Taxable tail” – if combination of bond proceeds (as approved for volume cap) plus equity from tax credits not enough to construct project and pay all of the closing costs, the issuer may issue additional taxable debt at the same time so long as financially feasible

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QUESTIONS? Mary Nash K. Rusher Hunton & Williams LLP (919) 899-3066 [email protected]

Mark Shelburne Novogradac & Company LLP (919) 889-2596 [email protected]

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