May 30, 1997 - From the May, 1997 issue

An Affordable Housing Roundtable: Assessing TCAC & “Uncertainty”

Not quite two years have passed since the California Tax Credit Allocation Committee (TCAC), under current Executive Director Don Maddy, adopted its new Qualified Allocation Plan (QAP) to distribute State and federal tax credits among affordable housing developers. The new lottey-based  system sought to lower rents and maximize the leverage of available tax credits. How successful has it been?

The Planning Report asked leaders in the affordable housing industry for their insight. TPR is pleased to present this roundtable discussion with TCAC’s Don Maddy; Ronne Thielen, Western Regional Director of tax credit investor Related Capital; Joan Ling, Executive Director of the Community Corporation of Santa Monica; and Lance Bocarsly, Principal in the real estate department of the law firm of Riordan & McKenzie.

Joan Ling: “Most of us, especially in the non-profit world, just idon’thave deep pockets to continue coming back round after round, hoping for a chance.”

When TPR last did a roundtable on TCAC in late 1995, one panelist made the following observation: "I think the last couple of rounds—ever since the bonus point system was put in place—had the unintended consequence of shutting out too many types or projects. I think that where the process went wrong is that public money and investor equity are not the only indicators of a good project." Two years Inter; how is TCAC working for community housing developers like you, Joan? 

Joan Ling: The number of TCAC applications has gradually been increasing for the last few years. At the same time, the amount of the tax credits we can get from the national pool has been decreasing. Another trend is that the applicants' projects are becoming larger and larger—the units-per-project have almost doubled in the applications submitted.

As a result, there's only a one-in-five chance of getting federal tax credit allocation in this round. We, as developers, need a certain amount of predictability that when we've gone that far we have a reasonable chance of getting an allocation. The screen needs to be raised. 

Several things could be done. First, we should recognize that perhaps small is better. In the current round, there are some large, 150- to 200-unit projects. Does it serve good public policy to build such huge projects made up of predominantly very-low­income households in one neighborhood, in one project? Reducing the project size cap from 200 to 120 units would begin to address this and obviously leave more to be allocated to everyone else. 

Another option is to cap the developer's fee, which is now set at $1.2 million. Dropping it to $750,000 could, in effect, encourage people to do projects more sensitively scaled to the community. 

We should also consider limiting the number of applications coming from affiliated entities, thereby discouraging developers from playing the numbers game.

Lance, you said there were clearly unintended consequences of the bonus system that was instituted by Don Maddy. Now it's two years later—what are the incentives and dis­ incentives that flow from the current qualified allocation plan (QAP)?

Lance Bocarsly: The current QAP process, as I see it, tried hard to address the issue of project diversity with varying degrees of success. In some sense, the problem today has to do with the lottery system. I suppose you have to impose the lottery at some point in your due diligence on a 

project. But the question becomes, at what point? 

For example, if we assess a project's financial feasibility and ask how many people are going to live in it paying specified rents: and then—everything else being equal—we apply the lottery, we still aren't even taking into consideration the competency of the developer. The ultimate question is, does this system rank all projects equally when the ultimate chances for success might not be equal? 

Turning to you, Ronne, what affordable housing proposals and projects have benefited under the current rules, and what deals are at a disadvantage? 

Ronne Thielen: With income targeting on the one side and with operating budget impositions on the other, it's still very hard to tell. The operating budget impositions are unfair to those developers who can manage equivalent properties for less could other developers. And again, as Lance was saying, the lottery system doesn't adequately address the issue of developer quality. 

It's become very difficult over the past year. There are a lot of new developers who, we have found, don't know anything about the program or what they've gotten into, but were lucky under the system—either by targeting the deepest affordability or winning by some other means.

The lottery does not help that at all; it only adds another level of guesswork to the whole process. Many of last year's winners' projects were extremely tight from an operating standpoint and were not well thought out as viable real estate. Such depth of income targeting will create difficult management problems and is not good public policy. Unfortunately, these mistakes will be with us for many years to come.

Joan, on the same theme, under the current QAP process, what housing projects are you encouraged to pursue, and which ones would you tend to avoid because you don't think they'll be competitive?

Joan Ling: Single Room Occupancy projects (SROs) have a very good chance of getting funded in the current QAP because there is a 10% set-aside for SROs. Preservation projects also have an excellent chance because 10% has been set aside for those projects, as well—and there were no applications under the preservation category in the first round. 

The State legislation for allocation of tax credits targets three types of housing: family housing, SROs and preservation. Perhaps it is time to revisit our priorities. 

California's preservation program stands to lose 125,000 units because of the potential termination of Section 8 certificates and prepayments. The problem is so great that the tax credit program is perhaps not the right place to address it. Our figures show that it would take roughly fifteen years of allocation at the current level to meet the preservation need alone.

And there are a lot of other problems with the preservation program. For example, the tenant portion of rents under the project-based Section 8 program are very low. Even if tax credits were used to preserve a project, the tax credit rents would be sometimes two to three times higher than what the tenants are currently paying. So that would clearly not solve the affordability problem. 

We expect that, as the tax credit program focuses on preservation projects, it's only going to increase the value of these projects to the seller—not serve the best interest of the tenants. Revisiting the policies behind the allocations might a good idea. 

Don, in January of this year, we carried a roundtable on affordable housing in which Ronne Thielen said, "TCAC policies and procedures in California have been in a mode or constant change in recent years, so it has been extremely difficult to know what kinds of properties will be available for an investment. A reliable pipeline of properties cannot be sustained where the rules regarding allowable cost, income targeting and determination of feasibility are continually shifting." Could you elaborate on the what the most recent changes are, and what you're trying to encourage and discourage in affordable housing production?

Don Maddy: One of the things we're trying to do is to recognize changes in the equity markets, and take advantage of that. We view ourselves as a partner in providing affordable housing. Some see only the investor and developer as partners, and view TCAC as the arm of the State whose role is simply to hand out assistance. 

Since we do hand out public benefits, we want to be an equal player at that table. Our policy changes seek to maximize our part of the deal—to get rents down as low as possible, facilitate as many units as we can, and, in the end, maximize the public good.

Ronne Thielen: I'm not sure what it means to be an "equal" player, but I certainly believe, as I did when I managed the Credit Allocation program, that TCAC is a significant partner in the tax credit program. As the administrator of this public benefit, it is critical that an allocating agency impose reasonable and attainable goals. Investors, lenders and developers should not be positioned by their state partner to deal with or be tempted by excessive or unreasonable goals. 

Don: two years after you reshaped the QAP process, can you give us a sense of what you didn't expect to happen that did, and what you've done to try to mitigate the unintended impacts of the changes? 

Don Maddy: Everyone is aware that there's going to be a floor rent and cost structure, but nobody can really agree on where that floor should be. There comes a point where changes to cost structure may not accomplish anything and new rent structures may, in fact, create a feasibility problem. 

That's the process you have to go through. We have now set a floor limit on the level to which we'll provide rent-reduction incentives. The level we've arrived upon is pretty close to where national figures and the people living in the projects indicate we should be. 

Another big issue is deciding if serving a population at 40% to 45% of median income will result in projects that aren't feasible. You have to strike a balance somehow. 

Lance, as the lawyer of choice for the nonprofit development community, what's your reaction to what you've heard? And what would be your clients' reactions? 

Lance Bocarsly: It depends on whether they're getting their projects funded or not.


It's actually quite admirable that TCAC is taking into mind the changes in the equity markets right now, because they have been incredibly volatile in the last couple of years. But my greatest concern—which most of us in this group probably share—is in setting these low cost-targets, are we creating more problems down the line? Do we worry about deferred maintenance in eight or ten years? Are we targeting costs too low? How can we be certain? 

And Joan, your reaction? 

Joan Ling: Don has done a good job in setting floors on operating expenses, rents and some benchmarks for costs. Nevertheless, there is still only a one-in­five chance of getting an allocation of tax credits right now. For developers, that is an impossible situation. 

Most of us, especially in the non­profit world, just don't have the deep pockets to continue coming back round after round, hoping for a chance. That's why raising the screen to reduce the number and size of applications is extremely important, as is revisiting our priorities for housing types. Should we be funding preservation projects, even though the state legislature mandates it? Should we be allocating 15% of our resources to senior projects? 

Again, reducing the maximum developer's fees, limiting the number of applications from affiliated entities, and discouraging mammoth projects from coming into the application process are ways to potentially reduce competition. 

Don Maddy (in response): One of my biggest problems in the tax credit policy debate over the last two years has been the lack of the desire by the majority of industry participants to raise the screen. We've watched demand go way up because the economy is coming back. But when you have this overwhelming level of demand—which is wonderful, because you get greater public benefits at the same time—it's difficult for people to get on track and work on projects long term, because they may not be going anywhere.

We have laid out many different proposals to raise the screen—we call them "Readiness Criteria." We tried to structure it so that there would be at least some debate, but the discussion shut off pretty quickly. Any time you raise those types of issues, it usually means the front-end costs are higher. And nobody wants to spend too much on the front end if they still don't have a chance to win the competition. 

You really have to raise the screen pretty high in order to shut out enough people to create even a two-to-one applications-to-funds ratio. 

The smaller project issue should be explored. One other thing that should be explored is regulating the amount of credit annually that any one applicant can receive. That would likely scale down the applications.

Joan Ling: How would you compare that to limiting the number of applications or number of tax credits allocable to affiliated entities? 

Don Maddy: The difficulty in trying to limit applications is that people create entities whose affiliation can't be traced. This is a fairly common problem. You can try, but people heading different entities have relationships you are not aware of. 

Ronne, Related Capital works throughout the country. How equitable and sensible are California's tax credit policies relative to those in other large states like New York or Illinois? 

Ronne Thielen: It’s hard to say. Each state is doing the job it believes it needs to do in its own realm. In Illinois, for instance, large families may not be the major priority, while seniors are. And Florida has come down really hard on a test for equity and how much is paid for a dollar of credit. I happen to disagree, however, with Florida's position—both from a policy standpoint and from my perspective as someone in the tax credit investor business. 

If you limit project size or reduce developer's fees, then you're going to start eliminating some major players from the past. That can be very bad. A good, experienced developer can very easily lose interest in what they have, and just go on to something else. 

It looks like this program is going to be around for a long time, and it would be a shame to eliminate some good quality for-profit developers and larger nonprofit developers who work outside of the tight city areas. 

Don, The chair of the House Committee on Ways and Means recently asked that the GAO (1) determine the characteristics of the residents and properties that have benefited from tax credits, and (2) assess the controls of the IRS and the states to ensure that state priority housing needs are met and housing project costs are reasonable, and the state and project owners comply with program requirements. With that report now out; could you give us your assessment of its impact on California's Tax Credit program? 

Don Maddy: It was an extremely positive compliment to the tax credit program and the people who have been working in it for ten years. The program is working at a much higher level than expected in a couple of different areas. The average household benefiting from the program earns 37% of median income. Even if you exclude those receiving Section 8 assistance, the average income was still in the 40% range. That was a very positive surprise to all of us. All told, the average development­cost-per-unit surveyed came to $60,000. Some had expected that cost to be much higher.

The report's only primary criticisms were directed towards states that were not doing things that seem to work well in most other states. 

It could not have been any more positive. The many negative expectations driving the commissioning of the report were refuted. And it showed that the program is likely the most successful housing program we have had in this country in many years. 

Lance, do you wish to concur? 

Absolutely. It was remarkable lo read. It complimented the program and touted it as the most successful housing program we have ever designed for this country. 

A lot of time was devoted to talking about how the program has stimulated low income housing development. The criticisms were relatively minor. And this should lead everyone to conclude that, given the success of the program, it needs to be sustained, and perhaps, expanded. 

In fact, I have heard a lot of people saying that since we have such a successful program, we ought to look increasing the $1.25-per-head funding level we've had for the last several years. That would go some distance to address Joan's concerns about applications increasing as credits are decreasing with the loss of the national pool. 

Let me turn back to you one more time, Don. In the January TPR affordable housing roundtable, we began with a quote from the Sunday New York Times Magazine: "There probably aren't more than a dozen people who have read the 1996 year Housing Appropriations bill. Eye-straining type breaks new ground in the revision of the social contract. With one obscure sentence, the federal government has essentially conceded defeat in its decades-long drive to make housing affordable to low income Americans. The death of affordable housing—what a strange notion in a nation as spectacularly housed as this one." What are your thoughts as someone who has been a pivotal player in housing policy in California on that assertion? 

Don Maddy: Recently, I asked Secretary of Housing and Urban Development Cuomo a question following his speech about HUD's retaliation against the preservation program. 

There has been criticism that preservation presents potential audit problems and that preserving existing housing would be primarily a boon to owners. But I've never seen an Administration turn its back so quickly on a program for which so much blood was let on the table only a few years earlier. 

If HUD is not going to continue to ask for funding to preserve the existing portfolio, then it is all going to come in through tax credits or other programs. I see HUD trying to keep production of public housing and other products up by using other funding sources—local funding sources and tax credits, among other things. 

I never thought the Clinton administration would be against housing programs. But education programs, crime programs and welfare reform are the popular programs right now. All of them need a shot in the arm, too, but housing is absolutely essential if you're trying to build a community.

The root cause of many of these social problems begins with housing deterioration—you can see it in any neighborhood. The U.S. Senate's been trying to keep the funding numbers up, and the House is following the Administration's lead on most points. But I really hope that people take a much harder look at affordable housing's contribution to community-building.


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