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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   December 2013

Building Multifamily on a Budget

Learn how initiatives like New York’s 80/20 program give tax incentives to developers

Building Multifamily on a Budget

Commercial mortgage brokers typically try to find ways not only to make sure that their clients are getting into viable investments, but also to get clients the best possible returns on their investments. One way to achieve this goal is to take advantage of the various federal, state and city incentives available for developers. The savings provided by these programs can turn an unviable project into an attractive one.

The 80/20 program

One such incentive program is New York’s 80/20 Housing Program, aka 80/20 program. This program provides owners and developers with significant financial benefits to encourage multifamily rental development that includes an affordable-housing component. Through this program, developers can take advantage of several tax exemptions, tax credits and tax-exempt interest rates, including:

  1. An exemption from the New York mortgage-recording tax: This tax is 2.8 percent.
  2. A 421-a real estate tax exemption: This provides a full real estate tax exemption for all improvements to the land for the construction period (for as long as three years), and for 20 years thereafter (12 years in full and eight years in phase out) for projects with on-site affordable units.
  3. Low-Income Housing Tax Credits (LIHTCs): These are dollar-for-dollar credits against tax liability, typically equal to 4 percent of total development cost, which comes with tax- exempt bond financing. The developer can hold these credits and use them as a dollar-for-dollar credit against taxes or sell them in the open market and receive the proceeds over 10 years or a shorter period.
  4. Tax-exempt low interest rates: Financing can be at an all-in construction rate as low as 3 percent. Although today’s savings between tax-exempt and taxable rates are less, reviewing the historical relationship between taxable and tax-exempt rates, 80/20 tax-exempt interest rates have been about 1 percent lower than taxable rates.

Requirements

Under the 80/20 program, a developer must set aside 20 percent of the units for tenants whose income does not exceed 50 percent of the area median income. These units should be of comparable size to the market-rate units and be distributed evenly throughout the lower 60 percent of the building. No more than 50 percent of the low-income units may be allocated to any particular floor. The top 40 percent of the building can be reserved exclusively for market-rate units. These low-income restrictions may last for as long as 35 years.

Scenario

To illustrate the benefits clients can achieve through the 80/20 program, compare a $200 million 80/20 project with bond financing in New York City to the same size market-rate project developed with conventional financing. The 80/20 program can provide net financial savings of more than  $20 million in the first 10 years compared to the conventional alternative. It also provides additional financial benefits in the form of larger loan proceeds at lower interest rates, resulting in a reduction in required owner equity.

Here are the assumptions:

  • Total development budget (including land): $200 million
  • Total development costs (excluding land): $130 million
  • Building specifications: 250,000 square feet in total area, and 210,000 square feet in net rentable area
  • Rental rate of market-rate units: $75 per square foot
  • Rental rate of affordable units: $13 per square foot
  • Construction/lease-up period: Three years
  • Hold period: 10 years from stabilization (total hold period of 13 years)
  • Construction-loan amount: $130 million (65 percent loan to cost)

With total development costs of $200 million and a construction-loan amount of $130 million, an exemption of the 2.8 percent mortgage-recording tax results in savings of $3.6 million. These savings, however, are absorbed largely by additional fees associated with the 80/20 program (bond- issuance fee, New York State Housing Finance Agency (HFA) issuance fee, bond-underwriter fee, etc.).

Upon stabilization, a participant in the 80/20 program can receive an abatement of real estate taxes associated with the improvements to the land. For the first 12 years after the building is completed, the owner pays the real estate taxes only on the predevelopment land assessment and not on the value of the improvements. This provides 100 percent abatement for all improvements. Years 13 and 14 have an 80 percent real estate tax abatement; years 15 and 16 have a 60 percent real estate tax abatement; years 17 and 18 have  40 percent real estate tax abatement; and years 19 and 20 have a 20 percent real estate tax abatement. The real estate tax abatement expires at the beginning of year 21.

In comparison, the conventional financing scenario generally includes full real estate taxes estimated at  25 percent to 30 percent of effective gross income. Assuming real estate taxes are 25 percent or $18 per square foot, the exemption would provide annual savings of about $3 million in the first year. These savings could increase by as much as 3 percent each year for the first 12 years, as taxes are abated to the original assessment yet the property continues to appreciate in value. The total projected savings in the first 10 years exceeds $35 million.

Because of the requirement to set aside 20 percent of the units for low-income housing, revenues will be lower by about $10.75 per square foot, or $2.2 million per year, but they will increase about 3 percent each year. The total reduced revenues in the first  10 years total about $22 million. Based on these assumptions, LIHTCs provide savings of as much as $8 million.

In a nutshell, the 80/20 program provides:

  • Savings from real estate taxes in excess of $35 million
  • A reduction of rental revenue of $22 million
  • Additional proceeds of $8 million from LIHTCs
  • Total financial savings exceeds $20 million or $2 million per year over the first 10 years

Interest rates

Although today’s tax-exempt rates are close to taxable rates, historically tax-exempt rates, on average, have been 1 percent lower than taxable rates. When this relationship returns to previous levels, the utilization of the 80/20 program should provide additional  interest-rate savings of about $1.3 million per year in the previous example.

Additionally, the 80/20 tax-exempt interest rate typically is based on a trailing 52-week moving average. In an increasing interest-rate environment, the floating interest rate for the 80/20 construction loan will increase more slowly than a conventional construction loan that is based on Libor.

Loan proceeds

Because of the higher net operating income resulting from the 421-a tax exemption, the property should qualify for significantly more debt than it would without the exemption, even after taking into account the reduced revenues from the low-income units.

Applying underwriting criteria of 1.2 debt-service-coverage ratio and a loan-sizing constant of 6.4 percent  (5 percent interest rate, 30-year amortization), this increased net operating income would generate additional loan proceeds of more than $10 million, reducing the owner’s equity requirement.

• • •

As multifamily continues to be a strong property sector in today’s commercial real estate market, many commercial mortgage brokers’ clients will be looking to maximize their potential investments in this area. Initiatives like New York’s 80/20 program can help developers and investors get the funding they need to move forward with multifamily projects. Many New York developers have benefited from the 80/20 program’s operational savings and financial benefits. With today’s still-low interest rates, commercial mortgage brokers should be able to explain to their clients how the 80/20 program and others like it can help make their multifamily development deals more attractive. 



 


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