TPR Roundtable: TCAC’s New Allocation Policy Analyzed

In the July issue of The Planning Report, Don Terner of BRIDGE Housing said that what we need for affordable housing producers "is long-term lending and well-oiled machinery capable of dispensing tax credits.'' He went on to say that "the current tax credit round is a disaster riddled with problems." Is the newly released Qualified Allocation Plan (QAP) from TCAC a step in the right direction? 

Phyllis Klein (PK): It is the belief among the lending community that there are problems with the current Qualified Allocation Plan (QAP) relating to quality control and long-term reduction in costs. This is significant to the long-term lending community, as lenders are in the project for 30 or more years. 

The concern about cost-competitiveness in the new QAP is that developers will produce projects to the lowest costs available in order to compete. Driving down costs may drive down quality. The concern is that the developers of projects necessarily have the least amount of long-term risk in the project. The investors and lenders are financially committed to the project for 15-30 years. Quality is therefore a top priority. 

What has been excellent about the tax credit program in the past has been the quality of the developments produced. That is why lenders have flocked to this field. 

Nancy Javor (NJ): The current QAP has a number of problems, not the least of which is the reliance upon the 22l(d)3 limits for cost control. Reducing costs per project is an admirable goal, but I think the use of 221(d)3 limits, which are based on HUD mortgage loan limits, is not an accurate measure of development costs in California. The National Council of State Housing Agencies acknowledged that when they cautioned states using the 221(d)3 limits to provide additional scrutiny and recognize that they don't work in either high-cost or low-cost areas. 

Don Maddy has said that his two goals are lower rents and efficient use of credit. Are those appropriate goals? Is it the misapplication of guidelines, or should there be other goals as well? 

PK: I think that those are worthy goals. All the lenders would agree. We have seen projects that have definitely cost too much money. Cost is an overall concern. I think also there should be another factor of need. You need to build these projects where the need is definitive, not simply "build it and they will come."

GS: I'm totally supportive of the goal of cost-cutting. We've been striving in the City of Los Angeles to cut development costs and to encourage projects that use fewer public dollars and which have a lower overall cost. However, the QAP is putting forward a cost-containment criterion that doesn't work on a state-wide basis. 

They're using a federal mortgage premise—the 221d(3) limits—which are very low for urban areas and fairly generous for rural areas. Limitations on housing costs in rural areas are actually higher than the actual cost of development. The caps on urban areas are actually much lower than the actual cost of development in the urban areas. Urban areas are unable to compete; rural projects can actually have higher costs than they have had historically and still be competitive.

Will the new TCAC allocation process be more predictable?

Gary Squier (GS): The extent to which the City of Los Angeles projects are going to be competing on the affordability side, the process will create predictability. We will know exactly where our projects will rank with respect to other cities because we know what fair market rents and project rents are likely to be. Unfortunately, we can only compete for 50 percent of the allocation because our new construction projects are not competitive on the cost competition.

Mayor Riordan recently wrote a letter [excepted in this month's TPR] to Governor Pete Wilson, State Treasurer Matt Fong, and State Controller Kathleen Connell, arguing that the tax credit committee was considering changes that would cost Los Angeles $35 million in lost housing investment, 1,000 jobs and 750 affordable housing units. What is your reaction to this letter from Los Angeles' Mayor? 

PK: I think that he is absolutely right. I think it greatly affects the urban and suburban areas. Union Bank funds projects throughout California; our projects in the San Jose-Santa Clara region, the Peninsula region and Los Angeles will be affected greatly. The concern is that there have been abuses of the program on the cost side, but TCAC needs to look at the abusers and direct attention to that issue rather than trying to gear the program to meet the lowest cost standard. 

It obviously costs a lot less to build in Fresno than it does in Los Angeles, and there are a multitude of factors that affect it. One factor is land cost; a second factor is affordability. An affordable unit at 60 percent of median in Los Angeles is a good percent below market. In Fresno that rent level could be at or even above market. By building 60% median rent units in Fresno or in Los Angeles we're not accomplishing the same goal in terms of creating more affordable units. Obviously Fresno needs affordable units as well as Los Angeles, but there is a differential in need. 

GS: The Mayor's letter was based on a draft of the QAP which was subsequently amended. The amendments were distributed 10 minutes before the meeting with the TCAC. Those amendments, which were distributed at the meeting included provisions that allowed projects in urban areas to increase their allocation of tax credits to partially offset the disadvantage that they were experiencing under the original proposal. In summary, the $35 million referenced by Mayor Riordan has been offset to some extent by the QAP. 

What do you believe the unintended consequences of the new TCAC policy will be?

PK: The problem is that developers will necessarily be trying to gear projects to the program instead of what makes a good real estate project. We've taken real estate considerations out of the criteria of what is a good tax credit project. I think that we're forgetting the bottom line—these are real estate transactions. This will greatly affect what will be produced.

GS: There will be a shift of resources from high-cost areas to smaller communities where housing need is lower. In some of those communities, which are already experiencing high vacancy rates, tax credit-subsidized projects will be built and put into competition with existing housing stock. These projects will draw tenants from older buildings that are already experiencing cash flow problems, and which may suffer consequences, perhaps even foreclosure. The effect could be profound in certain communities, where unsuspecting property owners will be faced with competition from new construction projects that are driven not by market considerations, but by the availability of the subsidy. 

NJ: I think one of the unintended effects of the QAP is that the cost limits for lower cost areas, for example in the Central Valley, will have no incentive to control the cost per project. If the intention of the QAP is to drive developers to control costs statewide in a fair and equitable manner, the unintended consequence is that it will do just the opposite in vast areas of the state because the 221(d)3 limits are higher than average development costs in those areas. 

I think the other unintended impact of the QAP is that it does nothing to control costs. One of TCAC's primary goals is to eliminate the very high cost projects, some of which we've seen developed in the LA area. Since the cost limits control only the eligible basis, or the amount that you're requesting for tax credits, you could still have a project costing $250,000 per unit get tax credits as long as they receive sufficient subsidies to make the project feasible. 

Between now and December a variety of requests for loans will come across your desk. What difficulties will these proposals likely have in meeting your requirements and being successful for tax credit allocation? 

NJ: Bank of America works on a statewide basis. We have a number of borrowers that are pleased by the current QAP because they'll do quite well under the current costs limits. Projects in lower cost areas—throughout the Central Valley—will do well. The areas that will be hurt will be the higher-cost, highly urbanized or coastal areas. Looking at it from a statewide perspective, I think that there will be a number of applications from jurisdictions in high-cost areas where developers may feel forced to reduce their costs in areas that, as lender and underwriter, are of great concern to us. 

We want to ensure that we're financing quality projects that meet the needs of the community and the end users—the tenants. We want to see adequate operating expenses budgeted for the long-term viability of the project. No project budget should be jeopardized simply to meet the ranking and rating criteria of the QAP. 

Elaborate for our readers on the following QAP provision: ''The tie­breaker in the affordability competition changed from credit utilization criteria to the percentage amounts the proposed rents are below fair market rents." 

GS: The original proposal affords projects and sponsors the choice between being evaluated in terms of affordability or being evaluated on project cost. If the developer chose to compete in what is called the affordability pool, the formula was structured so that all projects would write rents down to an equivalent level. This means that all projects coming in under that category would be given the same rank and TCAC needed a tie-breaker. 

The tie-breaker originally proposed would rank projects according to their development costs. Thus, projects coming in under the affordability side actually would be ranked in terms of development costs in the same way as projects that were being ranked under the cost competition. The industry felt that this created a situation where projects were being evaluated only in terms of development costs and that development costs were not being weighed fairly among communities.

The ultimately approved proposal by TCAC did not use development costs as a tie-breaker. Instead, the QAP uses the difference between HUD fair market rents and project rents to rank proposals. The revised proposal says to Los Angeles that its projects will be ranked among projects from other cities based on relative affordability. Because Los Angeles fair market rents are quite high and project rents quite low, Los Angeles projects will probably compete well on the affordability spectrum.

Gary, what impact do you think the new policy will have on your responsibilities in Los Angeles.

GS: The QAP will allocate tax credits to Los Angeles, but we must compete with high costs areas for fewer credits. Half of the credits will go to projects that compete on affordability, the other half will go to projects that compete because they have lower development costs. Virtually 100 percent of the urban new construction projects will be forced to compete to the affordability side of the competition. This means that the other half of the resources have been restricted to non-urban areas. Unfortunately, large cities make up about 80 percent of the demand for tax credits. So we will have increased demand for a smaller resource pool. 

Nancy, some have suggested in reaction to the release of the QAP that San Francisco will be hurt even more than Los Angeles. 

NJ: I would say that is probably true. At this point, I think Los Angeles has shown some foresight by coming out with a Notice of Funding Availability (NOFA) for fairly substantial dollar amounts that can be matched with conventional lenders to apply for tax credits in the first round. San Francisco has made it fairly apparent that they're not going to have sufficient time to prepare an RFP before the first round. I think that San Francisco is also at a disadvantage because the cost of projects in San Francisco is even more expensive than in Los Angeles—they have greater densities in a smaller geographic area, which requires in-fill on smaller sites and drives up land costs and development costs. They typically need underground parking, and multi-story buildings that will be required to have elevators. Their sources of funds usually also trigger the necessity for prevailing wages, which will also drive up the cost.

Lastly, Nancy, if you were the tax credit czar, how would you modify the TCAC program?

NJ: I think the committee was in a tough position because of pending Congressional actions on the tax credit program. I think it was apparent at the public meeting in late September that the TCAC committee members feel that they bad to adopt a plan—they couldn't delay. They needed to show that California was moving forward with the tax credit program; I think that's why you saw a motion to conduct an evaluation after the first round. If l would have any recommendation, it would be that between now and the end of the first round, TCAC staff take this as an opportunity to meet with industry representatives and come up with a better methodology than the use of the 22l(d)3 limits.