Affordable housing developers struggle as key funding source disappears

The Lynhurst Park Apartments was among the first new rental projects in southwest Indianapolis in years when it opened
in 2006.

The 154 units come with a pool, fitness center and laundry hookups. A spacious one-bedroom apartment
rents for as low as $548 per month. A four-bedroom, two-bathroom unit goes for as little as $829 per month.

It’s
no surprise that there’s a wait list for many of the units, which are reserved for individuals
and families with incomes below the Indianapolis-area medians. Herman & Kittle, the owner and developer,
wants to build 62 more units and even has the backing of federal low-income housing tax credits, which
are worth nearly $690,000 a year.

But nothing can happen until the local developer finds
a tax-credit investor. The Indianapolis company was working with a bank this month
on a deal that could close in September or October.

“Every transaction is more difficult and takes more
work,” said Todd Sears, vice president of finance for Herman & Kittle. “It can have an
indirect effect on the amount of units that get built.”

Affordable
housing developers nationwide are facing a drastically weaker market for tax credits. Fannie
Mae and Freddie Mac, which were major tax-credit investors, have exited the market. Other investors—chiefly
banks and big corporations—are losing money, and therefore don’t need to invest in credits
to offset their own income tax liability.

The Jefferson Apartments project at the corner of East 10th Street and Jefferson Street is being developed
with federal tax credits. (IBJ Photo/Robin Jerstad)

Without tax-credit investors,
affordable housing projects are like broken-down cars with full tanks of gas. Developers—both
commercial and not-for-profit—sell the credits, and use that money as equity
to attract conventional financing at a lower cost.

In Indianapolis, 11 projects received
a combined $9.9 million in annual tax credits in July 2008. More than a year later, about 40 percent
of those tax credits remain unused.

“At this point, if a deal hasn’t closed
on these, then they’re concerned,” said Jacob Sipe, a manager at the
Indiana Housing and Community Development Authority. The IHCDA decides which projects in the state
will receive some of the federal allocation.

Developers who received credits in 2008 have until the
end of 2010 to line up all their financing, build or renovate, and open apartments to renters. If developers
don’t use the credits, the U.S. Treasury can redistribute them to another
state.

One not-for-profit developer that’s counting itself lucky is the John H. Boner
Community Center, which is renovating and building 18 apartments and two condos
on the near east side. The Jefferson Apartments will become a “homeownership incubator,”
where residents get help finding jobs and cleaning up their credit, so they might
one day buy homes in the area.

James Taylor, the Boner Center’s executive director,
said he had no problem lining up National City Bank to buy $413,000 in annual credits last
fall. (The credits are good for 10 years.)

Then, in January, Cleveland-based National City canceled all its tax-credit
deals because of its sale to Pittsburgh-based PNC Bank.

Considering the turmoil in the financial
markets at the time, Taylor said he was worried there would be a major delay. But
in March, the Boner Center attracted M&I Bank, which provided a construction
loan and is scheduled to close on the credits this fall.

The Jefferson Apartments are the
cornerstone of a grand plan for neighborhood revitalization. It sits within an area that the Super Bowl
2012 host committee has adopted as its “legacy project.”

Taylor thinks the Super
Bowl tie helped attract Milwaukee-based M&I to the deal.

“We were just really
fortunate that M&I was able to see how this furthers their corporate objectives
here in Indianapolis,” he said.

Finding investors

With
Fannie and Freddie out of the picture, developers are competing for a much smaller pool of potential
investors. Jack Brummett, who runs a Lansing, Mich.-based investment pool from Indianapolis,
thinks Fannie and Freddie accounted for nearly half the activity in what was once a $9-billion-a-year
industry.

“Now they are zero,” said Brummett, senior vice president of the Great
Lakes Capital Fund. The fund invests in affordable housing projects in Wisconsin, Michigan, Illinois,
Indiana and upstate New York.

Great Lakes and other tax-credit peddlers are targeting banks.

Banks have an added incentive to invest in affordable housing because they must mind federal laws
against discriminatory lending. Investing in low-income housing tax credits helps the banks meet Community Reinvestment Act
requirements.

These days, national and regional banks can choose the best projects from multiple regions, and
they’re showing little interest in the Midwest. So Brummett launched a fund for small, Indiana-based
banks.

“The Indiana community banks are profitable,” Brummett said. “There are very few of
them that entered into the subprime market.”

Brummett said the new Indiana Community
Fund will have a much lower minimum investment, $250,000, rather than the typical
$1 million. He hopes to grow the fund to $15 million to $20 million.

If the community banks wade in now, they
can buy credits for 55 cents to 75 cents on the dollar, compared with 80 cents to 90 cents a year ago.

The credits are a wise investment, Brummett argued.

“We’ve never had
a foreclosure. We’ve never had a recapture of credits,” he said. “And we’ve never
asked an investor to put in more money than they committed to.”

Developers are eager
to see Brummett succeed.

“It’s a different ballgame out there than it was three years ago,”
said Bill Gray, executive director of the Riley Area Development Corp.

High-profile
successes

A not-for-profit developer, Riley Area has led such high-profile affordable-housing
projects as the Davlan Building on Massachusetts Avenue and the Rink Savoy at Vermont
and Illinois streets.

In April, Riley Area received $1.2 million in annual credits for Trail
Side on Mass Ave. The $10.6 million project calls for 63 one-bedroom apartments and 25,000 square feet
of retail space on the east end of the high-density corridor.

Riley
Area received another $658,000 for the St. Clair Apartments, a 33-unit senior housing project planned
in conjunction with the Boner Center.

The tax credits wouldn’t be the only resource
to go to waste if developers fail to attract investors. Local government and not-for-profit organizations
often foot the bill for pre-construction work.

At the Jefferson Apartments, for example, the city made a $500,000
bridge loan from its federal block grant allocation so the Boner Center could acquire a vacant building
and land for parking. The Boner Center received another $800,000 in grants from
four sources: Marion County Housing Trust Fund, United Way of Central Indiana, the David M. Cook
Foundation and the Indianapolis Neighborhood Housing Partnership.

“It’s a $30,000
to $100,000 process to even get a successful tax-credit application,” said Bill Taft, executive
director of Local Initiatives Support Corp. in Indianapolis.

LISC provides startup money
to inner-city developers so they can hire architects and consultants and perform
environmental tests. The not-for-profit has put forward about $200,000 in grants, enough to fuel
four projects.

Taft said LISC intends to recover that money once investors are on board,
and use it to fund a new round of planning for affordable housing.

“Right now, that’s
sitting stagnant,” Taft said. “Projects are not moving forward.”

Stimulus
infusion

Relief is in sight. In July, Indiana received $164 million in federal grants to
provide a dollar-for-dollar swap of credits for cash. The Indiana Housing and Community
Development Authority will provide the cash as long as developers can attract an investor to at least
a portion of their tax credits, Sipe said.

“We’re trying to help as many as we can,” he said.
“There’s still a limited supply of equity in the market today.”

Rural
projects, like one Herman & Kittle has proposed for Richmond, are especially difficult. Banks
collect fewer deposits in rural areas, so the bar for lending under the Community Reinvestment Act is
lower.

Sears said investors, especially on the coasts, also are less convinced of the need
for new affordable housing in small towns.

Herman & Kittle got its start in
rural areas and gradually moved into urban projects. The company recently landed Cleveland-based Key
Bank as an investor and construction lender for a 70-unit project at 34th and Meridian
streets called Thirty-four North.

Herman & Kittle is working with the Julian Center,
a domestic violence shelter, which will own the apartments.

Sears said
Herman & Kittle, which is privately held, plans to stay in the affordable housing business, but will
be more selective.

“This change has really put an emphasis on having strong partners
who are able to bring viable, feasible transactions,” he said.•