PUBLIC-PRIVATE PARTNERSHIPS FOR AFFORDABLE HOUSING

ROBERT J. SHEEHAN

There is a strong trend towards public-private partnerships to provide affordable housing. In many cases, the term public-private partnership is misleading. It connotes, at first glance, an image of a private sector for-profit business working in parallel, perhaps as an equal partner, with the public sector to provide some societal benefit - in this case affordable housing. But, the concept is not that simple.

The U.S. General Accounting Office (GAO) defines public-private partnerships as joint efforts between public and either private for-profit or the private nonprofit sector. The addition of nonprofit sectors adds another dimension, and in a growing number of cases all three types of entities are involved in a partnership. A partnership traditionally signifies that both the public and private partners share risks and responsibilities. Shared risk means that each partner could lose resources.

This article reports some of the preliminary findings of a study that our firm (Regis J. Sheehan and Associates) participated in as a member of a consortium of Canadian and United States consulting firms for the Canadian Housing and Mortgage Corporation (CHMC). CHMC is a government-sponsored corporation whose role is a combination of the role of Fannie Mae and the housing funding and research functions of the U.S. Department of Housing and Urban Development (HUD). As in the U.S., budget pressures in Canada effectively curtailed all funding for new nonprofit housing. CHMC has shifted its attention to finding alternative approaches to address the persisting low-income housing need.

Expanding the potential of public-private partnerships is one element in the search for new mechanisms. Although efforts in the public-private partnerships to provide affordable housing in the United States are directed toward homeownership, the emphasis here will be given toward their role in rental housing.

THE EVOLUTION OF FUNDING SOURCES

The new financing and funding mechanisms and partnerships 'that prevail today have evolved over the past 17 years. They evolved in an attempt to fill the void left by the cutbacks in federal funding for new housing construction made between 1981 and 1986. There were fundamental problems in the production of affordable rental housing with the federal cutbacks. With the limitations in total rental income from low-income households, affordable housing owners were faced with limited capacity to leverage debt financing from the rent stream, negating high levels of repayable debt.

Several factors were developed or became more refined in the early 1980s to help overcome cuts in federal funding for specific housing programs and provide a base for the increased use of public-private partnerships. They included: More active local government in housing assistance programs that still involved federal funding through various grant programs such as Community Development Block Grants; Better organized and more motivated community development organizations; More reliance on the ability to raise low-cost capital through state and local housing finance agencies, primarily through tax-exempt bonds; Development of mechanisms by banks and thrifts to meet the legislative requirements of the Community Reinvestment Act of 1977 for greater investment in low-income communities; and Expanded use of local government regulatory powers directed to encourage inclusion of affordable and low-income housing in new developments.

Public-private partnerships have begun to earnestly shape public policy since the mid-1980s. Legislation and policy were developed purposefully to reinforce and expand the potential and scope of public-private partnerships. New partnership models and mechanisms continue to evolve in an opportunistic fashion.

A watershed event arose in the means of producing affordable housing through partnerships that came with the passage of the 1986 Tax Reform Act. The act removed many very favorable tax provisions of the 1981 Economic Recovery Tax Act (ERTA). ERTA eliminated preferential treatment of capital gain for rental housing, reduced the depreciation period for investment properties, and imposed 'passive loss' restrictions on using losses from investment properties to offset tax liability on ordinary income. Reducing the marginal tax rates in the Tax Reform Act also reduced the value of the remaining deductions.

Most important to affordable housing was that the 1986 Tax Act introduced the Low-Income Housing Tax Credit (LIHTC). The LIHTC provides substantial tax benefits to investors in low-income housing, and in a sense creates the largest means of creating public-private partnerships. It is now the most significant incentive for affordable rental housing production in the United States. The Enterprise Foundation estimates that 94 percent of affordable rental housing production in the U.S. involves the LIHTC. It involves selling a stream of tax credits which private investors can use to reduce taxes annually over a 10-year period. Rental projects obtain infusions of equity from the sales of the tax credits, with no associated debt service costs (essentially free money).

The LIHTC also has a very substantial impact in expanding the institutional infrastructure around low-income housing production. Equity funds have been established by a number of states, localities, and major national intermediaries as conduits to assemble and allocate tax credits.

Partnership opportunities gained further opportunities through the 1990 National Affordable Housing Act through its HOME Investment Partnership Program. HOME provided federal funding to 'participating jurisdictions' based on the development of broadly defined affordable housing: strategies and state or local housing programs. The local initiatives could include resident-based rental assistance, new construction, and rehabilitation, and also may provide rental or homeownership assistance.

Stimulus for private sector participation in public-private partnerships in the 1990s became reinforced by three important pieces of federal legislation: The 1989 Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) imposed community lending of Federal Home Loan Banks and mandated public disclosure of Community Reinvestment Act ratings of individual institutions. FIRREA requires FHLB members to allocate 10 percent of their annual income to an affordable housing program; The 1992 Federal Housing Enterprises Financial Safety and Soundness Act required Fannie Mae and Freddie Mac to expand their secondary mortgage market programs to better accommodate affordable housing development and included specific targets for the purchase of multifamily rental loans for low-income housing; and The 1992 Housing and Community Development Act required HUD to implement measures to make credit more available through enhancements to induce private lenders to originate affordable housing loans and to encourage investors to buy these loans.

THE STUDY

A layering of sources for financing and partnerships is required to make most affordable new rental housing developments work. The myriad of tools and mechanisms for affordable housing created and/or refined since the early 1980s has produced many innovative public private partnership models that have worked.

The study has summarized 15 case studies. Five involve project-based partnerships for new rental development, three rehabilitation projects (one involved rental units), three represent new construction homeownership, and four involve ongoing partnerships all dedicated to increasing homeownership.

The five project based new rental developments were initiated and developed by community-based nonprofit organizations in partnership with public agencies and private lenders. Selected for presentation here is a case initiated by a private entrepreneur involved in a mixed commercial-residential use rehabilitation. The number of rental unit involved is small, but the case represents an idea of a partnership that may be duplicated or used in some form on a larger scale.

PUBLIC PRIVATE PARTNERSHIP CASE STUDY FROM PORT JERVIS, NEW YORK 

This project involved a mixed commercial-residential rehabilitation with 10 apartments and was initiated by a private entrepreneur who owns and operates a number of other mixed-use small developments. Although he operates the property on a for-profit basis, he is able to maintain the affordable rents in compliance with HOME regulations as a result of the public funding involved. He provided $293,000 of cash equity for the acquisition/rehabilitation.

A small building loan program, operated by a state-wide New York nonprofit lender consortium, provided a conduit for private financing. Public funding was provided through the city allocations of Community Development Block Grant (CDBG) and HOME funds. The housing is privately owned and operated but a covenant is placed on the property as a condition of the HOME funds restricting rents and incomes of residents.

The property was in a poor state of repair when the former owner was foreclosed. An established restaurant/tavern operated in part of the commercial ground floor space and the restaurant owner, already experienced in some real estate development involving mixed residential/commercial with affordable rental, purchased the property. The city of Port Jervis wanted to see the historic building rehabilitated as part of an overall effort to revitalize the downtown area.

The Community Preservation Corporation (CPC) is a nonprofit mortgage lending consortium of commercial banks, savings institutions, and insurance companies established in the City of New York in 1974 to finance affordable housing. The state passed special legislation enabling the State of New York Mortgage Agency (SONYMA) to package the secondary market loans originated by the CPC. SONYMA was able to do this by providing mortgage insurance on 100 percent of the mortgage. This in turn permits state pension funds to purchase these loans for their portfolios.

In a recent initiative, CPC has developed a new lending program specifically targeted to provide rehabilitation financing to owner/occupants of buildings with 20 or fewer units. The Small Building Loan Program provides technical support and advice, offers faster and simplified loan processing, and offers a construction loan at prime plus one (compared to prime plus 2 percent for more typical CPC construction financing.)

OTHER PARTNERS/FINANCIAL INVOLVEMENT

The CPC provided a construction loan for a 12-month period at prime plus 1 percent. CPC also placed the permanent funding with the New York State Common Retirement Fund (CPC continues to service the loan). This is a fixed rate loan with a 30 year term. Other financing included: Orange County - using its allocation of HOME funds from HUD; City of Port Jervis - using its allocation of CDBG funds from HUD Public Funding Programs Accessed; Small City CBDG allocation; and Orange County HOME allocation.

PACKAGING

CPC requires the county HOME funds and City CDBG funds to be used first, prior to drawing on the CPC construction loan and after the owner's equity. Because the public subsidies were interest free, this minimized interest carry charges on the funds during rehabilitation. Using the public funds first also mitigates risk for the private lender consortium.

The HOME loan is a soft second mortgage. It is registered as a co-second mortgage but carries no interest and is fully forgivable after 15 years if the property continues to comply with the covenant restricting rents and incomes. The loan provided with CDBG funds is also interest free but is repayable over a 20-year term.

IMPACT ON AFFORDABILITY

After renovation, the property will have 10 apartment units renting from $375 to $425 per month, affordable to households earning below 80 percent of area median income.

KEY FEATURES/INNOVATIONS

The project, initiated by a private entrepreneur, entailed significant private sector involvement. The CPC consortium was a significant participant, using a small property loan fund, providing construction financing, and originating permanent financing for resale to a pension fund investor.

Public funds total $325,000 and represent only 35 percent of total cost/financing. However, public funds were critical to the participation of the private lender in reducing loan to value ratio and risk. U

Sheehan is a vice president with Regis J. Sheehan & Associates, McLean, Virginia, and serves as NAA's economist.