The Tools to Build “80-20 Housing”
By Charles B. Katzenstein*

The barriers to new rental housing in Manhattan are enormous. Steep land prices, a scarcity of devel­opable sites, high construction costs and taxes and a formidable regulatory framework are just some of the deterrents to development. Yet, since the mid-1980s a confluence of benefits known as the “80-20 housing program” has led to the creation of much of the rental housing in Manhattan.

THE BENEFITS

The benefits of the 80-20 program are threefold¹: (a) Section 421-a real estate tax benefits; (b) tax-exempt bond financing; and (c) low income housing tax credits.

[1] Section 421-a Real Estate Tax Benefits

An 80-20 project qualifies for Section 421-a benefits even if the project is in the exclusionary zone (i.e., the area of Manhattan that generally is south of 96th Street and north of 14th Street does not qualify for these benefits). These benefits include a construc­tion period exemption (for up to three y­ears), so that the project is taxed on assessed value of the land only. This period is followed by a 20-year exemption from increases in real estate taxes due to the work.  There are full benefits for the first 12 years, with a 20% reduc­tion in benefits every two years thereafter. 

[2] Tax-exempt Bond Financing.

Financing costs are significantly reduced by tax-exempt financing that may be provided by one of two agencies in New York - the New York State Housing Finance Agency (“HFA”) and the New York City Housing Development Corporation (“HDC”)².  In its simplest terms, the agency issues tax-exempt “private activity bonds” that are used to pay for qualified project costs as per Internal Revenue Code Section 42.  Non-qualified costs are often financed with a much smaller taxable bond issue (called a “taxable tail”).  The bonds are secured, in part, by a mortgage covering the project.

[3] Low Income Housing Tax Credits

A qualifying project is entitled to Federal low income housing tax credits.  These credits of 4% per annum³ of a project’s “qualified basis”⁴ result in a dollar-for-dollar reduction income taxes and last for ten years.

THE REQUIREMENTS

To qualify for these benefits a project must meet the “80-20" rent and occupancy limits, satisfy the 95-5 test as to costs, and have certain physical characteristics.

[1] The 80-20 Rent and Occupancy Limits

The key characteristic of an 80-20 project is its mix of market rate and low-income apartments.  In order to maintain the tax exempt status of the bonds (and not lose the deductibility of the mortgage interest on the bonds), 20% of the apartments⁵ must beoccupied or available for occupancy during the “Qualified Project Period” at below-market rents, by Low Income Tenants.

The “Qualified Project Period” begins on the later of the date of issuance of the bonds or when at least 10% of the units are occupied.  The Qualified Project Period ends (i) when no bonds are outstanding; (ii) 15 years after occupancy of 50% of the units; and (iii) upon termination of a Section 8 Housing Assistance Payments contract, which ever occurs last.

Care must be exercised in the selection of Low Income Tenants in order to satisfy regulatory require­ments, avoid unfairness (and the appearance of unfair­ness) in the selection process and assuage any concerns of market rate tenants that their low income neighbors will detract from the “luxury”character of the pro­ject. The selection process starts with advertising in diverse media.  Potential applicants then have a lim­ited time period to request, complete and submit applications.  Submitted applications are picked at random, numbered and screened for eligibility. Acceptable tenants are then offered at least 12-month leases (units may not be rented on a transient basis).

Each apartment must have its own living, sleeping, eating, cooking and sanitary facilities; hotels, dormi­tories and the like do not qualify. 

In general no more than 5% of the total square footage of a mixed-use project may be set aside for non-residential space and no more than 5% of the pro­ject income may be derived from non-residential rents.

 Although tenant incomes must be re-certified annu­ally, rent increases are subject to Rent Stabilization limits (even if a tenant’s income exceeds a unit’s income limits) until the expiration of the Qualified Project Period when rents go to 30% of income.  The market rate units are also rent stabilized during the benefit period.

[2] Project Qualifications

The low-income units must generally be in propor­tion to the distribution of market-rate units (i.e., there must be a proportionate number of studio, one bedroom and larger apartments) and may not be physi­cally segregated in one section of the project. The square footage and location of units within a project are subject to agency review.

Under Internal Revenue Code Section 26, a project may consist of one or more contiguous, similarly de­signed buildings or structures containing five or more similarly constructed units, together with “function­ally related” facilities (such as a resident manager’s apartment, parking and recreational space for tenants).

[3] Qualified Costs; the 95-5 Test.    

At least 95% of the tax-exempt bond proceeds must be used for qualified project costs.  These include construction, land preparation, capitalized interest during construction, functionally related facilities (e.g., garage and recreational facilities) to the extent they are restricted to tenant use and other amounts charged to the project’s capital account for Federal income tax purposes. 

The cost of issuing bonds and developing commer­cial space are not qualified costs, although up to 2% of the face amount of the bonds may be used to pay the costs of issuance; and up to 5% of bond proceeds may be used for non-residential space and the costs of issu­ance.  If a project contains residential and commercial space, the capital costs of the common facilities and structural systems must be proportionally allocated between the two uses.  No more than 25% of bond pro­ceeds may be used for the acquisition of land.  Bond proceeds may not be used to acquire any existing struc­ture unless expenditures for rehabilitation made within two years after the later of the date of acquisition or the date the bonds are issued, equal or exceed 15% of the acquisition cost. 

PUTTING THE PIECES TOGETHER

As successful as it has been, 80-20 transactions are costly and complex, and the availability of bond financing is limited by the Federal bond cap alloca­tion.

[1] Bond Cap 

The availability of tax-exempt bond financing is limited by the annual $1.25 per capita “bond cap” imposed by Federal law. New York State has had an annual bond cap of approximately $908 million; and while there is usually enough for all qualified pro­jects, this may not hold true for a particular time period if there are other projects “on line” for bond financing.

[2] Getting Induced

The first step in obtaining 80-20 financing is to have HFA or HDC (as the case may be) take the formal step of passing an “inducement resolution.” Only costs incurred after (or shortly before) a project is induced will qualify. 

[3] Credit Enhancement

A variety of financial structures and terms are available depending upon what is acceptable in the capital markets of credit enhancement that are available. Whatever the structure, both HDC and HFA require that bonds receive an investment grade rating from Standard & Poor’s and/or Moody’s.  To achieve this, the bonds must be backed by a form of credit enhancement (with a mortgage of the project serving as collateral).  The credit enhancement may consist of (a) a direct pay letter of credit or conditional guarantee from a highly rated bank; (b) an irrevocable direct pay letter of credit, guarantee or mortgage insurance from a lesser rated institution which is backed by a surety bond from a highly rated surety or insurance company, (c) mortgage insurance from the Federal Housing Administra­tion, (d) a guaranty from the Federal National Mortgage Association (i.e., Fannie Mae) and (e) mortgage insurance from the State of New York Mortgage Agency. 

The credit enhancer usually performs many of the functions of a conventional lender. For example, during construction, the credit enhancer will monitor the progress of construction and authorize the disbursement of bond proceeds towards construction costs as the work progresses. 

ONLY IN NEW YORK

The 80-20 program works.  It works because of its package of benefits.  It works because rents on the market rate units are high enough to provide an inter­nal rent subsidy to the low-income units.  However the program also is a tribute to our culture.  Where else would one find such a mix of economic levels living side by side in the same building? As with many things, it is “only in New York.”

* Mr. Katzenstein is General Counsel to Rockrose Development Corp. and the author of The Law of Mortgage Commitments, which is published by West Publishing Corp. He is also Chairperson of the Programs Subcommittee of the Real Property Law Committee of the Association of  the Bar of the City of New York.  The author wishes to thank David R. Wine,  President, Related Residential Development (a division of The Related Companies L.P.),             

Kenneth G. Lore, Partner,  Swidler Berlin Shereff Friedman LLP, and Alan H. Wiener, President, American Property Financing, Inc. for participating as panelists in a program on 80-20 Housing moderated by Mr. Katzenstein at theAssociation on May 19, 1999.

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¹ This makes the 80-20 program markedly different from (and more politically palatable than) “subsidized housing” which involves annual budget appropriations and on-going bureaucratic administration.

² The New York City Housing Development Corp. also has a "taxable" 80-20 program in which taxable bonds are issued.  This article deals only with tax-exempt 80-20 financing.

³ Although referred to as the 4% credit, the actually percentage is determined by the Treasury Department based on a statutory interest rate-based formula.

⁴ A project’s qualified basis is equal to the product of its “eligible basis”  and the “applicable fraction.”  The “applicable fraction” is based on the number or area of the low income units versus the total number of units; the “eligible basis” is essentially the project’s adjusted basis for federal income tax purposes.

⁵ Federal law requires that at least 20% of units be occupied by those who earn no more than 50% of the area median income  (“Low Income Tenants”).  Alternatively, an owner may earmark 25% of a project’s units for households at or below 60% of area median income.  But the economics of New York City’s real estate market lends itself to the 80-20 formula and for “deep rent skewed” projects where average market rents are at least twice the average rents charged to Low Income Tenants.