As renters face job losses and other economic uncertainties resulting from Covid-19 and recent unrest, government-subsidized rental assistance is a stabilizing factor in the economy. The U.S. Department of Housing and Urban Development (HUD) Rental Assistance Demonstration program (RAD), a program created in 2012, converts public housing and certain privately held housing into new rental assistance subsidy contracts, allowing private investment and creating a new pipeline of redevelopment transactions. RAD transactions, when paired with Low-Income Housing Tax Credits (LIHTCs), provide valuable and attractive tax incentives for private investors.
One component of RAD allows public housing to convert to long-term Section 8 rental assistance. There are roughly a million public housing units in the U.S., administered by over 3,000 public housing authorities. Funding for public housing is provided by the government, but it varies from year to year and does not keep up with housing needs. Much of this stock faces a backlog of capital needs and could benefit from redevelopment. Prior to RAD, the ability to recapitalize public housing was limited. Through RAD, these developments can receive a predictable revenue stream through a 20-year subsidy contract, transfer ownership to public-private partnerships, secure debt, participate in LIHTC equity financing, and benefit from more rigorous asset management.
To date, RAD has closed over 1,200 public housing transactions, repositioning over 130,000 public housing units. These transactions have secured over $9 billion in hard construction costs. It would have taken those housing authorities decades to accumulate that much through annual public housing capital funding.
Another aspect of RAD focuses on privately held properties subject to certain HUD financing programs with limited recapitalization ability, including the Section 8 Moderate Rehabilitation (Mod Rehab) and Section 202/Project Rental Assistance Contracts (PRACs). Mod Rehab and PRAC funding must be renewed annually, and the projects have often lacked the necessary replacement reserves to keep up with capital needs. Through RAD, these properties can receive 20-year rental assistance contracts that can be collateralized and therefore leveraged to create redevelopment opportunities that were unavailable without those long-term contracts.
In other words, we can now redevelop these public housing, Mod Rehab, and PRAC properties, doing deals where we couldn’t before.
RAD has yielded great results. A 2019 study of public housing RAD properties by HUD’s Office of Policy Development and Research (PD&R) found that over 90% of residents surveyed stated that their housing was better as a result of RAD. RAD properties were able to address their capital needs and improve their physical condition, while the capital needs increased in non-RAD properties. RAD properties demonstrated greater liquidity and greater financial viability, while non-RAD properties demonstrated significantly greater risk of financial failure over the same time period. This RAD success has also led HUD to develop other public housing repositioning tools to allow for public housing redevelopment.
The risk in these deals is low because the operating income is known ahead of time. A RAD unit’s rent is set contractually and consists of a tenant rent portion and a rental subsidy portion. Tenant rent portions are limited to 30% of the household’s income. When tenant incomes drop, their portion of the rent drops, too. The government is contractually obligated to provide rental assistance subsidy to make up the difference up to the contract rent. The rent to the property owner stays the same.
The challenge is RAD rents tend to be lower than market. Many potential RAD transactions do not work without additional funding. This is why pairing LIHTCs with RAD is such a powerful combination. LIHTCs provide tax credits and depreciation losses to investors over 10 years in exchange for up-front equity investment. That equity investment provides the necessary capital, filling the gap in the development budget between the debt the project can support and the amounts needed to complete the project. Over 40% of RAD projects use LIHTCs, but there’s room for more. While the availability of competitive 9% LIHTCs is limited, most states do not use their full allocation of tax-exempt bond volume cap, which generates 4% LIHTCs as-of-right.
LIHTCs are excellent investments. A 2018 study by Cohn Reznick found that LIHTC properties experience foreclosure at rates far below 1% and far lower than conventional multifamily real estate rental properties. Even during the post-2008 foreclosure crisis, when conventional foreclosure rates increased above 4%, LIHTC properties experienced average foreclosure rates of less than 0.1% every year since 2000. At the same time, participant investors reported yields of 0.7% to 4.2% above the yields expected at closing.
Together RAD and LIHTCs are powerful tools for advancing the public interest while offering investors valuable benefits. Now more than ever, with economic uncertainties growing as a result of Covid-19 and nationwide protests, these transactions offer the opportunity to preserve affordable housing for our nation’s most vulnerable residents, strengthen low-income communities, and bring jobs to areas in need of reinvestment, all while generating low-risk returns for investors.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Kathie Soroka is counsel with Nixon Peabody in New York. Kathie served as Senior Counsel to the General Counsel at the U.S. Department of Housing and Urban Development (HUD) during the Obama administration before becoming counsel in Nixon Peabody’s Affordable Housing practice group.