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LIHTC Average Income Test: A powerful tool for preservation

June 20, 2019

As the LIHTC community comes to terms with the new Average Income (AI) test, much of the conversation has focused on AI’s value as a tool to promote a broader income mix -- or on concerns about AI’s complexity and compliance risks. 

But POAH (or Preservation of Affordable Housing, Inc.) is most focused on another facet of AI: its positive impact on preservation transactions. First and foremost, we view AI as a powerful tool to support renovation and extension of affordability for existing affordable housing properties with expiring use restrictions, mounting capital needs, or both. 

Since 2001, POAH has acquired, renovated, and extended affordability protections for 63 properties using the 4% LIHTC.  In more than half of those transactions, at least one unit was excluded from LIHTC basis – on average more than 10 units per transaction – often because the existing occupants were “over-income”, relative to the LIHTC program’s 60% AMI cap.  Rather than displace over-income households, POAH has typically omitted these units from the LIHTC affordability restrictions – and from the calculation of LIHTC eligible basis.  This has translated into a loss of up to $125,000 per unit in 4% LIHTC equity which could otherwise have supported increased rehab scope or reduced the demand for scarce state and local gap resources.

Now, with the advent of AI, preservation sponsors like POAH will be able to capture a new band of previously over-income households, between 60% and 80% of AMI, within LIHTC basis – protecting their units’ long-term affordability and generating significant new resources.  The AI strategy aligns well with the preservation of aging assisted properties, which often feature project-based rental assistance (which can accommodate lower-AMI designations) and/or other subsidy sources, like HOME, which may have required a moderate-income tier (corresponding to the higher-income AI designations).  Until enactment of a “grandfathering” option for over-income households, AI is the best tool we have for this purpose.

POAH’s first AI effort, the preservation of a mixed-income suburban property that launched in June 2018, is capitalizing on this opportunity.  The property has 11 households in the 60-80% AMI band – their units will be included in the LIHTC use agreement, generating more than $1M in new equity which will support replacement of aging HVAC equipment, reducing utility costs and improving resident comfort. This deal illustrates how AI can help leverage critical preservation resources to ensure greater affordability in a high-cost market.

Early experience suggests that LIHTC allocating agencies’ AI guidance should be relatively flexible in order to fully capture IA’s benefits for preservation transactions, which – unlike new construction projects – need to respond to the existing circumstances of a property and its residents.  Requiring that AI properties be 100% LIHTC, or requiring a uniform income mix across bedroom sizes or buildings, may be desirable in principle. But in practice, most existing properties have a more or less uneven income mix across their units and buildings, including some over-income households – and so if applied inflexibly, such requirements will preclude many communities from accessing AI’s benefits.

AI’s critics have argued that it introduces complexity and increases recapture risk – and they are not wrong.  But regulatory complexity and compliance risk are not new problems in the preservation field, and the industry has demonstrated time and again that these can be overcome with the right mix of vision and attention to detail. POAH is confident that experienced preservation sponsors can enhance their existing compliance regimes to contain AI’s risks.

For POAH, the AI compliance strategy starts with conservative underwriting designed to reduce the impact of individual non-compliant units, including a low-income percentage well over 40% and an average income designation below 60%, and a substantial discount to market for unassisted LIHTC unit rents.  Ongoing AI compliance needs both strong infrastructure – a detailed compliance policy, property management software with AI functionality, ongoing training for site staff – and focused, real-time oversight from the corporate compliance team and support from third-party compliance experts.

In the final analysis, the scale of AI’s benefits for some preservation transactions far outweighs the cost of managing its incremental complexity. That’s why we at POAH are excited to work with our partners in the LIHTC community, including LIHTC allocating agencies, to deploy this powerful new tool to advance our shared preservation mission.

Photo: Bedford Village (Bedford, MA) will be the first POAH community to use income averaging