HUD releases unexpected LIHTC income limits

HUD recently released its LIHTC income limits, and there’s some good news and some bad news.

HUD’s surprising announcement

Each year, the United States Department of Housing and Urban Development (HUD) releases a dataset known as the Area Median Income (or “AMI”) calculation, which is used to determine resident eligibility for HUD-assisted housing programs and Low Income Housing Tax Credit (LIHTC) properties. Industry participants watch this release closely because it benchmarks allowable rental amounts for the coming year, and, in some cases, may have a major impact on the viability of new projects under development. The good news is that the income limits increased in 98 percent of the HUD-covered jurisdictions, which means that more residents can potentially qualify for HUD housing programs.

However, the bad news is that HUD caps on income limit increases impacted nearly 87 percent of HUD-covered jurisdictions, meaning that developers and operators may find themselves restricted to rental limits significantly less than anticipated.

To understand why 87 percent of the jurisdictions are capped and why this matters, it is first necessary to understand the factors driving the income limit increases.

A brief history of area median income (AMI)

Eligibility for HUD housing programs is driven by the “area median income” for a given defined jurisdiction, defined as the midpoint where half of the families in that area have a gross income (before taxes or expenses) that is more than the median and the other half have a gross income that is less. In each area, households that earn between 0 - 30 percent of the AMI are considered to have “extremely low income” and households that earn between 31 - 50 percent are considered to have “very low income (VLI).”

AMI is not a static metric; the figures change in response to prevailing economic conditions and vary by geographic region. For example, the AMI in a relatively high earning place like the District of Columbia is likely to be far greater than in a rural area like Corson County, South Dakota. In the wake of the COVID19 Pandemic in 2020, AMI calculations accelerated along with wage inflation. Because allowable rents in LIHTC properties are tied to AMI, the rate of increase to AMI directly impacts the rate at which operators are permitted to increase their asking rents.

(To read more about the history of LIHTC income limits, check out this article.)

What is the change to the income limit?

Tax credit developers must pledge that some percent of their property’s units must remain available for lease to those families who earn 60 percent or less of the AMI in the market where the property is located. LIHTC properties cannot have less than 20 percent affordability, but most properties restrict 100 percent of units to affordability. Restriction to 60 percent of AMI is the minimum for a LIHTC unit; some owners are obliged to restrict units further to 50 percent, 40 percent, or even 30 percent in order to receive credit allocations.

From 2010 to 2021, HUD used the same formula and datasets to calculate AMI for release in mid-April of each year.

In 2022, HUD unexpectedly changed the cap calculation methodology. Instead of relying on its prior datasets, the agency utilized changes in median income derived from the American Community Survey data as two times the median income change. There is no accounting for inflation in the new methodology.

The change in methodology may seem minor, but the impact is significant. As a result of it, the percentage of HUD-covered areas subject to income limit increase caps rose from ~10 percent prior to the change to 87 percent after the change, including non-metro areas that had not been previously impacted.

The value of the cap also changed drastically. In 2022, HUD permitted rent increases up to 12.5 percent in many jurisdictions. That cap was dropped to 5.92 percent for 2023. HUD has indicated the formulaic changes are an attempt to better reflect the behavior of income growth in local areas.

What does it mean?

The impact of this slight, but critically important, change is felt differently by residents, developers, operators, and investors.

Residents

To illustrate the impact of HUD’s unexpected LIHTC income limits on residents and potential residents of affordable housing, consider the following scenarios:

Existing residents

A resident who, under the original projections, would potentially be facing a 9.5 percent rent increase cannot now be asked to pay more than 5.92 percent on top of the prior year in areas where the new caps apply. That translates into more money in residents’ pockets. This resident likely appreciates HUD’s rent cap. But others are impacted more negatively.

Potential residents

Consider this scenario:

Imagine an MSA where HUD’s calculated AMI figure for 2022 was $100,000. Now imagine an administrative assistant who earns $65,000 annually. In 2022, her income was 65 percent of AMI, and therefore she did not qualify to live in the 60 percent AMI Restricted LIHTC apartment unit near her job. Had HUD allowed the AMI increase to occur organically and in keeping with the formula used from 2010 to 2021, the 2023 AMI figure for this market would have become $109,500 and the resulting 60 percent income limit would have become $65,700. Our administrative assistant would have qualified and would have been able to rent an affordable unit at a restricted rent level.

Because of the 5.92 percent cap, however, the HUD AMI figure must be calculated at $105,920. The resulting 60 percent income limit would hit at $63,552, and our administrative assistant would not qualify for the unit. So where capping the AMI increase in 87 percent of markets has benefitted existing residents, a swath of individuals earning just above 60 percent of AMI has been prevented from benefitting from the LIHTC program at all.

Developers

When developers assess the financial feasibility of a planned LIHTC project, one of the key elements they consider is the rent estimate for each year of the planned holding period. To estimate rents over a multi-year time horizon, they rely heavily on HUD’s income limit calculations and often follow guidance set forth by Novogradac, a LIHTC specialist.

The impact could seem relatively minor: a multi-year pro forma for a LIHTC transaction is actually required to model only 2 percent annual rent growth. Over the past decade, however, annual permissible increases have been closer to 6 percent. The downstream impacts of capping income growth are significant. Most notably, a property is likely to produce a smaller amount of income, which means that it can’t support as much debt. As a result, developers must raise more equity to complete the “capital stack” for a given project.

Operators/owners

To grasp the significant impact of HUD’s unexpected LIHTC income limits on owners/operators, consider the following scenario:

Consider a LIHTC apartment building that brought in Scheduled Market Rent of $1,000,000 in 2022. That $1mm figure represents the maximum achievable rent permitted by Section 42 for that year. While planning for 2023, ownership saw that Novogradac was forecasting AMI growth of 9.50 percent. That would mean the apartment building could expect to earn up to $1,095,000 in 2023 income.

Once the cap was announced for 87 percent of jurisdictions nationwide, most owners discovered they could not achieve the 9.50 percent growth but would instead be limited to 5.92 percent. That means the Scheduled Market Rent can’t get above $1,059,200. This represents a “theoretical” loss of $35,800. (The full 9.5 percent income growth was never guaranteed, but the cap ensures it cannot be reached.)

A cap rate of 6 percent is reasonable for LIHTC asset valuations in many of the 87 percent of capped markets. $35,800 of forfeited income at a 6 percent cap rate represents value just under $600K. For the owner in this example, therefore, HUD’s unilateral decision eliminated more than half a million dollars in value for a property with no other meaningful differences in operations from 2022 to 2023.

Investors

Affordable housing properties are valued based on the amount of income they produce. So, lower income caps mean that the “exit” or sales price in a LIHTC deal is likely to be lower than it would have been if rental rates weren’t capped under the new HUD methodology. Consider the above example in which a half million dollars in asset value was wiped out by a programmatic change, resulting in a net impact on income of less than 4 percent. However, it should be noted that investors will continue to benefit from the reduction in their tax liability as a result of contributing equity to a project.

Navigate the changing landscape with Walker & Dunlop

Developing, operating, and financing LIHTC transactions can be an exceptionally time-consuming and complicated endeavor. In such transactions, it helps to have a trusted advisor like Walker & Dunlop. We have the experience and expertise necessary to successfully navigate the inevitable regulatory and financial hurdles. If you are a LIHTC developer, operator, or investor, reach out to us to discuss the LIHTC income limits changes and their impact on your portfolio or project.