With interest rates remaining relatively high and uncertainty in the market continuing in the aftermath of the election, Texas multifamily developers are lacking interested buyers for their projects. As it becomes increasingly challenging to secure sales of completed assets, many companies have paused their efforts and are awaiting a better market before moving forward with any new developments. This slowdown of building activity only exacerbates the housing affordability crisis that Texas is currently experiencing. Due to the shortage of housing at affordable prices and an unfavorable market that precludes developers from building, the low-income earners of Texas are struggling to find adequate places to live.
To combat this problem, multifamily developers are utilizing housing finance corporations as a way to proceed with new projects. Housing finance corporations were created under the Texas Housing Finance Corporations Act (the Act), which is codified in Chapter 394 of the Texas Local Government Code. The Act permits a local government to establish a legally incorporated entity known as a housing finance corporation (HFC) as a tool to increase the availability of affordable housing in a particular area. This works by the HFC issuing tax-exempt bonds to encourage the acquisition of land and construction of developments for affordable multifamily housing. As a result, builders develop housing that is subject to rent restrictions and reserved for use by low-income individuals and families. Then, in return for increasing the availability of affordable housing in the community, the project will be granted a 100 percent exemption from property taxes.
In order for a residential development to qualify for the tax exemption, the development must meet all criteria set forth in the Act as well as the following requirements established by relevant case law: (1) the HFC must hold fee simple title to the land on which the development is to be constructed and must lease such land to the developer (typically via a long-term ground lease to a special purpose entity formed by the developer), (2) the HFC must be included in the management structure of the ground lessee entity (ordinarily as a managing member or general partner), (3) upon the expiration of the ground lease, the development must revert back to the HFC, (4) during the term of the ground lease, the HFC shall retain an option to purchase the development, (5) if the ground lessee desires to sell its interest in the property, the HFC shall have a right of first refusal to match the offer of a third-party buyer, and (6) if the ground lessee financed the construction of the development and defaults under any such loan documents, the HFC must have the ability to cure any breach thereunder.
If the foregoing qualifications can be met, the developer and the HFC will enter into a memorandum of understanding that summarizes the terms of the agreement between the parties. Such memorandum will then be sent to the board of the HFC for approval. Once approved, counsels for developers and the HFC will coordinate the drafting and negotiation of the various documents needed to close the transaction.
In addition to the aforementioned ground lease and memorandum of understanding, such documents usually consist of: (a) a deed granting fee simple title to the land to the HFC, (b) a memorandum evidencing the existence of the ground lease, (c) a regulatory agreement establishing the percentage of units in the development that must be rented to low-income tenants and the required earnings of such tenants, (d) documentation of the HFC’s right of first refusal and option to purchase the development (which may be memorialized in separate documents or included as provisions within the ground lease), and (e) the company agreement or partnership agreement of the ground lessee. Upon closing, the memorandum of the ground lease and the regulatory agreement are recorded in the real property records of the applicable county and the developer commences construction of the project.
The tax exemption offered by an HFC is a benefit that can incentivize multifamily developers to proceed with affordable housing construction during economically challenging climates, which results in an increased supply of housing for Texas’ low income residents. Although this seems like a win-win scenario, there are people who oppose the HFC structure and the tax break it provides to for-profit developers. Accordingly, legislation has been proposed to reform the laws governing HFCs to implement stricter oversight and higher scrutiny of the transactions receiving 100 percent tax exemption. While this could result in a reduction of the amount of approved HFC projects, HFCs remain a powerful tool that can offer multifamily developers an alternative method of continuing business when the market is not favorable for traditional sales of developed assets.
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