Plans to sell and rehabilitate Paradise Manor, a large, subsidized housing project in Northeast Washington, are stalled by the specter of tax-law changes that could slash heavily into the profits of investors, according to a consultant working with the Mayfair Foundation, the nonprofit owners of Paradise Manor.
The proposal calls for selling the complex to investors seeking the tax deductions available under current law, with an agreement that the residents could buy Paradise Manor when the benefits are exhausted, probably in about 10 years, said Marilyn Melkonian, head of Telesis Corp., a housing consulting firm. The infusion of capital is needed to fund major renovation of the 20-year-old apartment buildings.
But uncertainty over what kind of tax law may emerge from Congress this year has real estate investors holding off on this and other major decisions. Many of the deductions and shelters that pull billions of dollars annually into multifamily housing, low-income projects and other types of real estate transactions could disappear or be sharply reduced if the bill passed late last year by the House of Representatives, or a similar measure, becomes law.
Several provisions of the House bill as it now is written would take effect retroactive to Jan. 1, 1986, raising the possibility that tax-favored investments made now suddenly could become less so later this year. The tax advantages often make the difference between profit and loss in real estate investments.
Congress is expected to change the dates to make most, if not all, parts of the law effective after its passage, but without more reassurance than has come from Capitol Hill so far, the real estate industry is leery of taking chances.
The "most dangerous" aspects of the bill for the industry are changes lengthening the depreciation period on property to 30 years, limitations on deductibility of interest, and a retroactive, more comprehensive alternative minimum tax, according to an analysis by the National Realty Committee, which represents developers, investors and owners of large-scale commercial real estate projects. Under the present law's accelerated method, large deductions for depreciation of property can be taken in the early years of ownership.
Most deals now "dead in the water" are those financed by limited partnerships and tax-exempt bonds, which state and local governments issue, tax analysts say. Investors pay no taxes on the interest they receive from the bonds.
Much of the multifamily rental housing built in the United States is financed through these two sources, and real estate industry leaders say the tax uncertainty will significantly slow construction. Resulting shortages of apartments will arise in a year or so, then rents will rise, believes Stephen D. Driesler, executive vice president of the National Multi Housing Council.
Brookings Institution economist Anthony Downs said, however, that other factors could offset "the negative effects of tax reform" on the rental housing supply and possibly push down rents. A flurry of multifamily housing construction starts took place late in 1985 by developers anxious to avoid the danger of losing tax benefits in 1986, he said. In addition, Downs said, money that investors once put into office-building construction now is going into rental apartments because of a nationwide oversupply of office space.
The House bill's restrictions on the bonds "dried up" that market on Jan. 1 of this year, according to Driesler. "The market won't come back until the tax uncertainty is cleared up," he said.
Several analysts also reported they know of no housing bonds issued so far in 1986. Tax-exempt bonds, issued as a way to provide housing for low- and moderate-income Americans, financed about 25 percent of all rental housing built in the United States in 1983 and 1984, according to a General Accounting Office report issued this month. To qualify for the low-cost financing the bonds provide, developers must agree to set aside 20 percent of the units they build for renters with incomes 80 percent or less of the area median. The remainder of the apartments may be rented to anyone.
Housing bonds also provide low-interest mortgages for first-time home buyers, about 300,000 last year, according to estimates.
Among the House bill changes causing investor jitters are provisions sharply limiting the dollar volume of tax-exempt bonds that could be issued annually, tightening the rules qualifying bonds for tax-exempt status, and calling for retroactive taxing of interest if conditions change so that the requirements no longer are being met. Thus, if the House bill became law with a Jan. 1, 1986, effective date, investors could find themselves holding taxable bonds they thought were going to be tax-free.
As interest rates rose in the late 1970s and tax code changes in 1981 allowed greater depreciation deductions in the early years of a project, more and more developers sought tax-exempt bonds because interest rates were lower and tax advantages greater, according to the GAO report.
The GAO report, made for the Joint Committee on Taxation, said tax-exempt bonds cost the U.S. Treasury $2.3 billion in lost tax revenue for 1983 and 1984, benefit developers, bondholders and others associated with issuance of the bonds, but largely fail to fill the needs of low-income tenants because they are charged market-rate rents in most developments.
The House bill would require builders to increase the number of units reserved for low- and moderate-income families to 25 percent, or lower the qualifying income to 70 percent of the area's median if only 20 percent of the units are set aside. To maintain the tax-exempt status, operators of the housing would have to certify every year that they are meeting the requirements. If they fail to meet this standard, interest income would be taxed retroactively to the date the bonds were issued, a requirement that would increase borrowing costs and make the bonds riskier for investors, according to an analysis by the accounting firm of Coopers & Lybrand.
More serious threats to bond-financed housing are the state caps the House bill would impose on the dollar volume of tax-exempt bonds for all purposes that can be issued annually, several analysts said.
The cap would be set at $175 per state resident, or $200 million, whichever is greater, and would have the most impact on state and local governments that have counted heavily on tax-exempt bonds to meet their housing needs, they said.
Montgomery County is one of these areas, according to county housing officials. Montgomery County financed an estimated 3,700 rental units with $278 million in tax-exempt bonds last year, with 740 of the apartments set aside for low- and moderate-income families.
Under the House bill's formula for allocating portions of the bond financing allowed each state, Montgomery County would receive about $25 million for housing, according to Vivian Benjamin, multifamily underwriter for the county's Housing Opportunities Commission. At least one-third of the money must go into multifamily development and one-third into single-family construction.
The $25 million would pay for 208 units in apartment buildings, of which about 40 would be reserved for low- and moderate-income tenants.
Syndications of the type the Mayfair Foundation hoped to put together for Paradise Manor in the District of Columbia would not attract many investors under the House bill, analysts said.
The new alternative minimum tax, "narrowing" of deductions and lower tax rates would combine to discourage most syndications or resyndications of low-income housing, according to Lawrence J. Ross, former chief counsel for the House Ways and Means oversight subcommittee in the late 1970s.
Irwin J. Deutsch, president of Century Pacific Investment Corp. of Los Angeles, said he has "put a number of projects on the back burner, waiting for legislative clarification." Century Pacific puts together syndicates, which invest in housing construction and rehabilitation, about 60 percent of them for low- and moderate income residents, he said.
The company considered investing in Paradise Manor, "but I put the project on hold," Deutsch said.
Existing subsidized housing like Paradise Manor could be especially hard hit, said Melkonian, who was HUD deputy assistant secretary for housing in the Carter administration. About 2 million low- and moderate-income units built in recent years under HUD programs have no other way to attract capital except through "tax-minded investment," Melkonian said.