The 4% credit, the 50% test, and why bond deals pencil now

A fixed 4% floor changed the math on bond-financed transactions. Here is what the floor did, what the 50% test requires, and where deals still fall short.

Two credits, two very different processes

The housing credit comes in two forms. The 9 percent credit is competitive: each state receives an annual allocation on a per-capita basis, and developers compete for it through the qualified allocation plan, usually in one or two rounds a year. Demand routinely exceeds supply by a wide margin, and a strong project can lose simply because a stronger one scored higher.

The 4 percent credit works differently. It comes attached to private activity bond financing rather than through a competitive round, and it is available as of right to any project that meets the requirements. There is no scoring, no rank order, and no losing to a better application. If the deal qualifies and the state has bond cap available, the credit is there.

The trade-off is size. The 4 percent credit generates roughly half the equity of a 9 percent credit on the same basis, which means bond deals need more debt, deeper subsidy, or lower cost to work.

The floor changed the arithmetic

For most of the program’s history, the “4 percent” rate was not actually 4 percent. It floated monthly against a Treasury-linked calculation, and through the low-rate years of the 2010s it drifted well below its nominal name, at times closer to 3.1 percent. On a large transaction that gap was worth millions in lost equity.

Legislation at the end of 2020 fixed the rate at a true 4 percent floor for bond-financed properties. The effect was immediate and substantial: the same project, unchanged, generated meaningfully more equity than it would have a year earlier. A great deal of preservation activity since then traces directly to that change.

The 50% test

To receive credits on the full basis of a bond-financed property, at least 50 percent of the aggregate basis of the building and the land must be financed with tax-exempt private activity bonds. Fall below that threshold and the credits are reduced or lost.

Two things follow. First, the bonds have to be sized against basis, not against what the permanent debt can support — which is why so many bond deals use short-term cash-collateralized structures that are redeemed shortly after completion. Second, bond cap is a finite state resource. In several states demand now exceeds the annual allocation, and what was once an as-of-right program has developed a queue.

The 50% test is the single most common place a bond deal gets into trouble late. Basis moves during construction. If it moves up and the bond size does not, the test can fail on a property that penciled cleanly at closing. Watch it continuously, not once.

Where 4% deals still fall short

Even with the floor, the 4 percent credit rarely closes the whole gap on its own. Transactions typically need one or more of the following:

Existing project-based rental assistance, which supports higher rents and therefore more debt
Soft financing from state or local housing trust funds, HOME, or the National Housing Trust Fund
A basis boost where the property sits in a qualified census tract or difficult development area, or where the state designates it
Seller financing or acquisition at below-market value, common in preservation and nonprofit transfers
A second credit, most often federal or state historic credits on an adaptive reuse

Where they work best

Acquisition-rehabilitation of existing assisted housing is the natural home of the 4 percent credit. The subsidy is already in place, the rents already support debt, and the credit fills the rehabilitation gap. Preservation of expiring affordability, year 15 resyndications, and public housing repositioning all fit the same profile.