Locke Lord QuickStudy: ‎2023 Changes to Texas Law: Property ‎Tax Exemption for Public Facility Corporations Owning ‎Affordable Housing

The 88th Regular Session (2023) of the Texas Legislature approved HB 2071 (the “Bill”), substantially revising the way public facility corporations can be utilized to own and operate affordable housing. While some provisions in this Bill may be subject to interpretation, the summary below reflects our Firm’s analysis of the Bill’s effect as of the date of this publication.

PFCs

A public facility corporation (“PFC”) is a nonprofit corporation that can be created by a municipality, county, school district, housing authority, or special district (a “Sponsor”) under Chapter 303 of the Texas Local Government Code (the “Code”). A PFC may be used by a Sponsor to acquire, construct, rehabilitate and otherwise operate a public facility, which is property devoted to a public use. Texas law has long recognized affordable housing as a public use. Affordable housing is typically understood as rental housing that places limits on both the household incomes of a certain percentage of the units, as well as the rents that can be charged to those households (“Restricted Units”).

Historical Tax Exemption for PFCs

Under the Code, and the Texas Tax Code, a public facility owned by a PFC generally is exempt from ad valorem taxation. However, when a public facility is leased to a private user that is not a governmental entity, that private user generally is responsible for ad valorem tax on the facility. In 2015, the Texas Legislature approved an amendment to the Code, containing an exception to the general rule. The 2015 law, in short, stated that if a PFC owned a multifamily residential development utilized for the purpose of affordable housing (an “Affordable Housing Property”^[1]) with at least 50% of the units reserved for households having an income less than 80% of the area median income (“AMI”), and leased the Affordable Housing Property to a for-profit entity for operation, the Affordable Housing Property would be exempt from all ad valorem tax. Under this law, real estate developers and owners (as applicable, an “Operator”) partnered with PFCs created by Sponsors to construct new affordable housing, acquire existing multifamily residential developments, or impose affordability restrictions on multifamily residential developments they already owned. With the PFC owning the Affordable Housing Property and leasing it the Operator, a 100% property tax exemption was available.

Issues with Former Law

Numerous Operators and PFCs used the 2015 law to obtain tax exemption for Affordable Housing Properties. However, the flaw in the 2015 law was that it did not impose requirements customary in the affordable housing industry to ensure that sufficient public benefit was generated in exchange for the tax exemption provided. While many PFCs worked with Operators to establish Affordable Housing Properties that provided meaningful rent reduction and a diverse array of affordable housing in higher opportunity areas, many transactions were closed that did not require rent restriction, disperse Restricted Units across all unit types, or mandate other guardrails standard to affordable housing. The lack of consistent and appropriate implementation drew public attention and a call for reform. The Bill answered that call.

Summary of New Requirements Under HB 2071

Application of New Law. The Bill acknowledges that PFCs (primarily those with a housing authority as a Sponsor) may own a variety of properties and engage in a variety of transactions. Some of these transactions are governed by federal programs that already impose their own affordable housing restrictions. Therefore, the Bill makes clear that its modification to both Chapter 303 and Chapter 392 of the Code do not apply to properties owned by PFCs that: (i) have at least 20% of their units as public housing; (ii) participate in the HUD Rental Assistance Demonstration program; (iii) receive financial assistance from tax-exempt bonds or (iv) receive financial assistance from low-income housing tax credits. However, the Bill does not specify whether a closing for any of the financing sources in sections (ii), (iii) and (iv) above must occur concurrently with the closing of the PFC structure).

Jurisdictional Issues. The Bill clarifies the jurisdiction within which a PFC may finance, own, or operate an Affordable Housing Property:

• When the PFC’s Sponsor is a housing authority, the PFC may operate only within the housing authority’s statutory area of operation. Per Section 392.019 of the Code, this suggests that a PFC created by a housing authority may use a cooperation agreement to finance, own, or operate an Affordable Housing Property in the area of operation of other housing authorities.
• When the PFC’s Sponsor is any other permitted form of entity, the PFC may operate only within the boundaries of that entity, regardless of whether any other law allows the entity to operate outside its boundaries in other circumstances.

Notifications and Approvals. Before entering into a transaction to acquire an Affordable Housing Property and lease it to an Operator:

• A PFC must deliver notice of the proposed transaction to the presiding officer of each taxing unit with jurisdiction over the Affordable Housing Property, at least 30 days prior to (i) the date the PFC takes action to approve the transaction and (ii) the date of any required public hearing. The taxing units receiving the notice are not required to provide their consent for the proposed transaction to close.
• At least 30 days before approving a transaction for an Affordable Housing Property, the PFC or its Sponsor must obtain an underwriting assessment from a professional entity that has experience with affordable housing and has no financial interest in the transaction. The underwriting assessment must be published on the PFC’s website^[2] and must allow the PFC to make a good faith determination that:
• For an occupied property, the amount by which the rent will be reduced on the Restricted Units will equal at least 60% of the anticipated ad valorem tax the property would have otherwise paid in the second, third, and fourth years of operation, without the affordability restrictions.
• For a newly constructed property, the property would not be feasible^[3] without the participation of the PFC.
• If the Sponsor is a housing authority, it must hold a public hearing at a meeting of its governing body to approve the transaction.^[4]
• If a majority of the members of the governing body of the PFC are not elected officials, the PFC must obtain approval for the proposed transaction from the governing body of the municipality, if the Affordable Housing Property is located in a municipality or, if not, the governing body of the county. Even if a majority of the members of the governing body of the PFC are elected officials, approval by the municipality or county may be required as described in the next subsection as it relates to Renovation Requirements (defined below).

Household Income Requirements. The following household income requirements apply to the Restricted Units in the Affordable Housing Property:

• Household income is calculated in accordance with HUD rules under 24 C.F.R. Section 5.609.
• Once a Restricted Unit is rented to a qualified household, it will continue to qualify as such even if the household’s income increases beyond the applicable household limit at the time of renewal, in accordance with the provisions of Section 42(g)(2)(D) of the Internal Revenue Code. This effectively adopts the standards used in the low-income housing tax credit program and allows a household’s income to increase up to 140% of AMI without creating an event of non-compliance, so long as the next available unit in the Affordable Housing Property is rented to a qualified household as a Restricted Unit at the applicable income level.
• Each Affordable Housing Property must reserve at least 10% of the units for households with incomes at 60% of AMI or less and at least 40% of the units for households with incomes at 80% of AMI or less^[5] (the “Baseline Income Requirements”). The Baseline Income Requirements clearly apply to (i) any Affordable Housing Property that is not occupied at the time of acquisition by the PFC, or (ii) any Affordable Housing Property that is occupied at the time of acquisition by the PFC and already restricted by a regulatory agreement with the Texas Department of Housing and Community Affairs (“TDHCA”) under Section 2306.185 of the Texas Government Code.
• For any Affordable Housing Property that is occupied at the time of acquisition by the PFC and is not already restricted by a regulatory agreement with TDHCA, the PFC and Operator have a choice whether to renovate the property. This requires spending at least 15% of the total gross cost of the Affordable Housing Property, as shown on the settlement statement, on rehabilitating, renovating, reconstructing, or repairing the Affordable Housing Property (the “Renovation Requirement”). The Bill does not define “total gross cost.” A reasonable interpretation would be to utilize the amount reflected on the closing settlement statement as being paid or financed in conjunction with the PFC’s acquisition of the Affordable Housing Property, as the language connects the settlement statement to the PFC’s acquisition. Fulfillment of the Renovation Requirement must commence no later than the first anniversary of the PFC’s acquisition of the Affordable Housing Property and must be completed no later than the third anniversary of the PFC’s acquisition of the Affordable Housing Property.
• For an occupied property that chooses to comply with the Renovation Requirement, the Baseline Income Requirements apply.
• For an occupied property that chooses not to comply with the Renovation Requirement, the Bill states that at least 25% of the units must be reserved for households with income at or below 60% of AMI. While the Bill is not entirely clear as to reserving units for households at or below 80% of AMI, a reasonable and conservative interpretation is that this provision must be combined with the Baseline Income Requirements. This would require at least 25% of the units to be reserved for households at or below 60% of AMI and at least 40% of the units to be reserved for households at or below 80% of AMI. Note, also, for an occupied property that chooses not to comply with the Renovation Requirement, the PFC is required to receive approval for the transaction from the municipality, if the Affordable Housing Property is located in a municipality or, if not, the governing body of the county (this additional requirement will be imposed whether or not the majority of the members of the governing body of the PFC are elected officials).

Rent Requirements. Rents for Restricted Units shall be calculated as defined by HUD and adjusted for household size.

• Annual rent charged for a Restricted Unit reserved for a household at or below 60% of AMI may not exceed 30% of 60% of AMI for the applicable household size.
• Annual rent charged for a Restricted Unit reserved for a household at or below 80% of AMI may not exceed 30% of 80% of AMI for the applicable household size.
• If a household is using a Section 8 Housing Choice Voucher to pay its rent and if the payment standard for the Housing Choice Voucher is less than the amount of rent established for the Restricted Unit above, the Operator may require the household to pay the difference.

Exemption.

• The Bill continues to authorize the ad valorem tax exemption based on a leasehold structure, in which the PFC owns the Affordable Housing Property and leases it to the Operator.

• The exemption does not apply to ad valorem taxes imposed by a conservation and reclamation district that provides water, sewer, or drainage services to the Affordable Housing Property unless the PFC has entered into an agreement with the district to provide a payment in lieu of taxes.
• An ad valorem tax exemption granted under Chapter 303 for an Affordable Housing Property lasts only for 30 years from the date of acquisition for a property that is occupied at the time of acquisition by the PFC or 60 years from the date of approval by the PFC for a newly constructed property. The Bill provides an opportunity to extend the date of termination of the exemption for another 30 or 60 years, as applicable, if, during the 5-year period preceding termination, the PFC notifies the governing body of the municipality or county, as applicable, of the request for extension and the extension is approved in the same manner as was originally required to establish the exemption.
• The Bill also continues the ability of an Affordable Housing Property to receive an exemption from sales tax for materials incorporated into the property, which was present in the 2015 law.

Tenant Protections.

• An Operator may not refuse to lease a Restricted Unit to a household because the household intends to pay its rent using a Housing Choice Voucher. Nor may the Operator impose a minimum income requirement whereby a household using a Housing Choice Voucher is required to have a monthly income in excess of 250% of the household’s monthly rent requirement.
• Each lease agreement for an Affordable Housing Property must include the following. The Bill does not distinguish between leases for Restricted Units and non-Restricted Units, so it should be presumed these requirements apply for all residents:
• The Operator may not retaliate against a resident for participation in a resident organization.
• Non-renewal of a resident’s lease is permitted only in certain circumstances, including the household’s material non-compliance with the lease or failure to provide required eligibility information.
• A household must be given 30 days’ advance notice for any nonrenewal of a lease.

Compliance.

• A PFC must post on its website information about each Affordable Housing Property it owns, including its compliance with the requirements of Chapter 303 of the Code and policies for households using Housing Choice Vouchers.
• An Operator must affirmatively market each Affordable Housing Property to households with Housing Choice Vouchers and notify local housing authorities of the Affordable Housing Property’s acceptance of Housing Choice Vouchers.
• The requirements for Restricted Units must be memorialized in a regulatory agreement filed in the real property records. The regulatory agreement must have a term of at least 10 years, subject to early termination for foreclosure or loss of the exemption for any reason other than the failure of the Affordable Housing Property to comply with the restrictions in the regulatory agreement.
• To be eligible for the exemption, an Affordable Housing Property that is occupied at the time of acquisition by the PFC must come into compliance with the requirement to reserve the Restricted Units by the first year anniversary of the acquisition.
• The Restricted Units must be dispersed among the various unit types in the Affordable Housing Property in the same proportion as the non-Restricted Units.

Audit and Monitoring. The Bill creates a compliance monitoring function for TDHCA and requires TDHCA to adopt rules related to the monitoring function by January 1, 2024. Specifically:

• A PFC must require the Operator to obtain and pay for an audit (the “Audit”) conducted by an independent auditor or compliance expert with an established history of addressing affordable housing compliance matters (an “Auditor”) that: (i) determines whether the Operator is in compliance with the applicable requirements of Chapter 303 and (ii) identifies the difference between the rents charged for the Restricted Units and the estimated maximum rents that could be charged for such units if they were not restricted.
• The first Audit for each Affordable Housing Property must be submitted to TDHCA and the chief appraiser of the applicable appraisal district not later than June 1 of the year following the first anniversary of: (i) the date of the PFC’s acquisition of an occupied Affordable Housing Property or (ii) the date a newly constructed Affordable Housing Property is first occupied by a resident. After filing the first Audit, an annual Audit must be filed no later than June 1 of each subsequent year.
• An Operator may not engage the same Auditor for more than three consecutive years. An Auditor that has been engaged for three consecutive years may be re-engaged after a two year lapse in which the Operator engages a different Auditor.
• Audits are subject to disclosure under Texas public information laws, provided that certain resident information may be withheld.
• Within 60 days of receipt of the Audit, TDHCA must review it and publish a report (the “Compliance Report”) with details of any findings of non-compliance. The Compliance Report must be available on TDHCA’s website and must be delivered to the PFC, the governing body of the PFC’s Sponsor, the Operator, the Texas Comptroller of Public Accounts, and, if the PFC’s Sponsor is a housing authority, that authority’s governing board.
• If the Compliance Report includes findings of non-compliance based upon the Audit, TDHCA or the applicable appraisal district must provide the Operator written notice of the non-compliance (a “Notice of Non-Compliance”) not later than 45 days after the date of initial submission of the Audit to TDHCA^[6]. The Notice of Non-Compliance must include specific reasons for the non-compliance and at least one option for corrective action to resolve the non-compliance, to be completed within 60 days of the date of the Notice of Non-Compliance (the “Cure Period”). The Notice of Non-Compliance must inform the Operator that failure to resolve the non-compliance will result in loss of the exemption. If an event of non-compliance is not cured to the satisfaction of TDHCA and the appraisal district during the Cure Period, the Operator must be given notice of the loss of the exemption for the applicable tax year covered by the Audit.
• An Affordable Housing Property that does not receive a Notice of Non-Compliance after submission of an Audit is considered to be in compliance.

Interim Study

The Bill commissions the Legislative Budget Board to study the long-term effect of tax exemptions granted under Chapter 303 for Affordable Housing Properties, including effects on public education funding. The study must be submitted to the Governor, Lieutenant Governor, and Speaker of the House of Representatives by December 10, 2024.

Effectiveness; Grandfathering

The Bill became effective on June 18, 2023 (the “Effective Date”), without the Governor's signature. 

The Bill can be difficult to read with regard to grandfathering for Affordable Housing Properties owned by PFCs on the Effective Date and those transactions between PFCs and Operators in progress but not closed on the Effective Date. Based on the plain language, our Firm believes the most accurate and conservative reading is as follows:

• Other than as noted below, (i) the Bill does not apply to any new construction Affordable Housing Property that was approved by a PFC or its Sponsor prior to the Effective Date, and (ii) the law in effect at the time the Affordable Housing Property was approved continues to apply. Although the Bill does not specify the type of approval required, our Firm believes that an approval should authorize the closing of a transaction and not just the negotiation and execution of initial agreements such as an MOU or term sheet.
• Other than as noted below, (i) the Bill does not apply to any Affordable Housing Property that was occupied at the time of the PFC’s acquisition, if such acquisition occurred prior to the Effective Date of the Bill; and (ii) the law in effect at the time the occupied Affordable Housing Property was acquired by the PFC continues to apply. An occupied Affordable Housing Property acquired by a PFC after the Effective Date must comply with the Bill.
• All Affordable Properties receiving an ad valorem tax exemption under Chapter 303, regardless of when approved or acquired by the PFC, must comply with the Audit and Monitoring provisions set forth above. The first Audit for each Affordable Housing Property approved or acquired by a PFC before the Effective Date will be due on the later of (i) June 1, 2024, or (ii) June 1 of the year following the year in which the Affordable Housing Property was first occupied by a resident, if newly constructed.

This paper is intended to summarize the provisions of HB 2071 and is not comprehensive. It should not be relied upon as a legal opinion.  Consult your counsel for advice on the impact of HB 2071 on any particular property.

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^{*Originally published June 19, 2023.}

^{[1] This term will be used throughout to refer to any multifamily residential development to which any provisions of Chapter 303 of the Code apply.}

^{[2] We note that Bill does not appear to specify when the underwriting assessment must be published on the PFC’s website.}

^{[3] “Feasible” is not defined but could logically be interpreted to mean that the construction and operation of the property with the Restricted Units would not be financially feasible without the tax exemption provided by the PFC.}

^{[4] Note that this requirement differs from the 2015 law in that it does not require a public hearing at a “regular” meeting of the governing body.}

^{[5] Note that this requirement differs from the 2015 law in that the 2015 law required income less than 80% of AMI. The Bill requires income at or below 80% of AMI or 60% of AMI, as applicable.}

^{[6] Note that the deadline for a Notice of Non-Compliance (45 days after receipt of the Audit) precedes the deadline for TDHCA’s publication of the Compliance Report (60 days after receipt of the Audit).}