USDA’s Rural Housing Service (RHS) recently announced changes in its Section 538 Guaranteed Rural Rental Housing Program (GRRHP). The program works with qualified private-sector lenders to provide financing to qualified borrowers to increase the supply of affordable rental housing for low- and moderate-income individuals and families in eligible rural areas and towns. Under the program, RHS offers guarantees of up to 90 percent of the loan amount. For-profit entities may borrow up to 90 percent and non-profit entities may borrow up to 97 percent of the total development cost or appraised value, whichever is less.

The program encourages cooperation among the USDA, private lenders, and other public agencies in addressing rural housing needs by guaranteeing loans. New multifamily construction, acquisition and rehabilitation, and revitalization of older stock, including projects previously developed under USDA’s Section 515 and 514 programs, are all eligible for GRRHP funding. These can be financially viable through various combinations of financing sources, including federal and state funds, tax-exempt bonds, and LIHTCs.

With the recently announced changes RHS will give priority to projects of affordable housing that give up Qualified Contract (QC) rights. This initiative is part of a broader initiative at the federal level to address the serious shortage of affordable housing and make sure that certain loopholes in the LIHTC program don’t enable existing units to be removed from the program.

Qualified Contract Loophole

The QC loophole in the LIHTC program is one of the major focuses of the new updates. The LIHTC program offers developers tax credits in exchange for committing to keep rents affordable for at least 30 years. However, the statute allows property owners to opt out of this commitment after only 15 years via the qualified contract provision. This loophole enables owners to apply to state agencies to buy their building at a price determined by a statutory formula that’s generally above market value for buildings subject to rent restrictions.

Unless the state or local agency can find a buyer within that year, the site can exit the program’s affordability restrictions and convert units to market rates. Originally intended to attract investors by offering an exit strategy, this provision has increasingly weakened the program’s goals. Experts estimate that over time, the loophole has cost 115,000 units of affordability and, each year, the loss is estimated at between 6,000 and 10,000 units.

Other federal agencies, such as HUD and the Federal Housing Finance Agency (FHFA), have each taken steps or announced an intention to take action to mitigate the use of qualified contracts. HUD’s Office of Multifamily Housing has issued a proposed notice that would restrict access to Federal Housing Administration Multifamily rental and Risk Share insurance programs to LIHTC owners who agree to waive any right to request a qualified contract. In late 2023, FHFA issued guidance to Fannie Mae and Freddie Mac barring the government-sponsored enterprises from becoming equity investors in sites for which the owner has not waived its right to a qualified contract. And recently, the Treasury Department has expressed the need for limitations to QCs to protect affordable housing, encouraging state agencies and federal programs to make waiver requirements for QC rights a condition of funding eligibility.

USDA’s New Policy

The revised GRRHP framework gives higher scoring priority to projects that waive QC rights, in line with the federal priorities to maximize affordability in LIHTC-supported housing. In this regard, applicants who use LIHTC financing and commit to long-term affordability by forgoing QCs will be better positioned for access to GRRHP funding.

By integrating GRRHP with LIHTC financing, the program maximizes its impact through getting owners to commit to longer periods of affordability. The changes demonstrate the USDA’s commitment to preserving and expanding the stock of affordable housing in the face of a continuing housing affordability crisis, particularly in rural areas.