The Future of Rural Rental Housing Finance

Federal budget recommendations and legislative proposals will affect the future of federal financial support for rural affordable rental housing.

Federal budget recommendations and legislative proposals are raising questions about the future of federal financial support for rural affordable rental housing projects and about how these much-needed developments will be funded in coming years. Past and recent data on properties and rural market analyses suggest that the Section 538 Rural Rental Loan Guarantee Program provides a beneficial service by financing new rural properties and by providing preservation funds for older Section 515 apartments. Although other funding avenues such as Fannie Mae, Freddie Mac or FHA are available and effective, none provides the same dedication to rural America as do the Rural Development programs.

Need vs. Budget Cuts

The high demand for affordable rural housing units often goes unnoticed in the mainly urban U.S., as only about 18 percent of the total population lives in rural America. In 2008, rural taxpayers reported an average adjusted gross income (AGI) of $43,616 compared with $60,841 for urban tax payers. The poverty rate was higher in rural areas (15.1 percent) than in urban areas (12.9 percent), suggesting a pressing need for new and/or updated units.

Given the need, it is disappointing that current budget cuts may adversely impact rural funding sources. Can rural economies thrive without the benefit of reliable and dedicated programs to provide and preserve housing for low to moderate income rural residents?

USDA is the single largest lender in rural America. In August 2010, its portfolio of 515-financed apartments consisted of 15,829 properties with 446,781 units. The average unit was 30 years old in 2010 and nearly 56% of the residents were elderly with an average adjusted annual income of $11,364.

The USDA 538 program, created in 1996, provides financing for new rural properties and preservation of older 515 apartments. Through some testy start-up years, owners and lenders eventually developed confidence in the 538 funding stream. To date more than 699 rural affordable housing projects have been guaranteed with the Section 538 program.

The 538 program, however, has become one of the early casualties in the budget deficit cuts. In FY 2010, the program received an appropriation of $130 million. In FY 2011 and FY 2012, the Administration requested zero funding. Congress appropriated $30.1 million for FY 2011 (all of which was committed to applications already in the pipeline) and the House sent the Senate an approved appropriation of zero funding for FY 2012. Without further program changes, the prospects for the 538 appear to be bleak. If the program does not continue, rural developers will have to be creative and persistent in their pursuit of capital.


Affordable multifamily apartments are particularly difficult to develop in rural areas. Rents necessarily need to be low to accommodate low incomes, developments are small because of smaller populations within a market area, and the economics of a small deal with cash flow from low rents are always challenging—not to mention the challenge of finding a bank interested in making the loan. Therefore a limited number of qualified developers/owners build and own rural housing.

The traditional mainstay rural multifamily lender has been the Rural Housing Service (RHS), formerly Farmers Home Administration (FmHA), for communities defined by RHS as 20,000 or less. Beginning in the 1970s, USDA made direct loans under cost containment requirements for Section 515 properties and provided a deep subsidy (down to 1%) for the interest rate. Preservation of the Section 515 units may be one of the biggest challenges to the affordable housing stock because the units are aging and owners have few preservation and maintenance options. Section 538 was created as a funding source for new construction and a source for rehabilitation dollars, and to be used along with existing sources such as Rental Assistance (RA) to keep rents low.

Many are eager to find viable solutions to finance the next generation of rural housing. HUD has previously made forays into rural America, and may do so again, but urban and suburban areas are more often its comfort zones. Specific experience and delivery systems are needed to finance housing in the countryside.

Alternatives to Rural Development Loans

The economic climate challenges the nation’s leaders to reduce spending, forcing budget cuts to popular programs. The hope of making the 538 program revenue neutral (thus not requiring an appropriation) is still alive, however developers with projects awarded 2010 and 2011 tax credits cannot wait and must find other debt solutions. Some of the funding programs that appear to be working as a substitute for the 538 are discussed below.

A new construction project in Texas had already received a tax credit allocation and its 538 loan was being processed when 2011 program funding was cut to 23 percent of the expected appropriation. To save the project and the tax credit award, HUD accepted the project into the FHA 221(d)(4) program for processing. With some delays in transitioning the loan from RD to HUD, the borrower was able to maintain a 40-year loan term, obtain a low interest rate, and hold onto the tax credit allocation.

The owner of a facility in Arizona with awarded tax credits and plans to rehabilitate 29 units and construct 20 new apartment units was seeking a 538 loan to take out the construction loan to serve as permanent debt in the spring of 2012. However, the borrower elected to go to Fannie Mae and abandon the 538 when appropriations were less than expected. The Fannie Mae loan was approved in seven weeks and the lender received a forward commitment, but there were trade-offs. For example, due to the full rate lock requirement, the interest rate was about 250 basis points higher than the anticipated rate on the 538. Additionally, the project was approved for a Fannie Mae 30-year amortization (18-year term) instead of a 40-year term on the 538. The drawback of the shortened loan amortization was more than offset by the ability to obtain a timely and reliable debt commitment.

Many 515 properties have been preserved using 4% tax credits, bonds and a 538 guarantee. The same objective can be accomplished using one of the government sponsored entities (Fannie Mae or Freddie Mac) instead of the 538.

One Ohio borrower preserved three Ohio properties (two non-515 rural and one urban) using one financing structure consisting of a tax-exempt bond with a Fannie Mae credit enhancement. The properties received $35,000 worth of rehabilitation per unit by using the Tax Credit Assistance Program (TCAP), bonds, 4% credits, a Financing Adjustment Factor loan (FAF) and HUD subordinate mark-to-market loans.

Given the uncertain future of the USDA 538 program, lenders and borrowers need to be prepared to use alternatives. The scenarios described above provide examples for how lenders and borrowers can continue to move their projects forward no matter how established housing programs fare.

Reprinted with permission from Lancaster Pollard and Tax Credit Advisor magazine.

Lancaster Pollard helps health care, senior living and affordable housing organizations expand and improve their services by providing financing solutions. The firm offers a full range of investment banking, mortgage banking and investment advisory services and has one of the largest groups of financial professionals dedicated to health care in the country. As a leading underwriter of bonds and mortgages, Lancaster Pollard has earned a reputation for delivering sound financial advice and the most cost-effective financing options available in the market.