New York City’s Voluntary Inclusionary Housing Program: A Hidden Gem for Affordable Housing Owners and Air Rights Purchasers

July 10, 2018Law360

Although New York City’s Mandatory Inclusionary Housing program received significant attention at the time of its adoption, the city’s Voluntary Inclusionary Housing program remains a viable means for developers and owners to create or preserve affordable housing. Through the program, owners can generate proceeds to pay for renovation work and ensure the long-term preservation of affordable housing units through the sale of development rights. This is particularly noteworthy since preservation units represent 68 percent of the affordable units covered by the Housing New York Plan — the city’s plan to create or preserve 300,000 affordable housing units.

To successfully execute one of these transactions, an affordable housing owner must carefully coordinate with the New York City Department of Housing Preservation and Development, the preservation project lender and air rights purchasers. By putting these three pieces together, affordable housing owners can undertake critical improvement projects and generate funding for long-term preservation of affordable units and developers can acquire development rights for new residential development projects.

Program Background

Under the Voluntary Inclusionary Housing program, a preservation project can generate development rights, referred to as inclusionary air rights, that affordable housing owners can transfer to sites within the same community district as the preservation project, referred to as the generating site, or within an adjacent community district and within a half mile of the generating site. Pursuant to the city’s zoning resolution, the amount of inclusionary rights generated is based on the amount of affordable housing preserved, the zoning district and whether public funding is involved in the preservation project. In an R-10 district, a preservation project can generate two times the square footage of floor area being preserved if the generating site has not received public funding in the last 15 years, and 1.25 times the square footage of floor area being preserved if the generating site has received public funding in the last 15 years. In inclusionary housing designated areas and in special districts, the zoning resolution specifies the ratio that applies regardless of whether the generating site received public funding.

Developing the Affordable Housing Plan

To begin the approval process, an applicant prepares and delivers an affordable housing plan to the HPD, which must include information demonstrating the applicant’s ability to undertake the preservation project and maintain the preserved affordable housing. In the plan, the applicant also identifies the administering agent who will be responsible for ensuring that units are rented in accordance with the regulatory agreement that the applicant will execute with the HPD. In addition to being subject to the HPD’s review and approval, the applicant presents its plan to the local community board as required under the zoning resolution. The HPD will not approve the plan until the community board provides comments (or informs HPD that it has no comments). If the community board does not respond within 45 days, then HPD can proceed with approval of the plan.

Negotiating and Executing the HPD Regulatory Agreement

To memorialize the requirements and obligations stated in the affordable housing plan, the applicant and HPD negotiate and execute a regulatory agreement that is recorded on the property prior to the issuance of any inclusionary air rights. The regulatory agreement sets forth the project’s rent and affordability requirements, the construction work’s scope and completion timeline, and the applicant’s obligations for managing the preservation project. As noted above, the project’s administering agent has ongoing monitoring obligations to ensure compliance with the regulatory agreement requirements. The funding of reserve accounts is a particular item of focus in the regulatory agreement because the proceeds from the inclusionary air rights transactions are used to fund the long-term preservation of the affordable housing units. As a result, the applicant needs to develop a plan that directs proceeds to fund operating, capital and replacement accounts for the affordable housing units. Additionally, in the event that the project generates excess proceeds, the regulatory agreement will include a provision detailing the decision-making process between the applicant and HPD for use of those excess funds.

Lining up Preservation Project Financing

In addition to reaching agreement with HPD, the applicant has to identify financing sources for the preservation project. A preservation project lender seeks to ensure that the applicant has an approved affordable housing plan and agreed-upon regulatory agreement with the HPD. Additionally, as is customary with any construction financing, the applicant and lender work together so that the project has an agreed-upon set of plans, budget and schedule that must also be consistent with what is required pursuant to the regulatory agreement. Most importantly, the lender looks to have the applicant provide one or more executed inclusionary air rights purchase agreements, because proceeds from these transactions will ultimately pay off the loan, since a preservation project does not itself result in increased rental revenues.

Air Rights Transactions: Key Points for Sellers and Buyers

Given the importance of air rights sale proceeds to the lender, the applicant must identify one or more buyers of inclusionary air rights to enable the project to proceed. While the purchase agreement negotiated in these air rights transactions has a number of terms similar in nature to those found in a customary real estate purchase agreement, parties usually focus on certain key terms. Most importantly, the agreement typically includes the air rights buyer to make a deposit that is far larger than what is made in a typical real estate purchase. The deposit can be as high as 50 percent of the purchase price and, in certain instances, it may be the entire purchase price, if the deposit represents the only collateral that the lender is going to receive. The outside date for project completion is another term that the parties are likely to discuss at great length. While the air rights purchaser wants to be certain about the timing of the air rights transfer, the applicant must make sure the contract’s schedule provides enough cushion to make the lender comfortable that it will not lose the deposits. The lender also requires notice and cure provisions so that it can step in and have the project completed if the applicant defaults.

Given the size of the deposit, the air rights purchaser will seek to make sure that the preservation project remains on track to be completed in a timely fashion and that it has appropriate protections under the contract if the applicant defaults. At the outset, the purchaser should conduct an appropriate level of diligence on the applicant and the preservation project to have comfort that the applicant has the experience and funding to complete the project. Additionally, purchasers usually seek to include milestones in the contract, so that it does not need to wait until the very end of the process to find out that the preservation project is not being completed in a timely manner. Lastly, the purchaser will seek to include a liquidated damages clause or other appropriate remedy to ensure that the applicant does not seek to subsequently sell the inclusionary air rights to another purchaser because of an increase in the market value of the rights.

In addition to working with the lender on the purchase agreements, the applicant has to notify the HPD as well. As part of this notification, the purchaser verifies that the use of the inclusionary air rights will comply with the zoning applicable to the purchaser’s site. Additionally, the HPD must determine that the purchase price for the inclusionary air rights represents an amount that is at least equal to the price per square foot of land for existing developable sites in the same community board district. Once the applicant provides the notice and the HPD approves the purchase price, the applicant can request that HPD deliver a permit notice, the “DOB Letter,” to the New York City Department of Buildings, describing the affordable housing being preserved at the generating site. Once the DOB receives the notice, it can issue permits to the purchaser’s site for the portion of the development utilizing the inclusionary air rights.

Project Completion and Air Rights Transfers

Upon completion of the preservation project, the applicant notifies the HPD so that the HPD can visit the site and confirm that the applicant has completed all required preservation work. Once confirmed, the HPD issues a “Certificate of Completion of Affordable Units” and “Certificate of Eligibility” stating the amount of affordable housing floor area preserved by the applicant. This step enables the applicant to close on the inclusionary air rights transactions into which it has entered and allows the applicant to repay its construction loan with sale proceeds. The issuance of these certificates by HPD also enables DOB to issue certificates of occupancy for the portions of the purchaser’s site utilizing the inclusionary air rights.

An inclusionary housing preservation project requires an affordable housing owner to coordinate efforts with the HPD, its lender and inclusionary air rights purchasers. This multiparty coordination results in significant value for owners who stand ready to renovate their property and ensure the long-term preservation of their affordable housing units. It also represents an under the radar opportunity for developers looking to access inclusionary air rights for a new residential project.

This article originally appeared in the July 9, 2018 edition of Law360.