This article is co-authored with Jerome Garciano, senior counsel at Akin. The article first appeared in Tax Credit Advisor.

In April of 2024, the U.S. Environmental Protection Agency (EPA) announced the winning applicants chosen by the agency to administer the three Greenhouse Gas Reduction Fund (GGRF) initiatives funded with $27 billion from the Inflation Reduction Act (IRA): the $14 billion National Clean Investment Fund (NCIF); the $6 billion Clean Communities Investment Accelerator (CCIA); and the $7 billion Solar for All (SfA). To complement the tremendous expansion of energy tax credits in the Internal Revenue Code, these funding initiatives are designed to provide a historic financial investment in clean technology to lower greenhouse gas and air pollution while building needed infrastructure and economic development in low-income and disadvantaged communities.

The EPA selected 68 applications to oversee the administration of the GGRF awards. The chosen awardees will use those funds received by the EPA to invest in green financing products and investment ecosystems, as well as initiatives at a more granular level, such as investments in the electrification of single-family homes, decarbonizing multifamily developments, including net-zero and deep energy retrofits for affordable housing projects and advancing energy efficiency in commercial projects.

While climate change investment in the transportation and electricity generation sectors is also a major focus of GGRF, this article focuses on funding for building and real estate. It is expected that the creation of a robust national green financing ecosystem and infrastructure will stimulate innovative loan and investment products. The vehicles for deploying capital for green initiatives are expected to fall into three main buckets – equity, grants and low-interest loans. Community Development Financial Institutions (CDFIs), Housing Finance Agencies (HFAs), banks and community lenders will work with the primary recipients to provide green mortgages and subordinate loans, credit enhancements, loan guarantees and loan loss reserves, as well as grants and equity investments for decarbonization projects and working capital for solar and energy efficiency projects.

Debt finance

In the multifamily affordable housing development space, debt finance commonly takes the form of construction loans, bridge loans and permanent loans. Loans are further identified by their lien position (senior or junior debt), can be collateralized or unsecured, and can be amortized (hard debt) or non-amortized (soft debt).

Loans in multifamily affordable housing development are also generally part of a larger capital stack that not only incorporates other debt but also equity raised from tax credits, such as Low Income Housing Tax Credits (LIHTC), Historic Tax Credits (HTC) and/or New Market Tax Credits (NMTC). Rental subsidies and tax-exempt bond programs are important factors, as they provide enhanced cash flow and interest rate subsidies supporting debt financing structures.

Additional considerations for a loan under GGRF

Currently, all awardees are still in the process of finalizing their agreements with the EPA, with details of their financing programs coming out later in 2024 through early 2025. However, we can glean some insight into their planned approach now, based on how the various awardees have worked with multifamily affordable housing projects in the past, as well as what they proposed to the EPA in their formal applications. Some of the approaches described in the applications include decarbonization/electrification mortgage loans, contractor lines of credit, net-zero rehab loans, energy tax credit bridge loans, below-market rate senior debt and risk-adjusted-priced junior debt.

The applications selected by the EPA indicate plans to issue senior or subordinate loans with low interest rates (estimated ranges noted in the awarded applications range from 0.25 to five percent), loan terms ranging from three to 40 years, and loan-to-value rates of 70 to 100 percent, depending entirely on the wide range of possible development projects from acquisition of green equipment, to retrofitting a property, to new construction of net-zero emissions buildings.

Senior loans

A senior loan by its definition requires a higher lien position on real estate collateral than other debt. For instance, if the project funding includes any debt or insured debt from the U.S. Department of Housing and Urban Development, HUD requires its debt to have the first lien position (with few exceptions), and HUD must approve the existence of all other collateralized debt to protect its interests in the assets. Under GGRF, a senior loan may be used to fund the construction of a net-zero building and would be collateralized; if HUD were involved, HUD would have to approve the property being collateralized by the GGRF loan. Senior loans are usually amortized but do not have to be. Also, be aware some existing third-party lenders may be unwilling to subordinate their loans. Energy tax credit projects funded by tax-exempt bond financing may also be impacted by a reduction in tax credit basis.

Subordinate loans

Payments on subordinate loans are made only if there is sufficient available surplus cash generated by the project. (Surplus cash is characteristically defined in the ownership, regulatory or debt agreements.) Subordinate loans may have very small, fixed payments throughout the life of the loan instead, with any amounts not paid on time due in full at maturity. This loan structure has the benefit of not negatively impacting eligible basis in a tax credit arrangement (as a grant may) while leaving much-needed funds in the project. The loans may be secured by a lien on the real property and security interest in the associated property.

A note of caution here: some loan options ultimately offered may incorporate a forgivable component up to a certain percentage of the debt at maturity, this could create an eligible basis issue for tax credits claimed on a portion of the asset, as well as a phantom income event for the forgiven portion of the debt.

Bridge loans

Bridge loans (aka gap loans) through the new “Direct Pay” option for IRA tax credits were also mentioned in the applications as a potential vehicle to help fund the “greening” costs of a project. This option is mostly limited to nonprofits. While there are not yet any agreements or transactions to review, the structure of any such bridge loans would be expected to be low-interest loans, likely collateralized by the green asset(s) or an assignment of the bridged tax credit or direct pay amount. As a rule, bridge loans tend to be short-term, which is an additional cash flow consideration for the developer. Of note, there are potential special considerations and/or caveats concerning Direct Pay, such as possible basis reduction issues, which may or may not be relevant to the nonprofit owner.

Other issues

Historic tax credits

A lien issue also exists for certain HTC deals that enter a master lease structure. In this scenario, the lessor entity that owns the asset and holds the debt collateralizing the asset would be the entity receiving the GGRF loan as the lessee (tenant) does not own anything associated with the property. Typically, in these structures, the lessee has more positive cash flow from tenant rents than the lessor; the lessor receives funds sufficient to pay debt service and operating costs. Adding another loan into this structure will often mean the lender would be required to sign a Subordination Non-disturbance and Attornment Agreement (SNDA). Meaning unless there is a default on the lease, the lender remains attached only to the lessor and cannot access the lessee’s cash flows.

Land Use Restriction Agreements (LURAs)

Affordable housing developers are intimately familiar with Land Use Restriction Agreements (LURAs) and their impact on restricting the rents a project is allowed to charge its tenants. In the LIHTC industry, LURAs are typically in place for 15 to 30 years. One of the GGRF’s focus areas is low-income housing, which means to obtain the funding, whether loans or grants, there is speculation that developers may see rent-restriction vehicles, such as a LURA or a regulatory agreement to be a part of the deal. A developer just looking to bring in green upgrades to their property or build a green building will probably not want to encumber the property with multiyear rent restrictions tied to an area median income if this becomes an option.

Tenant relocation

It is likely a project developer will be required to comply with the Uniform Relocation Assistance and Real Property Acquisitions Policies Act. This means that to the extent low-income households must relocate because of a project funded under GGRF, developers will be required to make temporary housing available to them at the same rent.

Prevailing wage, apprenticeship and project labor agreements

One of the biggest changes to the clean energy tax credit programs was the introduction of prevailing wage and apprenticeship requirements for certain projects to access prior or enhanced tax credit amounts. Similarly, the GGRF programs are expected to implement Davis-Bacon requirements around labor, wage and workforce development unless the EPA provides exemptions. Fortunately, most multifamily affordable housing developers are already accustomed to Davis-Bacon regulations and requirements.

For the affordable housing developer who wants to take advantage of the GGRF opportunities, it’s important to maintain an open dialogue with business advisors to address any concerns, whether it’s about unwanted income, basis and tax credit recapture or preferred returns. If there is another government agency involved—local, state and/or federal—a developer needs to understand those contracts or regulatory agreements.

As the guidance from the EPA continues to take shape over the next few months, stay tuned for a follow-up on this segment.

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