JR Lephew

The Low Income Housing Tax Credit (LIHTC) is a federal tax credit created through the Tax Reform Act of 1986, and was designed to encourage private investment in affordable housing by commercial real estate stakeholders, whether it be in new construction, acquisition, or rehabilitation of existing rental housing. Since its inception, LIHTC has become both the most successful and the longest-running national affordable rental housing incentive program in history, as well as the most important resource for CRE professionals to create and preserve affordable housing in the United States.

LIHTC: An Opportunity for CRE Developers and Investors

The LIHTC program, which is administered by the Internal Revenue Service (IRS), does not provide direct housing subsidies. The program provides tax incentives in exchange for capital for development and/or financing costs to encourage developers to create and preserve affordable housing. These tax credits are proportionally set aside for each State based on its population and are distributed to the State’s designated tax credit allocating agency. These State agencies then distribute the tax credits based on the State’s affordable housing needs paired with Federal and State-specific program requirements. This is done through what is known as the Qualified Allocation Plan (QAP) process.

Most importantly, the end effect is to generate private equity investment into public housing. The program ends up preserving existing multifamily housing structures as well as producing a new stock of affordable housing. The average multifamily development ranges from 50-100 units, typically a low- to mid-rise building or a track/row home. The impact of the 30+ year program has been immeasurable: 45,000+ projects representing 3M+ units of affordable housing. This is important because housing prices continue to rise while wages remain stagnant; however, gentrification also plays a role in displacing residents as property values rise.

The structure of typical LIHTC deals creates a 15-30-year cycle, depending on deal structure, to recapitalize/reinvest/refinance deals as the previous credits expire. This falls in line with typical renovation timelines of 15-20 years (as many major building structure components and systems start to age, such as mechanical equipment, appliances, finishes, and roofing, etc.).

Currently, key funds for LIHTC investments come from the Department of Housing and Urban Development’s HOME Investment Partnership Program, Community Development Block Grant, Affordable Housing Program, and the National Housing Trust, among others. Even though corporate tax cuts may lead to less interest in LIHTC deals, the emergence of the Opportunity Zone investment program can help re-energize investment in affordable housing projects. So while the status of adjacent Federal programs are up in the air and may affect the future of LIHTC, policy changes and incentives can continue to spur private investment.

Executing Successful LIHTC Deals: Challenge Through Complexity

Broadly, there are two types of  equity tax credits: 4% & 9% Bond Tax Credits, awarded through state-specific QAPs. These QAPs set requirements, application deadlines, and the affordability period for deal structure. 10-year claims require 15-year compliance and 30-year affordability compliance. 4% Bond Tax Credits provide 30% subsidy and require an additional 50% of funding through tax credit bonds – these are not as competitive. 9% Bond Tax Credits provide 70% funding without requiring additional funding – these are state distributed and extremely competitive. Hard debt is funded through a conventional mortgage, while soft debt comes from a government source. The average LIHTC deal is approximately 45% equity, consisting of roughly 24% hard debt and 21% soft debt.

If structured correctly, LIHTC is always a profitable investment, regardless of the commercial real estate cycle. However, it is especially hot right now, as we near the late stages of the post-Recession real estate cycle, when development deals and investment opportunities may not be as robust as in previous years. Secondly, many of the 15-year tax credit deals from the past recession have come through, so investors may be looking for opportunities to find new projects and investments. In turn, this has attracted some stakeholders who are new to LIHTC programs, and may not understand all the complex intricacies involved with applying for the program and adhering to the strict guidelines. To this end, one can see why there are so many stakeholders and sources in the capital stack structure of a LIHTC deal.

Therefore, more and more due diligence and risk management oversight is being sought to ensure that federal and state regulations are met, and proper use of funds is planned. Depending on the needs of the various capital stack stakeholders, these services may include environmental compliance, review of structural/building code standards and conformance, as well as accessibility standards, and green/energy efficiency compliance for multifamily housing.

Additionally, there are enormous state by state differences, both in terms of specific due diligence requirements, who is qualified to assess projects, and how they are reported. Some states require a certified architect or engineer to do all Capital Needs Assessments. In other states, accessibility compliance is required above and beyond typical debt reporting standards. Further still, some states differ in documentation requirements, and how reports are delivered (some even have their own template format). And all the application deadlines are different, so if you miss that window, you must start again in the following year, which may require additional/new due diligence assessments.

If all of this is sounding incredibly complex to execute, that’s because it is! Suppose you are a real estate developer looking to get tax credits for a renovated housing development in Florida, but you have no idea where your financing will come from. Underwriting structuring and due diligence risk management for Fannie Mae, Freddie Mac, or HUD financing vary greatly. Maybe midway through the process, an equity investor comes on board later who needs a totally different set of reporting standards. How do you proceed?

 

Choosing the Right LIHTC Consultant is Critical for Executing Deals

The single biggest factor for executing a successful LIHTC deal is choosing a knowledgeable, experienced consultant who can help you navigate the intricacies of reporting standards, who understands State-specific requirements and meeting hard deadlines, and who can guide you through the meticulous underwriting and due diligence assessment process. Due to recent changes in the corporate tax laws, a LIHTC deal may or may not be a profit-driver for all stakeholders, depending on circumstances. Furthermore, a good consultant will be able to evaluate a potential property’s environmental, physical and accessibility needs and help you decide whether the deal is worth your bottom line, given the stringent reporting standards, or if it is (in some cases) more prudent to pass, especially if you know the source of your lending.

Choose a consultant who has a deep understanding of the rules and mandatory requirements for getting tax credit applications processed and ultimately approved. Also important is the ability to assist you with projects that are already at various stages in the 15-30 year LIHTC cycle, providing support whether you are a project sponsor, investor, or a lender.

Because of the multi-disciplinary and complex nature of these deals at every stage of the life cycle, your team of licensed professional consultants could include civil, mechanical and structural engineers; environmental professionals; geologists; architects and energy specialists. As requirements increase, reporting and adherence to the standards becomes more vital for approval. A full suite of risk management and due diligence services are essential for all stages of implementation, including environmental site assessments to construction risk management, building science, industrial hygiene and more. Your team should ideally possess the technical skills, staff resources and portfolio experience needed when navigating the stringent requirements of a LIHTC deal.