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Low-Income Housing Tax Credits
Lecture Notes
National Trust for Historic Preservation
November 4, 2010
Washington, DC
John Linner
National Development Council
1946 N. 13th, #484, Toledo, OH 43604
ph: 419-242-5713
jlinner@nationaldevelopmentcouncil.org
National Development Council
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Tax Credits
•
A direct, dollar-for-dollar reduction of tax liability
•
Two kinds for rental housing
1. Historic Rehabilitation Tax Credits (HRTCs)
2. Low-Income Housing Tax Credits (LIHTCs)
• Intended to give investors an incentive to make
investments that have a public purpose
National Development Council
Low-Income Housing
Tax Credits (LIHTCs)
• Introduced in Tax Reform Act of 1986
• Extended in Revenue Reconciliation Act of 1993
• Intended to encourage investment in low-income
rental housing
• Principal federal subsidy for low-income housing
• Annual credit for 10 years
National Development Council
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For Permanent Rental Housing
• Excludes nursing homes, health care facilities
• Must be for “general use”
• Normally, minimum six month initial lease term
(exception for SRO’s, housing for the homeless)
National Development Council
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Three Threshold Criteria
1.
Incomes of occupants
2. Rent restrictions
3. State agency approval
National Development Council
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Income/Occupancy
• 20 percent of units must be occupied by tenants with
incomes below 50 percent of area median income
(AMI)
OR
• 40 percent of units must be occupied by tenants with
incomes below 60 percent of AMI
• Election must be made by time building is placed in service
• Must be met in first year credits are claimed
• Receive credits only on units occupied by qualified
low-income tenants (applicable fraction)
• Maximum credit award requires 100 percent lowincome occupancy
National Development Council
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What Counts as Income?
•
•
•
•
•
•
•
•
•
Gross wages and salaries
Social Security, pension, retirement
Disability, worker’s compensation, unemployment
Welfare
Alimony, child support
Earned income tax credit > taxes
Interest, dividends or imputed income
Qualifying amount is “anticipated” total
Once qualified, a household’s income may rise above LIHTC
limits without disqualifying unit
• Annual recertifications may be waived for 100 percent low-income
projects
National Development Council
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Rent Restrictions
• All units receiving LIHTCs have rent restrictions
• Restrictions based on number of bedrooms, imputed
household size, and AMI
• Imputed household size equals number of bedrooms x 1.5
persons per bedroom (one person for a 0-bedroom unit)
• Rent cannot exceed 30 percent of income qualifier (either 50 or
60 percent of median) for the assumed household size
• Maximum rent includes all utilities except telephone
National Development Council
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Computation for Two-Bedroom Unit
• Imputed household size is 2 x 1.5 persons/bedroom = threeperson household
• DC median income for three-person household is $92,400
• 60 percent of median is .60 x $92,400 = $55,440 or $4,620
per month
• Maximum two-bedroom rent is 30 percent of $4,620 per
month, or $1,386 per month
• If utility allowance for two-bedroom unit is $125 per month
maximum contract rent is $1,386 – 125 = $1,261 per month
National Development Council
Computation for a One-Bedroom
Unit
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• Imputed household size is 1 x 1.5 persons per bedroom = 1.5
persons
• If DC median income for one person is $71,900 and median for
two persons is $82,200, median for 1.5 persons is midpoint or
$77,050
• 60 percent of median equals $46,230 or $3,852 per month
• 30 percent of median is $1,155 per month
• If utility allowance for one-bedroom unit is $100 per month,
maximum contract rent is
$1,155 - $100 = $1,055 per month
National Development Council
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Computation for a One-bedroom Unit (cont.)
• Maximum rents do not include rental assistance
(Section 8) or payments for supportive services from
government agencies or non-profits
• Maximum rents do include any tenant payments for
services that are required as a condition of occupancy
• In assisted living projects, services must be optional or
funded by agencies
National Development Council
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Tenant Charges for On-site Facilities
• If tenants must pay to use on-site facilities (garage
spaces, storage spaces), then either
• Payments count against maximum LIHTC rent, or
• Costs of facilities are excluded from basis
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LIHTC Rents (cont.)
• Income qualification is based on the individual
household’s income. Must be below threshold for that
household.
• Rent is based not on tenant’s household size or
income but on threshold for imputed household size
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Maximum Rents May Decline
• Maximum gross LIHTC rent may decline with decline
in AMI, but cannot be less than initial maximum
• Maximum contract rent may decline because of
increase in utility allowance
National Development Council
LIHTC Projects Must Remain Lowincome on a Long-term Basis
• Rent and income restrictions are in force for a
minimum of 15 years (compliance period)
• Additional 15-year “extended use obligation”
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State Agency Approval
• LIHTCs are administered by states
• Each state receives $2.15 LIHTCs per resident ($2.465
million minimum) for 2011
• State agency allocates credits
• Creates own allocation plan
• Underwrites projects
• Monitors projects
• At least 10 percent set aside for projects sponsored by
non-profit organizations
• States may require low-income occupancy for longer
than 30 years
National Development Council
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Two Kinds of LIHTCs
• 70 percent present value (9% credit) – presently fixed
at 9.0%
• 30 percent present value(4% credit) – floats and is
adjusted monthly – 3.24% for November of 2010
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Two Kinds of LIHTCs (cont.)
• Most projects are “9% deals” - receive 9% credit on all
rehabilitation work or new construction
• Others are “4% bond deals” - receive 4% credit on all
rehabilitation work or new construction
• Also sometimes receive 4% credit on the building
portion of acquisition on a rehabilitation project
National Development Council
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Grants Excluded from Basis
• No credits on costs funded with grants
• Convert grants into loans
National Development Council
New Construction/
Substantial Rehabilitation
• Annual credit for 10 years
• Substantial rehabilitation requires spending the
greater of
• $6,000 per unit, or
• 20 percent of remaining depreciable basis
• “9 percent deal” - receive 9% credit on basis items
(improvement costs)
OR
• “4 percent bond deal” - receive 4% credit on basis
items
National Development Council
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Example
New Construction Project
USES
$500
5,000
1,000
$6,500
SOURCES
Land
Resid. Improvement
Comml. Improvement
TOTAL
$2,000
1,350
3,150
$6,500
Bank Loan
HOME
Equity
TOTAL
LIHTCs
$5,000
x
.09
450
x
10
$4,500
National Development Council
Credit Basis
Maximum LIHTC/Year
Total LIHTCs over 10 years
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Example
30% Basis Increase for Difficult Development Areas and
Qualified Census Tracts
USES
$1,000
6,000
$7,000
SOURCES
Land
Resid. Improvement
TOTAL
$1,500
586
4,914
$7,000
Bank Loan
HOME
Equity
TOTAL
LIHTCs
$6,000
x
1.3
7,800
x
.09
702
x
10
$7,020
National Development Council
Resid. Improvement
Credit Basis
Maximum LIHTC/Year
Maximum LIHTCs over 10 years
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30% Basis Increase contd.
• A state may also provide the 30% basis increase for
any project that the state believes needs additional
credits in order to be feasible
National Development Council
Improvement Basis
(9% or 4% Credit)
• Include
•
•
•
•
•
•
•
•
•
•
•
Construction and supervision
Architectural, engineering, design fees
Construction financing costs (fees, appraisals, interest)
Developer fees
Permits and inspection fees
Performance bonds
Furnishings
Environmental assessment
Development consulting fees
Property taxes and insurance
Community service space (qualified census tract, serve
primarily low-income residents, limits on percentage of
building basis)
National Development Council
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Not Considered Part of Construction
or Rehabilitation Basis
• Exclude
•
•
•
•
•
•
•
•
Permanent financing expenses
Syndication costs
Tax credit application fees
Reserves
Acquisition expense (land or building)
Off-site improvements (generally)
Organizational expense
All costs attributable to non-residential (exception for
community service space)
• All costs attributable to market-rate units
National Development Council
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Acquisition Credit
• Can also receive 4% credit on portion of acquisition
price attributable to building
• Available with substantial rehabilitation only
• Must spend greater of $6,000 per unit or 20% of building
basis
• Must meet “10 year placed in service rule”
• Waivers for REO’s, preservation projects
National Development Council
Acquisition/Rehabilitation
In Difficult Development Area
USES
$2,000
5,000
$7,000
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SOURCES
Acquisition (1/2 building)
Rehabilitation
TOTAL
$1,800
867
4,333
$7,000
Bank Loan
HOME
Equity
TOTAL
LIHTCs
$5,000
x
1.3
6,500
x
.09
585
x
1,000
.034
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Rehab
Credit Basis
Credit on Rehabilitation
Existing Building Value
Credit on Acquisition
National Development Council
585
+ 34
$619
Credit on Rehabilitation
Credit on Acquisition
TOTAL LIHTC/YEAR
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Historic Rehabilitation Tax Credits
Reduce LIHTC Basis
$4,000,000 Rehabilitation
x
.20 Credit Rate
=
$800,000 RTC
$4,000,000
800,000
= $3,200,000
x
.09
$288,000
National Development Council
Rehabilitation
RTC
LIHTC Credit Basis
Maximum Annual LIHTC
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Historic Rehabilitation Tax Credits Reduce LIHTC Basis (cont.)
• With 30% LIHTC basis increase
=
x
=
x
=
$4,000,000
800,000
$3,200,000
1.3
$4,160,000
.09
$374,000
National Development Council
Rehabilitation
RTC
LIHTC credit basis increase
Maximum annual LIHTC
Issues in Combining
LIHTCs and RTCs
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• Compliance with historic standards may increase
costs
• RTC’s reduce basis for LIHTCs – even greater impact
if project is eligible for 30% basis increase
National Development Council
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Master Tenant Leases
• Tax code allows RTCs to be passed through to a
tenant
• Create separate partnership (master tenant) to lease
building and take RTCs
• No basis reduction on LIHTCs
• Used most often on large bond deals
National Development Council
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Example
• Project with $10 Million of Historic Rehabilitation in Qualified
Census Tract
No Master Tenant
$10,000
- 2,000
$8,000
x 1.3
10,400
x .0324
$337
National Development Council
Rehab
HRTC
LIHTC Basis
LIHTC/Year
Master Tenant
$10,000
x 1.3
$13,000
x .0324
$429
Rehab
LIHTC Basis
LIHTC/Year
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Typical Credit “Prices”
• RTCs - $.80-.90 per dollar
• LIHTCs - $.65-.80 per dollar
• Prices are negotiated between developers and
investors
• Prices have declined sharply since peak in 2006-2007
National Development Council
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Competition Problem
• Most states have two or three times as many proposed
projects as they can fund
• Makes the application process increasingly uncertain
• Incur substantial predevelopment costs with no
assurance of feasible project
National Development Council
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Solution – Bond Deal
• Qualify for “4%” credit outside state’s normal
allocation process
• Requires allocation of “private activity” bond cap
• State gets $95 per resident in bond cap (compared to
$2.15 per resident in LIHTC’s)
National Development Council
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Tax-Exempt Financing and LIHTCs
• Projects with 50 percent of costs funded with taxexempt financing automatically receive 4% credit
without state approval outside state’s LIHTC
Allocation process
• Financing must be from state’s volume cap for private
activity bonds
• Often mixed-income projects
National Development Council
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Must Fund Half of Development Costs
With Tax-exempt Debt
• Must pay for 50 percent of cost (land plus depreciable
basis) with bond proceeds
• Rent restrictions may limit the amount of permanent
debt
• Can meet the 50 percent test with tax-exempt interim
financing and pay down with investor equity and soft
permanent debt
National Development Council
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Problem – 4% Credit Yields
Fewer Credits and Less Equity
x
x
x
$100,000
.09
$9,000
10
$90,000
.70
$63,000
National Development Council
Basis
LIHTC/Year
LIHTCs
Equity/Unit
$100,000
x
.0324
$3,240
x
10
$32,400
x
.70
$22,680
Basis
LIHTC/Year
LIHTCs
Equity/Unit
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Need More Debt to Do Bond Deals
• Higher “must pay” debt > higher NOI > higher rents
• Without higher rents > large amounts of deferred
payment loans (HOME, CDBG, AHP, State or local
subsidies)
National Development Council
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Two General Types of Bond Deals
• Relatively high rents, NOI sufficient to support
Enough permanent debt to meet 50 percent test
• Often mixed income with significant portion of units at
market rate
• 100 percent of units at tax credit rents, meet 50
percent test with interim financing
National Development Council
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Bond Deals Are Often Riskier
• Higher rents, more market risk
• More debt service than “9%” tax credit projects
• Frequently done with FHA insurance - lower debt
coverage requirements, less margin for error
National Development Council
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Bond Deals (cont.)
• Advantages of 4% bond deals
• Less competition for bond cap than for tax credits
• May be faster – do not have to wait for LIHTC round
• Disadvantages of bond deals
•
•
•
•
Less equity, more debt
More players
Higher transaction costs
Lower investor interest today
National Development Council
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Who Are the
Limited Partners in Tax Credit Deals?
• Corporate equity funds
• Large corporate direct investors
• Private placements
• Equity funds for individuals
National Development Council
Methods of Organizing the
Ownership of an LIHTC Project
• Limited Partnership
• Limited Liability Company
Objectives
• Limited liability for investors
• Direct pass-through of credits, losses and gains
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Limited Partnership
• At least one General Partner (GP)
• At least one Limited Partner (LP)
• GP owns 0.01 percent
• LP owns 99.99 percent
• GP manages partnership
• LP is passive investor
• LP has limited liability
• GP has unlimited liability
National Development Council
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Limited Liability Corporation (LLC)
• A corporation taxed like a partnership
• At least one manager (like a GP)
• At least one member (like an LP)
• Advantages over Limited Partnership
• Limited liability for all owners
• Investors can have role in management
National Development Council
Investors Invest For
Tax Benefits - Credits, Losses
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• LP invests solely for tax benefits - gets 99.99% of the
tax credits and the losses
• Developer/GP tries to capture as many of the cash
benefits as possible (developer’s fees, cash flow,
residuals)
National Development Council
Ways Of Diverting
Cash Flow To GP
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• Deferred developer fees
• Payments on GP loans
• Partnership management fees
• Incentive management fees – limited to lesser of 8090 percent of cash flow or some percentage (10-15
percent) of effective gross
National Development Council
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Investors Also Value Losses
+
=
x
=
Principal Payments
Reserve Deposits
Depreciation
Amortization
Accrued Interest
Taxable Income (Losses)
Tax Rate
Taxes (Tax Savings)
National Development Council
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Doing a LIHTC Project – Step One
• Applying for credits
•
•
•
•
•
Site identification and control
Preliminary design concept and budget
Information about the development team
Market/feasibility analysis
Financial projections
•
•
•
•
Operating pro forma
Estimate of credits
Sources and uses
Letters of interest from financing sources
National Development Council
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Site Control
• Option
• Ground lease
• Purchase
National Development Council
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Market Analysis
• Compare LIHTC rents to market rents
• Market vacancy rates
• Vacancy/waiting lists in other subsidized projects
• Population trends
National Development Council
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Financial Projections
• Construction sources and uses
• Permanent sources and uses
• Operating pro forma
• 15-year cash flow
National Development Council
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Construction
Sources And Uses
USES
SOURCES
BANK
Site Acquisition
Off-Sites
On-Site Imp.
Construction
Contingency
Bond
Permits, Fees
Arch. & Engineer
Const. Super.
Soils Test
Environ. Assess.
Const. Loan Fees
Const. Interest
Real Estate Tax
Insurance
Appraisal
Legal
Consulting
Title
Marketing
Perm. Loan Fee
LIHTC Application
TOTAL
National Development Council
HOME
$50,000
$374,000
45,000
15,000
15,000
355,000
L.P. EQUITY
$50,000
25,000
5,000
5,000
$100,000
25,000
15,000
900,000
45,000
15,000
50,000
90,000
20,000
2,000
3,000
5,000
40,000
5,000
10,000
2,000
10,000
10,000
2,000
10,000
5,000
5,000
$270,000
$1,369,000
171,000
50,000
90,000
20,000
2,000
3,000
5,000
40,000
5,000
10,000
2,000
10,000
10,000
2,000
10,000
$499,000
$600,000
TOTAL
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Permanent
Sources And Uses
USES
SOURCES
PERM. LOAN
Pay Const. Loan
Rollover HOME
Rollover Equity
Vac. Reserve
Oper. Reserve
Audit
Perm. Loan Fee
Synd. Costs
Dev. Fee
TOTAL
National Development Council
HOME
$367,000
L.P. EQUITY
DEFER. DEV FEE
$132,000
$50,000
$499,000
600,000
270,000
20,000
50,000
8,000
5,000
40,000
200,000
$50,000
$ 1,692,000
$600,000
270,000
20,000
50,000
8,000
5,000
40,000
150,000
$392,000
$600,000
$650,000
TOTAL
Pro Forma Income
and Expense Statement
Gross Residential Income
Commercial Income
Other Income
Total Gross Income
$150,000
40,000
2,000
192,000
Residential Vacancy
Commercial Vacancy
Effective Gross Rent
7,500
6,000
168,500
Operating Expenses
Taxes
Insurance
Maintenance
Management
Utilities
Replacement Reserves
Operating Reserves
TOTAL
10,000
6,000
12,000
13,000
10,000
6,000
8,000
65,000
Net Operating Income
113,500
Debt Service
91,600
Cash Flow
$21,900
National Development Council
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Letters of Interest
from Financing Sources
• Bank construction loan
• Bank permanent loan
• Public gap loan
• Investor equity
National Development Council
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Doing a LIHTC Project – Step Two
•
Closing the deal
•
Receive credit award – don’t have a deal without an
allocation of credits
Negotiate financing commitments
•
•
•
•
•
•
•
•
Investor – letter of intent, partnership agreement
Permanent lender
Construction lender
Gap lender
Final design and budgeting
Select contractor
Construction loan closing
National Development Council
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Doing a LIHTC Project – Step Three
• Construction
•
•
•
•
Monitor progress and quality
Control change orders
Keep project on schedule
Get certificate of occupancy
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Doing a LIHTC Project – Step Four
• Operations
•
•
•
•
Permanent loan closing
Rent-up
Management
Disposition
National Development Council
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Rent-up
• Qualification of tenants
• Meeting 20/50 or 40/60 threshold
• 100 percent occupancy of low-income units
National Development Council
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Management
• Tenant income qualification
• Compliance
• Maintaining financial records
• Tax returns
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Key Issues in Calculating Returns
• When project is placed in service
• Reaching 100 percent rent-up
• Percentage of annual credit amount in first year
• Additional tax savings from losses
National Development Council
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Key Deadlines in LIHTC Process
• Place in service by 12/31 in year of credit award or get
carryover allocation
• To get carryover, incur 10 percent of costs by 12/31 in year of
credit award or within 12 months of credit award
• If get carryover, place in service within 24 months of 12/31 in
year of credit award
• Must meet low-income threshold in year credits claimed
• Establish basis in year placed in service or following year
National Development Council
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Meeting 10 Percent Carryover Test
• Must incur costs equal to 10 percent of basis plus land
costs
• Minimize cash outlay by
• Accruing 20 percent of developer fee
• Buying land with seller note
National Development Council
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Establishing Basis of a Building
Total basis-eligible costs
x Percentage rented to qualified tenants (Applicable Fraction)
= LIHTC Basis
• Applicable fraction is lesser of percentage of units or
percentage of square footage leased to qualified tenants
• Units not rented to qualified tenants when basis is
established may be added the following year, but
credits will be at 2/3 rate for balance of compliance
period
National Development Council
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Calculating Credits for the First Year
• Unit eligible in month first occupied by qualified
tenant
• Units rented in January receive 12 months, in
February receive 11 months, etc.
• Portion of the annual award not received the first year
is received in the eleventh year
National Development Council
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Example
•
•
•
•
Project with 15 identical units
Annual allocation of $100,000 of LIHTCs
Placed in service in by May 1st
Five units rented in May, June and July
Month
May
June
July
New Units
Rented
5
5
5
Credit/Months
Per Unit
8
7
6
Total
Credit/Months
40
35
30
105
Potential Credit/months = 12 months x 15 units = 180 credits/month
105/180 = 58.333%
$100,000 x 58.333% = $58,333 LIHTCs in First Year
National Development Council
Investors’ Primary Objective Is
Tax Credits
69
• Pay in advance for credits promised in the
future
• Often have 80 or 90% of money invested upon
completion, before a project has qualified for
any LIHTCs
• How do they manage the risk?
• Tax Credit Adjusters
National Development Council
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Credit Adjusters
• Investors reduce capital contributions if
• Shortfall in total credits promised in partnership
agreement
• Delay in delivering credits
• Reduction in equity to maintain the investor’s
yield from the project
National Development Council
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Three Kinds of Adjusters
• Adjuster for shortfall in total LIHTCs delivered
-- reduce capital contributions
• Adjuster for delay in delivery of LIHTCs -reduce capital contributions
• Adjuster for units that go out of compliance -investor gets cash flow to make up for lost
credits
National Development Council
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Shortfall in Total Credits
• Investor agrees to invest $.70 per $1.00 of
LIHTCs. Commits $7 million in equity for $10
million in LIHTCs over 10 years
• Project only qualifies for $9.8 million in
LIHTCs, a shortfall of $200,000
• $200,000 x $.70 = $140,000 reduction in
capital
• Capital reduced to $6,860,000
National Development Council
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Delay in Credit Delivery
• In first year, units become qualified for credits
when they are first rented to qualified tenants
• Sooner units are leased, more credits delivered
in first year
• Credits not delivered in first year are delivered
in year 11 -- much lower value
• Investors want credits sooner rather than later
National Development Council
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Example
• 12-unit project with $144,000 annual LIHTC allocation
• Leasing schedule is four units in January, four units in
February, four in March
Month
Jan
Feb
Mar
#Units
4
4
4
Credit Months/Unit
12
11
10
Credit Months
48
44
40
132
• Project could generate a maximum of 144 credit months:
132/144 = 91.67%
• 91.67% of $144,000 is $132,000 -- year one credits
• Projected delivery -- $132,000 for 2010, $144,000 for 2011-19,
$12,000 for 2020
National Development Council
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Example (cont.)
• Slow delivery because of completion delay and slow
leasing reduces year one credit
Month
Feb
Mar
April
May
#Units
3
3
3
3
Credit Months/Unit
11
10
9
8
Credit Months
33
30
27
24
114
114/144 = 79.17% of annual
79.17% x $144,000 = $114,000 Year one credits
Promised $132,000
Delivered 114,000
Shortfall $18,000
Investor will reduce capital contributions for delay in delivery
National Development Council
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Example (cont.)
• Investor agreed to invest $.70 per $1.00 assuming
91.67% of annual credit amount in first year:
$1,008,000
• Agreement provides for credit adjuster of $.65 per
$1.00 shortfall in year one credits
• Shortfall of $18,000 x .65 = $11,700 downward
adjuster
$1,008,000
- 11,700 Adjuster
$996,300 Capital
• Increases deferred developer fee
National Development Council
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Future Reduction in Tax Credits
• If units go out of compliance, credits could be
reduced in the future, after the investor has
contributed all its capital
• Investor gets distribution of cash to make up
for lost credits
National Development Council
78
Most Projects Have Adjustments
• Adjuster for late delivery is most common
• Adjuster for shortfall on total credits is
relatively uncommon
• Adjuster for units going out of compliance is
very rare
National Development Council
Key Participants in
Typical LIHTC Deal
• Private permanent lender
• Private construction lender
• Public “gap” lender
• Tax credit investor (Limited Partner)
• Developer (General Partner)
National Development Council
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Private Permanent Lender Concerns
• Marketability – rents, vacancy
• Adequate operating budget
• Property management
• Adequate reserves – rentup, replacement, operating
• Debt coverage
National Development Council
Private Permanent
Lender Protections
• First mortgage or deed of trust
• Subordination of rent restrictions
National Development Council
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Private Construction
Lender Concerns
• General contractor
• Developer’s experience/finances
• Adequate construction budget
• Permanent sources’ conditions for funding
(completion, rent-up)
National Development Council
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Private Construction
Lender Protections
• First mortgage or deed of trust
• Subordination of rent restrictions
• Completion guarantees
• Performance and payment bonds
• Timing of funding
National Development Council
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Public Agency Concerns
• Regulatory compliance – CDBG, HOME, etc.
• Maximizing private financing
• Avoiding foreclosure by senior lender – adequate debt
coverage
• Insuring completion
• Long-term affordability
National Development Council
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Public Agency Protections
• Performance and payment bonds
• Regulatory agreements
• Right to cure loan defaults
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Investor Concerns
• Completion by developer
• No defaults for 15 years
• Compliance for 15 years
• Internal rate of return
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Investor Protections
• During development stage
• Staged pay-ins, inspections
• Completion guarantees
• Performance and payment bonds
• During operations
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Deferred developer fees
Credit adjusters
Operating reserves
Developer operating deficit guarantees
Right to remove General Partner to cure defaults
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Developer Concerns
• Size and timing of developer fee
• Operating reserves
• Share of cash flow and residuals
• Buyout price
• Operating deficit guarantees
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Reserves
• Rent Up Reserves
• Funds to cover cost of operations from close of
permanent financing to breakeven
• Funded from capital budget (sources of funds)
• Operating Reserves
• Funds to cover shortfalls from operations for the term of
permanent financing
• Funded from capital budget or from operations or both
• Replacement Reserves
• Funds to cover cost of replacement of building systems
when needed
• Funded from capital budget or from operations or both
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Key Partnership Issues
• Timing of capital contributions
• Amount during construction
• Amount by permanent closing
• Requirements for final payment
• Operating deficit guarantees
• Maximum amount
• Duration
• Reserves
• Amount
• Provisions for release
• Developer fee
• Timing of paymanet
• Amount payable
• Credit adjusters
• Completion guarantees
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Asset Management
• If you fund a LIHTC project, you have a 15-year asset
management responsibility
• Oversee project on behalf of investor
• Is the project performing?
• Is the project providing information (financial
statements, audits, K-l’s) in a timely manner?
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Asset Management Responsibilities
• Make sure the project is completed -- within budget,
on time
• Make sure project delivers tax credits on time
• Make sure the project meets all regulatory
requirements -- LIHTC, HOME, etc.
• Make sure the property is well maintained
• Make sure the project can generate sufficient income
to pay debt service and expenses
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What Is Needed to
Manage Assets Effectively?
• Information to track performance
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Budgets, schedules and deadlines
Financing documents and regulatory agreements
Construction and property management documents
Financial statements and operational reports
Site visits
• Analysis and follow-up
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Asset Management During
Construction
• Construction risk: most common issues
• Change orders
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•
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Hidden conditions
Changing governmental requirements
General partner “upgrades”
Inadequate plans and specs, architect’s errors
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Weather
Permitting, inspections
Disputes with subcontractors
Availability of materials
• Delays
• Issues with contractors
• Construction deficiencies
• Failure to perform
• Design and construction deficiencies
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Asset Management During
Construction
• Potential impacts of these problems
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Increased project costs, completion at risk
Failure to meet critical deadlines -- loss of credits
Delayed rent-up and credit delivery
Reduced payable developer fee
Undercapitalized reserves
Reduction in equity
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96
Asset Management during construction (cont.)
• What the asset manager needs to watch
• Is the project on schedule?
• Is the work being completed in accordance with the
approved plans and specs?
• Are the subcontractors being paid?
• Is there sufficient money remaining to complete the project?
• Change orders
• Remaining margin for error
• Cost increases funded first from contingency;
• next from payable developer fee;
• next from developer’s personal funds
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Asset Management during construction (cont.)
• Managing the risk: protections
• Insurance
• Architect’s professional liability (errors and omissions)
• Builder’s risk
• Liquidated damages from contractor
• Payment and performance bond/letter of credit
• Sign-off on construction draws
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Asset Management During Lease-up
• Getting the project built is just the beginning
• Lease-up must start long before construction
ends
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Asset Management during lease-up (cont.)
• Lease-up risk: most common issues
• Delayed occupancy
• Delayed construction completion
• Slow lease-up
• Market and marketing
• Qualification of tenants
• Organization/property management
• Failure to achieve projected rents
• Post lease-up occupancy
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Asset Management during lease-up (cont.)
• What the Asset Manager needs to watch
• Is the project on schedule to lease up and reach stabilized
occupancy within the timeframe originally projected?
• Restricted units
• Market rate units
• Commercial space
• Is the project meeting regulatory requirements?
• Is the project on schedule to deliver credits as projected?
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Asset Management during lease-up (cont.)
• What the Asset Manager needs to watch
• Is the project on its way to financial and operational
stability?
• Is occupancy stabilized?
• Are rents meeting projections?
• Are expenses tracking projections as project leases
up?
• Is project on target to convert to permanent
financing?
• Are reserves being funded?
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Asset Management during Lease-up (cont.)
• Most common “mistakes” during lease-up
• Not understanding or confirming project’s
regulatory restrictions
• Filling previously qualified units before all LIHTC
units have been qualified
• Relaxing screening requirements
• Not tracking inquiries and applicants
National Development Council
Asset Management during
Operations
• What the asset manager needs to watch
• Is the project meeting financial and operating
projections and obligations?
• Debt service, taxes, insurance, reserves
• Is the property being well managed and well
maintained?
• Is the project in compliance with all regulatory and
reporting requirements?
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Asset Management during operations (cont.)
• Operations risk: most common issues
• Negative cash flow -- revenues are insufficient to meet all
financial obligations
• Potential consequences
• Mortgage default
• Inability to convert to permanent financing
• Delay in investor capital contribution
• Inadequate maintenance
• How do you know?
• Quarterly financial statements, annual audit
• Failure to pay taxes and insurance or to fund reserves
• Delinquency on loan payments
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Asset Management during operations (cont.)
• Source of the problem?
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Rents lower than anticipated
Vacancy higher than anticipated
Rent concessions and incentives
Expenses higher than anticipated – which ones?
Restrictions - too many units at 30 or 40% AMI
Commercial space
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Asset Management during operations (cont.)
• Operations risk: poor maintenance
• Maintenance neglected, condition declines
• How do you know?
• Site visits
• Reports from other agencies – HUD, State
• High turnover
• Rising vacancy
• 8823
• Potential solutions
• Change in management
• Increased GP oversight
• Removal of general partner
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Asset Management during operations (cont.)
• Operations risk: non-compliance
• Rent and income restrictions of applicable programs
(LIHTC, HOME, CDBG, etc.) and other requirements are
not followed
• Potential consequences
• Loss of tax credits, credit adjusters
• Action by public agencies
• 8823
• How do you know?
• Regular site visits, file review
• State agency review
• Potential solutions
• Increased GP involvement
• Third party review
• Compliance training for management
• Change in property management
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Partnership Operating Statements
• Balance Sheet
• Assets -- what the partnership owns
• Current and long-term
• Liabilities -- what the partnership owes
• Current and long-term
• Partners’ equity -- difference between assets and
liabilities
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Operating Statements
• Typical partnership assets
• Current (should become cash within 12 months)
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Petty cash
Accounts receivable---tenants, governments
Reserve accounts---replacement, operating
Prepaid expenses (taxes, insurance)
• Long-term
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Land
Buildings
Furniture and equipment
Minus depreciation
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Operations
• Typical partnership liabilities
• Current (due within 12 months)
• Current portion of long-term debt
• Accounts payable
• Accrued taxes, insurance, interest
• Long-term
• Mortgages
• Deferred developer fees
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Questions on Assets
• Cash on hand?
• Accounts receivable---is management collecting?
Are tenants paying?
• Government receivables
• Are the reserve accounts properly funded?
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Questions on Liabilities
• Accounts payable reasonable? Are vendors being
paid?
• How do current liabilities compare to current assets?
• Can they be paid?
• Accruals
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Operating Statement
• Profit and Loss or Income Statement
• Current and prior year comparison? Trends?
• Compared with budget
• Debt coverage ratio (DCR)
• Notes
• Accrual vs. cash
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Most Common Measure of Operating
Strength --- Debt Coverage Ratio
Debt Coverage Ratio
DCR =
National Development Council
NOI
Required Debt Service
115
Net Operating Income
Rents
+ Other Income
Cash Collections
- Operating Expenses
- Reserve Deposits
Net Operating Income (Cash
Available to Pay Debt Service)
National Development Council
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Calculating NOI from Financial Statement
Financial statements are prepared on accrual basis
Need to adjust for tax-deductible non-cash expenses and nondeductible cash expenses, and non-cash income
Income (loss)
- Non-cash income
- Non-deductible cash expenses
+ Tax-deductible non-cash expenses
+ Discretionary expenses
+ Interest
Net Operating Income
National Development Council
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Calculating NOI from Financial Statement
• Non-cash income (rare)
• Cancellation of debt, debt forgiveness
• Non-deductible cash expenses
• Required reserve deposits
• Non-cash, tax-deductible expenses
• Depreciation of property
• Amortization of intangibles
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Calculating NOI from Financial Statement
• Discretionary expenses – paid to partners
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Partnership management fee (to GP)
Tax credit compliance fee (to GP)
Asset management fee (to LP)
Incentive management fee (to GP)
• Interest – 3 kinds
• Must pay interest
• Discretionary interest (residual receipts)
• Accrued interest - deferred
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Calculating the Debt Coverage Ratio (DCR)
+
+
+
+
=
Net Income (Loss)
Non-cash Income
Depreciation/Amortization (non-cash)
Asset Management Fees (discretionary)
Partner and Incentive Mgt. Fees
(discretionary)
Interest Expense (part of debt service)
Required Reserve Deposits
Net Operating Income (NOI)
DCR =
NOI
Required Debt Service
National Development Council
What Happens at the End of the
Compliance Period?
• Sale for fair market value with split of residuals
• Sale for “minimum price”
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Minimum Price Sale
• Debt plus taxes
• Property is transferred to general partner
• General partner assumes all debt and gives limited
partner enough cash to pay “exit” taxes
National Development Council
When Does An Investor Have Exit
Taxes?
• When the investor’s capital account is negative
Capital contributed
- HRTC’s
- Losses
+ Income
- Cash distributions
Capital account
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Exit Taxes contd.
• If investor’s capital account is negative, the investor
has exit taxes
• HRTC’s and losses reduce capital account
• Losses increased by non-cash tax-deductible expenses
• Depreciation
• Amortization
• Accrued interest
• Losses reduced by non-deductible cash expenses
• Principal payments
• Reserve deposits
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Exit Taxes contd.
+
+
=
Depreciation
Amortization
Accrued Interest Payments
Principal Payments
Reserve Deposits
Losses
National Development Council
Most “9% Credit” Deals
Today Have No Exit Tax Liability
125
• Investors putting in large amounts of equity - less
chance of losses exceeding capital contributions
• With more equity, less need for accruing subordinate
loans
National Development Council
Types Of Projects Today
That Often Have Exit Taxes
• Historic rehabs
• Tax-exempt bond deals
• Projects with minimum units low-income
• Projects with large accruing loans
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Considerations in Negotiating “Exit”
• What’s the property’s value? Greater than
debt?
• NOI > debt service?
• Substantial cash flow?
• Extended use agreement, other long-term rent
and income restrictions
• Deferred maintenance, capital improvement
needs
• Who wants to own it?
National Development Council
Questions to Ask
When Evaluating LIHTC Deal
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•
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•
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Is the site a good residential location?
How do the rents compare to market?
Is the operating budget adequate?
Sufficient contingency/developer fee to cover cost
overruns?
Sufficient operating reserves/developer fee to fund
operating deficits?
Does the developer have sufficient capital and
motivation to make it work for 15 years?
Adequate operating “margin for error”?
Exit strategy?
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