Low-Income Housing Tax Credits

National Development Council

Low-Income Housing Tax Credits

Lecture Notes

National Trust for Historic PreservationNovember 4, 2010Washington, DC

John LinnerNational Development Council

1946 N. 13th, #484, Toledo, OH 43604ph: 419-242-5713

[email protected]

1


2

Tax Credits

• A direct, dollar-for-dollar reduction of tax liability

• Two kinds for rental housing1. 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


3Low-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


4

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)


5

1. Incomes of occupants

2. Rent restrictions

3. State agency approval

Three Threshold Criteria


6

• 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 low-income occupancy

Income/Occupancy


7

• 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

What Counts as Income?


8

• 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

Rent Restrictions


9Computation for Two-Bedroom Unit

• Imputed household size is 2 x 1.5 persons/bedroom = three-person 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


10Computation for a One-Bedroom Unit• 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


11

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


12Tenant 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


13

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


14

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


15LIHTC Projects Must Remain Low-income 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”


16

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


17

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


18

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


19

Grants Excluded from Basis

• No credits on costs funded with grants

• Convert grants into loans


20New 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


21ExampleNew Construction Project

USES SOURCES$500

5,000 1,000$6,500

LandResid. ImprovementComml. ImprovementTOTAL

$2,0001,350

3,150$6,500

Bank LoanHOMEEquityTOTAL

LIHTCs$5,000

x .09450

x 10$4,500

Credit Basis

Maximum LIHTC/Year

Total LIHTCs over 10 years


22Example30% Basis Increase for Difficult Development Areas andQualified Census Tracts

USES SOURCES$1,000 6,000$7,000

LandResid. ImprovementTOTAL

$1,500586

4,914 $7,000


LIHTCs$6,000

x 1.37,800

x .09702

x 10$7,020

Resid. Improvement

Credit Basis

Maximum LIHTC/Year

Maximum LIHTCs over 10 years


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

23


24Improvement 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)


25Not 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


26

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


27Acquisition/Rehabilitation In Difficult Development Area

USES SOURCES

$2,000 5,000$7,000

Acquisition (1/2 building)RehabilitationTOTAL

$1,800867

4,333$7,000


LIHTCs

$5,000 Rehabx 1.3

6,500 Credit Basisx .09

585 Credit on Rehabilitation

1,000 Existing Building Valuex .034

34 Credit on Acquisition

585 Credit on Rehabilitation

+ 34 Credit on Acquisition$619 TOTAL LIHTC/YEAR


28

Historic Rehabilitation Tax Credits Reduce LIHTC Basis

$4,000,000 Rehabilitationx .20Credit Rate=$800,000RTC

$4,000,000 Rehabilitation- 800,000 RTC=$3,200,000LIHTC Credit Basisx .09

$288,000 Maximum Annual LIHTC


29

Historic Rehabilitation Tax Credits Reduce LIHTC Basis (cont.)

• With 30% LIHTC basis increase

$4,000,000 Rehabilitation- 800,000 RTC=$3,200,000x 1.3 LIHTC credit basis increase=$4,160,000x .09= $374,000 Maximum annual LIHTC


30Issues in Combining LIHTCs and RTCs

• Compliance with historic standards may increase costs

• RTC’s reduce basis for LIHTCs – even greater impact if project is eligible for 30% basis increase


31

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


32

Example

• Project with $10 Million of Historic Rehabilitation in Qualified Census Tract

No Master Tenant Master Tenant

$10,000 Rehab- 2,000 HRTC$8,000x 1.3

10,400 LIHTC Basis

x .0324$337 LIHTC/Year

$10,000 Rehabx 1.3

$13,000 LIHTC Basisx .0324

$429 LIHTC/Year


33

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


34

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


35

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)


36Tax-Exempt Financing and LIHTCs

• Projects with 50 percent of costs funded with tax-exempt 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


37

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


38

Problem – 4% Credit Yields Fewer Credits and Less Equity

$100,000 Basisx .09

$9,000 LIHTC/Yearx 10

$90,000 LIHTCsx .70

$63,000 Equity/Unit

$100,000 Basisx .0324

$3,240 LIHTC/Yearx 10

$32,400 LIHTCsx .70

$22,680 Equity/Unit


39

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)


40

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


41

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


42

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


43Who Are the Limited Partners in Tax Credit Deals?

• Corporate equity funds

• Large corporate direct investors

• Private placements

• Equity funds for individuals


44Methods 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


45

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


46Limited 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


47Investors Invest ForTax Benefits - Credits, Losses

• 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)


48Ways Of DivertingCash Flow To GP

• Deferred developer fees

• Payments on GP loans

• Partnership management fees

• Incentive management fees – limited to lesser of 80-90 percent of cash flow or some percentage (10-15 percent) of effective gross


49

Investors Also Value Losses

Principal Payments+ Reserve Deposits- Depreciation- Amortization- Accrued Interest= Taxable Income (Losses)x Tax Rate= Taxes (Tax Savings)


50

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


51

Site Control

• Option

• Ground lease

• Purchase


52

Market Analysis

• Compare LIHTC rents to market rents

• Market vacancy rates

• Vacancy/waiting lists in other subsidized projects

• Population trends


53

Financial Projections

• Construction sources and uses

• Permanent sources and uses

• Operating pro forma

• 15-year cash flow


54ConstructionSources And Uses

USES SOURCES

BANK HOME L.P. EQUITY TOTAL

Site AcquisitionOff-SitesOn-Site Imp.ConstructionContingencyBondPermits, FeesArch. & EngineerConst. Super.Soils TestEnviron. Assess.Const. Loan FeesConst. InterestReal Estate TaxInsuranceAppraisalLegalConsultingTitleMarketingPerm. Loan FeeLIHTC Application

$374,00045,00015,000

5,00040,000

10,000

10,000

$50,000

15,000355,000

50,00090,00020,000

2,0003,000

5,000

10,000

$50,00025,000

171,000

2,000

10,0002,000

5,0005,000

$100,00025,00015,000

900,00045,00015,00050,00090,00020,000

2,0003,0005,000

40,0005,000

10,0002,000

10,00010,000

2,00010,000

5,0005,000

TOTAL $499,000 $600,000 $270,000 $1,369,000


55PermanentSources And Uses

USES SOURCES

PERM. LOAN

HOME L.P. EQUITY

DEFER. DEV FEE TOTAL

Pay Const. LoanRollover HOMERollover EquityVac. ReserveOper. ReserveAuditPerm. Loan FeeSynd. CostsDev. Fee

$367,000

20,000

5,000

$600,000$132,000

270,000

50,0008,000

40,000150,000 $50,000

$499,000600,000270,000

20,00050,000

8,0005,000

40,000200,000

TOTAL $392,000 $600,000 $650,000 $50,000 $1,692,000


56Pro Forma Incomeand Expense Statement

Gross Residential IncomeCommercial IncomeOther Income

Total Gross Income

$150,00040,000

2,000192,000

Residential VacancyCommercial Vacancy

Effective Gross Rent

7,500 6,000168,500

Operating ExpensesTaxesInsuranceMaintenanceManagementUtilitiesReplacement ReservesOperating ReservesTOTAL

10,0006,000

12,00013,00010,000

6,000 8,000

65,000

Net Operating Income

Debt Service

Cash Flow

113,500

91,600

$21,900


57Letters of Interest from Financing Sources

• Bank construction loan

• Bank permanent loan

• Public gap loan

• Investor equity


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

58


59Doing a LIHTC Project – Step Three

• Construction• Monitor progress and quality• Control change orders• Keep project on schedule• Get certificate of occupancy


Doing a LIHTC Project – Step Four

• Operations• Permanent loan closing• Rent-up• Management• Disposition

60


61

Rent-up

• Qualification of tenants

• Meeting 20/50 or 40/60 threshold

• 100 percent occupancy of low-income units


62

Management

• Tenant income qualification

• Compliance

• Maintaining financial records

• Tax returns


63

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


64

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


65Meeting 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


66

Establishing Basis of a Building

Total basis-eligible costsx 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


67Calculating 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


68

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

MonthNew Units

RentedCredit/Months

Per UnitTotal

Credit/Months

MayJuneJuly

555

876

4035

30105

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


6969Investors’ Primary Objective IsTax Credits

• 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


7070

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


7171

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


7272

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


7373

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


7474

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 #Units Credit Months/Unit Credit MonthsJan 4 12 48Feb 4 11 44Mar 4 10 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


7575

Example (cont.)

• Slow delivery because of completion delay and slow leasing reduces year one creditMonth #Units Credit Months/Unit Credit MonthsFeb 3 11 33Mar 3 10 30 April 3 9 27May 3 8 24

114

114/144 = 79.17% of annual79.17% x $144,000 = $114,000 Year one credits

Promised $132,000Delivered 114,000Shortfall$18,000

Investor will reduce capital contributions for delay in delivery


7676

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


7777

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


7878

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


79Key Participants in Typical LIHTC Deal

• Private permanent lender

• Private construction lender

• Public “gap” lender

• Tax credit investor (Limited Partner)

• Developer (General Partner)


80Private Permanent Lender Concerns

• Marketability – rents, vacancy

• Adequate operating budget

• Property management

• Adequate reserves – rentup, replacement, operating

• Debt coverage


81Private Permanent Lender Protections

• First mortgage or deed of trust

• Subordination of rent restrictions


82Private ConstructionLender Concerns

• General contractor

• Developer’s experience/finances

• Adequate construction budget

• Permanent sources’ conditions for funding (completion, rent-up)


83Private ConstructionLender Protections

• First mortgage or deed of trust

• Subordination of rent restrictions

• Completion guarantees

• Performance and payment bonds

• Timing of funding


84

Public Agency Concerns

• Regulatory compliance – CDBG, HOME, etc.

• Maximizing private financing

• Avoiding foreclosure by senior lender – adequate debt coverage

• Insuring completion

• Long-term affordability


85

Public Agency Protections

• Performance and payment bonds

• Regulatory agreements

• Right to cure loan defaults


86

Investor Concerns

• Completion by developer

• No defaults for 15 years

• Compliance for 15 years

• Internal rate of return


87

Investor Protections

• During development stage• Staged pay-ins, inspections• Completion guarantees• Performance and payment bonds

• During operations• Deferred developer fees• Credit adjusters• Operating reserves• Developer operating deficit guarantees• Right to remove General Partner to cure defaults


88

Developer Concerns

• Size and timing of developer fee

• Operating reserves

• Share of cash flow and residuals

• Buyout price

• Operating deficit guarantees


89

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


90

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


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?

91


92Asset 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


93What Is Needed toManage Assets Effectively?

• Information to track performance• 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


94Asset Management During Construction

• Construction risk: most common issues• Change orders

• Hidden conditions• Changing governmental requirements• General partner “upgrades”• Inadequate plans and specs, architect’s errors

• Delays• Weather• Permitting, inspections• Disputes with subcontractors• Availability of materials

• Issues with contractors• Construction deficiencies• Failure to perform

• Design and construction deficiencies


95Asset Management During Construction

• Potential impacts of these problems• 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


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


97

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


98Asset Management During Lease-up

• Getting the project built is just the beginning

• Lease-up must start long before construction ends


99

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


100


• 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?


101


• 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?


102

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


103Asset 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?


104

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


105


• Source of the problem?• 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


106


• 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


107


• 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


108

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


109

Operating Statements

• Typical partnership assets• Current (should become cash within 12

months)• Petty cash• Accounts receivable---tenants, governments• Reserve accounts---replacement, operating • Prepaid expenses (taxes, insurance)

• Long-term• 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


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 = NOIRequired Debt Service


Net Operating Income

Rents + Other Income Cash Collections - Operating Expenses - Reserve Deposits Net Operating Income (Cash

Available to Pay Debt Service)

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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 non-deductible 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


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• 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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• Discretionary expenses – paid to partners• 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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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 = NOIRequired Debt Service

Calculating the Debt Coverage Ratio (DCR)


120What 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


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


125Most “9% Credit” Deals Today Have No Exit Tax Liability

• Investors putting in large amounts of equity - less chance of losses exceeding capital contributions

• With more equity, less need for accruing subordinate loans


126Types Of Projects TodayThat Often Have Exit Taxes

• Historic rehabs

• Tax-exempt bond deals

• Projects with minimum units low-income

• Projects with large accruing loans


127127Considerations 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?


128Questions to Ask When Evaluating LIHTC Deal

• 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?

Low-Income Housing Tax Credits

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