September 18, 2019 Comments Off on Low Income Housing Tax Credits: Five Things CRE Investors Need to Know Views: 1574 National News

Low Income Housing Tax Credits: Five Things CRE Investors Need to Know

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By JR Lephew, Principal and Technical Director, Partner Engineering and Science, Inc.

The Low-Income Housing Tax Credit (LIHTC), a federal tax credit created through the Tax Reform Act of 1986, was designed to encourage private equity investment in affordable and public housing by commercial real estate stakeholders. LIHTC has become 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. The 30+ year program has resulted in over 45,000 projects, representing the creation of over three million units of affordable housing.

The LIHTC program, which is administered by the IRS, provides tax incentives in exchange for capital for development and/or financing costs to encourage developers to create and preserve affordable housing, including new construction, acquisition, or rehabilitation of existing properties. These tax credits are proportionally set aside for each state based on 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 and Federal and State-specific program requirements. This is known as the Qualified Allocation Plan (QAP) process.

LIHTC investments are an attractive option for portfolio diversification and to take advantage of continued opportunities in the multi-family sector. However, CRE stakeholders should be aware of these five issues affecting LIHTC deals before moving forward.

1. There is a complex capital stack
Typical LIHTC deals involve many agencies and/or sources of funding, all of whom may have different reporting standards and requirements. 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. There are two types of equity tax credits for LIHTC investments: 4% and 9% Bond Tax Credits, awarded through state-specific QAPs. These QAPs set requirements, application deadlines, and the affordability period for a deal structure. 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.

2. Compliance standards vary state to state
In addition to the complex capital stack structure, LIHTC deals can have enormous state by state differences. This can come in the form of specific due diligence requirements, what type of consultant is qualified to assess projects, and how compliance requirements 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. Some states differ in their documentation requirements, and how reports are delivered (with some requiring their own template format). Finally, application deadlines differ from state to state, and if you miss that window, you must start the process again in the following year, which may require additional paperwork or assessments.

3. Due diligence and risk management requirements may be extensive
Because there are so many stakeholders and sources in the capital stack structure of a LIHTC deal, there has been a trend towards more due diligence and risk management oversight to ensure that federal and state regulations are met, and proper use of funds is planned. Required services may include environmental compliance, a review of structural/building code standards and conformance, accessibility standards review, and green/energy efficiency compliance for multifamily housing.

4. Pick a knowledgeable consultant to guide you
Executing a successful LIHTC deal can hinge on 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. 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. Finally, your consultant should be able to assist you with projects that are already at various stages in the 15-30-year LIHTC cycle, and provide support whether you are a project sponsor, investor, or a lender. Your multi-disciplinary team should ideally possess technical skills, staff resources and portfolio experience to navigate the requirements of a LIHTC deal.

5. Try to know your source of funding early in the process
Underwriting structuring and due diligence risk management for Fannie Mae, Freddie Mac, or HUD financing vary greatly. If an equity investor comes on board later in the deal, they may require a totally different set of reporting standards, especially Property Condition Assessments for existing buildings. Understanding your source(s) of funding as early in the process as possible will help your consultant determine the most efficient and complete requirements to execute your transaction without delays.

If structured correctly, LIHTC can be a profitable investment regardless of the commercial real estate cycle. However, as we near the late stages of the post-recession real estate cycle, when development opportunities may not be as robust as in previous years and many of the 15-year tax credit deals from the past recession are starting to mature, investors may be looking for opportunities to find new projects and investments. For stakeholders new to LIHTC programs, understanding the complexities and strict guidelines is the key to a successful investment.

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