Two weeks ago I attended the IPED Housing Tax Credits 101 conference in Boston, Massachusetts. The conference walked through the basic rules governing a Low Income House Tax Credit (LIHTC) deal, starting with Section 42 of the Internal Revenue Code to calculating the tax credit allocation, to the Qualified Allocation Plan (QAP) to the 15-year compliance period and 15-year extended use period. The conference was very informative-besides providing a basic 101 on how Low Income Housing Tax Credits (LIHTC) work, it also provided insight into the investor who plays a important role in funding these deals.
There has been a recent return of investor capital in the LIHTC world, causing the price of low income housing tax credits to rise. However, investors are still cautious, which is apparent in their underwriting standards. PNC presented on the issues focused on during the underwriting process, which I share here:
• Assess validity of each category of operating expenses (administration, repairs and maintenance, utilities, payroll, taxes, insurance, and replacement reserves) by identifying market study comparable properties and comparable properties within the investor’s portfolio as well as reviewing the performance of the developer’s portfolio and developer’s data including the tax credit application.
• In response to declining debt service coverage over the term of the investment, investors are sizing permanent loans so that they will have 1.15 coverage in Year 15 (end of compliance period) and increasing requirements for operating reserves (and in many cases not releasing the reserves before the end of the compliance period).
• To minimize the negative impacts of short term rental subsidies, investors require: the rental subsidy term to equal or exceed the 15-year compliance period, a “retenanting” reserve to cover all or a portion of operating deficits and guarantees on operating deficits resulting from loss of rental subsidies for the full compliance period.
• Quantify the costs of state agency public policy requirements imposed on the sponsor (provide units at lowest feasible rents, supportive services, energy efficiency, etc.) and verify that the sponsor is doing what was promised in the application.
• Conduct holdback analysis- identify potential problems and quantify risk, make sure there are enough funds to cover any potential risks. Investors are less willing to pay a considerable amount of the development fee at closing. In addition, they want higher levels of construction contingency.
• Obtain guarantees for development completion, operating deficits, repurchase, tax credit adjustments and recapture.