Transcript Slide 1

Tax Credits 101
Presented to the
Conn-NAHRO 2014 Annual Convention
Uncasville, CT
August 25, 2014
Tom Davis
[email protected]
617-502-5902
What is Recap?
• A real estate consulting firm offering strategic and
transactional advice focused on affordable housing
– Strategic advice with portfolio reviews, policy analysis, business
planning, etc.
– Transaction services such as recapitalizations, refinancings,
redevelopment planning, year-15 exits, acquisitions and sales
– Asset management services such as asset monitoring, asset
repositioning and valuation of partnership interests
• Assisting many public housing authorities across the country
with planning, RAD transactions and LIHTC transactions
• Prepared the CT State-Sponsored Housing Capital Plan
• On-Site Insight is a Recap subsidiary which does Capital Needs
Assessments and Green CNAs
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Tax Credits 101 Agenda
• What LIHTC Is – Overview of the Program
• How the Tax Credit Works – The Basics
• Who is Involved – Organizational Structure and Roles
• What an LIHTC Deal Looks Like – Sources and Uses
• What the Issues Are – Negotiation Points with Investors and
Developer Partners
• What to Prepare For – Operational Issues
• What the Future Holds – Planning to Get Out of the Deal in
15 Years
• How to Get Started – Preparing for the Deal
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Low Income Housing Tax Credit Program Overview
• LIHTC drove an $11.5 billion investment in affordable housing
in 2013.
• Capital subsidy which reduces the need for debt service in the
operating expenses, but no operating subsidy
• Tax credit (dollar for dollar benefit from the LIHTC) plus
ancillary tax deductions (depreciation and losses)
• Commitments
– Minimum number of units must be subsidized (either 20% of the units
rented to households below 50% of AMI or 40% of the units rented to
households below 60% of AMI)
– Income limits – at move-in and over time
– 15 year compliance period plus extended use period (15 years or more)
– Rent restricted to 30% of “imputed” income
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LIHTC Comes in 2 Flavors – “9%” and “4%”
• The 9% LIHTC
– Amount available statewide is based on a formula - $2.30 per capita
but not less than $2,635,000 per state
– CHFA gets roughly $8 million in credits to allocate each year – the
resulting investment is much more.
– Leverages between two and three times the equity investment of 4%
credits, but very competitive to get. The competition is governed by
the Connecticut “Qualified Allocation Plan” – the “QAP.”
• The 4% LIHTC
– Associated with tax exempt bonds and private activity bonds. The
theory is that the bonds are another form of subsidy, so no need to
double-subsidize.
– Subject to volume cap but generally not competitive
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How It Works - Oversimplified
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Looking at the Pieces – Eligible Basis
• Non-Basis Eligible Items
– Land (as distinct from buildings)
– Permanent financing fees & LIHTC fees
– Organizational costs & some legal
– Reserves
• Acquisition – Sometimes in Eligible Basis – “TRAP”
– Ten Year Rule – Not “Placed in Service” within the last 10 years (lots of
exceptions)
– Rehab – Rehab must exceed 20% of acquisition cost
– Anti-Churning – Buyer and seller not related (50% interest)
– Purchase – Must be a legitimate purchase
TRAP mnemonic thanks to Judy Crosby, Esq.
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Looking at the Pieces – Eligible Basis Adjustments
• Federal Grants
– Reduces eligible basis by the amount of
the grant
– HOME, CDBG, HOPE VI/Choice
– If convert it to a loan within safe-harbor
terms, it doesn’t reduce the basis
• Basis Boost
– 130% Boost in certain situations
– Qualified Census Tracts – high poverty areas
– Difficult to Develop Areas – determined by HUD
– States have some authority to set DDAs
– Doesn’t apply to acquisition
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Looking at the Pieces – Applicable Fraction
• LIHTC is only designed to subsidize
the affordable units
• % affordable by units or by square
footage – whichever is lower
• Includes:
• Excludes commercial space (consider
New Markets Tax Credits)
– Common Space
– Amenities if used “exclusively” by residents
– Community service facilities (can be available to others)
– Management office
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Looking at the Pieces – Applicable Percentage
• The “9%” or “4%” tax credit really
isn’t 9% or 4% (except when it is)
• The rates float on a monthly basis.
For September 2014, they are 7.56%
and 3.24%
• The last few years, Congress has fixed the 9% rate at 9% - a
huge benefit to projects and there is advocacy to make that
permanent and to fix the 4% rate.
• The Applicable Percentage sets the annual tax credit
• The tax credit can be claimed for 10 years
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Revisiting the Numbers – a 4% Example
• Taxpayer can also claim depreciations and losses
Note – 130% basis boost doesn’t apply to acquisition. Simplified for presentation purposes.
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Organizational Structure and Roles
• To monetize – or “syndicate” – the tax credits, you need a
taxpayer who needs them and a “pass-through” entity.
• In pass-through entities, the tax benefits generally follow
ownership percentages
• Basic Structure:
General Partner
0.01% Ownership
Daily Management/Control
Owner Entity
Holds Title to Property
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Limited Partner
99.99% Ownership
Restricted Role
The Owner Entity
• Owns the real estate
• Is a limited partnership or
limited liability company
• Is disregarded as an entity
for tax purposes
• Not independently taxed (unlike a corporation)
• Default is that tax benefits follow the ownership percentage,
although there can be some other allocations
• To syndicate the LIHTC, the investor will want to own 99.99% of
the owner entity
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The Sponsor Side – Ownership
• General Partner, also known as the GP or Managing Member
• Sponsor(s) creates the GP and owns shares of the GP
• Why more than one sponsor?
– Partnerships
– Tax reasons
• Potential share-splits
Sponsor 1
X% Ownership
of GP
– 79-21
– 60-40
– 51-49
– 50-50 (with tie-breaker mechanism)
– Almost any other
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Sponsor 2
X% Ownership
of GP
The Sponsor Side – Development Services
• Services only - consultant
• Services plus risk – developer
• Services, risk and ownership interest – partner
• If related to GP, additional tax concerns to watch out for
Developer, Developer
Partner or Development
Consultant
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Sponsor 1
X% Ownership
of GP
Sponsor 2
X% Ownership
of GP
The Investor Side – Money Partner
• Limited Partner, also known as the LP, Member or Investor
Member
• It is generally a fund holding $50M-$150M in deals
• Can be either a direct investor
or a syndicator
• Economic investors vs.
CRA investors
Investor
Investor
Investor
Syndicator/
Investor
Direct
Investor
OR
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Investor
The Investor Side – Enforcement Partner
• Special Limited Partner, also known as the SLP, Member or
Special Member
• Sometimes part of the partnership as a vehicle for the Investor’s
enforcement of remedies if there is a default
• LP sometimes drops to 99.98% ownership so SLP gets 0.01%
Investor or
Syndicator
Special Limited
Partner
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Pricing the Investment
• Time value of money – present value of $1,485,783, influenced by
the pay-in schedule and Placed in Service date
• Community Reinvestment Act value
• Let’s assume roughly $0.91 on the dollar, or $1,350,000
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The Sources and Uses
• Assume the Net Operating Income can support some debt
• Permanent debt is sized based on NOI
• During construction, the bonds must finance at least 50% of
the basis to generate the 4% tax credits
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The Investor’s Concerns – Major Risks
• Real Estate Risk
– Underwriting
– Due diligence
• Structuring Risk
– Tax opinions
• LIHTC Risks
– The units are never available for rent
– The units get rented to the wrong people or at the wrong rent
– The property doesn’t stay solvent and gets foreclosed on
• Opportunity costs
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Mitigating the Investor’s Risks
• The units are never available for rent
– Ensure the team has the knowledge/experience to implement the
transaction
– Quality of the GC, payment & performance bonds, etc.
– Construction completion guaranty
• The units get rented to the wrong people or at the wrong rent
– LIHTC compliance experience and audits
– Compliance and 15-year recapture guaranty
• The property doesn’t stay solvent and gets foreclosed on
– Property management experience
– Operating deficit guaranty
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Mitigating the Investor’s Risk
• Underwrite the sponsor’s financial capacity to back the
guaranties (liquidity and net worth)
• Delay payment of the developer fee to later equity
installments
• Adjuster provisions (basis, timing and compliance)
• Capitalized reserves
• Rights to force a change of property management agent
• Rights to remove the general partner
• Rights to require repurchase of the LP interest
• Focus on projects of significant scale – usually over $2 million
in total equity investment
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Challenges for the PHAs - Scale
• Smaller properties don’t have the scale to be attractive
investments
• Strategies to streamline the process and
reduce transaction costs
– CHFA efforts to standardize investor relationship
• Strategies to manufacture scale
– One PHA, multiple properties
– Multiple PHAs in a joint venture
– Multiple PHAs in a parallel venture
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Challenges for the PHAs – Experience
• Net worth and liquidity levels may be insufficient to back the
guaranties
– Bring in deep pocket but they may want control to mitigate their risk
– Share some of the potential fees and financial upside
– Potentially distinguish construction from operating guaranty
• Knowledge and experience with development may be limited
– Bring in consultant, turnkey developer or developer partner
• Knowledge and experience with LIHTC compliance may be
limited
– Use third party management or compliance desk reviews
– Mentoring systems
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Negotiating with Developer Partners
• Terms of the relationship
– Roles and division of the development work (project management,
scoping the rehab, permitting, resident relations/relocation, etc.)
– Share of the developer fee (note IRS ruling – must do some work for it)
– Property management
– Role of affiliated companies (i.e., does the developer have an affiliated
general contractor or property management company)
– Exposure on the guaranties
– Ownership
– Ground lease
– Cash flow distributions
– Residual value
• For-profit, non-profit or other PHA
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Operations
• Renting Units and Continued Occupancy
– Rent setting: utility allowances and all required fees
– Section 8 Overhang
– Marketing and the affordability band
– Verifications, adjusted income
– Over-income households at placed-in-service date
– Over-income households at 140% of the move-in limit (or 170%)
• Compliance issues
– Next available unit rule
– No full time students
• Cash flow waterfall – payoff of developer fee and seller
financing
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Long-Term Planning and Year 15
• Back end analysis – can the debts theoretically be paid off?
• Tracking capital accounts
– Bigger issue in 4% transactions where the initial investment is less
than in a 9% transaction
– Losses influence capital accounts
• Exit taxes
• Right of First Refusal, Purchase Option and Qualified Contract
• Assume the investor will want to maximize value
• Treatment of reserves
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How to Get Started – Evaluating Your Deal
• Self Evaluation
– Can the deal attract investor interest? Can you manufacture scale
working with your peers?
– Do you have the knowledge and the financials the investor will want?
– How much control might you be willing to give up in order to
overcome these hurdles?
– Do you have other options?
• Assemble an experienced team
• Review your scope and your tenant mix
• Develop refined financial projections – build on the
information CHFA made available through the Capital Plan
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Thank You
Please feel free to contact me with questions
Tom Davis
[email protected]
617-502-5939
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