Michael Zukerman, managing director, Whitestone Realty Capital LLC
As published in Scotsman Guide’s Commercial Edition, September 2012.
Commercial mortgage brokers working with real estate developers must familiarize themselves with the various federal and state tax-credit programs that are available for their clients, as these can reduce costs and make a deal more attractive. One of these programs that provides significant tax incentives to developers is the Low-Income Housing Tax Credit (LIHTC) — an indirect federal subsidy to finance the development of affordable rental housing for low-income households.
This program, introduced in the 1986 Tax Reform Act, can provide a great advantage to multifamily developers who are focused on affordable housing — a niche that has been in higher demand since the recession.
In the past few years, affordable housing developments have been popular with almost everyone. Investors typically have required low debt-service-coverage ratios — mostly 1.15. Fannie Mae and Freddie Mac have been successful in this arena, and in addition, there’s secondary market activity where developers with tax credits unable to complete projects are selling portfolios at a discount.
This continued interest provides an opportunity for commercial mortgage brokers who are versed in the details of the LIHTC program. The program offers two tax-credit rates:
- The 9 percent tax-credit rate. This credit rate is allocated through a competitive scoring system based on the value that the sponsor brings to the project such as lower rents, green elements, experience, site control, mixed use of units, etc.
- The 4 percent tax-credit rate. This credit rate is as a matter of right to developers.
The federal government is not involved in the process. Instead, the developer submits an application to the appropriate state agency, gets its allocation and the private market provides and monitors the capital. The program, therefore, varies from one state to the other. Each state has its own qualified allocation plan (QAP), and developers must review their states’ respective requirements.
The LIHTC provides funding to developers who monetize credits by selling them to investors like banks, a group of investors or syndicators. The investors take a tax credit equal to a percentage of the cost incurred for development of the affordable-income units in a project. The project is considered either partially affordable or fully affordable. Developers then complete the project, certify its cost and rent it to low-income tenants.
The investors make a capital contribution to the partnership or the limited liability company that owns the project and receives all losses and profits in exchange for being allocated the entity’s LIHTCs over a 10-year period. The developer receives certain fees as determined by the QAP and receives cash flow as agreed between the developer and investor pursuant to an incentive-management agreement or something similar.
Although this process may seem complex and time-consuming, the LIHTC provides commercial mortgage brokers with an opportunity to add value to their clients’ deals. The more you educate yourself and your clients about this program, the smoother the process can be.