Exploring Low-Income Housing Tax Credits [Part 2]

Learn about LIHTC loan syndication and how developers utilize the program in the second part of this educational series.

In the first entry of this series, we explored the basics of the Low-Income Housing Tax Credit and how the program works. Next, we will delve into the usage of the program by developers, and how these loans are syndicated.

The LIHTC Process for Developers

In order to secure LIHTC credits for a development, a developer must first propose the project and apply with a state’s Housing Finance Authority (HFA). If the HFA agrees to approve the credits, then the developer and the HFA can enter the negotiation process for the project’s Land Use Restriction Agreement (LURA). A LURA limits the maximum rent that the owner of a property can charge, usually based on a specific percentage of the area median income (AMI), which is a statistic published by HUD that attempts to estimate the median income level in a given area. After this is taken care of, the project can begin construction or rehabilitation after which it can be certified by the HFA. Once this is all taken care of, then the units of the property may actually be leased to residents. Properties must be re-certified on an annual basis in order for investors/developers to continue to receive tax credits.

To get tax credits in the first place, an investor needs to own shares in the project itself, which typically occurs through them owning a part of an LLC or being in a direct partnership with the developer. Developers tend to want the investor to own as much of the LLC or partnership as possible, as this means that there will be a much larger investment on their behalf into the property. In order to determine the exact amount of an investor contribution, the developer will create a projected cost for the credits, and apply a specific discount rate (agreed upon by both parties). Those numbers will be multiplied by the share of the LLC/partnership an investor actually owns.

For example, if a developer projects the credit at $1 million, and the investor owns 90% of the LLC (or other ownership vehicle), and the investor and developer have agreed to a discount rate of 75%, then the investor’s contribution can be calculated as follows:

$1 million x 90% x 75% = $675,000

The purpose of the discount is to act as an incentive for investors. The discount exists because an investor would not typically put their money into a project unless they were actually going to make a profit.

Developer and Investor Specifics for LIHTC Funded Projects

As we mentioned before, an investor/developer would need to set aside a certain number of units for tenants making no more than a certain percentage of the area median income (AMI) in the area in which the property is located. Usually, they must either set aside 20% of the units for borrowers who make equal to or less than 50% of the AMI OR set aside 40% of the units for borrowers who make 60% or less of the AMI. These, however, are only the federal minimums, and many states often require more strict requirements for set-asides (i.e. larger percentages of units at lower percentages of the AMI). It is worth noting that the higher percentage of units set aside, the more credits an investor will be eligible for. However, since there is a limited amount of LIHTC credits in each state, it isn’t uncommon for states to institute a ceiling on how many affordable units a property may have.

How LIHTC Syndication Works

While many developers seek out individual LIHTC investors, this isn’t the only option available. In some cases, developers partner with a syndicator, which pools multiple real estate projects into one large LIHTC fund. The syndicator will then sell the tax credits to investors, which reduces the risk for individual investors in the event that a single project will go out of compliance. Additionally, investment in LIHTCs is popular since LIHTC properties have foreclosure rates significantly lower than the average rate for multifamily properties.