Sep 11, 2023

I'm new to real estate and want to learn more about Low Income Housing Tax Credit Investing and Development. I've read some posts here on Low Income Housing / Section 8 development, but info on this seems to be quite atomized / sparse, and I would like to learn more.

Hypothetical Example of LIHTC project from ChatGPT, arbitrary numbers

Project: Developer wants to build a 50-unit affordable housing complex in a low-income neighborhood. Total development cost estimated at \$10 million. The developer applies for LIHTC through its state housing agency, which provides the developer w/ tax credits

Tax Credit Calculation: LIHTC is calculated as a % of qualified development costs. Rate is typically between 9% and 4% of the eligible basis. Assuming a 9% rate:

Eligible Basis = \$10MM. LIHTC Amount = Eligible Basis × LIHTC Rate LIHTC Amount = \$10MM × 0.09 = \$900k per year for 10 years -> \$9MM

Syndication and Investors: Developers may not have enough taxable income to fully utilize the LIHTCs themselves. So they may seek investors, banks or corporations, to purchase the tax credits. Investors provide upfront equity to the developer in exchange for the tax credits.

Developer + Equity Investors form LLC: The Tax Credit Investors provide equity upfront to developer to fund the project, typically [~75%-80%] of the present value of the project, and investors in exchange receive LIHTCs of \$900k per year, for 10 years, in addition to receiving other benefits like D&A.

Project Financing: With the upfront equity from the investors, the developer can secure additional financing, such as a construction loan or other sources of capital, to cover the remaining development costs.

After project is built, I assume they can rent units out to low income tenants or section 8 tenants. Section 8 rent is also subsidized to a certain percentage.

From my surface level understanding, I have a few general questions:

1) For LIHTC investors:
a) Investors benefit from LIHTC tax credits + deductions from depreciation. But how to quantify the benefit to these investors, as they'd have \$800k in cash outflows to purchase \$900k worth of yearly tax credits, which exceeds the yearly yields of a few hundred thousand in additional net income from tax savings. Assuming they can also benefit from D&A deductions. Any other ways for investors to make or save money?
b) Would the tax credit investors also own 75-80% of the project or do they receive that proportion of the cash outflow?

2) For developers:
a) How much equity do developers typically put in themselves, assuming they receive large portion of financing upfront from investors? Or is the remainder of the project financed with construction & bridge financing, local subsidies etc, and developers put in little to no money themselves?
b) If the rest is debt financed, to what extent of ownership would developers have in the project? Or would they essentially receive a development fee + proceeds from future cash flows + exit price?

3) In General: Any other thoughts to add or things I may have misunderstood from the above? I understand one of the barriers of entry is the knowledge and experience required to build one of these projects, and the hassle of operating one, screening for tenants etc. Aside from that, any other insights anyone may have about tax credit investing, section 8 housing or development?

Would very much appreciate any insights. Thank you.

Region

Based on the most helpful WSO content, here's a breakdown of your questions:

1) For LIHTC investors: a) The financial benefits for investors primarily come from the tax credits and deductions from depreciation. The tax credits provide a dollar-for-dollar reduction in their federal tax liability, which can be quite significant. The depreciation deductions can also provide substantial tax savings. The exact quantification of these benefits would depend on the investor's specific tax situation. b) The investors typically do not own a majority of the project. They are primarily in the deal for the Community Reinvestment Act benefits and are usually targeting an after-tax IRR in the 4-5% range. They get all of the tax benefits of owning the real estate but typically very little of the cash flow.

2) For developers: a) The amount of equity that developers put in can vary widely depending on the specific project and the developer's financial situation. However, it's common for developers to receive most of the operating cash flow (around 90%) and a fee. The rest of the project is typically financed with a combination of tax credit equity, hard debt, soft debt, and grants. b) The extent of ownership that developers have in the project can also vary. However, they theoretically get most of the value at the end of the compliance period, referred to as year 15.

3) In General: One of the main barriers to entry in this field is indeed the knowledge and experience required to build and operate these projects. The process of applying for credits, getting allocated a certain amount based on the project, and partnering with an investor limited partner (ILP) can be quite complex. Additionally, the process of leasing the building or rehabbing the structure can also be challenging. Despite these challenges, this niche in commercial real estate often goes unnoticed, and there's a need for user-friendly resources to help people learn about it.

Sources:

I'm an AI bot trained on the most helpful WSO content across 17+ years.

Additionally, what would be the risks for the tax credit investors for putting in capital into these projects assuming the developer is able to build & operate? Assuming they get many of the benefits of owning real estate, what risks do they bear?

Okay now this is some interesting stuff. Following out of curiosity, genuinely eager to learn about these deals too if they work similar to how op described.

For the purpose of argument, I'm going to agree with all of your assumptions, though there is obviously a lot of nuance in there that is being missed.  On the whole though it is a pretty good broad strokes summary of LIHTC development.

1) For LIHTC investors:
a) Investors benefit from LIHTC tax credits + deductions from depreciation. But how to quantify the benefit to these investors, as they'd have \$800k in cash outflows to purchase \$900k worth of yearly tax credits, which exceeds the yearly yields of a few hundred thousand in additional net income from tax savings. Assuming they can also benefit from D&A deductions. Any other ways for investors to make or save money?

One of the reasons almost all tax credit investors these days are banking institutions is because they also can credit dollars invested in LIHTC towards their CRA requirements.  Also, not all tax credits are bought dollar for dollar - in some markets you pay a substantial discount, so you're buying a dollar of credits for 80 cents or whatever it may be (it also can be more - prior to 2017 LIHTCs in NYC were trading for close to a \$1.30/credit)

b) Would the tax credit investors also own 75-80% of the project or do they receive that proportion of the cash outflow?

This is open to negotiation.  Generally speaking the one non-negotiable is that the developer gets the paid and (usually) deferred fee.  We'll get to it below, but the deferred developer fee is really just a euphemism for free cash flow, which gets swept to pay the developer's fee.  Which is has to, because by statute you must pay that fee back within 15 years.  However, beyond that, it really depends on the deal - in some places, the tax credit investor gets a split of free cash flow and also a percentage of any upside on a sale.

2) For developers:
a) How much equity do developers typically put in themselves, assuming they receive large portion of financing upfront from investors? Or is the remainder of the project financed with construction & bridge financing, local subsidies etc, and developers put in little to no money themselves?

I'll speak for the people I know - no, developers don't put any money in themselves.  We front predevelopment costs (which get paid back at construction closing), but there is no "equity" requirement.  However, this is complicated by the fee structure.  Under your example, you have a \$10mm TDC project.  Lets say the state in which you're building allows a 20% fee on all eligible costs (which for this example we'll assume is all costs, but that isn't usually true) - that means you are entitled to \$2mm.  That's a pretty big number for a small deal!  What generally happens is that some portion of that gets paid at construction closing, another slug gets paid when you complete construction + lease up, and the remainder gets deferred and paid out of cash flow.  That deferred portion functions a lot like equity, and in fact if you wanted to invest equity in the deal, that's the hinge for your sources, so every dollar of equity put in would mean another dollar of developer fee paid up front.  Obviously that doesn't make a lot of sense from a cost of capital perspective, but it is possible that it occurs sometimes.  I haven't seen it though.

b) If the rest is debt financed, to what extent of ownership would developers have in the project? Or would they essentially receive a development fee + proceeds from future cash flows + exit price?

You've pretty much got it, though it varies wildly from state to state.  To take New York, for example - the state and city housing authorities have gotten in the habit of throwing a metric ton of subsidy (e.g. cheap sub debt) at projects.  Partially this is to offset expensive building and land costs, but it also means that you end up with giant balloon payments when your regulatory agreement expires.  In other words, the City is buying itself the option to preserve affordability in 30 years, because there is almost no way the project will be able to repay the massive debt load unless there has been major appreciation (which is unlikely in a mature market like NYC, I think).  So in that case, you'd have little choice but to extend and pretend with the City and agree to another xx years of affordability.  That would likely mean another rehab of the asset, so you'd still get paid and have a job to do, you just can't convert it into market rate housing (which you can theoretically do by presenting a qualified contract to the housing authority).  This isn't true in other states, where even after just 15 years of affordability you can basically turn LIHTC into market rate housing and thus have a pretty substantial back-end profit, more like a regular development deal.  All of which is to illustrate the massive complexity, sophistication, and disparity in how various states and even local municipalities finance LIHTC.

3) In General: Any other thoughts to add or things I may have misunderstood from the above? I understand one of the barriers of entry is the knowledge and experience required to build one of these projects, and the hassle of operating one, screening for tenants etc. Aside from that, any other insights anyone may have about tax credit investing, section 8 housing or development?

I'm happy to opine if you have a more specific question, but it is hard to boil down an entire industry to a couple words of wisdom.  Also, LIHTC and Section 8 are not necessarily related, though they often go hand in hand.  LIHTC is a tax credit (and perhaps more broadly indicative of a range of policies that favor public-private partnerships to build housing) and Section 8 is a rental credit.  You often seen Section 8 in LIHTC properties, but they are not intrinsically related.

However, you've got a pretty decent understanding of how LIHTC works, so kudos to you for that!  Figuring out the local intricacies of it is the knowledge barrier to entry you mention, and it takes years to get a handle on that even in one market.

LIHTC is a fee generation business; the physical real estate is a byproduct of a process.You (developer) have been awarded LIHTC because your project scores well. You need to turn those credits into upfront equity to get your project built. You essentially sell 99.99% of your project to the tax credit investor.

OZY -  do LIHTC developers get a ~20% development fee  to construct affordable buildings? I believe its closer to 15% of TDC (I just want to make sure that all of this information we are putting out there is accurate for the readers and would like to confirm so I can have a better understanding as well.) thanks for the great explanation in your post though. this is the OZY I like

anyways, most state housing agencies will require you to defer 50% of your development to be paid out of cash flow during the first 15 years. Most GP/LP partnership agreements have language that the cash-flow split starts after all development fees have been paid, so the GP get paid first, but it's still suboptimal.additionally, if the property can't repay the developer fees over the 15 year period, you (GP) must contribute equity to the deal to cover the shortfall. The property then pays you (GP) your development fee with this money.

Being that the GP owns approx .01% of the project, you're going to negotiate a cash-flow split with your LIHTC LP ahead of time. There isn't a set rule for these percentages.. pari passu, 90/10 GP/LP split etc. There are many ways to skim the cat here. On a typical 200 unit LIHTC deal, the GP might contribute 100k in equity. The rest of the capital stack is made of 3-7 different sources. LIHTC credits, traditional debt, soft funds, grants, etc. 100k might seem small, but after the credits are sold, the GP only owns .01%. Also, they are floating +-500k in pursuit costs for a project that might not get funded. The risk, like the risk in all development, is pretty significant.

StabilizedYOC

LIHTC is a fee generation business; the physical real estate is a byproduct of a process.You (developer) have been awarded LIHTC because your project scores well. You need to turn those credits into upfront equity to get your project built. You essentially sell 99.99% of your project to the tax credit investor.

This is accurate insofar as competitive 9% credits go (with which I actually don't have a ton of experience) - 4% credits are as-of-right, and at least in the markets I've worked in, tend to be less about "scoring" well and more about political and community priorities.  For example, in NYC, Bill de Blasio had a strong push to let more of that business go to housing focused non-profits, so viable jobs being sponsored by a non-profit were more likely to get in the pipeline.

And while you are mostly correct about the "fee generation business" this also can vary by location.  As I said, some states have fairly lax standards when it comes to QCs, so you can actually convert to pseudo-market rate and capture some back end value.  Or wait 30 years and have the regulatory agreements expire, and end with a market rate building (albeit one that is likely to be very dilapidated).  Generally you don't see that, because the resyndication process is so lucrative, but... it is possible.

OZY -  do LIHTC developers get a ~20% development fee  to construct affordable buildings? I believe its closer to 15% of TDC (I just want to make sure that all of this information we are putting out there is accurate for the readers and would like to confirm so I can have a better understanding as well.) thanks for the great explanation in your post though. this is the OZY I like

It varies state by state - every year, every state releases a QAP (Qualified Allocation Plan) which spells out permissible fees and a whole host of other underwriting standards.  In New York, you get 10% of acquisition basis (land) and 15% of rehab/construction basis.  Some places you get up to 25% across the board.  20% was just easy math to follow.

anyways, most state housing agencies will require you to defer 50% of your development to be paid out of cash flow during the first 15 years. Most GP/LP partnership agreements have language that the cash-flow split starts after all development fees have been paid, so the GP get paid first, but it's still suboptimal.additionally, if the property can't repay the developer fees over the 15 year period, you (GP) must contribute equity to the deal to cover the shortfall. The property then pays you (GP) your development fee with this money.

Yep.

Being that the GP owns approx .01% of the project, you're going to negotiate a cash-flow split with your LIHTC LP ahead of time. There isn't a set rule for these percentages.. pari passu, 90/10 GP/LP split etc. There are many ways to skim the cat here. On a typical 200 unit LIHTC deal, the GP might contribute 100k in equity. The rest of the capital stack is made of 3-7 different sources. LIHTC credits, traditional debt, soft funds, grants, etc. 100k might seem small, but after the credits are sold, the GP only owns .01%. Also, they are floating +-500k in pursuit costs for a project that might not get funded. The risk, like the risk in all development, is pretty significant.

For OP, this is accurate, and reinforces the (unfortunately common) answer of: it depends.  Ownership and fee splits and all that is negotiable, as in most real estate matters.  But StabilizedYOC does point out one major issue in LIHTC, which is funding predev costs.  These come back if you manage to close, but it's a real risk.  Though over the last several years I've seen a lot more equity investors get interested in this kind of platform investing, whereby they inject a significant slug of capital to go spend money on predevelopment in return for a piece of a business.  Great idea for someone looking to grow very quickly, or do more than 1 project a year or so, but comes with all the usual strings.

Can you extrapolate on the "re-syndication" process & how that can result in a substantial capital event in year 15 while preserving affordability? I'm close to an owner/operator in CA who has pulled significant dollars out of their portfolio via this vehicle, but I think it also has to do with the fact that their deals are almost all project-based HAP.

Are developers with project-based contracts in place able to renegotiate their scheduled rents w/ the housing authority after a certain period and as long as the tenant-paid portion remains below a certain AMI threshold?

Jmrunk

Can you extrapolate on the "re-syndication" process & how that can result in a substantial capital event in year 15 while preserving affordability? I'm close to an owner/operator in CA who has pulled significant dollars out of their portfolio via this vehicle, but I think it also has to do with the fact that their deals are almost all project-based HAP.

So a resyndication is basically a refinance.  After Year 15 of your tax credit compliance period, you've (hopefully) complied with all the statutory requirements of your initial bond issuance (the tax credits are attached to muni bonds at first - recycled bonds are a thing but lets ignore than for now).  So you're an owner sitting on an asset, which probably needs a fair bit of sprucing up, or you want to put in the latest green energy doo-dads, or whatever.  The feds decided that they would allow a new owner (so, an arm's length transaction) to basically re-do the original deal: issue bonds, sell the tax credits, and the whole shebang.  If I am the original developer/owner, this is great - presumably there has been some substantial market appreciation in the last 15 years, so I have the opportunity to sell the asset, pay back my debt (in most cases), and maybe realize a little profit on top of all that.  The new owner gets all the benefits I did 15 years ago.  However, your state housing authority is going to want something in return for all this, and generally speaking that means extending the original regulatory agreement as well, so it runs for another 30 years (instead of the 15 years left to go on the original deal).

Project based HAP is a different beast entirely, which I'm happy to discuss... but it's not directly linked to LIHTC.

Are developers with project-based contracts in place able to renegotiate their scheduled rents w/ the housing authority after a certain period and as long as the tenant-paid portion remains below a certain AMI threshold?

As always, it depends.  Some contracts (1s and 2s) are marked up every 5 years.  Some (3s and 4s) are every 20.  Some get OCAF increases (operating cost adjustment factors) every year as well, which is generally around where local inflation ends up.  Some contracts are just marked to market (and can therefore go down) while some are only marked up to market; those tend to trade at a premium for obvious reasons.

Section 8 is its own complex beast, is the short version of the story, but in general tends to be less restrictive than LIHTC in terms of regulatory structure and stricture.

Yeah this was a really interesting post.

I had no idea these opportunities existed! Will definitely read up more on this area.

If you want to learn more about these programs, why not live in Starrett City for a few weeks?

Ozymandia I believe you would have more knowledge on this tax credit program I’m posting below:

I was doing some preliminary research and got some information on projects that qualify.

How does this differ with LIHTC exactly and what projects qualify? Have you looked into the Aspire program?

——————————————-

A new 14-story, 350-unit mixed-use building located in Newark across the street from the Broad Street Station for New Jersey Transit has been approved by the board of the New Jersey Economic Development Authority for \$90 million in tax credits through the Aspire program, it was announced Wednesday.

The award represents 60% of the eligible project costs of \$150 million. The building is located at 81-93 Orange St.

Aspire is a place-based economic development program created under the New Jersey Economic Recovery Act of 2020 to support mixed-use, transit-oriented development with tax credits to commercial and residential real estate development projects that have financing gaps. All residential Aspire projects must include at least 20% affordable housing.

Don’t want to step on Ozymandia’s toes here but the simplest way to think of Aspire is as NJ state LIHTC-lite (i.e., a 10 year credit meant to incentivize affordable housing, but only to a degree). Leaving program qualifications, etc. aside, the key difference from a financing perspective is that unlike almost all other tax credits, NJ has structured the program such that credit purchasers will only pay for the credits annually when delivered (over 10 years) rather than upfront at completion. You can’t borrow against that with a typical short-term tax credit bridge loan, though you can get a construction to perm loan that takes those future sales proceeds as collateral, which can get you to a higher leverage point than you would otherwise be able to. So it’s not as efficient as most other programs, which I hate as a NJ taxpayer, but as usual, the market seems to have come up with a workaround.

So essentially the project developer in that scenario only starts out with a small fraction, the rest is debt, and then as they receive more TCs, the equity/debt ratio increases until loan is fully paid off... Is that the workaround or is there another one?

StabilizedYOC

Ozymandia I believe you would have more knowledge on this tax credit program I’m posting below:

I was doing some preliminary research and got some information on projects that qualify.

How does this differ with LIHTC exactly and what projects qualify? Have you looked into the Aspire program?

——————————————-

A new 14-story, 350-unit mixed-use building located in Newark across the street from the Broad Street Station for New Jersey Transit has been approved by the board of the New Jersey Economic Development Authority for \$90 million in tax credits through the Aspire program, it was announced Wednesday.

The award represents 60% of the eligible project costs of \$150 million. The building is located at 81-93 Orange St.

Aspire is a place-based economic development program created under the New Jersey Economic Recovery Act of 2020 to support mixed-use, transit-oriented development with tax credits to commercial and residential real estate development projects that have financing gaps. All residential Aspire projects must include at least 20% affordable housing.

I have not used the Aspire credit nor learned anything about it, so I don't want to opine on any differences with LIHTC.  Presumably as a tax credit it functions just like low income housing tax credits, but offsets NJ State taxes instead of federal taxes.

I’ve worked first-hand on an NJ Aspire-awarded project, and spoke with two other awarded developers, and very quickly come to realize the value of these credits. Investors are incredibly hesitant to invest in these due to New Jersey’s reputation with ERG (the former ‘aspire’ program). It was very poorly run and provided various risks to tc investors. Latest I’ve heard these need to be bridged throughout the 10-year credit period which produce. Going through NJ EDA also comes with the requirement of prevailing wage, which further reduces the enhancement from the credits. All that being said, obviously it it still a decent project gap financing tool

thank you for the info. what is the credit pricing for Aspire TC's?

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