Why do developers typically greatly exceed the minimum set aside requirements for LIHTC, often making their developments mostly/all affordable? Is this to be eligible for other grants/subsidy that will complete the capital stack? is it to have a more competitive application to be awarded tax exempt bonds/credit? If you don't get more tax credit equity for making 100% of units affordable vs 40% or 20% why would one do this, aside from being altruistic?
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To be more competitive when bidding for the tax credits. If you have the minimum set asides but another project is 100% at 60% ami then they’ll just award the credits to the more affordable property. For example, you see deeper set asides in California now that the bidding process is more competitive
In addition to winning competitive credit awards it can also be difficult to attract an investor for a project that has a high percentage of market rate units.
This isn't quite how it works.
Minimum set asides are in place to qualify the overall project, yes, but you only get allocated credits pro rata for the affordable units (plus associated common spaces). So if you have a 100 unit project that costs $10mm, and you hit the 40% minimum set aside, you only get allocated credits on $4mm of that basis (obviously it's more complex than that, in terms of eligible cost, but take it as a rule of thumb).
So it's not accurate to say that there is no effective difference between the 100% affordable property and the one that hits the min set aside. You get additional monetary incentives to increase the amount of affordable in your project.
That being said, all the things that Monkeydawg and maineiac42 said are true as well, from a qualitative standpoint.
Good content. I always chuckle when I read questions like OPs because they show how confusing LIHTC transactions can be when people try and analyze them the same way a sponsor would a typical RE deal.
Yeah I don't blame anyone, it's complicated stuff and the ways in which the statutes and regs get interpreted can vary state by state, so it's always helpful to give another perspective.
But as you say, it's a way more complex development process than a traditional debt/equity deal and I suspect most non-affordable developers don't really understand that and make the mistake of trying to make sense of these deals through the lens of building, say, a market rate rental building. They may both be multifamily deals but there is a lot more daylight between LIHTC development and traditional MF than people suspect
I think you mean development fee.
I guess this is true, but thinking about LIHTC in terms of IRR is not quite right. Technically, LIHTC developers make infinite IRRs - they often (maybe always, not familiar with the provisions in every state) put zero equity into a deal, and if you have no denominator, you can't have an IRR.
Whatever qualitative reasons affordable developers may have (and there are plenty), the economic reasoning is that when you compare to a market rate development, you have a risk free return of xx%. Depends on the state. For example, in NY, the allowed developer fee is essentially 12.5% of TDC; yes, you have construction and bad boy and all those risks, but effectively no lease up or market risk. And you're making that return on day 1.
To me, that's FAR more attractive than building a market rate site and hoping to get to a 16-17% IRR in my best case scenario. Especially one that is based in large part on a favorable exit down the line. That being said, I'm conservative on this stuff - were I starting a company today, and had the knowledge base to do whatever, I would 100% be in affordable. It's a business that is immune to the business cycle, and I'd rather take my 8-9% IRR without any equity down every year for the next 30 years rather than have to gamble everything I have on every deal for a decade until I'm in a position where I can run 2-3 development projects and still insulate my personal financial position from that of the business.
I know several individuals who got their start in affordable development, amassed enough capital to hot have a worry in the world, and then slowly moved into other more traditional developemt projects while maintaining their affordable development business with a couple PMs and a small prop mgmt team. This seems to be the winning formula to move to entrepreneurship if you aren't already wealthy.
Dev Fee - is robust for Affordable 12-25% vs Market Rate 3-6%. You typically must defer 25-50% of the dev fee so more like 50% of the fee paid over the construction period (2 years.) You do more work on an affordable deal with 60 units (LIHTC are typically smaller) than a Market rate with 250 units and have minimal upside, (think how that Dev Fee looks on 60 units vs 250 units).
IRR –You are correct IRR investors aren’t in affordable, but that’s also why you don’t see 50% affordable and 50% market rate deals its either/or not mixed to answer the post’s question
I spent 3 years in LIHTC and now I’m in market rate. The challenge with affordable is the competitive process, scale, and lack of long term upside.
If you worked in LIHTC for 3 years you should know nobody is collecting a 25% fee. It's generally capped around 15%.
Your second point is also incorrect. You do see mixed deals quite often, but they are not preferable in every market or under every states program requirements.
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