Q&A: Affordable Housing Acquisitions

It seems like there has been more interest in the affordable housing sector in this forum over the last 6 months or so and wanted to give others an opportunity to ask questions. I spent 3 years at a LIHTC syndicator investing as an LP in LIHTC transactions where I saw a wide variety of transaction types including everything from a ground up 9% transactions, 4% acq rehab of project based section-8 properties, to adaptive re-use deal that combined LIHTCs, historic credits, and solar investment credits. We also acted as a development consultant tot he GP on deals of the same types. I currently work at a family owned holding company focused on buying affordable assets nation wide. 

 

Thank you for the AMA! What is compensation like in LIHTC vs Market rate CRE? Is it easy to transition from LIHTC to traditional REPE/Developement and vice versa?

 

Looking at real estate comp reports I would say there isn't any noticable difference between affordable and other asset classes.

At the junior level is is probably pretty easy to lateral between asset classes, but generally people don't come into affordable beyond the analyst/associate level because of all the quirks and regulatory issues specific to affordable.

 

I got interested in affordable housing during undergrad fter a family friend introduced me to a colleague of theirs who is a LIHTC developer. Out of undergrad I took a job as an associate at a local developer working on site acquisitions and leasing. Met with a VP from the syndication firm (I didn't know what a syndicator did at the time) when I was networking and they reached out to me about a year and a half later when they were hiring an analyst.

The most complex deals I worked on as a syndicator were a tenant in place RAD conversion (public housing to lihtc) and adaptive reuse transactions that involved layering LIHTCs, Historic Credits, and Solar Investment Credits to create new housing. In both cases we also acted as the development consultant and that was when I confirmed I wanted to get over to the principal side. Learning the finer points of structuring these transactions can put hundred of thousands or millions in the GP/ Developers pocket but not make much of a difference to the syndicator or investor.

There are sharp people at every major syndication firm you can find, but I will say that I have heard from multiple sources that Alden Torch is a nightmare to work at.

As far as getting your start, I would recommend syndication (acquisitions not asset management), working on the development/lending team at an allocating agency, or shooting for associate roles at nonprofit developers.

 

May you walk us through how LIHTC works? From what I see, as a developer, you would apply to a state agency, then if they grant you the credits, you solicit equity investors in the project so that the tax credit benefits pass through to them. I am also aware that there are formulas based on construction costs to calculate how much tax credits you are eligible for. I also believe there are 15 year holding period and 30 year affordability requirements. So basically, to make money on a deal just underwrite at an appropriate construction cost, forecast 30 years of rent regulated cash flow, and thereafter calculate market rate rental terminal value to get desired IRR levels? How do you perform valuation for LIHTC development deals? What IRR or returns should you expect for LIHTC properties? Are we talking single digits or high teens? I work in NYC, exclusively on the luxury side, and given the push for more affordability, have tried to understand some of the local laws, but they are a maze and always require legal consultants.

 
Most Helpful
tjlk24:
May you walk us through how LIHTC works? From what I see, as a developer, you would apply to a state agency, then if they grant you the credits, you solicit equity investors in the project so that the tax credit benefits pass through to them.

Yes, the investor will typically acquire a 99.99% interest in the partnership and get that % of profits and losses. LIHTCs follow dpereciaiton so this structure is essential to delivering the benefits to the investor. 99/100 times the developer will deal exclusively with the syndicator to determine credit pricing, terms, etc. The work involved for the GP on the equity raise is really in negotiating docs answering DD questions and getting to a close. It is much more similar to securing agency debt than it is to raise LP equity for a ground up market rate multi family project.

tjlk24:
I am also aware that there are formulas based on construction costs to calculate how much tax credits you are eligible for.

There are hard and fast rules/formulas for determining how much credit you can qualify for. Google "LIHTC eligible basis" if you want to learn more. The kicker is that of you are trying to do a 9% transaction the allocating agency can somewhat arbitrarily decide how much credit they are going to give projects based on their Qualified Allocation Plan (QAP). On a 4% transaction you are awarded the credits by right so long as you use Tax Exempt Bonds. The use of bonds comes with it's own layer to regulations as well. In some states bonds are a scare resource so you have to compete for those as well, in other states they get used up so you can just walk in and meet the minimum requirements.

tjlk24:
I also believe there are 15 year holding period and 30 year affordability requirements.

The credit period is 10 years and the compliance clawback period is 15 years. This basically means your investor will be in the deal for 15 years. After that they are usually looking to be bought out. 30 years is the statutory minimum to maintain affordability unless you go through a qualified contract process. Most states now make you sign away your rights to the qualified contract process and also require longer affordability periods. I have seen many deals that come with 99 year affordability restrictions.

tjlk24:
So basically, to make money on a deal just underwrite at an appropriate construction cost, forecast 30 years of rent regulated cash flow, and thereafter calculate market rate rental terminal value to get desired IRR levels? How do you perform valuation for LIHTC development deals? What IRR or returns should you expect for LIHTC properties? Are we talking single digits or high teens? I work in NYC, exclusively on the luxury side, and given the push for more affordability, have tried to understand some of the local laws, but they are a maze and always require legal consultants.

Except for some instances in major markets for deals with HAP contracts most LIHTC developers are not looking at the profitability of these deals based on the their long term cash flows nor do they give a shit about their IRR. More so than any other type of development, LIHTC developer fees are earned income. The goal is to spend as little money as possible on predevelopment, get it all reimbursed when your LP closes into the partnership, and collect a six or seven figure developer fee over the next 2 year period from construction through stabilization. Cash flow and residual value would be important if you were comparing two deals but the ability to get the credits and collect a fee without contributing any equity are the primary concerns.

If you are looking at adding an affordable component to a luxury development you will not be using credits. You'll just need to think of the affordability as a concession to get the deal approved. Perhaps you can get some sort of density bonus that will actually make the affordable scenario more attractive, but most municipalities don't go far enough to actually incentivize developers IMO. I have experience working in NYC working with HPD so feel free to PM me if you have more specific questions.

 
tjlk24:
So basically, to make money on a deal just underwrite at an appropriate construction cost, forecast 30 years of rent regulated cash flow, and thereafter calculate market rate rental terminal value to get desired IRR levels? How do you perform valuation for LIHTC development deals? What IRR or returns should you expect for LIHTC properties? Are we talking single digits or high teens? I work in NYC, exclusively on the luxury side, and given the push for more affordability, have tried to understand some of the local laws, but they are a maze and always require legal consultants.
maineiac42:
Except for some instances in major markets for deals with HAP contracts most LIHTC developers are not looking at the profitability of these deals based on the their long term cash flows nor do they give a shit about their IRR. More so than any other type of development, LIHTC developer fees are earned income. The goal is to spend as little money as possible on predevelopment, get it all reimbursed when your LP closes into the partnership, and collect a six or seven figure developer fee over the next 2 year period from construction through stabilization. Cash flow and residual value would be important if you were comparing two deals but the ability to get the credits and collect a fee without contributing any equity are the primary concerns.

So would it be fair to say affordable housing development is essentially fee-driven? Seems like a really sweet spot where if you can find deals, have experience with tax credits, have track record, and nominal networth/cash, then you can pretty much consistently generate a lot of fee income. I guess the trade-off is forgoing the potential upside in capital appreciation/cash flows over time if the project were market rate.

In a high cost of living city where there's a large delta between market and affordable rent, once a project's affordability period wears off, wouldn't it be increasingly appealing to consider converting the project into market rate? Is this frowned upon? Hence the reason for 99-yr affordability restrictions?

How sensitive is affordable development to the business cycle? Are agency allocations / investor demand for tax credits pretty consistent year to year? I'm trying to understand the demand/supply for tax credits. In terms of end-investors -- I would assume these are typically larger entities with long term tax liabilities they'd like to offset?

Have you considered breaking out on your own?

 

I love working on adaptive re-use projects. Taking an old brick mill and turning it into housing in a historic downtown is just a cool real estate project. The capital stacks on these deals also tends to be more complex which makes them more interesting to UW. You could be dealing with 10 different sources that all come with their own regulations and quirks and I find fitting those puzzle pieces together and "cracking the code" to be very rewarding.

Most NPs are underfunded and are happy to be brought a deal. My approach is to find a deal first and then if it needs a NP to get some sort of tax abatement or win the credits in order to pencil out, they can be found after.

 

Thanks for doing this. How steep is the learning curve for someone in who has a few years experience in market rate development already?

What do you think are the key requirements for someone to start their own first affordable deal?

How is the level of competition in this space?

 

Very steep. Understanding multifamily basics will give you a decent foundation but you would basically be learning an entire new business on top of that. I have seen a couple people who think that it's all about the underlying real estate and think the credits are just gravy, they don't last very long. Every developer I have spoken to said that they will gladly take anyone who understands LIHTCs and show them the ropes on development, but they would be much less likely to take a seasoned developer and try to train them in LIHTC financing.

You need a track record working with the program, a predevelopment capital source (minmum $250k cash) and enough guarantee capacity to satisfy your investor. The syndicator I worked for typically required combined NW of the gaurantors equal to the LP investment amount and liquidity equal to half the developer fee at a minimum. If they were new to the LIHTC world or had recently had staff turnover we required a development consultant and 3rd party property manager.

 

In terms of a prospective analyst getting into LIHTC, vs other types of development - how easily translatable is the knowledge you gain of one city or state to other cities or states? You mentioned your company works all over the country, does this mean that there is a leadership structure with general knowledge of LIHTC that hires specialists in each jurisdiction they operate in and these specialists provide the boots on the ground knowledge of the locality's ins and outs in terms of regulations, politics, and credit awards? To what extent are these specialized skills transferable to other aspects of development? I am curious about this as a masters student but not sure I want to commit the time to specialize if it means committing to the city I'm in for the rest of my days...

 

Appreciate all the helpful information provided in this thread. I'm beginning my role as an analyst with an affordable housing syndicator in nyc next week. I'm trying to get a clear understanding of the process and learn as much as I can before the first day. Do you have any books/websites you recommend checking out before I start? Thanks!

 

Thanks for doing this, I’m actually interning in this space right now and have been put in charge of the application process for getting LIHTC’s from a few different states. A bit of an odd question, but in addition to the questions I see here could you think of more in depth topics I could try to speak to my boss about? Trying to get a wider understanding of the affordable housing space.

 

Not original poster but I’ll chime in. They’re usually 20 year contracts and almost always renew. Have very technical inspection process so have to cross your t’s and dot your i’s. Generally easy to finance because of the income certainty. There’s brokerage arms that’s specialize in affordable housing writ large instead of just HAP but sure you could ask for them to send just the HAP deals

 

Also curious could anyone share the different types of affordable housing? I'm seeing LIHTC (lower income housing), I've heard of MIH, is section-8 another type or HAP all different types or is it just lower and middle income housing and it's all based on % of AMI and different types land in different buckets depending on certain programs like section 8?

 

Also curious could anyone share the different types of affordable housing? I'm seeing LIHTC (lower income housing), I've heard of MIH, is section-8 another type or HAP all different types or is it just lower and middle income housing and it's all based on % of AMI and different types land in different buckets depending on certain programs like section 8?

"All" is tough because there is a lot of regional variation.

HAP is kind of a catch all term for a lot related but different subsidy programs, because it can encompass programs like Section 8 or Section 42 (which is tied to LIHTC developments).  As you might imagine, the whole thing is complex, which is why breaking into this industry is difficult.

Section 8 is a HUD (a.k.a. federal) program, which has both project based vouchers, in which the subsidy is tied to the building it's issued to, and tenant based vouchers, which are tied to specific tenants and thus are at risk of leaving

LIHTC is also federal - it's a tax credit program for which the basic concept is that developers receive tax credits for building qualified affordable housing, which they can then use or sell to raise cash for said project.

MIH is specific to NYC, as far as I know, and is a program which incentives for-profit developers to construct affordable housing by allowing them to increase the buildable square footage of their development parcel in return for designating a certain number of units (30%, at the moment) as affordable.

Happy to discuss or explain any of them at greater length if you have specific questions, but "list them all" is a little broad.

 

My firm recently purchased a large vacant office building with the plan for adaptive reuse into resi. Is it stupid for us to not do 4% LIHTC on this? Not 100% affordable but mixed income (especially when we’re setting aside 20% of the units anyway)

This is also in a QCT.

Is there anything other incentives I should be looking at?

 

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