Investing in Low Income Housing Tax Credits Essay

Overview of the LIHTCThe Low Income accommodate impose extension (LIHTC) admits incentives for corporations and individuals to deck in the acquisition, development and rehabilitation of low-priced lodging. The program offers federal evaluate assent to private candor investors that work with profit or non-profit developers in constructing or renovating rental straitlacedties for low-income tenants, those who earn 60 pct or less of the medial family income for their county. As of 2010, the program has sparked the structure of over 1.7 million lodgement units byout the country. The IRS altogetherocates federal levy impute to Housing Credit Agencies (HCAs) in all(prenominal) state found on its population. HCAs award ascribe to living accommodations developers based on their Qualified Allocation Plan (QAP), a rigorous and agonistic application used to determine which developers ordain receive the attribute. Once assign atomic fleck 18 acquired, equity investors purchase an amuse in the business entity generating the value credits, namely a restrict henchmanship or exceptional financial obligation comp any.The equity generated from the investors purchase is used to storehouse the spot development. The measure credits be redeemed annually by investors over a ten-year period following the exit that the retention becomes functional, or placed in service. The derive of task credits, and subsequently the count of equity raised, is calculated by computing the eligible basis, or the dollar amount of all depreciable cost of the proposal (which excludes the cost of land acquisition and operating reserves) minus ineligible sources of funding like grants or federal subsidies. The eligible basis is because multiplied by the portionageage of eligible r flatue enhancement credit units in the insure (at least 20 portion and up to 100 percentage of all units in the building) to calculate the equal basis. The investor whitethorn l ater convey either 9 percent or 4 percent of the qualified basis amount in evaluate credits per year, depending on whether the watch is a wise construction or rehabilitation of an existing structure..As of March 2012, the average price for a credit is around $.94. price fluctuates depending on the geography of the deal, the size of the run into, the perceived seek of failure, and whether the project is a new construction or rehabilitation. In order to redeem the credits, the prop essential(prenominal) rent either 20 percent or much of the units to tenants whose incomes ar at or below 50 percent or less of the argona median gross income, or 40 percent or much of the units to tenants whose incomes ar at or below 60 percent or less of the area median gross income.The keeping must fulfill these and other(a) operational desirements for a 15-year configuration period. loser to meet these requirements during the compliance period results in an IRS retaking of revenue enhancement credits plus interest and penalties. Many states offer their own inexpensive housing tax credits to come with further incentives by increasing potential drop returns. Projects in accepted areas (Difficult information Areas) receive a 30 percent increase in qualified basis as well.Options for Investment in LIHTCLIHTC transactions are structured such that the developer manages the day-to-day operation of the property while the investor takes a considerive role in instruction and collects just about all the tax credits. The parties ready a restrict partnership or limited liability accompany where the investor is typically a 99.99% limited partner or non-managing member and the developer is a 0.01% general partner or managing member. This mode shields investors from liability beyond their majuscule contributions and allows the developer to maintain control over management affairs. There are two methods of put in LIHTCs. The first is a head enthronization or private placement, where the investor purchases the rights to future tax credits from a single developer in return for an equity contribution. The developer and investor course of study a limited partnership where the investor retains a 99.99% ownership interest and claims use of 99.99% of the tax credits and other benefits.Large banks and blue-chip corporations are the typical direct investors, mainly because they possess vast amounts of financial and administrative resources. Private placements are adequate namely for single entities that manage their own investment affairs and desire complete transparency throughout the project. These investors generate more brighten equity since they save costs otherwise incurred by hiring family unitd property to take away and underwrite the low-priced housing development project. Another avenue through which to invest in tax credits is with a syndicator, a financial intermediary that raises funding from umteen investors, usually on an annual basis, and makes equity capital contributions to multiple affordable housing projects. Indirect Investment through classd funds leaves a means by which individual investors, handsome association banks, and small corporations without the resources of large banks can invest in LIHTCs.A syndicator go away pull back investors and form a limited partnership agreement where the syndicator typically holds a .01% interest as general partner and various investors will comprise the other 99.99% ownership interest as limited partners. This limited partnership syndicate fund will then become the 99.99% limited partner in several LIHTC projects to allow tax credits to pass through to investors. The syndicator investigates the market for affordable housing development and chooses a number of projects in which to invest.The syndicator then directs private equity capital from the limited partners of the syndicate fund to multiple affordable housing developments and returns tax credits choke off to each investor in proportion to their capital contribution. A few syndicate funds have got missions that are aligned with non-profit developers. A syndicators hear with affordable housing development is invaluable to investors as it minimizes risk and increases investor confidence. The syndicator does all due sedulousness and underwriting for the project, so investors can take a nonoperational role. Syndicate funds are ideal for investors that cannot afford to hire family managers, compliance specialists, and underwriters to oversee development.A Worthwhile Investment AlternativeA tax credit provides a dollar-for-dollar reduction in tax liability, conflicting deductions that simply reduce the amount of ratable income for a particular taxable year. Even though investors take capital based on the amount paid per tax credit, other tax benefits are transferred to the investor in the form of passive spilles and deductions available to any holder of rental satisfyi ng estate property. These include property depreciation deductions, interest expenses, business and support costs, and others. Savings from tax-deductible expenses whitethorn not have the financial impact of a tax credit, but it provides a quantifiable saving to the investor that helps add measured value to tax credits beyond the amount of proportional tax liability they reduce. A qualifying tax credit investment results in a decrease of tax liability.The economic return on the investment, therefore, is not subject matter to state or federal taxation, unlike dividends or interest income from stocks or bonds. A dollar amount of taxable income is thus inherently less valuable than an identical amount of tax credits. Certain passive loss restrictions and the Alternative Minimum tax render tax credits less useful for the large majority of individual investors. Nonetheless, LIHTC projects were giving investors returns as high as 25%-30% during the early stages of the program. After growing competitor change magnitude pricing in the market for tax credits, yields have systematically shown 4%+ annual returns in recent days. LIHTC projects provide excellent returns for the risk involved, considering other investment alternatives available. term the stock market has historically given over investors long-term returns of approximately 10% per year on average, there are sharp fluctuations from year to year.The stock market is also considered a more risky investment in comparison to U.S. treasury bonds or other incarnate notes. The yields on these safer bonds are much less than that of the stock market. Investments in tax credits provide an interesting combination of risk easing potential and impressive earning yields. Unfortunately, the average investor has no control over the paygrade of a certain corporate protective cover, much less the performance of a mutual or index fund. However, private placement investors and syndicate fund managers can and do pro vide for close oversight requirements through contractual obligations imposed on the developer, which in turn helps mitigate risk of project failure. A rise in the valuation of a corporate warrantor usually requires an indicator of increase earnings in the future, whether it is the introduction of a more efficient manufacturing technique, the release or upgrade of a new or existing product, or a similar corporate action.every increase in the value of a security may be short-lived. An investor only realizes gain after a sale that gain is taxed. LIHTC projects, on the other hand, do not require unblemished securities markets to move in order to obtain a profit. Aside from rigorous paperwork and professional fees, the tax credits will eventually fall in the hands of the investors so long as the developer does not fail to meet the various compliance requirements for the specified period. With continuous oversight, investors and fund managers can establish durationlines for performan ce that may readily identify any setbacks or obstacles to issue. This may afford time to expedite construction or development and perhaps cure any potential defects in the plan. On the downside, securities markets provide instant liquidity LIHTC projects require at least 11 years to harvest all profits.Timelines provide further protection when equity contributions are made in repartee to the developer meeting certain milestones that render project completion more likely. By disbursing equity in stages, investors exert more control over the projects development and may elect to alter the course of the project. For instance, the investor may attempt to remove the developer if confidence is undermined. The 15-year compliance period provides an identifiable date of exit, after which all profits (in the form of tax credit use) have been harvested.If investors decide to exit the venture, a secondary market has emerged where an investor may be able to sell the credits to third parties. L egislation passed in 2008 allows limited partners to sell their ownership interests in affordable housing properties without facing retaking so long as the properties continue to operate as affordable housing. This allows a shortened holding period of up to 11 years as long as the property meets the 15-year compliance requirements. These advantages are by and large unavailable to stock market investors and make tax credits a safe, viable and profitable investment alternative. These benefits apply uniformly to any tax credit investor.Large Banks, Larger BenefitsLarge banks and financial institutions are provided with a number of benefits that are generally inapplicable to individual and corporate investors, which in turn make credits more valuable and increases their market price. Banks subject to the Community Reinvestment Act (CRA) are required to engage in certain activities that improve community development. Direct investments and loans made to LIHTC projects, or syndicated fund s that invest therein, are considered qualified activities under the CRA.Banks receive corroboratory CRA consideration not only for these loans and investments to community projects, but also when equity is transferred to LIHTC projects that serve broader statewide or regional areas that include a particular banks assessment area. An unsatisfactory CRA rating can cause banks to be denied or delayed in undertaking certain business activities like mergers, acquisitions, or the expansion of services. Thus, banks have strong incentives to invest in affordable housing development. LIHTCs are often a top choice for banks, who are oblige to make community development contributions, because not all CRA qualified activities provide similar returns.Financial institutions also benefit from establishing banking relationships with real estate developers. This allows banks to puff up their revenues by providing new services to the project like pre-development loans, construction loans, owe fi nancing, and credit lines. Bridge loans are especially enticing, where banks loan large amounts of capital to syndicated funds or other Private Placement investors without the cash reserves to make the up-front equity contributions required by developers before any tax credits can be redeemed.Moreover, banks have the financial capacity to create long-lasting resources to assist in affordable housing investment. The underwriting and due diligence for a LIHTC project requires a number of services and incurs various costs. While syndicated funds spread these costs over a number of investors, banks are in a eyeshot to pay for these costs themselves. By establishing recrudesce departments to oversee tax credit financing, banks make a one-time investment in an oversight apparatus that will operate over an indefinite number of LIHTC projects. These in-house professionals will increase in value as their experience expands and power improves. Any bank with the capacity to conduct private p lacement investment in LIHTCs believably does so.Syndicated Funds Investment Mechanisms for the Unsophisticated Tax Credit InvestorA multi-investor syndicated fund provides a number of additional benefits to potential tax credit investors. It is helpful to analogize syndicated funds to mutual funds for the goal of identifying their advantages. Just like mutual funds, where fund managers collect funding from many investors and create a diversified portfolio that is professionally managed, syndicated funds act in a similar fashion. Syndicated funds invest in multiple affordable housing developments, often in various geographic regions and with different housing developers. This allows investors to spread risk amongst different LIHTC projects so that if one project fails, their entire equity commitment is not lost. drop with multiple investors allocates risk of loss more evenly and makes LIHTC investments a safe investment alternative.Furthermore, reputable syndicated funds are pro fessionally managed by experienced, sophisticated tax credit professionals that probably have more knowledge about tax credit investing than any prospective investor. Few institutions and entities have enough capital reserves to fund an entire project single-handedly syndicated funds combine investor contributions, allowing small entities like community banks and mid-size companies to have the flexibility of choosing how much capital to contribute to tax credit investment. The end result is an excellent mechanism through which unconventional tax credit investors can participate in the emulous market for tax credits. Even though funds collect a percentage fee, diversified portfolios will likely contain projects in DDAs to provide marginal increases in tax benefits.Corporations and Tax Credits A Goodwill Investment.LIHTC are beneficial to corporations because annual tax credits have a positive impact on earnings per share, since credits reduce tax liability without diluting earnings. Tax credits are usually a profitable investment because most companies sustain consistent tax liability for years on end. Tax credit investment declined during the 2008 market downturn, but has steadily increased with general economic improvement. Companies like Google, Verizon, Liberty Mutual, and others have invested in affordable housing developments across the country.An additional and measurable economic benefit to corporations is the increased value of a trademark or goodwill associated with a company that invests in community development. This type of investment may also attract positive publicity and media coverage, which in turn may increase corporate securities valuation. Large corporations are also in a coveted position to undertake direct investment and avoid paying fees to syndicated funds.Safe, but non That Safe.While LIHTC investments may be safer than comparable investment with similar yields, the risks must be identified for informed decision- do. Potential tax cr edit recapture and loss is the greatest riskthe project must maintain particularized requirements over a period of 15 years and strict deadlines must be met. The investor must assume the risk of any impediment to completion of construction, no matter how farfetched, and recapture liability remains with the initial investor even if the credits are sold on the secondary market. Risk of failure extends for a prolonged period of 15 years where strict operational requirements must be met.Due to the speculation involved in predicting construction costs, securing subsequent financing, and meeting compliance deadlines in light of potentially unanticipated adverse events, a project must be very incisively calculated to increase the chance of success. Entities and individuals that invest in syndicated funds are in a better position to identify risks due to stringent government-imposed requirements for prospectuses and offering memoranda to be distributed to all potential investors.Inexperie nced syndicators business leader overlook a key responsibility that can cause the project to fail. Repurchase obligations arguably provide a false sense of security to investors because most developers have small balance sheets and cannot afford to match the investors contributions. The risks involved in LIHTC investment can be mitigated with proper planning, continuous oversight, and an experienced syndicator. Banks with in-house asset management units can oversee property maintenance. Although investors cede lien priority to the primary mortgage holder, foreclosure rates are relatively low and occupancy rates relatively high. Tax credit projects are viable investment alternatives. 1 . Catherine Such, Low Income Housing Tax Credits. Federal Reserve Bank of San Francisco Community Investments (Mar. 2002), http//www.frbsf.org/community/investments/lihtc.html. 2 . Michael J. Novogradac, Investing in Low-Income Housing Tax Credits, OCC Community Developments. (Mar. 2010), http//www.o cc.gov/static/community-affairs/community-developments-investments/spring06/ investinginlowincome.htm. 3 . Id., satisfy Understanding Low Income Housing Tax Credits How to vouch equity Investments and Evaluate Syndication Options. Corporation for Supportive Housing (Mar. 2006),http//documents.csh.org/documents/ ResourceCenter/DevOpsToolkit/UnderstandingLIHTCspdf.pdf. 4 . Sherrie L. Rhine, Low-Income Housing Tax Credits Affordable Housing Investment Opportunities for Banks. Community Affairs Development (Feb. 2008), launch in Real Estate Law Clinic Course Reader, at p. 75. 5 . Lance Bocarsly, Real Estate Law Clinic Lecture. (Thursday September 6, 2012, 430pm.) 6 . Understanding Low Income Housing Tax Credits How to Secure loveliness Investments and Evaluate Syndication Options, supra, Corporation for Supportive Housing (Mar. 2006.) 7 . In actuality, the percentage of qualified basis that determines the amount of tax credits is not exactly 9 or 4 percent. The rate for the 4 percent credit floats in accordance with the Applicable Federal Rate and may fluctuate above or below 4 percent. The 9 percent credit will float beginning in 2013, although current formula has been proposed to extend the 9 percent credit floor. House of Representatives Bill 3661 is making its way through Congress. See Mark Anderson, Tax Credit at Risk for Low Income Housing. Finance and Commerce (April 26, 2012, 435 pm). usable at http//finance-commerce.com/2012/04/tax-credit-at-risk-for-low-income-housing/. 8 . Low-Income Housing Tax Credit Facts & Figures, Novogradac Affordable Housing Resource Center. http//www.novoco.com/low_income_housing/facts_figures/index.php. 9 . Tim Iglesias and Rochelle E. Lento, The Legal Guide to Affordable Housing Development. implant in Real Estate Law Clinic Course Reader, at p. 28. 10 . Rhine, supra, Low-Income Housing Tax Credits Affordable Housing Investment Opportunities for Banks. Found in Real Estate Law Clinic Course Reader, at p. 87. 1 1 . Understanding Low Income Housing Tax Credits How to Secure Equity Investments and Evaluate Syndication Options, supra, at p. 4. 12 . Id. 13 . Id. 14 . Novogradac, supra, Investing in Low-Income Housing Tax Credits. 15 . James L. Logue III, How LIHTC Funds Can sponsor Banks Invest in Affordable Housing. OCC Community Developments (Spring 2006). http//www.occ.gov/static/community-affairs/community-developments-investments/ spring06/howlihtcfunds.htm. 16 . Id.