The temptation of unexpected cash from the sale of low-income housing tax credit (LIHTC) properties has motivated many limited partners to push harder than anyone expected for high sales prices for the properties they have invested in.
“There’s this windfall to the limited partner,” said David Leon, partner with Broad and Cassel, at AHF Live: The Affordable Housing Developers' Conference on Nov. 22 in Chicago.
Most LIHTC properties clearly say in the partnership agreement that any proceeds from a sale of the property will be split between the partners with 20 percent of the proceeds going to the limited partner and 80 percent to the general partner. In an LIHTC partnership, the general partner is typically the developer of the property while the LIHTC investor is a limited partner. Many limited partners are claiming unexpectedly large shares of the proceeds from liquidation.
Suddenly, a sale that meant little to these limited partners can turn into millions of dollars in surprise profits, and these limited partners are motivated to push for the highest sale price the overheated market for apartment properties can provide. If the affordability of the property is not protected by an extended-use agreement, the limited partner could put pressure on the general partner to allow the affordability restrictions to expire at the property.
A surprise windfall can be created by a nuance of the LIHTC partnership agreement. Before the proceeds of a liquidation of an LIHTC partnership are divided between partners, the proceeds must first be tapped to balance the accounts for the property, including paying for closing costs of the sale, replenishing reserves, and settling any loans. Depending on how the property has been accounted for over 15 years, many investors have not worked down the “capital account” that represents their initial equity investment in the property. A liquidation of the partnership can trigger of payout on that capital account that can turn into an unexpected pay day for limited partners.
Limited partners who might have been happy with a small share of a low sale price may suddenly realize that they have something tangible to gain by selling the property for the highest price possible.
“The market is very strong,” said Spencer Hurst, national director of the Tax Credit Group of Marcus & Millichap, who helps arrange the sale of many LIHTC properties. “Multifamily is very much in favor as an asset class.” The average LIHTC property sold over the year ending this October had an actual capitalization rate of 6.7 percent, according to Marcus & Millichap—a cap rate represents the income for a property as a percentage of the sale price.
If you're a general partner in an older LIIHTC project that has this vulnerability in its partnership agreement, there may still be time to rectify the situation. “Stay out of the liquidation section of the partnership agreement,” said Leon. Instead of a sale of the property, consider raising capital for repairs through a refinancing of the properties debt.
General partners may also be able to reduce the pot of gold that could tempt limited partners to try and increase the proceeds of a sale of the property. Without actually losing money, general partners can account for their properties in a way that reduces the amount the investors are entitled to when the partnership is liquidated. “Do everything you can do to create [accounting] losses to drive down the investor’s capital account,” said Leon. LIHTC properties should claim bonus depreciation whenever possible, for example.
A tough assessment of the local rental market can also help. Investors might over-estimate how high the rents can reasonably go in the local market for an 15- or 16-year-old apartment building, even once rent restrictions are removed.
If your structuring a new partnership agreement for an LIHTC property, make sure your agreement avoids these problems. Negotiate for the right to purchase the limited partner’s interest in the property. Make sure you investor does not have the right to force a sale of the property.