The low-income housing tax credit (LIHTC) has helped make affordable housing a reality for millions of Americans. However, the major tax benefits that make LIHTC projects attractive to investors are fully realized in 15 years. Then what?
For projects with credits allocated after 1989, federal law mandates that affordability must be extended for at least another 15 years. A provision in the Internal Revenue Code allows a developer to opt out of the extended-use requirement for a particular project, with state approval, if the state is unable to find a buyer at a formula price (see Affordable Housing Finance, July 2004, page 34, and September 2004, page 56).
And by Year 15, most investors are looking for exit strategies. Nonprofit developers, however, seek solutions to sustain affordability.
A number of disposition options are available to LIHTC partners, including selling a property to the developer, which may continue to operate it as affordable housing; transferring the property to a charitable organization or government entity; or finding investors to reinvest in the property by using new tax credits to upgrade it for the next 30 years. Federal law allows nonprofit organizations, tenants, tenant co-ops, or government agencies the right of first refusal to purchase properties at a bargain price. If adequate financing is feasible, this can be a winning strategy for everyone.
Selling properties to residents represents another viable option. There are several strategies that allow for resident ownership, including lease-purchase agreements, cooperative (co-op) conversions, and condominium conversions.
In some cases, projects are designed from the beginning for eventual sale to residents. These projects are set up under a lease-purchase concept, with the understanding that residents will buy their units when the project reaches Year 15.
The Cleveland Housing Network (CHN) pioneered this strategy when the LIHTC program was in its infancy. In January 2005, CHN and The Enterprise Social Investment Corp. (ESIC) began transitioning the latest group of 50 homes, which were developed in 1990, and expect to sell 90% of these units to residents.
Lease-purchase programs offer a tangible benefit to low-income residents: the opportunity for homeownership. These residents are more likely to take an active role in the care of their units, and may even invest their own funds in maintenance and upgrades. Also, residents who plan to buy their units are less likely to move out. This helps maintain high occupancy rates for the duration of a project, minimizing vacancy losses and related expenses.
Conversions of projects to housing cooperatives after Year 15 can also be an option to preserve continued affordability. Housing cooperatives are corporations in which each resident is a shareholder. This gives real ownership and control to tenants through an elected board of directors. Because members have input into the long-term direction of the co-op, this transition strategy can ultimately increase the stability of a community, encourage continual improvement, and reduce operating expenses, turnover and crime.
When investors and developers consider co-op conversions, there are a number of factors to keep in mind, including the amount of debt on the property, property rehabilitation needs, and sources of loans for tenants who wish to finance their units.
Across the country, more and more residents are being priced out of neighborhoods as a result of booming real estate markets. The multifamily industry has recently capitalized on this trend by converting more than $1.6 billion worth of apartments into condominiums in the first five months of 2005 alone. This opt-out provision that developers can take advantage of after Year 15 makes the condo conversion option more attractive to profit-motivated developers as the market continues to heat up.
However, this trend also presents a valid opportunity to address sustainability solutions for affordable housing. The potential of converting an LIHTC property into mixed-income condos is intriguing.
To make this approach feasible, some of the units in a project may have to be sold at market rates to enable the sale of other units to low-income buyers. Nonprofits may want to consider these options as well. In an effort to preserve affordable housing, the transition of LIHTC properties to condominiums or co-ops warrants further exploration.
For ESIC, the goals are to deliver an investor’s projected return and to preserve affordability by transferring those properties sponsored by nonprofit organizations directly to those groups. ESIC has transitioned 22 projects to date, with an additional 78 projects eligible for disposition through 2007. As partners work through the disposition process for an increasing number of LIHTC projects, an effective exit strategy combined with well-considered options to sustain affordability ultimately benefits all.
John Brandenburg is managing director of asset management at Enterprise Social Investment Corp. (ESIC). He manages ESIC’s activities related to ESIC portfolio performance and property disposition. If you’d like additional information on Year 15 dispositions, please contact John Brandenburg at (410) 772-2554.