- Common mistakes in management of LIHTC assets
- Keeping tabs on restrictions and requirements
- The benefits of third-party asset management
- Resources required to manage LIHTC assets
Investing in low-income housing tax credit (LIHTC) projects provides investors with a predictable return while providing safe, affordable housing to low-income families.
However, all the risks inherent in real estate investments exist with tax credit projects, along with substantial additional compliance restrictions, and other risks unique to the tax credit program. By neglecting asset management, investors risk reducing the potential performance of their investments.
In a worst-case scenario, the results can be materially damaging to the investment value. Third-party asset management is no panacea and only so much can be done to fix a bad deal. However, an experienced third-party asset manager can provide cost-effective oversight of the construction, lease-up, financial, operational and compliance aspects of LIHTC projects for the most sophisticated investors.
The margin of error in tax credit investing is decreasing due to higher prices, lower yields and tighter underwriting. Asset management is essential to preserve the tax benefits and protect the quality of the underlying assets over the life of the investment.
The primary objectives of LIHTC asset management are to optimize and preserve the investor’s benefit stream (typically tax credits and passive losses) and protect the real property generating the benefits. Asset management achieves these objectives through effective, ongoing monitoring and analysis of property performance and benefit delivery, including fiscal and operating statement reviews, regular site visits, and discussions with the developers, general partners and property managers.
Often, once the property is acquired, the investment is effectively shelved. Depending on internal corporate organization and prior experience in LIHTC investment and ownership, some or all of the necessary components of professional asset management may be ignored.
Common mistakes in management of LIHTC assets
At some institutions, producing revenue can take precedence over portfolio and asset management. The focus is often on acquiring and underwriting the asset investment, and personnel assigned to these front-end tasks may not retain full responsibility for the asset beyond the closing. A successful LIHTC investment program can result in the rapid accumulation of a sizable portfolio of project and/or fund investments, and the challenge of effectively managing that portfolio can overwhelm an acquisition-oriented investment team.
Even institutions that actively manage their LIHTC assets can make inadvertent mistakes. Organizations that don’t invest in LIHTC assets as part of their day-to-day business may assign the handling of these assets to personnel with responsibility over many dissimilar assets, including non-real estate investments. This can occur in banks, insurance companies or utilities where an LIHTC investment might be assigned to the treasury, tax department or commercial real estate areas that have little or no specialized expertise in managing tax credit assets.
For example, a treasury or tax management group monitoring the investment might do a good job in accounting for, and utilizing, the tax benefits received, but it may not investigate the various complex factors that go into producing the correct amount of tax benefits from the lower-tier partnership level.
Similarly, a commercial real estate division would have the know-how to monitor a property’s physical condition, maintain appropriate levels and types of insurance, and verify the accuracy of title and survey reviews. But the same staff may not have experience in critical LIHTC areas such as:
- Resolving tax credit-sensitive variations in the construction and initial leasing process;
- Identifying and resolving LIHTC compliance problems, including any issues not disclosed by the developer/general partner;
- Initiating third-party reviews of construction progress, leasing procedures and file maintenance;
- Properly calculating qualified and eligible basis; and
- Preparing cost certifications and Form 8609s accurately and on time.
Also of potential concern is a division of responsibility for managing LIHTC investments among different areas of a corporation, none of which have expertise in tax credit investing. The biggest risk in this approach is that no one group or individual has true oversight over the investment once it has been acquired.
Keeping tabs on restrictions and requirements
LIHTC projects are multifamily real estate assets burdened with many complex and overlapping restrictions and legal requirements that must be met over the life of the investment. Violations of these requirements can produce potentially disastrous results.
Yield. Ineffective asset management, such as construction and lease-up delays, can affect the timing of the investment benefit flows or lead to earlier-than-planned capital contributions. Being forced to invest funds earlier or receive benefits later lowers the estimated yield.
Cash flow. Many LIHTC transactions generate cash flow beyond that needed to operate the project. There are often arrangements to share this excess cash flow among the general partners and investor limited partner(s). Effective oversight assures this investment benefit will be received on a timely basis.
Unfavorable publicity. Poor construction or lease-up, tenant problems, or the lack of quality, ongoing property maintenance can result in unfavorable publicity for the project and the investor.
Reduction in qualified basis. Unexpected decreases in the project’s qualified basis can occur if ineligible costs are incurred or eligible costs are not properly documented. A reduction can also occur if apartment units are improperly leased or documented such that one or more units do not qualify as a tax credit unit, or if the minimum number of units is not completed on time and leased to eligible tenants. A reduction in qualified basis at any time within the 15-year tax credit compliance period may result in tax credit recapture, together with an associated interest charge based on the recaptured amount.
Additional capital required. Investors who forgo asset management of their LIHTC projects can be unpleasantly surprised by additional capital requirements that might have been mitigated or avoided entirely with timely intervention. Investors may have to contribute additional money to a project to avoid a foreclosure, to reduce hard debt service on the project or to complete repairs or additional improvements.
Some investors, either by design or default, rely upon the developer or project general partner to act as the investment watchdog and to promptly identify and resolve material issues related to their investment. Unfortunately, the structure of most LIHTC transactions creates a serious conflict of interest for developers who are asked to “manage” the investment on behalf of the limited partner. For example, a for-profit developer may try to cut construction costs to pay for cost overruns in other areas, in order to avoid paying for such overruns out of its own development fee. These changes may hurt the project in the long run, and they may be implemented without the investor’s knowledge or consent.
The benefits of third-party asset management
Investors who do not desire to develop and maintain internal resources to properly manage their investments should consider outsourcing some or all of such management responsibilities to professional LIHTC asset management firms.
When provided throughout the life cycle of the LIHTC investment, professional asset management can enhance the asset’s value (including resale pricing in the event of a corporate disinvestment). More importantly, it helps avoid unplanned reductions in the investment’s performance or value.
Professional management services include comprehensive monitoring of the project through construction, lease-up and stabilization; fiscal review; frequent project inspections; and dialogue with the general partner, developer and property management agent throughout the 15-year federal LIHTC compliance period. An LIHTC asset management firm can also ensure partnership agreement and tax credit compliance.
Historically, the significant providers of such asset management services have been LIHTC syndication firms, who manage large national portfolios of LIHTC projects owned by investment funds. These firms have typically developed advanced computer databases for LIHTC ownership and management, and employ many of the more experienced tax credit asset managers and compliance specialists in the industry.
Resources required to manage LIHTC assets
A competent LIHTC asset management firm will have each of the following attributes:
Commitment to technology. Effective asset management is driven by technology. If not available internally, investors can outsource some or all of the reporting responsibilities to make use of the technological capabilities of third-party asset managers, particularly those who have developed advanced database platforms that can assimilate and transfer critical property information to the investor electronically.
Experienced personnel. The specialized expertise of an asset manager in tax credit compliance, real estate and financing is needed to review and analyze the project data produced by the technology. The asset manager can then recognize operational and market trends, anticipate potential issues and implement appropriate solutions.
Staying power. All tax credit compliance periods are at least 15 years in duration. Make sure your asset management firm has the capitalization and resources to cover you for that length of time.
J. Patrick Galvin is general counsel and director of Columbia Housing’s Asset Management Group, headquartered in Portland, Ore. Timothy A. Kurtz is vice president and senior portfolio manager in Columbia Housing’s Pittsburgh offices. Columbia Housing is a national syndicator of LIHTC investments.
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