The low-income housing tax credit (LIHTC) helps finance the vast majority of affordable housing being built in the county. Each year, it spurs the construction or rehabilitation of approximately 75,000 or more units of affordable housing.
The program has an impressive history of both providing needed housing and strong financial performance that can be attributed to rigorous underwriting at multiple levels.
“Developers are famous for optimism, but too much optimism can result in unachievable pro formas and ultimately bad deals,” says Mark Sween, vice president and project partner at Dominium, explaining that his firm has implemented practices to make their development pro formas realistic.
He and other industry leaders share how they are underwriting their LIHTC projects and keeping them on track.
1. Be Conservative on Pricing
It’s better to be conservative when estimating LIHTC equity pricing than it is to be overly optimistic and fall short of expectations. “In our experience, the LIHTC equity market has settled down from the dramatic volatility in pricing we experienced in the first quarter of 2017, but with tax reform still not addressed by Congress and the ongoing political uncertainty that has become the new normal, I think the equity market will still be unpredictable over the next year,” says Richelle “Shelly” Patton, principal of Tapestry Development Group. “A conservative equity price estimate in budgets may help mitigate the unknown risks in the months ahead.”
2. Review Comparables
At Dominium, all new deals have at least three “comps” from the firm’s existing portfolio, according to Sween. “We use actual operating expenses from the comps’ financial statements and have to justify any differences,” he says. “This means new deals’ operating expenses are based on how similar properties really do run under our property management.”
Herman & Kittle Properties has three different models to evaluate new construction, acquisition-rehab, and general partner acquisition opportunities, says Jeff Kittle, president and CEO. Each one is programmed to evaluate the nuances of each investment type, such as credit delivery schedules, post-rehab net operating income adjustments, utility conversions, etc.
3. Know Your Guarantor and Sponsor
Make sure you’ve got your arms around who and what the guaranty entity is, what its obligations are, and what covenants/restrictions are in place, says Adam Oates, president of SunTrust Community Capital.
4. Schedule Review Meetings
The Herman & Kittle team holds multiple investment committee reviews to scrutinize underwriting. It also holds biweekly underwriting meetings between the development and finance teams to review models at concept stage and discuss finance structures based on deal parameters, market conditions, Community Reinvestment Act needs, and other factors, Kittle says.
5. Have a Story
Think about your elevator sales pitch. “Know the three or four things that can help a third-party make sense out of a deal,” says Oates. “Build your narrative around that.”