In today’s unpredictable affordable housing market, general partners (GPs) need to be planning for Year 15 when a development nears its 10th year. Due to uncertainty from a new administration and plans for a tax overhaul, it’s important the managing GP work closely with the limited partner (LP) on how Year 15 issues should be addressed in the operating agreement, including a possible outright sale of the asset before Year 15. We offer some recommendations on how to manage the process in these uncertain times.
Begin early and start by reading the partnership agreement; addressing all steps from operations to exit in Year 15. Any changes to the agreement should be included in your review. As tax reform talks intensify, make sure the agreement reflects any potential impact of a serious adjustment to corporate tax rates and its impact on your exit strategy. Tax reform talks have caused the market for credit buyers to pause initially, repricing credits as low as 85 cents, with some buyers leaving the market. Also, pay attention to price fluctuations, since credits have moved from an average $1-plus in 2016 to 92 cents-plus in 2017.
In this market, it’s all about yield to tax credit investors. Often, on a Year 15 sale, LPs get costs of sale and all exit taxes covered. However, LPs often don’t share in back-end returns from a project sale. This could change to assure better credit pricing initially, but with the prospect of a new tax structure, you will need to create room for potential changes.
GPs must assign responsibilities for a valuation of the project from an experienced low-income housing tax credit (LIHTC) real estate broker and evaluate terms of existing and future financing options. Remember to document your conclusions and refer back to this article.
1) In reviewing partnership terms, look for first rights of refusal language (these vary) and processes to be used when exercising those rights.
2) Evaluate “waterfall” of funds derived from sale. Assess the LP’s capital account, project selling costs and all taxes required with your accountant.
3) Conduct a capital needs assessment evaluation for a 10- to 15-year timeframe by a professional third-party engineer, or your property manager and maintenance team.
4) Conduct a market evaluation of the project: a) Ascertain new conventional or LIHTC projects being developed in your market.
b) Assess historic occupancy and current rents versus maximum rents allowable.
5) If another LIHTC play is anticipated, underwrite the property to calculate gap money needed to complete the transaction.
6) Check with the state agencies for redevelopment potential and if soft money can be reused and under what circumstances.
7) If there is a buyout of the LP: a) Consider it an outright sale without discount to partnership interest.
b) Include distribution of the cash accounts and reserves.
c) Internal sources of money may be required to complete the buyout due to capital stack of debt on the project.
d) All obligations and resources should be considered in the proceeds; priority payment may be necessary before proceeds are shared.
e) After the sale of the project, partnership agreement is often dissolved. The partnership and GP should be prepared to cover all transactions costs.
It is best to have a clearly defined process after closing of the initial LIHTC play, when the issues are fresh.
Factors impacting Year 15 as an outright sale or new play
Outright sale as a yield-driven sale: Most Year 15 projects are sold to yield-driven “conventional” buyers that agree to maintain affordable compliance and retain experienced property managers.
Project pricing in terms of cap rate: LIHTC family projects often sell 225 to 350 basis points over long-term debt pricing, with senior housing projects being priced 150 to 250. Physical plant conditions always impact pricing. A 100% Sec. 8 subsidy in either program (Housing Choice Voucher [HCV] or Project-Based Rental Assistance [PBRA]), improves cap pricing 50 to 100 basis points. While capital among buyers is plentiful and long-term debt rates are low, pricing remains favorable to sellers. Additionally, while cuts have been proposed for HCVs, PBRA funding would remain relatively steady under the current budget proposal. It also needs to be noted that the FY 2017 Omnibus increased the cap on Rental Assistance Demonstration First Component properties to 225,000.
HUD’s influence: Secretary Ben Carson has gone on a listening tour attempting to find ways to better transition residents out of affordable housing units and into gainful employment, a major concern of his. During this tour, he discussed a need for residents to have the right attitude for success. Additionally, Secretary Carson expects that any cuts in funding will be subsequently restored through proposed infrastructure spending. While housing hasn’t been specified as part of the infrastructure package, planning is still in the early stages.
Nonprofits serving as GP in all LIHTC projects: Perhaps, nonprofit GPs should be required in all projects with certain financial benefits, like property tax exemption and sharing back-end equity in an equity sale.
As information becomes increasingly available, expect specialty sources online to discuss how LIHTC parties evaluate Year 15; they can disclose some troubling issues and detail how they were resolved. Finally, concerning planning for an exit, it should be noted that if the parties cannot come to mutually agreeable terms of a sale or buyout, legal counsel may be required, but only when absolutely necessary.
James Lampman, senior vice president at Colliers International, has over 30 years of commercial real estate experience, specializing in affordable housing nationwide. His specialization covers all forms of housing for seniors, both affordable and care-provider facilities, and affordable housing for families.
Kevin Morris, senior vice president at Colliers International, spearheads the firm’s affordable housing division. He has a broad range of experience in project-based deals, including Rural Development (RD Sec. 515) and low-income housing tax credit projects, which included both general partner interest transfers and fee simple sales.
Benjamin Price is an independent feature writer in affordable housing.
