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When running a multifamily investment and management business, there is no shortage of problems and complications. So why would a multifamily owner welcome more complication such as buying a Low-Income Housing Tax Credit (LIHTC) or project-based Section 8 (Housing Assistance Payments Contract, or HAP) deal?
There are many reasons and misconceptions that have led to market-rate investors not considering affordable housing deals. But with the stark realities of the COVID-19 crisis, primarily that over 30 million Americans have lost their jobs as of mid-May, the demand for affordable housing will continue to grow. There are several affordable housing programs that a multifamily owner should have some familiarity with, and the LIHTC is one of the biggest.
Affordable housing investments may not work for every owner, but some of them are less complicated than many might think. As one of few investment real estate brokers exclusively focused on the affordable housing space, I’ve been afforded a perspective on how multifamily deals are made in many different forms, from market-rate, unrestricted sales to the most complicated LIHTC deals, where multiple levels of capital financing are joined from multiple government bodies. Let me explain a little bit more about the LIHTC and HAP programs before I dive into misconceptions about this type of multifamily investment.
Basics Of The LIHTC
The Low-Income Housing Tax Credit was created by the IRS in the Tax Reform Act of 1986 as a tool to create affordable housing. Simply put, the LIHTC is a subsidy to a property developer in exchange for making housing affordable. Some might even call it a form of profitable rent control. Tax credits are allocated to state housing finance agencies to divvy up among pools of potential projects. Developers apply for the credits, which can be monetized to an investor partner for the benefit of the project, in exchange for a promise to keep rents and tenant incomes below a certain level. The baseline for incomes is 60% of the area median income, but there frequently are units restricted to lower levels as well. A developer and tax credit investor make a partnership and commitment to these restrictions for an initial term of 15 years, generally followed by an extended term of at least another 15 years.
Using the LITHC to create one of these developments is complicated and difficult. Many multifamily investors have asked my advice on entering the market in this capacity. My advice is don’t do it. Learning how to execute developments using the LIHTC is a full-time business for the vast majority of market participants. If you want to build or renovate housing with the LITHC and have no direct experience, I recommend finding a partner who does.
Diversify With Less Complication
Many multifamily investors assume that LIHTC properties are frequently sold to developers using a new LIHTC allocation. This is rarely the case. Most states allocate competitive tax credits toward new construction. Pricing and other deal terms for noncompetitive credits are much stronger when a property has a HAP contract. As a result, even experienced LIHTC developers frequently use conventional financing to purchase existing LIHTC properties.
After the initial compliance period, LIHTC properties are often sold when the tax credit investor looks to exit their partnership with the developer. While restrictions on rents and tenant incomes are still in place, the IRS can no longer recapture the tax credits in the event of noncompliance. This scenario makes for an opportune time to exit.
In many markets, these properties operate more like conventional housing than landlords realize. Tenants pay their rent. There is more paperwork involved, primarily from the process of income-verifying tenants, but it’s nothing that a sophisticated apartment management operation can’t handle. The LIHTC is complicated when used as a financing vehicle. In the event of a sale after the property is developed and operating, buyers will typically use conventional financing. The operation of the apartment building is only slightly more complicated than a market-rate apartment.
Project-Based Section 8 (HAP Contracts)
While the LIHTC is a subsidy to the developer, HAP contracts are a subsidy to the tenant, allowing a market-rate rent to be paid to the apartment owner. Many landlords are familiar with Section 8 vouchers, which are issued by a local housing authority for tenants to use to pay rent. Tenants can take these vouchers to any property when they are looking for a new place to live. HAP contracts, though, stay with the property. As long as there is a tenant who qualifies, the rent will primarily be paid through the contract. Usually this is a direct contract with HUD, though housing authorities can issue them.
There is a limited supply of these contracts and high demand from a niche group of investors. In recent years, our team has observed these niche buyers becoming more selective, making it harder to sell smaller properties (under 100 units) in tertiary markets. This could lead to excellent buying opportunities for an investor willing to roll up their sleeves to make an entrance into the affordable housing market.
Making The Jump
A qualified multifamily investment broker is a good place to start if you decide to look into these properties. There are a few of us around the country who specialize in affordable housing, but plenty of market-rate apartment brokers occasionally get a lead on a LITHC or HAP deal. Talk to one about what they have seen in the market and where the next opportunity might be.
There is certainly more to purchasing and operating a LIHTC or HAP property than what I’ve touched on in this article. Each state has its own agency overseeing the programs, and each has different requirements. Talk to attorneys, accountants, property managers or other investors who have worked in affordable housing. With the right help, it shouldn’t take long to be prepared to act when you see the right opportunity to enter the growing market of affordable housing investment.