Investing in Low Income Housing Tax Credits Essay Example for Free

expending in suffering Income Housing Tax Credits EssayOverview of the LIHTCThe Low Income Housing Tax Credit (LIHTC) provides incentives for corporations and individuals to invest in the acquisition, development and rehabilitation of affordable admit. The program liberty chits federal assess attribute to private scum bagdor investors that give with profit or non-profit developers in constructing or renovating rental properties for low-income tenants, those who earn 60 sh ar or slight of the median family income for their county. As of 2010, the program has sparked the construction of everywhere 1.7 million lodgement units throughout the country. The IRS allocates federal evaluate credits to Housing Credit Agencies (HCAs) in each state based on its population. HCAs award credits to housing developers based on their Qualified Allocation Plan (QAP), a rigorous and warring application used to determine which developers will receive the credits. erst credits are acq uired, equity investors purchase an kindle in the trading entity generating the impose credits, namely a limited partnership or limited monetary obligation comp each.The equity move oerd from the investors purchase is used to computer memory the property development. The tax credits are redeemed annually by investors over a ten-year completion following the date that the property becomes accomplishmental, or placed in service. The go of tax credits, and subsequently the center of equity raised, is calculated by computing the legal basis, or the dollar amount of all depreciable costs of the go out (which excludes the cost of land acquisition and operating reserves) minus ineligible sources of parentageing like grants or federal subsidies. The eligible basis is then multiplied by the partage of eligible tax credit units in the project (at least 20 percent and up to 100 percent of all units in the building) to calculate the qualified basis. The investor may later claim either 9 percent or 4 percent of the qualified basis amount in tax credits per year, depending on whether the project is a new construction or rehabilitation of an real structure..As of March 2012, the average price for a credit is around $.94. Price fluctuates depending on the geography of the deal, the size of the project, the perceived risk of failure, and whether the project is a new construction or rehabilitation. In order to redeem the credits, the property moldiness rent either 20 percent or more than of the units to tenants whose incomes are at or below 50 percent or slight of the area median gross income, or 40 percent or more of the units to tenants whose incomes are at or below 60 percent or less of the area median gross income.The property must fulfill these and opposite operational invitements for a 15-year compliance period. Failure to meet these requirements during the compliance period results in an IRS recapture of tax credits plus interest and penalties. Many states offer their own affordable housing tax credits to provide however incentives by increasing potential returns. Projects in certain areas (Difficult Development Areas) receive a 30 percent cast up in qualified basis as well.Options for enthronization in LIHTCLIHTC transactions are structured such that the developer manages the day-to-day operation of the property while the investor takes a passive voice role in management and collects virtually all the tax credits. The parties pretend a limited partnership or limited obligation company where the investor is typically a 99.99% limited partner or non-managing member and the developer is a 0.01% general partner or managing member. This method shields investors from liability beyond their uppercase contributions and allows the developer to maintain control over management affairs. There are two methods of investing in LIHTCs. The first is a direct coronation or private fix, where the investor purchases the rights to future tax credits from a single developer in return for an equity contribution. The developer and investor form a limited partnership where the investor retains a 99.99% ownership interest and claims use of 99.99% of the tax credits and other benefits.Large banks and blue-chip corporations are the typical direct investors, mainly because they possess vast amounts of financial and administrative resources. Private placements are adequate namely for single entities that manage their own investiture affairs and desire complete transparency throughout the project. These investors generate more net equity since they save costs otherwise incurred by hiring syndicated specie to choose and downstairswrite the affordable housing development project. Another route through which to invest in tax credits is with a syndicator, a financial intermediary that raises funding from many investors, usually on an annual basis, and makes equity capital contributions to multiple affordable housing projects. Indirect Investment through syndicated funds provides a means by which individual investors, low-down community banks, and small corporations without the resources of large banks can invest in LIHTCs.A syndicator will attract investors and form a limited partnership agreement where the syndicator typically holds a .01% interest as general partner and various investors will comprise the other 99.99% ownership interest as limited partners. This limited partnership syndicate fund will then become the 99.99% limited partner in several LIHTC projects to allow tax credits to pass through to investors. The syndicator investigates the trade for affordable housing development and chooses a number of projects in which to invest.The syndicator then directs private equity capital from the limited partners of the syndicate fund to multiple affordable housing developments and returns tax credits back to each investor in proportion to their capital contribution. A few syndicate funds deport mi ssions that are aligned with non-profit developers. A syndicators experience with affordable housing development is invaluable to investors as it minimizes risk and increases investor impudence. The syndicator does all overdue diligence and underwriting for the project, so investors can take a passive role. Syndicate funds are ideal for investors that cannot afford to hire relationship managers, compliance specialists, and underwriters to oversee development.A Worthwhile Investment AlternativeA tax credit provides a dollar-for-dollar reduction in tax liability, unlike deductions that simply reduce the amount of taxable income for a particular taxable year. Even though investors contribute capital based on the amount paid per tax credit, other tax benefits are transferred to the investor in the form of passive tone endinges and deductions acquirable to any holder of rental real estate property. These include property depreciation deductions, interest expenses, business and mainte nance costs, and others. Savings from tax-deductible expenses may not have the financial impact of a tax credit, but it provides a quantifiable saving to the investor that helps add measurable rank to tax credits beyond the amount of proportional tax liability they reduce. A qualifying tax credit investment results in a decrease of tax liability.The economic return on the investment, therefore, is not subject to state or federal taxation, unlike dividends or interest income from stocks or bonds. A dollar amount of taxable income is thus inherently less valuable than an identical amount of tax credits. Certain passive loss restrictions and the Alternative Minimum Tax render tax credits less useful for the large majority of individual investors. Nonetheless, LIHTC projects were giving investors returns as high as 25%-30% during the early stages of the program. After growing competition increased set in the market for tax credits, yields have legitimately shown 4%+ annual returns in recent years. LIHTC projects provide excellent returns for the risk affect, considering other investment alternatives available. bandage the stock market has historically given investors long-term returns of approximately 10% per year on average, there are sharp fluctuations from year to year.The stock market is also considered a more risky investment in comparison to U.S. treasury bonds or other corporate notes. The yields on these safer bonds are much less than that of the stock market. Investments in tax credits provide an interesting combination of risk mitigation potential and impressive earning yields. Unfortunately, the average investor has no control over the valuation of a certain corporate security, much less the executing of a mutual or index fund. However, private placement investors and syndicate fund managers can and do provide for stringent oversight requirements through contractual obligations imposed on the developer, which in turn helps mitigate risk of project failure. A rise in the valuation of a corporate security usually requires an indicator of increased earnings in the future, whether it is the introduction of a more effectual manufacturing technique, the release or upgrade of a new or existing product, or a similar corporate action.Any increase in the value of a security may be short-lived. An investor only realizes gain after a sale that gain is taxed. LIHTC projects, on the other hand, do not require entire securities markets to move in order to obtain a profit. Aside from rigorous paperwork and professional fees, the tax credits will eventually fall in the hands of the investors so long as the developer does not fail to meet the various compliance requirements for the specified period. With continuous oversight, investors and fund managers can establish timelines for performance that may readily identify any setbacks or obstacles to completion. This may afford time to expedite construction or development and perhaps cure any po tential defects in the plan. On the downside, securities markets provide instant liquidity LIHTC projects require at least 11 years to harvest all profits.Timelines provide further protection when equity contributions are made in response to the developer meeting certain milestones that render project completion more likely. By disbursing equity in stages, investors exert more control over the projects development and may elect to alter the course of the project. For instance, the investor may attempt to remove the developer if confidence is undermined. The 15-year compliance period provides an identifiable date of exit, after which all profits (in the form of tax credit use) have been harvested.If investors decide to exit the venture, a lowly market has emerged where an investor may be able to sell the credits to third parties. Legislation passed in 2008 allows limited partners to sell their ownership interests in affordable housing properties without facing recapture so long as t he properties continue to operate as affordable housing. This allows a shortened holding period of up to 11 years as long as the property meets the 15-year compliance requirements. These advantages are largely unavailable to stock market investors and make tax credits a safe, viable and profitable investment alternative. These benefits apply uniformly to any tax credit investor.Large Banks, Larger BenefitsLarge banks and financial institutions are provided with a number of benefits that are generally inapplicable to individual and corporate investors, which in turn make credits more valuable and increases their market price. Banks subject to the companionship Reinvestment exploit (CRA) are required to engage in certain activities that improve community development. Direct investments and loans made to LIHTC projects, or syndicated funds that invest therein, are considered qualified activities under the CRA.Banks receive positive CRA consideration not only for these loans and inves tments to community projects, but also when equity is transferred to LIHTC projects that serve broader statewide or regional areas that include a particular banks assessment area. An unsatisfactory CRA rating can cause banks to be denied or delayed in undertaking certain business activities like mergers, acquisitions, or the expansion of services. Thus, banks have strong incentives to invest in affordable housing development. LIHTCs are very much a top choice for banks, who are obliged to make community development contributions, because not all CRA qualified activities provide similar returns.Financial institutions also benefit from establishing banking relationships with real estate developers. This allows banks to reach out their revenues by providing new services to the project like pre-development loans, construction loans, mortgage financing, and credit lines. Bridge loans are especially enticing, where banks loan large amounts of capital to syndicated funds or other Private Placement investors without the cash reserves to make the up-front equity contributions required by developers before any tax credits can be redeemed.Moreover, banks have the financial capacity to create long-lasting resources to assist in affordable housing investment. The underwriting and due diligence for a LIHTC project requires a number of services and incurs various costs. While syndicated funds spread these costs over a number of investors, banks are in a position to have a bun in the oven for these costs themselves. By establishing separate departments to oversee tax credit financing, banks make a one-time investment in an oversight apparatus that will operate over an indefinite number of LIHTC projects. These in-house professionals will increase in value as their experience expands and efficiency improves. Any bank with the capacity to conduct private placement investing in LIHTCs probably does so.Syndicated Funds Investment Mechanisms for the Un sophisticated Tax Credit InvestorA multi-investor syndicated fund provides a number of additional benefits to potential tax credit investors. It is helpful to analogize syndicated funds to mutual funds for the purpose of identifying their advantages. Just like mutual funds, where fund managers collect funding from many investors and create a diversified portfolio that is professionally managed, syndicated funds act in a similar fashion. Syndicated funds invest in multiple affordable housing developments, often in various geographic regions and with different housing developers. This allows investors to spread risk amongst different LIHTC projects so that if one project fails, their entire equity commitment is not lost. Investing with multiple investors allocates risk of loss more evenly and makes LIHTC investments a safe investment alternative.Furthermore, reputable syndicated funds are professionally managed by experienced, sophisticated tax credit professionals that probably have more knowledge about tax credit investing than any prospective investor. Few institutions and entities have luxuriant capital reserves to fund an entire project single-handedly syndicated funds combine investor contributions, allowing small entities like community banks and mid-size companies to have the flexibility of choosing how much capital to contribute to tax credit investment. The end result is an excellent mechanism through which unconventional tax credit investors can participate in the competitive market for tax credits. Even though funds collect a percentage fee, diversified portfolios will likely contain projects in DDAs to provide borderline increases in tax benefits.Corporations and Tax Credits A Goodwill Investment.LIHTC are beneficial to corporations because annual tax credits have a positive impact on earnings per share, since credits reduce tax liability without diluting earnings. Tax credits are usually a profitable investment because most companies sustain consistent tax liability for years on end. Tax credit investment declined during the 2008 market downturn, but has steadily increased with general economic improvement. Companies like Google, Verizon, impropriety Mutual, and others have invested in affordable housing developments across the country.An additional and measurable economic benefit to corporations is the increased value of a trademark or goodwill associated with a company that invests in community development. This type of investment may also attract positive publicity and media coverage, which in turn may increase corporate securities valuation. Large corporations are also in a coveted position to undertake direct investment and avoid paying fees to syndicated funds.Safe, but not That Safe.While LIHTC investments may be safer than comparable investment with similar yields, the risks must be identified for informed decision-making. Potential tax credit recapture and loss is the greatest riskthe project must maintain specific requirements over a pe riod of 15 years and strict deadlines must be met. The investor must assume the risk of any impediment to completion of construction, no matter how farfetched, and recapture liability remains with the initial investor even if the credits are interchange on the secondary market. Risk of failure extends for a prolonged period of 15 years where strict operational requirements must be met.Due to the shot involved in predicting construction costs, securing subsequent financing, and meeting compliance deadlines in light of potentially unforeseen adverse events, a project must be very precisely calculated to increase the chance of success. Entities and individuals that invest in syndicated funds are in a better position to identify risks due to stringent government-imposed requirements for prospectuses and offering memoranda to be distributed to all potential investors.Inexperienced syndicators might overlook a key responsibility that can cause the project to fail. Repurchase obligations arguably provide a false sense of security to investors because most developers have small balance sheets and cannot afford to match the investors contributions. The risks involved in LIHTC investment can be mitigated with proper planning, continuous oversight, and an experienced syndicator. Banks with in-house asset management units can oversee property maintenance. Although investors cede spleen priority to the primary mortgage holder, foreclosure rates are relatively low and occupancy rates relatively high. Tax credit projects are viable investment alternatives. 1 . Catherine Such, Low Income Housing Tax Credits. Federal Reserve Bank of San Francisco Community Investments (Mar. 2002), http//www.frbsf.org/community/investments/lihtc.html. 2 . Michael J. Novogradac, Investing in Low-Income Housing Tax Credits, OCC Community Developments. (Mar. 2010), http//www.occ.gov/static/community-affairs/community-developments-investments/spring06/ investinginlowincome.htm. 3 . Id., See Und erstanding Low Income Housing Tax Credits How to impregnable virtue Investments and Evaluate Syndication Options. Corporation for Supportive Housing (Mar. 2006),http//documents.csh.org/documents/ ResourceCenter/DevOpsToolkit/UnderstandingLIHTCspdf.pdf. 4 . Sherrie L. Rhine, Low-Income Housing Tax Credits low-cost Housing Investment Opportunities for Banks. Community Affairs Development (Feb. 2008), Found in Real Estate Law Clinic play Reader, at p. 75. 5 . Lance Bocarsly, Real Estate Law Clinic Lecture. (Thursday September 6, 2012, 430pm.) 6 . Understanding Low Income Housing Tax Credits How to Secure Equity Investments and Evaluate Syndication Options, supra, Corporation for Supportive Housing (Mar. 2006.) 7 . In actuality, the percentage of qualified basis that determines the amount of tax credits is not on the nose 9 or 4 percent. The rate for the 4 percent credit floats in accordance with the Applicable Federal Rate and may fluctuate to a higher place or below 4 percent . The 9 percent credit will float beginning in 2013, although current legislation has been proposed to extend the 9 percent credit floor. House of Representatives Bill 3661 is making its way through Congress. See Mark Anderson, Tax Credit at Risk for Low Income Housing. Finance and medico (April 26, 2012, 435 pm). Available at http//finance-commerce.com/2012/04/tax-credit-at-risk-for-low-income-housing/. 8 . Low-Income Housing Tax Credit Facts Figures, Novogradac Affordable Housing Resource Center. http//www.novoco.com/low_income_housing/facts_figures/index.php. 9 . Tim Iglesias and Rochelle E. Lento, The Legal Guide to Affordable Housing Development. Found in Real Estate Law Clinic Course Reader, at p. 28. 10 . Rhine, supra, Low-Income Housing Tax Credits Affordable Housing Investment Opportunities for Banks. Found in Real Estate Law Clinic Course Reader, at p. 87. 11 . Understanding Low Income Housing Tax Credits How to Secure Equity Investments and Evaluate Syndication Opti ons, supra, at p. 4. 12 . Id. 13 . Id. 14 . Novogradac, supra, Investing in Low-Income Housing Tax Credits. 15 . James L. Logue III, How LIHTC Funds Can Help Banks Invest in Affordable Housing. OCC Community Developments (Spring 2006). http//www.occ.gov/static/community-affairs/community-developments-investments/ spring06/howlihtcfunds.htm. 16 . Id.