Since the introduction of the Low Income Housing Tax Credit program in 1986, the majority of commercial equity investors in affordable housing projects have been those seeking tax credits in return for their equity contributions. We have recently seen a new trend emerging among traditional tax credit investors – equity investments in affordable housing projects that are past their LIHTC “credit periods” but still subject to the the LIHTC restrictive covenant or “extended use agreement”.
The goal of these investments is to preserve existing affordable housing developments in situations where a developer may be tempted to convert (or sell its project to be converted) to a market rate project in a hot multi-family housing market.
The investment strategy of these so-called “Preservation Funds” involves purchasing affordable housing projects or membership interests in entities that own projects, holding the project in its portfolio for a period of years while maintaining rents at affordable levels, and then selling the project to an affordable housing developer who will rehabilitate and recapitalize the project and maintain it as affordable housing. Rather than receive tax credits, investors receive a return in the form of net cash flow and the appreciation in value of the Project upon its eventual sale.
Sponsors of Preservation Funds will look to leverage their experince in underwriting low income housing projects, their understanding of the low income housing market and their long-standing relationships with the affordable housing developer community to identify investment prospects. Underwriting projects for Preservation Fund investments will be quite different than underwriting an LIHTC transaction – with cash flows and projected resale values gaining more importance in the absence of the value provided through the LIHTCs. Sponsors of Preservation Funds will look for deals with a healthy NOI, or the prospect of boosting a project’s NOI through expense reductions and modest rehabilitations and rent increases.
Preservation Funds will use a variety of structures to accomplish their goals — including the purchase of the fee simple title to a project, purchase of limited partnership interests in a project, and purchase of both the general and limited partnership interests in a project. Preservation Fund sponsors may provide debt financing in addition to equity financing and may even be looking for opportunities in non-rent or income restricted projects that have rents in the affordable or moderate income range.
Preservation Funds offer an exciting new opportunity to preserve affordable housing units for a period that extends beyond the traditional 30 year extended use period required for LITHC projects. Developers who have projects for which the LIHTC credit period has expired may want to explore the possibility of a sale of their project to a Preservation Fund.