LIHTC (low-income housing tax credit) deals thrive on their win-win nature. General partners (GPs) get the financing they need to build and operate their projects. Limited partners (LPs) get a high-value investment supported by the tax credits. But what happens if (or, more realistically, when) your LIHTC deal falls out of that win-win balance? This consideration is particularly important for the more than 500,000 LIHTC projects rapidly approaching the magical Year 15, when most investors/LPs look to dispose of their interest in LIHTC partnerships.
Whether it’s a common Year 15 exit, or other circumstances that lead the LP to exit the project, all partners involved in a LIHTC deal should have a clear plan in place for navigating a smooth and successful separation — no matter how far off that transition point may seem.
WHY YOU NEED TO BE PREPARED FOR YEAR 15
Various circumstances can make an LIHTC deal less financially beneficial or viable for LPs, but almost all LIHTC projects will reach this inflection point at Year 15. The tax credits effectively end at Year 15, changing the math of the partnership. In fact, most investors look at LIHTC projects as 15-year investments — and they fully expect to exit the project in year 16. Over the next five years, more than 635,000 LIHTC projects will reach Year 15, and many GPs will find themselves unprepared to navigate this Year 15 exit. This can jeopardize the future of the project. It can even leave the GP open to being pushed out of the project entirely.
KNOW YOUR OPTIONS
GPs have several options for how to move forward when an LP exits at Year 15. It’s important to understand all of these options — and the nuanced considerations, taxes and regulatory implications of each — in order to identify the best option for your organization and your project:
- Continue to operate as-is and hold: The “wait and see” approach is the default option for many projects. Depending on where you are in the lifecycle of your project, it may make sense to wait and consider other options at a later point — when you have a more accurate sense of market conditions, your organization’s financial position, etc.
- Resyndicate the project: Resyndicating essentially allows another limited partner to step in to finance the project going forward from Year 15. This likely involves a 4% tax-exempt bond transaction. There are many technical considerations — seller financing, a deferred developer fee and/or soft debt may be needed. You should also understand the various rules and requirements that will govern the resyndicated deal going forward.
- Purchase the LP ownership interest: The purchase option enables the GP to buy out the LPs interest in the LIHTC project. The purchase price can vary, depending upon the terms and conditions of the applicable Partnership or Operating Agreement. In some cases, it may be the remaining debt plus any exit taxes. In other instances, it may depend upon a discounted cash flow analysis considering the ongoing operations of the Partnership after Year 15. In other cases, it may depend upon another appraisal methodology. It is, however, rarely simple, and where a non-profit right of first refusal exists, it can potentially be more complicated. Other factors, including capital needs and reserves required, may also impact the purchase price.
- Sale of the project: This option allows all partners to fully exit the project through a sale to a third party, but may be inconsistent with LIHTC preservation goals as well as partner goals and initiatives. If a sale is pursued, both the GP and LP must work out a long list of details before the property can be offered for sale — asset distributions, considerations with soft debts, reserves, waterfalls, capital accounts and more.
- Qualified contract process: In some cases, the building can be transitioned to the market after the initial 15-year compliance period through the qualified contract process, but this too may be inconsistent with LIHTC preservation goals as well as stakeholder goals and missions. If a qualified buyer is not found by the State Agency within one year of the project being placed into the Qualified Contract process, then the long-term affordability requirements may eventually be phased out entirely.
- Litigation: Most parties are able to negotiate a Year 15 exit plan that meets all partners’ needs and goals. Occasionally, though, parties struggle to reach an agreement — and there have been several documented cases where LPs have used their ownership interest as leverage, holding the property “hostage” to get the GP to agree to demands or even wedge the GP out of the deal entirely. You should know that litigation is an option for Year 15 exit issues — albeit a last resort. Law firms that specialize in LIHTC deals — including Winthrop & Weinstine — successfully represent GP parties in LIHTC litigation to help them take back control of their partnerships and reach amenable exits or goals.
BEST PRACTICE: MAKE YOUR YEAR 15 EXIT PLAN BEFORE THE DEAL IS SIGNED
A clearly defined Year 15 exit plan is part of a healthy foundation for an LIHTC project partnership. Ideally, planning for Year 15 begins as the initial deal is being negotiated. Addressing Year 15 during the initial underwriting gets all parties on the same page about the long-term future of the project — and helps ensure the project is managed properly to avoid issues during the Year 15 exit.
ONGOING MONITORING IS ESSENTIAL
A lot can change in 15 years. That’s why it’s important for all parties to regularly re-assess the Year 15 plan. It’s also critical that your financial and legal consultants monitor operations to make sure you’re doing everything correctly (maintaining the right documentation, managing capital accounts, etc.) to keep the Year 15 exit plan on track.
NOW IS THE TIME: THE SOONER YOUR PLAN, THE SMOOTHER THE TRANSITION
Continually rising demand for affordable housing in the Twin Cities market and elsewhere will make LIHTC projects a strong investment opportunity well into the next decade. Whether you’re just beginning to negotiate a LIHTC deal, are several years into a project, or are rapidly approaching Year 15, it’s never too early — or too late — to put a Year 15 exit strategy in place. Start by talking to your legal and financial consultants about the options available to you. Together, you can determine a Year 15 plan that meets all parties’ needs and goals — and you can begin taking proactive steps to ensure a smooth, successful transition for your project.
*This article originally ran in the June 19, 2019, issue of Finance & Commerce.