Financing Multi-Family Housing: Structuring the Low Income House Tax Credit and Tax-Exempt Bonds Documenting Transactions for Investors and Developers

Transcription

1 Presenting a live 90-minute webinar with interactive Q&A Financing Multi-Family Housing: Structuring the Low Income House Tax Credit and Tax-Exempt Bonds Documenting Transactions for Investors and Developers THURSDAY, AUGUST 25, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Philip C. Genetos, Partner, Ice Miller, Chicago & Indianapolis Janice E. Hetland, Partner, Lathrop & Gage, St. Louis The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10. NOTE: If you are seeking CPE credit, you must listen via your computer phone listening is no longer permitted.

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5 FINANCING LIHTC PROJECTS WITH 4% CREDITS AND TAX-EXEMPT BONDS Presented by: Janice E. Hetland August 25, 2016

6 Statutory Authority for Federal Low-Income Housing Tax Credits The statutory authority for Federal Low Income Housing Tax Credits ( LIHTC ) is set forth in Section 42 of the Code, as supplemented by its implementing Treasury Regulations LIHTC is a permanent tax credit under the Code and was enacted into law to spur development of affordable housing for low and very low income households Under Section 42, there are two potential sources of LIHTC: (i) the 70% present value LIHTC (the 9% Credit ) (ii) the 30% present value LIHTC for federally subsidized buildings (the 4% Credit ), which since July 31, 2008 is available for buildings financed by private activity bonds, exempt from tax pursuant to Section 103 of the Code, the proceeds of which bonds are used, directly or indirectly, with respecting to such building, or its operations L a t h r o p & G a g e L L P

7 TYPICAL LIHTC STRUCTURE General Partner 0.01% interest Investor Limited Partner 99.99% interest; pays equity for LIHTC Credits Developer Fees Limited Partnership Leases to tenants First Mortgage Loan Subordinate Mortgage Loans L a t h r o p & G a g e L L P

8 9% LIHTC Credit Under Section 42 of the Code, each State annually receives a volume cap allocation of 9% Credit (the LIHTC Volume Cap ). Developers apply for the 9% Credits from the State, and must satisfy the requirements of Section 42, as well as the requirements of the Qualified Allocation Plan ( QAP ) of the State for the year in question From the developers submitting applications, the State analyzes the projects submitted and the goals of the State under its QAP, and then issues reservations to the developers of the affordable housing projects which are selected to receive 9% Credits, in the dollar amount of 9% Credits set forth in the reservation This Credit amount is often less than the amount for which the developer applied The 9% Credit is an annual dollar amount, payable annually during the Section 42 Credit Period following completion of the development of the project A 10 year period, assuming timely lease up of units to qualified households. The 9% Credit is only available for buildings which are not directly or indirectly federally subsidized L a t h r o p & G a g e L L P

9 4% LIHTC Credits Under Section 42(b) of the Code, the 4% Credit is available for a building which is federally subsidized. Pursuant to Section 42(i)(2), a building is deemed to be federally subsidized for any taxable year, if, at any time during the taxable year, or any prior taxable year, there is or was outstanding any obligation, the interest on which is exempt from tax under Section 103 of the Code, the proceeds of which were used (directly or indirectly) with respect to such building or the operation thereof ( Tax Exempt Bonds ). The Tax Exempt Bonds are private activity bonds issued to finance the land and qualified basis costs of development of the LIHTC building (or multi-building project), which are issued under State Bond Volume Cap L a t h r o p & G a g e L L P

10 LIHTC Project Components Not Federally Subsidized New Construction Acquisition/ Rehabilitation 9% Credits Acquisition 4% Rehabilitation 9% Federally Subsidized 4% Credits Acquisition 4% Rehabilitation 4% L a t h r o p & G a g e L L P

11 4% Credit Equity As the following slide documents, the 4% Credits raise substantially less LIHTC equity for the Project than do the 9% Credits Developers look to 4% Credits for projects which are not awarded 9% Credits, or for potential multi-phase projects where not enough 9% Credits are available Often state credit agencies will encourage developers of certain projects to apply for 4% Credits Because less equity is raised in a 4% Credit transaction, in addition to the proceeds of the Tax Exempt Bonds and investor equity, there is typically more subordinate mortgage debt on the Project, which is usually payable from cash flow of the Project prior to maturity HOME Investment Partnership Act funds Federal Home Loan Bank AHP funds Other Federal, State or Local funds There also is typically more deferred development fees L a t h r o p & G a g e L L P

12 Calculation of 9% Credit Equity versus 4% Credit Equity Assumptions: Project with total development costs of $10 million $9 million of costs are eligible basis costs 100% LIHTC Units Price per LIHTC Credit is $ L a t h r o p & G a g e L L P

13 Calculation of 9% Credit versus 4% Credit (cont d) 9% Credit 4% Credit Qualified basis (100% LIHTC) $9,000,000 $9,000,000 Credit Percentage x 9%* x 3.15%** Potential Annual Credit $810,000 $283,500 Credit Reserved $650,000 $N/A Total Credit available during Credit Period $6,500,000 $2,835,000 Credits to Investor (99.99%) $6,499,350 $2,834,717*** Equity received ($1.00/Credit) $6,499,350 $2,834,717 *Permanent rate for 9% Credit pursuant to 2015 Tax Extender **August 2016 rate; rate changes monthly ***Assuming achievement of 50% Test L a t h r o p & G a g e L L P

14 Components of 4% Credit Transaction Costs of the land and eligible basis building costs for each building in the Project must be financed by Tax Exempt Bonds Critical to verify that the bonds are tax exempt, pursuant to Section 103 of the Code, and private activity bonds, subject to valid State bond volume cap allocation, taken into account under Section 146 of the Code 42 (m) letter issued by Bond Issuer State Housing Credit Agency generally underwrites the project to determine consistency with the QAP Bond Counsel Opinion IRS Form 8038 Election of Applicable Percentage Regulatory Agreement reflecting 20/50 or 40/60 election L a t h r o p & G a g e L L P

15 Financed by Tax Exempt Bonds This determination is made based on the costs of the land and eligible basis of the building (which will include personal property) that is paid from tax exempt bonds These costs can include costs for which the developer has already paid, and which are reimbursed from Bond proceeds, provided that the costs are incurred no more than 60 days prior to Bond inducement. 50% Test Pursuant to Section 42(h)(4), if 50% or more of the aggregate basis of the land and building are paid from the Tax Exempt Bonds, then the eligible basis costs of the entire development is eligible for the 4% Credits Critical Planning Point: If less than 50% of such costs are paid from Tax Exempt Bonds, then only the percentage of costs actually paid by such Bonds are includible in eligible basis for the 4% Credits L a t h r o p & G a g e L L P

16 Financed by Tax Exempt Bonds (cont d) The Bonds need to be issued and spent to finance development costs during the construction period Based on existing IRS guidance, the Bonds must remain outstanding until after placement in service of the buildings in the Project. Ready and available for its specifically assigned function Occupancy permits AIA Certificate of Completion Following placement in service, the Bonds may be paid down or paid off and refinanced by other mortgage debt Mortgage loans from state housing credit agencies FHA insured loans (non-recourse, fixed rate, generally 40 year term) Federal Home Loan Mortgage Corporation (Freddie Mac)/Government National Mortgage Association (GNMA) Bond take out Permanent component of Tax Exempt Bonds remaining after pay down from investor equity at completion L a t h r o p & G a g e L L P

17 9% / 4% Projects Typically occurs where not enough 9% Credits were awarded to a developer for its project In lieu of multi-year phased projects Critically important that each project financing is totally separate from the other project, with no common financing and no cross collateralization (See IRS Technical Advice Memorandum and PLR ), so that the 9% Credit project won t be deemed to be federally subsidized Structure Separate buildings/condominium units (See IRS Notice 88-91, inter alia, which concludes a condominium unit is a separate building under Section 42 of the Code) Separate ownership Separate loans L a t h r o p & G a g e L L P

18 Bond Purchaser as Substantial User under Section 103 of the Code Treasury Regulation provides that the tax exemption on Bond interest does not apply while the obligation is held by a substantial user of the facility A substantial user is a non-exempt person who regularly uses the facility in its trade or business Typically occurs when the investor in the owner entity is affiliated with the Bond purchaser (private placement of the Bonds) Bond interest would be taxable while Bonds are held by such affiliate Bond documents need to provide for the Bonds to bear interest at a taxable rate during that period Bond interest would become tax exempt again when transferred to a non-substantial user This does not affect the 4% Credits available for the Project L a t h r o p & G a g e L L P

19 Contact Information: Janice E. Hetland Lathrop & Gage LLP 7701 Forsyth Boulevard, Suite 500 St. Louis, Missouri Phone: L a t h r o p & G a g e L L P

20 Lathrop & Gage LLP provides this material for informational purposes only. The material provided herein is general and is not intended to be legal advice. Nothing herein should be relied upon or used without consulting a lawyer to consider your specific circumstances, possible changes to applicable laws, rules and regulations and other legal issues. Receipt of this material does not establish an attorney-client relationship. Lathrop & Gage LLP is very proud of the results we obtain for our clients, but you should know that past results do not guarantee future results; that every case is different and must be judged on its own merits; and that the choice of a lawyer is an important decision and should not be based solely upon advertisements. This material is based on the law as it existed on August 25, L a t h r o p & G a g e L L P

21 BOND FINANCING Of Rental Housing Projects Ice on Fire

22 Bond Basics Interest on bonds issued by state and local governments is excludable from federal income taxation The Tax Code provides a "subsidy" for certain specific eligible projects Because of income tax exemption, bond purchasers are willing to accept lower interest rate and frequently longer maturities Two types of bonds Governmental not used often for housing projects Private Activity Most Typically, For Profit Housing Facility (Tax Credits can also be used and are used to reduce the debt issued 501(c)(3) owned projects (no tax credits): often debt is more highly leveraged. These bonds have many characteristics of governmental bonds Ice on Fire 22

23 Bond Basics (Cont'd) Bonds must be issued by a state or local government Issuer acts as "conduit" and loans proceeds to borrower Borrower repays bonds with revenues of project Repayment can be secured by a mortgage on project Security structure, financial covenants, and security may be similar to conventional loan Publicly marketed bonds more typically have credit support, such as Letter of Credit, FNMA, GNMA or FHA, or bond insurance. Bonds are rated Privately placed bonds more often have no credit support Section 8 assistance contracts can also be used as credit support but typically a lower rating results. Ice on Fire 23

24 501(c)(3) Entity Roles The most obvious role is that of the owner/borrower in fulfillment of its exempt purpose. 501(c)(3) bonds have many benefits over private activity bonds for private developers. The exempt purpose of the 501(c)(3), though, defines the applicable limitations on the operation of the project. If the exempt purpose is the provision of affordable housing, the IRS safe harbor to qualify for 501(c)(3) status is two-pronged: A. that the project meet the rules for a Qualified Residential Rental Project (20/50 or 40/60 tests described later); and B. that for 75% of the units rents must be affordable to people whose income is not higher than 80% of area median income. No rent restrictions per se, but rents must be affordable Need to assure private uses are acceptable Ice on Fire 24

25 501(c)(3) Roles (cont'd) The second role is as an investor in the partnership formed to own and develop the project subject to either the Section 42 rules for credits or the Section 142 rules for bonds. This project is financed with bonds in the same manner as a private developer would This structure is used where the 501(c)(3) entity qualifies for certain grants that can be used to fund the project and reduce either the debt or equity needed. Often, the tax credit or bond allocation programs provide preferences for involvement of 501(c)(3)s in the developer Ice on Fire 25

26 Eligible Project Costs Construction/Rehab costs New Equipment Costs Land Acquisition (20%) Capitalizable Start-up Costs Interest on bonds during construction A&E and other similar soft costs Developer fees Costs of Issuance up to 2% Reimbursement after Notice of intent Ice on Fire 26

27 Types of Projects Single building Multiple buildings Scattered Sites Ice on Fire 27

28 Housing Structures No Credit Support Issuer Borrower Trustee Bond holders Collateral Ice on Fire 28

29 Housing Structures Credit Support from MBS Issuer Borrower Trustee Bond holders FHA Mortgage MBS GNMA Ice on Fire 29

30 Allocation Processes for Bonds No allocation process for 501(c)(3) owned projects. No tax credits and no private activity bond volume Where a project has at least 50% of its eligible basis financed with tax exempt private activity bonds, the project may receive 4% credits outside of the 9% credit volume limitation Bond volume is allocated annually by a state or local agency, often the same state agency that allocates the tax credits. Bonds fund the portion of the project costs not funded with equity raised from 4% tax credits and other sources the developer can access Allocation formula may give preferences for areas in need, non-profit participation, higher standards than 20/50 or 40/60 or agreement to maintain restrictions for longer period Allocation agency can also be the issuer Ice on Fire 30

31 Comparison of Financings 501(c)(3) bonds typically fund virtually of the project costs, except to the extent of any grant funding Private activity bonds for private developers typically fund 60-65% of the project costs, with LIHTC funding of 30% and other sources of 5-10%. Conventional debt for 9% LIHTC projects typically funds 25% of the project costs, with LIHTC funding of 70% and other sources of 5% Ice on Fire 31

32 Multifamily Housing Bonds For profit borrowers must apply for "volume" Volume is allocated by Federal govt. annually to states based on population. State then allocates the volume to a single state agency to decide or to bigger cities and the state agency. In some states, the housing agency recommends to the primary state finance agency how the bond volume should be allocated No volume necessary for 501(c)(3) Bonds Ice on Fire 32

33 Multifamily Housing Bonds (Cont'd) Rehabilitation Requirement for existing property Rehabilitation expenditures within 2 years must equal or exceed 15% of cost of acquisition of real property financed with bonds. 100% for structures. Proceeds may not be used to acquire equipment other than equipment integrated into the building (HVAC) Not required for 501(c)(3) Bonds, but then subject to the requirement for Qualified Residential Rental Project, which most 501(c)(3)s must meet to qualify "Qualified Residential Rental Project" set aside (20% of units occupied by tenants with income equal to 50% of area median, adjusted for family size) set aside (40% of units occupied by tenants with income equal to 60% of area median, adjusted for family size) Term of restriction is longest of (a) term of the tax-exempt bonds, (b) term of Section 8 assistance, or (c) 15 years Complete facilities (living, sleeping, eating, cooking, sanitation); Not used on transient basis Ice on Fire 33

34 Multifamily Housing Bonds (Cont'd) Public Hearing Required by Issuing Agency 2% Limitation on Costs of Issuance Bond Counsel, Issuer fees, Financial Advisor, Underwriter's Fee, Underwriter Counsel, Rating Agency Fees Funding for Land is limited to 20% Substantial User or Related person may not hold Bonds on a tax exempt basis Ice on Fire 34

35 Bond Structures FHA insurance normally long term fixed FHA/GNMA long term bonds normally fixed FNMA long term bonds fixed or variable Letter of Credit FHLB enhanced fixed or variable Guaranteed by Credit Investor Rated Only transactions based upon full evaluation of project features and/or Section 8 HAP contract Short Term tax exempt bonds solely to secure 4% credits Ice on Fire 35

36 Short Term Tax Exempt Bonds Volume cap bonds need only be for 50% of project costs Volume cap bonds need only be outstanding until in service date Where 9% LIHTC is not available and tax exempt financing is expensive using short term tax exempt financing to secure the 4% LIHTC may be advantageous in some cases Ice on Fire 36

37 Financing Basics Inducement Resolution Allows for reimbursement (acquisition, construction, rehab costs) Working Group Borrower owns the projects, usually manages the project, repays the bonds and provides impetus for decisions, such as notice of marketing, credit support Issuer authorizes the bonds payable solely by Borrower Bond Counsel delivers the opinion that bonds are valid and interest is tax exempt i.e., the project qualifies on its face CPA Involvement Underwriter/Bank sells or buys bonds Underwriter Counsel prepares disclosure documents Liquidity/Credit Enhancement bond insurer, letter of credit, FHA, GNMA, FNMA Trustee to act on behalf of Bondholders Rating Agency? Ice on Fire 37

38 Financing Basics (Cont'd) Financial Covenants Tested periodically to ensure ability to repay debt Debt Service Coverage: cash flow greater than debt service Liquidity test: ensures sufficient cash available to operate Debt to capital: limit amount of debt financing Capital expenditure limits Occupancy/Lease Up Limitations on corporate activity Mergers, divestitures Additional debt tests Ownership changes Ice on Fire 38

39 Financing Basics (Cont'd) Amortization Variety of repayment options depending on revenue stream from the financed project & strategic plans Term tied to useful life of the property financed Max = 120% of the average useful life Other considerations: Existing debt Future debt Ice on Fire 39

40 INTRODUCTION TO BOND FINANCING of Rental Housing Projects Ice on Fire