INDUSTRY SURVEY: Qualified Contracts Volume

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Policies Vary Widely by State

Just as Low Income Housing Tax Credit (LIHTC) allocating policies and priorities differ from state to state, so too does the qualified contract (QC) process. As more and more LIHTC properties reach Year 15, Novogradac & Company LLP and Tax Credit Advisor (TCA) teamed up to examine and understand national QC trends and implications.

TCA surveyed state allocating agencies and received responses from 35 states representing more than 70 percent of annual allocations. This representative sample is a good foundation for examination.

The survey focused on two aspects of QCs:

  • the state’s experience over the last three years, and
  • current qualified allocation plan (QAP) policies regarding QCs.

While these two areas may seem to have a great deal of overlap, they are distinct. In general, QAPs are prospective, effectively becoming a part of the contract between owners and the agency governing many aspects of operation. QC requests are based on terms in place at the time of allocation more than 15 years ago.

The survey revealed wide disparity among the responding states.

Qualified Contract Background
LIHTC property owners agree to abide by household income, maximum rents, physical suitability and other restrictions for at least 30 years after initial occupancy. This is commonly known as the “extended use period” and assures the sustenance of affordable housing. QCs offer a way to end the restrictions earlier.

Most often, owners consider implementing the QC process because they:

  • believe there is greater value in the property as a result of material difference between LIHTC and market rents;
  • want to accommodate over-income tenancies (have been turning away potential residents);
  • desire to end the property’s compliance with various rules; and/or
  • anticipate converting the real estate to a nonresidential use.

The first question in the QC process is eligibility. The QAP may preclude the possibility or offer additional points to sponsors who agree to forego the opportunity. Over time, more and more agencies limited owners’ ability to use the QC process. Therefore the number of submissions decreases over the long-term.

If the property is eligible, the owner may request a QC after the 14th year of the compliance period. The agency then has a year to find a buyer to make an offer-at-price determined using a federally mandated formula. If it cannot do so, the extended use restrictions terminate.

In summary, the price is the sum of the following components (for more information refer to Treasury Regulation §1.42-18 and consult with a qualified tax professional).

1)   The fair market-value of the non-low-income (unrestricted) real estate, meaning the market-rate portion of a mixed-income property and the underlying land of any development.

2)   For the LIHTC portion:

  • a) outstanding indebtedness, meaning the remaining secured principal balance, including developer fee notes, up to the amount of qualifying building costs (i.e., eligible basis),
  • b) plus adjusted investor equity, or the aggregate amount of cash invested by owners for qualifying building costs (eligible basis), increased by consumer price index (CPI),
  • c) plus other capital contributions not adjusted by the CPI,
  • d) less cash distributions, including to owners and related parties and cash available to be distributed at the time of the sale.

The result of this calculation almost always is greater than any reasonable market valuation.

There are two important limitations. First, a successful QC eliminates only the IRS restrictions, any others remain (e.g., agreements made in exchange for local support). Second, QC tenants have three years of no termination without good cause and rent increases limited by LIHTC rules.

Survey Results
TCA asked agencies to report the number of QC requests and outcomes for 2014 through 2016. Most interesting is the extensive variation: half of all QC requests were reported in four states; 13 states accounted for approximately 90 percent of all QC requests; and a dozen states reported none at all.

The comparison is starker when considering states are unequal in terms of number of LIHTC properties. California and Arkansas illustrate this disparity. The former has 12 percent of the U.S. population and yet reported no QC requests over the three-year period surveyed. By contrast, Arkansas is home to one in 100 Americans and reported 21 percent of all QC requests.

The number of units within a property also affects the results. Florida reported the fifth largest total number of requests, but had more units in those properties (2,732) than the four states that reported more QC requests, combined (2,694). The average number of units per property in Florida was 248, compared to 38 units per property in the other four states.

More than 30,000 units were the subject of a QC request in 2014, 2015 or 2016. Because termination of the extended use agreement was the reported outcome 95 percent of the time, QCs are responsible for a loss of nearly 10,000 LIHTC units per annum in very specific market areas.

One very interesting result is that, despite the challenges previously discussed with the financial calculation, agencies reported nine instances of an offer being provided at the QC price.

Agencies also reported differences in their QAPs:

  • 15 agencies have some form of incentive to forgo the ability to request a QC, although it is important to recognize these often serve as requirements (often properties cannot secure an award without scoring these points),
  • 14 agencies prohibit requesting a QC as a condition of the allocation (including California, explaining the numbers above), and
  • six allow owners to opt out.

These provisions apply to nine percent allocated LIHTCs; some agencies have different policies for tax-exempt bond properties.

The clear takeaway from these results is that state policies account for the wide variation in the use of the QC process far more directly than any market or ownership characteristic.

H. Blair Kincer is a partner in the metro Washington, D.C. office of Novogradac & Company LLP in the firm’s government consulting and valuation advisory services (GoVal) group. Mr. Kincer specializes in the following primary practice areas: market analysis and appraisal of various types of mixed income and affordable housing projects, new markets tax credit (NMTC) industry consulting, Historic Tax Credit (HTC) consulting, and market analysis and appraisal in the alternative energy industry. The real estate appraisal practice has specialized competencies in the U.S. Department of Housing and Urban Development (HUD) MAP program, HUD rent comparability studies and valuation of all tangible and intangible assets involved in affordable housing development. In the NMTC arena, Mr. Kincer specializes in various analyses involving evaluating debt and real and financial asset value/appraisal questions. Further, he has developed reasonableness opinions and market verifications of various fees and relationships to assist tax counsel with evaluating structures in light of recent Internal Revenue Service (IRS) revenue rulings. His experience in the renewable energy industry includes solar, wind, and other energy facility appraisals and impact analyses of renewable energy assets provided to affordable housing developments. Mr. Kincer, a certified LEED Green Associate, brings to his practice a broad understanding of green building technologies, best practices and the LEED Rating System. Mr. Kincer is also a member for the Counselors of Real Estate (CRE) and of the Appraisal Institute. Prior to joining Novogradac & Company LLP, Mr. Kincer was vice president of acquisitions for a regional developer where he specialized in financial and economic feasibility analysis. His responsibilities included finding and processing potential acquisitions for rehabilitation using tax credit and tax-exempt bond financing. Mr. Kincer served as a manager with Ernst & Young LLP, where he performed portfolio valuations, market analysis and loan pool performance reviews. His areas of specialization include retail and hospitality. Mr. Kincer received his bachelor’s degree from West Virginia University and his MBA from Duquesne University. He is a member of the Appraisal Institute and a certified general appraiser in Connecticut, Kentucky, Maine, Maryland, Massachusetts, Mississippi, North Carolina, New York, Pennsylvania, Rhode Island, South Carolina, Tennessee, Virginia, Washington, and Wyoming.
Mark Shelburne is Director of Georgia DCA’s Office of Housing Finance. The Office is responsible for allocating tax credits, bond volume, and appropriated funds for affordable rental housing. Prior to joining DCA Mark was a Senior Manager with Novogradac Consulting LLP, where he advised state agencies, local governments, financial institutions, and developers on topics including allocation policy, supportive housing, IRS compliance, program innovation, and fair housing. Before then he was with the North Carolina Housing Finance Agency, where he coordinated the QAP, initiated award-winning programs, testified before Congress, worked with agencies in many other states, and wrote a book on LIHTCs. Mark also was in-counsel for an equity investor. He has degrees in law, planning, and public policy from UNC Chapel Hill.