Abstract
The Low Income Housing Tax Credit Program (LIHTC) was created by the Tax Reform Act of 1986 and was first utilized by the real estate development community during 1987. Section 42 of the Internal Revenue Code (IRC s. 42), as amended, is the federal law that governs the LIHTC Program. Each year the IRS allocates tax credits to each state based on population as defined in IRC s. 42. Under the LIHTC Program, developers of rental housing must meet certain affordability tests and the property must remain in compliance with the low income tenant set aside and rent restriction requirements for a period of not less than 15 years from the first taxable year of the credit period. Depending upon the state, property rent restrictions can last for 30 years or more.
Tax credits are currently allocated to developers by each state's housing development authority. From the inception of the program in 1987 through 2000, each state historically received an annual allocation of $1.25 times the state population (subject to a minimum allocation). During 2000, Congress increased the limit by 40% to address the impact of inflation since the inception of the program. The 2001 limit is $1.50 times the state population and will increase to $1.75 times the state population in 2002. Beginning in 2003, the limit will be adjusted annually for inflation.
The affordable housing investment process is usually initiated by property developers who structure projects in order to receive tax credit awards from state housing agencies. Property developers bring together all aspects of a project: land, permits, architect plans, construction team, financing, legal, and property management. Property developers also negotiate equity investment agreements with individual investors (often community development banks) or with syndicators. In these negotiations, the syndicator usually acquires a 99% limited partnership interest in the operating partnership that owns the LIHTC property, while the property developer acts as general partner. The terms of the negotiation include price, payment benchmarks, developer guarantees, and residual interest splits.
Syndicators bundle multiple properties in a limited partnership and sell interests in the partnership (usually referred to as a Fund) to either investors or guarantors. Investors receive tax credits, taxable losses (or income), and cash distributions from the underlying Fund investment. Guarantors establish partnerships (called the guaranteed partnership) to purchase the unguaranteed Fund. Limited partnership interests in the guaranteed partnerships are then sold to guaranteed investors. the amount of the investment made by the guaranteed investors less the cost of the underlying Fund investment represents the guarantee fee earned by the guarantor.
In exchange for the guarantee fee, a guarantor assumes virtually all of the risks that threaten the realization of the investor's guaranteed yield except for risks associated with a future change in the tax law and the individual investor's specific tax capacity. A guarantor's risks can be categorized as follows:
- Sponsor Risk
- Specification Risk
- Construction Risk
- Lease up Risk
- Operation Risk
- Tax Compliance Risk
- Legal Risk
- Reinsurance Risk
- Sponsor Risk and Fee Sharing Risk
Guarantors have a strong incentive to manage and mitigate each of the above risk factors that could result in a guarantee fund not achieving its projected yield and a guarantor making cash payments to the investor to cover any shortfall in the guaranteed yield. In addition, guarantors also face pressure from independent auditors, rating agencies and regulatory bodies reviewing their guaranteed affordable housing risk exposure. Given these challenges, the Chief Risk Officer and senior management team of the guarantor often look for the most innovative way to manage the impact of guarantee related earnings volatility on their organization's financials.
Tax credits are currently allocated to developers by each state's housing development authority. From the inception of the program in 1987 through 2000, each state historically received an annual allocation of $1.25 times the state population (subject to a minimum allocation). During 2000, Congress increased the limit by 40% to address the impact of inflation since the inception of the program. The 2001 limit is $1.50 times the state population and will increase to $1.75 times the state population in 2002. Beginning in 2003, the limit will be adjusted annually for inflation.
The affordable housing investment process is usually initiated by property developers who structure projects in order to receive tax credit awards from state housing agencies. Property developers bring together all aspects of a project: land, permits, architect plans, construction team, financing, legal, and property management. Property developers also negotiate equity investment agreements with individual investors (often community development banks) or with syndicators. In these negotiations, the syndicator usually acquires a 99% limited partnership interest in the operating partnership that owns the LIHTC property, while the property developer acts as general partner. The terms of the negotiation include price, payment benchmarks, developer guarantees, and residual interest splits.
Syndicators bundle multiple properties in a limited partnership and sell interests in the partnership (usually referred to as a Fund) to either investors or guarantors. Investors receive tax credits, taxable losses (or income), and cash distributions from the underlying Fund investment. Guarantors establish partnerships (called the guaranteed partnership) to purchase the unguaranteed Fund. Limited partnership interests in the guaranteed partnerships are then sold to guaranteed investors. the amount of the investment made by the guaranteed investors less the cost of the underlying Fund investment represents the guarantee fee earned by the guarantor.
In exchange for the guarantee fee, a guarantor assumes virtually all of the risks that threaten the realization of the investor's guaranteed yield except for risks associated with a future change in the tax law and the individual investor's specific tax capacity. A guarantor's risks can be categorized as follows:
- Sponsor Risk
- Specification Risk
- Construction Risk
- Lease up Risk
- Operation Risk
- Tax Compliance Risk
- Legal Risk
- Reinsurance Risk
- Sponsor Risk and Fee Sharing Risk
Guarantors have a strong incentive to manage and mitigate each of the above risk factors that could result in a guarantee fund not achieving its projected yield and a guarantor making cash payments to the investor to cover any shortfall in the guaranteed yield. In addition, guarantors also face pressure from independent auditors, rating agencies and regulatory bodies reviewing their guaranteed affordable housing risk exposure. Given these challenges, the Chief Risk Officer and senior management team of the guarantor often look for the most innovative way to manage the impact of guarantee related earnings volatility on their organization's financials.
Page
1 - 66
Year
2002
Categories
Financial and Statistical Methods
Risk Pricing and Risk Evaluation Models
IRR
Financial and Statistical Methods
Simulation
Monte Carlo Valuation
Financial and Statistical Methods
Risk Pricing and Risk Evaluation Models
RAROC
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Dynamic Risk Modeling
Solvency Analysis
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