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Appraising the assets of low-income housing tax credit properties.

Some aspects of low-income housing tax credit (LIHTC) properties are unique and bear special considerations when ad valorem tax value appraisals are undertaken. In this article, ad valorem tax regulations are covered with direct references to Texas codes and court rulings, but general concepts offered here can be of help in most states as guidelines. Also, the assistance of competent local legal counsel should ensure adequate case and code references. The disagreement is over whether only tangible assets are subject to ad valorem taxes.

LIHTC facilities have unique characteristics that must be considered before a proper appraisal can be performed under nearly any set of guidelines. These "individual characteristics that affect the property's market value" must be incorporated according to Texas Tax Code [section] 23.01(b).(1) This concept was sustained in Fairchild Aircraft Corp.,(2) which ruled that the late 1990 sale by the bankruptcy trustee of a bankrupt property should be considered in establishing its assessed value even though exchanges after January 1 are normally not. This inclusion in the assessed value was deemed one of the property's individual characteristics.

Tarrant Appraisal District v. Colonial Country Club(3) speaks more directly to a situation similar to LIHTC-type properties and their associated restrictions that do affect the fee simple interest or fee simple estate (absolute).(4) The taxpayer in Tarrant filed deed restrictions on their property limiting the land's use to recreational, park, and open space for a minimum of 25 years. The taxpayer, a country club, felt the deed restrictions qualified for special valuation provisions under the Greenbelt Act.(5) The owner said the highest and best use under this provision was a golf course, which would result in a substantially lower value than the appraisal district had indicated. The district's opinion of the highest and best use was mixed single-family and multifamily and ignored the deed restriction.

The Tarrant court found that the land use restrictions were valid. Any concerns over notice were unfounded because filing in the deed records gave constructive notice to all. Also, the land use restrictions were enforceable and the property was in compliance. Again, this seems to support further the idea that the individual characteristics of a property should be considered in determining value under the Texas Tax Code.


LIHTC facilities came about as a result of the need for the federal government to furnish affordable housing for low-income individuals and families. Established under the Budget Reform Act of 1986,6 LIHTC was renewed annually with broad political support until becoming permanent via the Revenue Reconciliation Act of 1993.(7) An editorial in the Lubbock, Texas, Avalanche-Journal summed up the impact of this successful government program when it stated, "Since its creation in 1986, the $3 billion program has leveraged more than $12 billion in private investment to produce more than 900,000 homes and apartments."(8) Construction and renovation continue.

LIHTC may be totally dedicated to low-income living quarters, but this arrangement is not mandatory. They can also be a mix between low-income and conventional market tenants. To be affordable, a sponsor can choose to serve 50% or 60% of the median income for the project area as defined by the Department of Housing and Urban Development (HUD). If the developer elects the 50% plateau, a minimum of 20% of the units must be set aside for low-income housing. Alternatively, if the sponsor chooses 60% at least, 40% must be set aside.

All LIHTC complexes have indirect subsidies designed to encourage equity investment of private funds and facilitate feasibility. The primary form that these indirect subsidies take is tax credits, which may be used to offset federal income tax liabilities directly by the owner or owners. Both individuals and corporations are eligible.

The down side is that no direct government payment is procurable to offset the low rent structure. Participants in the program are subject to the other risks indicative of the multifamily industry as well as some unique to LIHTC. According to attorney Herbert Stevens, these risks involve:

1. Foreclosure.

2. Delivery of the project tax credits. (Generally the total cost of the project minus the tangible value [real estate], as supported by its income potential defined under the LIHTC agreement, equals tax credits.)

3. Management and compliance.

4. Other typical real estate risks.(9)

The program is designed to promote private investment through the incentive of tax credits. This inducement is the defining individual characteristic of the program and LIHTC multifamily projects. Also, unlike most other government housing programs, most of which are administered by HUD, this one operates under the Department of the Treasury. Specifically, the Internal Revenue Service oversees it. Tax credits are allocated by the various state housing authorities to individual projects and must be recertified yearly.

Certain directives must be adhered to initially and over the original participation period to stay in compliance. The performance period is 15 years even though the tax credits are available only for 10 years. If the property does not maintain conformity, the penalties are quite onerous. Tax credits are available only to that part of the property designated for low-income occupants. The remainder, if any, must be a self-sustaining conventional, market-oriented operation.

Once incomes are established, the total permissible housing payment for low-income residents can be calculated based on 30% of a typical family's monthly income. The total housing payment allowed per floor plan is based on the size of the family assumed to be living there regardless of the true number of occupants. Examples are:

* One-bedroom rent is based on the income of 1.5 people.

* Two-bedroom rent is based on income for three people.

* Three-bedroom rent is based on income for 4.5 people.

The appraisal and the value of LIHTC property are directly affected by the assigned rents and these permissible rents define the maximum accessible income.(10)

The low-income rent may be all that is available to sustain the property. "If it is insufficient to maintain the project (as is probably the case), the tax shelter benefits of the tax credits and other subsidies must be used to assure project viability," according to author Richard Polton.(11) Other subsidies in this case might refer to depreciation losses, below-market financing, and low interest loans for the 15-year term of the project.

The purpose of the LIHTC program is to establish and maintain an adequate inventory of affordable housing for low-income families. This is why the property must commit to a minimum participation of 15 years and the recapture provisions are so stringent.(12) In other words, the limitations can be and are enforced. These two individual characteristics of LIHTC facilities are very important to an appraiser's considerations because both the court rulings and the Texas Tax Code mandates seem to pivot on one or the other, as is apparent in the following:

1. The Texas Tax Code [section]1.04(7) says, in effect, that valid and enforceable deed restrictions must be considered when an appraiser is establishing value.

2. The Tarrant court found the deed restrictions under the Greenbelt Act valid and enforceable and, therefore, a necessary inclusion in determining market value.

3. Compliance, recording, and enforcement treaties for LIHTCs affect a property's fee simple conditional(13) value in similar ways that the Greenbelt Act does. For instance, IRC [section]42(h)(6)(B)(vi) compels the state to require the owner to file the "Declaration of Land Use Restrictive Covenants" (LURC) associated with the LIHTC's giving constructive notice. Also, these covenants vest local administration in the Texas Department of Housing and Community Affairs,(14) which is very similar to the Greenbelt Act and requires tax credits to be established each year. Further, the covenants also provide the state with a "first right of refusal" on the 15th year, should the owner decide to leave the program. The option for an "extended use period" of another 15 years is in the LURC. Notice must be given in the 14th year. The sales price is based on a predetermined formula that ensures equity plus interest on the equity at inflation, but not to exceed 5.0%.(15) No windfalls are anticipated. Finally, penalties for withdrawal or noncompliance are quite heavy.

4. The enforcement and compliance directives of LIHTC are entirely independent of the availability of tax credits.

It is true that restrictions run for only 15 years initially, and generally the economic life of a multifamily project is longer. On the other hand, the presence of the optional extended use period or extended low-income housing commitment suggests that they may actually stretch for a full 30 years.

In many cases there is significant debt that will be due at the end of the holding period, Most investors seem to look for a return of their initial equity at the sale and anticipate minimal capital appreciation.(16)

Paraphrasing, the "model" investor gives little credence to any residual that might accrue at the end of the compliance period. Another factor in this reasoning may be that many of these properties are really major rehabilitations over "bone structures" that may already be 20-30 years old.

All of this points to the fact that LIHTC properties are distinct. They require a somewhat different appraisal process in order for the appraiser to arrive at a reasonable market value - one that is not grossly excessive for a particular facility.

An LIHTC project is generally predicated on rents that are affordable to low-income individuals and families. The maximum income obtainable by the property is often constrained because of these affordability standards. Also, these housing payments cannot be changed without proper documentation (e.g., HUD median income reports) and government approval. All of these elements result in an enterprise that is, more often than not, infeasible and projects only limited prospects for direct economic returns. The principal motivation is the tax credit. From a total package standpoint, the following benefits are proffered:

1. Low-income tax credits.

2. Cash flow (limited prospects).

3. Depreciation losses that can be used to counteract certain types of income.

4. Capital gains on residual value. (Given little contemplation by the typical investor in this market because the state has a 15-year renewal option and first right of refusal with the price determined by equity plus interest.)

5. Availability of below-market financing and low interest, enticements that can be and often are quite influential.(17)

The total project value is derived from two primary components: the real estate, and the tax shelter benefits, along with the third element, financing inducements. As Polton stated, "For purposes of an appraisal report, the logical approach is to classify these two benefits as tangible value (i.e., the benefits attributable to the real estate) and intangible value (i.e., the benefit attributable to the LIHTC)."(18)

Further support for this concept is offered by the Uniform Standards of Professional Appraisal Practice (USPAP).(19) According to Polton, the inclusion of Advisory Opinion AO-14 on the appraisal of subsidized housing is an important step in bringing uniformity to the appraisal standards for low-income housing. This section defines subsidized housing as:

[S]ingle- or multi-family residential real estate targeted for ownership or occupancy by low- or moderate-income households as a result of public programs and other financial tools that assist or subsidize the developer, purchaser or tenant in exchange for restrictions on use and occupancy. The United States Department of Housing and Urban Development (HUD) provides the primary definition of income and asset eligibility standards for low- and moderate-income households. Other federal, state and local agencies define income eligibility for specific programs and developments under their jurisdictions.(20)

This definition recognizes that public program contributions are used to encourage this type of development and are given in exchange for restrictions on use and occupancy. An appraiser must give consideration to the incentives and their positive or negative influence on value. If the stipulations are long term, such as LIHTC, the appraiser must evaluate the intangible value when appraising low-income housing based on USPAP. Because ad valorem assessments do not typically have the right to include intangible values, allocating values between tangible and intangible components is important.

These public inducements take many forms. All of them are classified as intangible, and while they facilitate development of the real estate, they are different and separate from the tangible assets. Some of the more common catalysts are:

* Legal modification of property (zoning, for example).

* Direct financial incentives. based on this author's investigations, participants in this arena generally anticipate second mortgages with interest rates near 2%, down payments in the 5%-10% range, and the tax credits. These inducements are generally mandatory to make the development feasible and may have a strong influence on value.

* Indirect financial incentives. These include tax credits or depreciation.

Finishing with USPAP, tax credits and depreciation are normally thought of as neither real estate nor assessable assets. According to USPAP, tax credits are clearly part of the intangible value and not subject to assessment for ad valorem taxes.

An appraiser who consults Polton and USPAP, and conducts his or her own research, including discussions with other appraisers and those active in this submarket, should conclude that an appraisal of the total package would involve the two-tiered method outlined previously. Normally the tangible assets will be valued founded on cost, income, and sales comparison approaches. (The income approach almost always yields the best indicator, and no actual arm's length sales of LIHTC complexes have been unearthed to date.)

The second most conspicuous component of value is the tax credits (intangible asset or value). They are best valued based on consultation with brokers active in the market who can have information on the current discounts investors are paying to purchase ownership interest for the use of the tax credits. The second technique, which is used as a backup, is to conduct a discounted cash flow analysis of the remaining annual tax credit payments at a rate supported by this same research.

The value of the whole is then the sum of these components (tangible and intangible value or assets). Another alternative - and the most correct methodology - is to conduct a discounted cash flow analysis of the real estate's net operating income over the 15-year holding period and combine this with the DCF analysis of the tax credits, along with the contributory value of the other intangibles (e.g., below-market financing, low interest rates) over their remaining duration. The appraiser would need the following elements: tax credits, depreciation, available financing and interest payments on loans for the 15-year term projected, projected income tax and capital gains tax rate of the investor, and reversionary value. Then the appraiser can analyze the after-tax cash flow and apply a market-derived yield rate on equity that will lead to an estimate of value that includes both tangible and intangible assets.

Current banking regulations offer further support for this divided character of value where LIHTCs are being considered. FIRREA requires - and consequently most first mortgage lenders follow suit and seek - a value estimate presuming no incentives. This estimate satisfies the conventional definition of market value under FIRREA and should qualify as an appraisal of the tangible asset.

By definition, benefits from the real estate are referred to as the tangible value or asset and are subject to the Texas Tax Code regulations. Benefits gleaned from the tax credits are designated as intangible values or assets. based on the preceding discussion and references, it would appear that this intangible asset is equivalent to intangible personal property and, therefore, is not subject to property taxes in Texas.(21)

This two-part nature of the property's value does seem to demand a departure from the normal requirement based on fee simple (absolute fee) ownership supported by conventional market rents. Ordinarily, a property is valued in absolute fee and at current market rents regardless of its actual income situation and potential. The reason is that the value of all property rights (i.e., the fee simple interest) is the sum of the values of the owner's leased fee interest and the tenant's leasehold interest.(22) Justification for the LIHTC deviation is based on the following factors:(23)

1. The subject is operating under limited potential due to the restrictions associated with LIHTC regulations administered by the Internal Revenue Service (IRC [section] 42).

2. These restrictions are long term and enforceable. Constructive notice has been given and penalties are severe.

3. The characteristics of this program do combine to affect profoundly the fee simple conditional interest retained by the owner in the tangible assets. (The federal government now owns and controls some of the absolute fee or fee simple bundle of rights.)

4. The owner cannot or will not sell, transfer, or exchange unless certain conditions are met and government approvals are obtained beforehand.

5. The owner needs to meet certain reporting, record-keeping, and documentation edicts beyond conventional practice.

6. Texas Tax Code [section] 23.01(b) says in part that "each property shall be appraised based upon the individual characteristics that affect the property's market value."(24) Further, the courts have upheld and reaffirmed this instruction.

7. By definition, the value of LIHTC property is basically determined by two components. The first is the tangible asset or the real estate and the second is the intangible asset or tax credits, which are traded like commodities, stocks, or bonds on the market. The Texas Tax Code exempts these latter types of assets.(25)

8. Unlike a lease or rental agreement, the LIHTC stipulations adversely affect the value of the fee simple conditional interest in the tangible asset and do not simply divide the benefits or value between the leasehold and leased fee estates.

The appraisal of subject property must have considered all of these factors when the final value is determined. The subject is being appraised based on the fee simple conditional estate retained by the owner after acceptance and recording of the enforceable LURC. The Dictionary of Real Estate Appraisal defines fee simple conditional as:

A fee simple estate that may be terminated when a specified event occurs, which may be at any time or not at all. The condition does not automatically terminate the estate; the grantor, the heirs, or a designee must act to terminate it.(26)

One of the best examples of this type of division of the "bundle of rights" and ownership is a utility easement.(27) Because of the conclusions outlined and their apparent correlation with the Texas Tax Code, recent court rulings, stated purpose of the report, and USPAP, the report should deal primarily with estimating market value for the tangible asset or value (real estate).

The value of the whole LIHTC package should be determined before a final decision about highest and best use, however. First, an income analysis should be done, supported by conventional market rents and operating expenses under the typical management concept. The result of this study can be compared to the value of the tangible and intangible assets associated with this particular LIHTC complex. Whichever undertaking (conventional, market oriented, or LIHTC) produces the highest value should be the highest and best use of this particular project as improved.

Recapitulating, the primary characteristics to look for are that the LURC was filed in the deed records (runs with the land), the restrictions are enforceable, and the subject is in compliance.

In closing, investment managers use standardized forms for many of their computations. One form that might be of help in the valuation process for the LIHTC property (tangible and intangible assets) is the "Cash Flow Analysis" form (2-81 F612) available from the Realtors[R] National Marketing Institute of the National Association of Realtors[R].(28)

Editor's Note: This article was presented as a topical paper at the Appraisal Institute's national meetings in San Antonio, Texas, in June 1998.

1. Texas Tax Code [section]23.01(b) (West 1996).

2. Fairchild Aircraft Corp., 124 B.R. 488 (1991).

3. Tarrant Appraisal District v. Colonial Country Club, 767 S.W.2nd 230 (Tex.Civ.App. 1989).

4. Appraisal Institute, The Dictionary of Real Estate Appraisal, 3d ed. (Chicago, Illinois: Appraisal Institute, 1993), 140.

5. Greenbelt Act, Texas Tax Code [section]23.81-23.87 (West Publishing 1996).

6. PL 99-514; Richard E. Polton, "Valuing Property Developed with Low-income Housing Tax Credits," The Appraisal Journal (July 1994): 446-454.

7. Revenue Reconciliation Act of 1993 - PL103-66.

8. "Tax Credit Paying Off," Avalanche-Journal (May 29, 1997).

9. Polton, 446-454.

10. Ibid.

11. Ibid., 449.

12. Internal Revenue Code [section]42(j)(1996).

13. Appraisal Institute, The Dictionary of Real Estate Appraisal, 3d ed. (Chicago, Illinois: Appraisal Institute, 1993), 140.

14. Texas Government Code [section]2306 (West Publishing 1996).

15. Personal interview with Efraim Gonzales, ESG Consultants, Inc., Houston, Texas, 1997.

16. Polton, 450.

17. James Doherty, "More on Low-Income Housing," Letters to the Editor, The Appraisal Journal (April 1995): 260-261.

18. Richard E. Polton, "Assessment Issues in the Valuation of Subdsidized Housing," Assessment Journal (November/December 1996): 40-49.

19. The Appraisal Foundation, Uniform Standards of Professional Appraisal Practice (Washington, D.C.: The Appraisal Foundation, 1998).

20. Ibid., Advisory Opinion AO-14; Polton (1996), 43.

21. Texas Tax Code [section]11.02(a)(West 1996).

22. Richard E Williamson and Sam M. Chappell, "Taxation of Income-Producing Property: What Is the Appropriate Right to Value?," The Appraisal Journal (April 1997): 191-196.

23. J. David Allison, "The Impact of the Federal Low-Income Housing Tax Credit Program on Real Property Taxation in Texas," working paper, Amarillo, Texas, October 1996.

24. [section] 2301(b).

25. Texas Tax Code 1.04(6) (West Publishing 1996)

26. The Dictionary of Real Estate Appraisal, 140.

27. Impact of Electric Power Transmission Line Easements on Real Estate Values states, "Two estates or properties must be identified: (1) the fee ownership, and (2) the easement...The important point concerning an easement grant, however, is that the grantee has only those rights specified." Conversely, the owner gives something that would normally be considered part of the absolute fee and he retains fee simple conditional ownership of the remaining "bundle of rights." Real Estate Valuation in Litigation says that "just compensation" must be given because what the owner does retain is something less than what he had before the taking.

28. Contact the Realtors National Marketing Institute at 430 N. Michigan Ave., Chicago, IL 60611. (800) 621-8738 or (312) 329-8200.


Some qualified low-income housing projects are discussed in the following: CCH-EXP, 97FED 4385.01, 4385.014, 4385.015, 4385.05, 4385.07, 4385.084, 4385.09 (CCH Incorporated 1997).

Texas Department of Housing & Community Affairs. Information Guide: Low-Income Housing Tax Credit Program. Austin: Texas, Department of Housing & Community Affairs, 1996.

George E. Jordan, MAI, is the principal of Appraisals Unlimited, Dallas, Texas. He earned a 85 in agricultural economics from Texas A & M University,College Station. He specializes in the appraisal of multifamily and agricultural properties. Contact: P.O. Box 181072; Dallas, TX 75218. (214) 320-5906.
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Author:Jordan, George E.
Publication:Appraisal Journal
Date:Jan 1, 1999
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