Misconceptions Associated With Low Income Housing Tax Credit (LIHTC) Valuations.
This article attempts to clarify many of the misconceptions associated with the Low Income Housing Tax Credit (LIHTC) program. Historically, market participants have used the term "tax credit value" to describe the price paid for an equity investor's limited partnership interest, which is more than just the component value of the dollar-for-dollar tax credits. Challenges associated with the appraisal of a LIHTC project are discussed and related to the Uniform Standards of Professional Appraisal Practice (USPAP).
Low Income Housing Tax Credit (LIHTC) is a government-sponsored incentive program designed to promote the development of housing for low to moderately low income families, while requiring a minimum of government involvement in day-to-day operations. Unlike previous government housing programs that were administered by the Department of Housing and Urban Development (HUD), the LIHTC program is governed by the federal tax code and is jointly administered by the Internal Revenue Service (IRS) and state housing agencies.
The LIHTC program was first introduced in Section 252 of the Tax Reform Act of 1986 and was codified as Section 42 of the Internal Revenue Code of 1986, as amended. The first tax credits were issued in 1987. Although the LIHTC program was first approved on a year-to-year basis, it became a permanent program by the Omnibus Budget Reconciliation Act of 1993.
There are no monthly rent subsidies involved in the LIHTC program. Each project awarded tax credits must be financially feasible with the restricted rents submitted to and approved by the state housing agency, or, if applicable, the more restrictive rents attached to monetary grants that are often used as part of the financing package.
To offset development costs, LIHTC program sponsors (developers) receive a dollar-for-dollar reduction in their federal tax liability based on a
percentage of the qualified project development costs, less the amount of any federal grants received. These dollar-for-dollar tax reductions are known as tax credits. Tax credits are issued over a ten-year period, but project rent restrictions must have a 15-year minimum duration. Tax recapture penalties are imposed if any units fall out of compliance with, or are voluntarily removed from, the program prior to the end of the 15-year period. Post 1989 projects are also encumbered with an extended use commitment that restricts the rents for an additional 15 or more years (i.e., 30 or more years total). Additional tax credits are not awarded to the sponsor (developer) for the additional l5-year extended use commitment and tax recapture penalties are not applicable.
Tax credits are an intangible enhancement included in the affordable housing bundle of rights that runs with real property ownership. Both the tax credits and the rent restrictions survive a sale when the conditions of sale are at market. However, tax credits cannot individually be separated from the real property rights and sold separately -- tax credits always coincide with the real property ownership.
Sponsors and developers may also require grants and sub-market financing to make projects financially feasible. Tax-exempt bonds, monetary grants, government programs, and sub-market and market financing is often provided by multiple sources at the same rime. The sale of limited partnership interests also provides project equity, which is used to reduce the amount of debt to be financed.
Typically, LIHTC real property ownership is structured through a partnership  arrangement with one or more general partners. General partners may be for-profit or non-profit entities, or a combination of both. Tax credits and other real property rights may be passed through to equity investors as part of a limited partnership agreement.  Each LIHTC project is structured differently, depending upon the needs and concerns of the parties involved.
In most instances the general partner retains between a 0.0 1% and 1% ownership interest in the limited partnership and sells the ownership balance to the limited partners. The sale price is the limited partner's total equity contribution, which may be different than the amount specified in the commitment letter.  The general partner manages the project and assumes responsibility for day-to-day operations.  Limited partners are passive investors and are liable only to the extent of their capital contribution and the potential recapture of the tax credits, if the project becomes non-compliant. In other words, the limited partners own a non-recourse limited partnership interest with a pass-through of real property ownership rights, but have no control over the day-to-day operation of the project.
Figure 1 depicts the basic structure of an LIHTC project. In many instances the limited partner is a syndicator that pools a number of LIHTC projects into one offering. The pass-through benefits are usually the same as in the direct placement, but the syndicator receives a fee for structuring the pooled syndication.
In addition to the tax credits, various tax deductions and real property ownership rights, such as improvement depreciation, loan interest deductions, cash flow after-debt service,  and real property reversionary rights, are typically passed through to the limited partners (equity investors). Therefore, the term "tax credit" is often inappropriately used in the market, since tax credits from a limited partner's investment perspective include more than just the value of dollar-for-dollar tax credits allocated by the state housing agency.
To investors, tax credits are more desirable than tax deductions, since tax credits are a direct reduction in federal income tax liability and not an offset against income (like depreciation). Offsets against income have different tax savings for different investors because the tax benefit is based on the investors income tax bracket.
How the Program Works
Each state housing agency receives an annual tax credit allotment from the federal government based on the state's population--$1.50 per person in 2001, increasing to $1.75 per person in 2002. The per person allotment is the same for each state. The state housing agency is then responsible for allocating the tax credits to the most favorable proposals. This program is referred to as the "9% tax credit program," since tax credit allocations to individual projects are based on about 9% per year of the qualifying units' eligible construction costs for ten years. Loan financing terms may vary substantially by geographic location and/or sources of funds (public, private, grants, etc.).
There is also a 4% tax credit program separate from the 9% program that is sponsored and administered by each state. Projects that qualify for the 4% tax credit program do not have to compete for the limited number of 9% tax credit dollars allocated to each state. An annual 4% tax credit for ten years of the qualifying units' eligible construction costs are granted to projects that use tax-exempt mortgage revenue bond financing for at least 50% of the project cost basis. The restricted rent levels and tenant qualifying income limits are the same for both programs. In both the 9% and 4% programs, multi-layers of financing are typical and each financing source usually includes certain tenant income and/or profile limitations that are more restrictive than the state requirements.
Most equity investors base their limited partnership purchase price on a yield analysis, so the price paid on a per tax credit dollar basis received from the 4% program is higher than under the 9% program for similar structured transactions because 4% transactions contain a higher rate of passive losses to equity. In other words, equity investors in the market recognize and consider the impact of passive losses (intangible enhancements) associated with real property ownership and do not base their purchase price on just the dollar-for-dollar tax credits.
Project demand for tax credit allocations in most regions of the United States is much greater than the supply. In order to increase the probability of selection, applicants' proposals have become more aggressive by lowering tenant income thresholds and adding project amenities. All units in a complex do not have to be part of the LIHTC program; however, tax credits are only applicable to that portion of the project that serves qualified low to moderately low-income tenants.
Tenant income limitations are met in one of two ways. At a minimum, either 20% of the units in a development are set aside for families with a maximum of 50% of the median household area income, or 40% of the units are set aside for families with a maximum of 60% of the median household area income.
Based on HUD-published data, each state housing agency annually establishes the maximum gross restricted rent level for each unit type (studio, 1-bedroom, 2-bedroom, etc.) in specific geographic areas. The restricted rents in a defined area are the same for all units with the same number of bedrooms, regardless of size (square footage), how many people actually occupy the unit, project age/condition, view amenities, corner premium, ground floor access, proximity to pool, etc. 
The maximum gross rent allocated for each unit type includes all utilities, except telephone and specific optional items. A standard utility cost per unit type, as published by the local housing agency, is typically subtracted from the gross restricted rent level if the project's rental agreements require tenants to pay their own utilities.
The maximum rents established by the state housing agency are all inclusive on a gross basis; therefore, qualifying tenants may not be charged additional monthly fees for covered parking, garages, storage units, laundry, food service, etc., if the cost of the item was included in the qualified construction costs. If the service item was not included in the qualified construction costs, the sponsor may offer these optional items to the tenants for an additional fee, but cannot require a tenant to rent the items as part of the rental agreement. When market rents are less than or equal to the specified restricted levels, the actual rents obtainable at a LIHTC project may have to be less than market to attract tenants, due to the intrusive income screening requirements.
Management cost at an affordable housing apartment project may be higher than at a similar market-rent apartment project because of the increased paperwork required by the various government agencies. The extra management expense, however, may be offset by a lower tenant turnover rate. LIHTC project expenses should be analyzed and compared to local market data from other LIHTC projects because expenses will vary due to the different requirements set by each state housing agency.
Historically, market participants have used the term "tax credit value" to describe the price paid for the equity investor's limited partnership interest, which is more than just the value of the dollar-for-dollar tax credits. This nomenclature has caused considerable confusion in appraisal reports since investors and lenders typically distinguish between the two terms and concepts. The issues associated with valuing limited partnership interests are different than those associated with establishing the tax credit component of value.
Issues Associated With Limited Partnership Valuations
Appraisers currently use a variety of techniques to arrive at a limited partnership value estimate, or "tax credit" value. A popular method is the sales comparison approach, where the appraiser identifies sales of other limited partnership interests and reduces the data to a dollar per tax credit unit of comparison, e.g., $0.75 per tax credit dollar. A price range of the limited partnership sales (often incorrectly referred to as "tax credit" sales) is presented and an opinion of value is reached, which is usually reported at, or close to, the equity investment in the subject limited partnership.
In reality, it is the limited partnership interest, not the tax credit component of value, that is estimated using the dollar per unit technique. If the purpose of the appraisal assignment is to value the limited partnership interest, then the sales comparison approach may be applicable. However, sufficient market data must be available to support adjustments for the differences between the limited partnership assets and the transaction parameters of each sale.
Tax credits are a wasting asset and the tax credit component of value enhancement decreases each year of the allocation period. Since the tax credits are passed on to the equity investors, the intangible portion of the decreasing real property value is reflected in the value of the limited partnership interest. For this reason, investors typically rely on a discounted cash flow analysis to value limited partnership interests. Direct capitalization is generally not applicable. Appraising an existing limited partnership interest may present more challenges than an initial offering, since the volume of market data is typically diminished. Buyers of the limited partnership interest may also require a discount for a seasoned partial interest sale because a higher percentage of the remaining benefits will result from passive losses rather than from the remaining tax credits.
Issues Associated With Tax Credit Valuations
Many real estate appraisers will unwittingly accept an assignment to independently value the tax credit component of value but actually value the limited partnership interest. This type of analysis and reporting is misleading to the intended user of the appraisal report The vast majority of these appraisers do not fully understand the complexities of the analyses required for compliance with USPAP and other regulatory requirements. An analysis of the tax credit component of value that does not include the valuation of LIHTC ownership characteristics is too simplistic to be valid for lending purposes.
Credit officers for financial services institutions generally have limited appraisal experience and rely on professional real estate appraisers' opinions of value for underwriting. To determine the collateral value to be used for lending, a reported "tax credit" value that is really a limited partnership value may unwittingly be combined with the real estate value. This combination results in double counting the various real property right components and overstates the collateral value, which diminishes the lender's credit quality.
Double counting of realty components is primarily noted in construction loans made prior to the sponsor (developer) selling the limited partnership interests. Once the sponsor (developer) sells the limited partnership interest, the tax credits are not available for loan collateral. However, financial benefits created by assumable sub-market mortgage revenue bonds are typically considered an intangible enhancements and may add to the value for collateral purposes.
In the event that an LIHTC property is not able to generate sufficient revenues to cover the debt service, the limited partners may be asked to contribute additional equity to the limited partnership. Since the limited partnership is an agreement between only the general and limited partner(s), it is not an encumbrance on real property ownership. In other words, in the event of a liquidation sale, the limited partners have recourse only against the general partner. They may not seek relief from the property because they have no encumbrance against the real property ownership. Once a liquidation sale occurs, a new buyer may sell the remaining balance of the limited partnership benefits to different limited partners. This is one of the reasons that equity investors will pay more for a limited partnership interest with a general partner that has a history of successful projects, versus one that is new to the LIHTC process. Therefore, if the lender requests a liquidation value, the tax credit component of value must be included since tax credits coincide with real property ownership.
It is common for multiple lenders to be involved in the financing of proposed LIHTC projects. One lender may be responsible for construction lending, while a different lender provides the term loan. To conserve financial resources, both lenders typically use the same appraisal report. Since underwriting and supplemental appraisal requirements vary from lender to lender, the use of extraordinary assumptions and hypothetical conditions may be required as part of the appraisal process. When appropriate and with proper disclosure, USPAP allows the use of both extraordinary assumptions and hypothetical conditions in the same appraisal report.
The challenge in trying to value only the tax credit component of a limited partnership interest is the lack of available market data that independently isolates the dollar-for-dollar tax credit component of value. Investors do not typically value the individual components of a limited partnership interest (tax credits, financing, cash throw-off, etc.); rather, they consider the entire bundle of rights purchased as a single entity. In other words, in addition to the dollar-for-dollar tax credits, the market price typically includes tangible and intangible enhancements from depreciation of improvements, loan interest expenses,  sub-market financing terms, after-debt cash flow, and the ownership reversionary rights of the real estate. Also, if the type of ownership (for-profit, non-profit, etc.) provides a relief from real estate taxes, it is reflected in the cash flow and contributes to the amount paid for the limited partnership interest and/or is reflected in the amount of financing obtained.
With the exception of dollar-for-dollar tax credits, all of the other limited partnership benefits are inherent in real property ownership and are not specific to tax credit transactions. Therefore, in order to arrive at an independent component of value for the dollar-for-dollar tax credits and to eliminate double counting, overlapping of the real property bundle of rights components (appreciation/depreciation, loan interest write-off, reversionary property rights, and cash throw-off after debt service) must be removed from the limited partnership value.
Investors typically use one overall discount (yield) rate to value the entire cash flow. To apply this same discount rate to just the tax credit or any other individual component of cash flow would be misleading, since all the components have different risk rates and thus, different discount (yield) rates. Each LIHTC partnership is structured differently. It is common for limited partners to vary the magnitude and timing of each capital contribution, which also influences the discount (yield) rate and the price paid.
Since there is no known market data to support the individual component discount rates, appraisers lacking in LIHTC knowledge and experience cannot accurately establish an opinion of value with a DCF analysis. Any tax credit component of value that was calculated using an investor overall discount rate may be misleading to the intended user of the report and is not an acceptable practice. An investor's overall discount rate considers the cash flow from all of the LIHTC property rights received over the projected holding period, not just the allocated tax credit benefit period.
The USPAP Competency Rule requires that "prior to accepting an assignment or entering into an agreement to perform any assignment, an appraiser must properly identify the problem to be addressed and have the knowledge and expertise to complete the assignment competently; or alternatively, must: (1) disclose the lack of knowledge and/or experience to the client before accepting the assignment; (2) take all steps necessary or appropriate to complete the assignment competently; and (3) describe the lack of knowledge and/or experience and the steps taken to complete the assignment competently in the report." 
The Competency Rule applies to both the product type and the analytical method. The Competency Rule requires an appraiser to have both the knowledge and experience required to perform a specific appraisal assignment competently. Therefore, if an appraiser is offered the opportunity to perform an LIHTC appraisal assignment but lacks the necessary knowledge and/or experience, the appraiser must disclose their lack of knowledge and/or experience to the client before accepting the assignment. The appraiser must then take the necessary and appropriate steps to complete the appraisal assignment competently. This may be accomplished in various ways, including, but not limited to, personal study by the appraiser, association with an appraiser who has the necessary knowledge and experience, or the retention of others (such as lenders, accountants, lawyers, syndicators, etc.). 
This article concludes that the all-inclusive valuation of LIHTC projects (real estate, tax credits, financial enhancements, and ownership benefits) is extremely complex and beyond the scope of a typical real estate appraisal assignment. There is considerable confusion in the market concerning the difference between the LIHTC "tax credit" component of value and the limited partnership value. Appraisers who report a limited partnership value as a "tax credit" component of value are misleading the intended users of the reports, and the reports would appear to be contrary to USPAP and regulatory requirements.
Since credit officers rely on professional real estate appraisers to provide accurate opinions of real property value for the underwriting process, confusing the intangible tax credit component of value with the limited partnership value may overstate the lenders collateral. If the real estate value provided by the appraiser is unwittingly combined with a limited partnership value, several items would be double counted and the combined opinion of value would overstate the whole value of the real property.
To be in regulatory compliance, the author concludes that real estate appraisers must follow the requirements as outlined in the USPAP Competency Rule when providing an opinion of value for the tax credit component of value. This may require the assistance of other professionals outside of the real estate appraisal field to value the intangible enhancements associated with an LIHTC project.
Ronnie J. Hawkins, MAI, SRA, manages the Bank of America Real Estate Risk Assessment office in Las Vegas, Nevada. Mr. Hawkins graduated from the South Dakota School of Mines and Technology in Rapid City, South Dakota with a BS degree in mechanical engineering. He has been actively engaged in real estate brokerage, lending, and appraisal practice for 21 years.
(1.) The legal structure of an LIHTC is complex and often includes multiple general and limited partnership agreements. For simplicity, only a limited partnership agreement is illustrated in Figure 1.
(2.) There could be multiple limited partners; however, the limited partner is typically a large corporation or a syndicator.
(3.) commitment letters contain adjustment clauses that allow the equity contribution to be adjusted up or down to compensate for delivery time, construction costs differences, change in Unit mix, etc.
(4.) The IRS precludes the non-recourse limited partners from receiving tax benefits if the general partners have a greater risk during the compliance period. Therefore, term financing is secured with non-recourse notes signed by the general partners. During the term-loan period general partners are typically responsible for operating deficits, compliance, and tax credit basis guarantees. During the construction phase, the general partners are liable for completion of the project and performance of the agreements.
(5.) Cash flow after debt service is often held in a trust account for the benefit of the limited partners, rather than distributed annually.
(6.) The 2001 rents are published in the Federal Register, 24 CFR Part 888, Part III Department of Housing and Urban Development, Tuesday, January 2, 2001. The document is also available from www.huduser.org.
(7.) Uniform Standards of Professional Appraisal Practice, (Washington, DC: The Appraisal Foundation Trust, 2001): 9.
(9.) Paraphrased from the Comment section of the Competency Rule, with editing by the author.
Appraisal Institute. Affordable Housing Valuation, Student Handbook (Chicago: Appraisal Institute, 1997).
Freedman, R. "Affordable Gold." Realtor Magazine (April 2000): 44--48.
Fried, J. "Low-Income Housing Tax Credits-An Update." The Real Estate Finance Journal (Summer 1991): 42--49.
Guarino, D. "Valuation of Affordable Housing with Tax Credits." The Appraisal Journal (October 2000): 406--410.
Jordan, G. "Appraising the Assets of Low-Income Housing Tax Credit Properties." The Appraisal Journal (January 1999): 41--46.
Nahas, D. "Appraising Affordable Multifamily Housing." The Appraisal Journal (July 1994): 455--464.
Novogradac, M. "Financing Affordable Housing." Commercial Investment Real Estate (March/April 1999): www.ccim.com/JrnlArt/990208.htm.
Polton, R. "Valuing Property Developed with Low-Income Housing Tax Credits." The Appraisal Journal (July 1994): 446--454.
Randall, R. and D. Hoffman. "Creating Affordable Housing Through Nonprofit/For-Profit Partnerships." The Real Estate Finance Journal (Fall 1993): 71--76.
Helpful web sites
HUD User--Policy Development and Research Information Service: www.huduser.org.
Internal Revenue Service: www.irs.gov.
National Council of State Housing Agencies: www.ncsha.org.
Office of the Comptroller of the Currency: www.occ.treas.gov.
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|Author:||Hawkins, Ronnie J.|
|Date:||Oct 1, 2001|
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