Due Diligence for Affordable Housing
If you are thinking about getting involved in a multifamily affordable housing transaction, there are a number of due diligence items you will need to include in your investigation that are not typically checked out in a conventional transaction.
The Low Income Housing Tax Credit Program (also known as the Section 42 housing program), is a federal tax program established by Congress and governed by federal income tax legislation. It is administered at the state level, usually by the State Department of Community Affairs, the State Department of Housing & Community Development, the State Housing Finance Authority, or an agency with a similar name.
It is an extremely competitive program, and nationwide only about one out of every three applications is successful. In most cases, an applicant must already have a track record in this type of development or team up with someone who has the experience, to even be considered for tax credits.
However, those of us who do not wish to suffer the brain damage necessary to do this work can still participate, by joint venturing or partnering with others, or by securing properties that might be successful in such a competition. We can either get them under contract and sell them to the appropriate developer, or broker the sale of the property.
So how do we prepare ourselves to successfully do this? Here are a few ideas.
There are two general items that are of value across the board, in every state. First of all, if you are dealing with an existing multifamily property, keep in mind that there is a major advantage to the developer if the property has been owned by the seller for at least ten years. If so, the developer can get tax credits on the purchase price of the existing buildings as well as on the improvements. Second, there is a major advantage to the developer if the property, whether it be vacant land or an existing development, is located in what is known as a Qualified Census Tract (QCT). A list of these can be found on the HUD website. Location in a QCT means that the developer can get 30% more tax credits than if the property is not located in such an area. Typically, a Qualified Census Tract has median income that is lower than the norm in a larger area, such as a county or metropolitan area. Occasionally, however, there are pockets of higher incomes within these QCTs, and these are areas that developers often look for, especially if they plan to submit mixed-income transactions.
The next area that would be useful to understand is exactly how the competitive process works in the state in which the potential opportunity is located. Each state prepares an annual Qualified Allocation Plan (QAP), laying out the rules for the state’s program. The QAP is typically on a website, so it is easily accessible. It will tell you everything you need to know about the process for obtaining an allocation of Tax Credits within the state. This includes what is necessary to put together an application, when the deadlines are, what the limits are per transaction and per developer, and most importantly, what the criteria are for the competitive scoring of the applications.
This is usually done on a point basis. The applicant gets so many points for each element that is included in the application. For example, there may be points available if a local governing body passes a resolution approving the application (although in another state this may be an absolute requirement). Or there may be points for having a certain percent of market-rate tenants. The applicant may be able to get points for having an all-brick building, or for certain architectural elements, such as cupolas, arches, or other historical reproduced physical features of the building. There may be points for being located in a historic building, in a “Main Street” Community, in an area targeted by the local government for neighborhood improvements, for energy-conserving building practices, for providing for better than the normal requirement for accessible units, or for being located near shopping centers and services.
In any case, the better you understand the scoring criteria, the better you will be able to pick a site or property that has the potential for a high score. This is important, because in the end, if your application does not score high enough, all your work goes for naught.
In addition to this somewhat “offbeat” due diligence, of course, there is the regular due diligence that must be done. This includes, of course, the location, surrounding land uses, topography, physical nature and condition of the property, visibility, accessibility, transportation networks, environmental and engineering concerns, soil tests, the availability and capacity of local services such as water and sewer, the ease or difficulty of local zoning and building processes and officials, as well as local politicians.
If you have not yet been involved in this, or have not been involved recently, be prepared for an eye-opening experience. Due to the competition, in many states the bar has been raised, and many of the properties being built today are of higher quality than any conventional developer can build in the same areas.
Good luck in your endeavors.