Understanding LIHTC and How a Deal is Structured

The Low-Income Housing Tax Credit (LIHTC) program, introduced in 1986, is one of the most crucial tools for financing affordable housing in the United States. By offering tax credits to developers and investors, it incentivizes the creation and rehabilitation of rental properties for low-income individuals and families. Administered by the U.S. Department of Housing and Urban Development (HUD) and allocated by state agencies, LIHTC helps make affordable housing projects financially feasible, enabling private developers to contribute to solving the housing crisis.

At the heart of the program, developers apply for tax credits in exchange for ensuring that their housing projects remain affordable to low-income tenants. These credits are spread over a 10-year period and provide significant tax relief to investors, making it possible for developers to raise the necessary equity to move forward with their projects. However, there are different types of credits—the 4% and the 9% credits—that play distinct roles in shaping how a LIHTC deal is structured.

The 9% tax credit is the more competitive and valuable of the two, providing a larger subsidy that allows developers to raise more equity for their projects. It is typically awarded to new construction projects or substantial rehabilitation efforts. These credits are distributed on a competitive basis by state housing agencies, which assess applications based on their potential to address local affordable housing needs. The larger amount of equity raised through the 9% credit can reduce the need for additional funding sources, such as loans or state subsidies, which makes it highly attractive to developers.

On the other hand, the 4% tax credit is typically used for projects involving the acquisition or rehabilitation of existing buildings. While it provides less equity than the 9% credit, the 4% credit is more widely available. Unlike the 9% credit, which is distributed competitively, the 4% credit is generally awarded on a non-competitive basis as long as the project meets certain requirements. Many developers choose to combine both types of credits in a single project to maximize funding and ensure financial viability, especially if the project involves the rehabilitation of older properties.

The choice between using the 4% or 9% credits significantly influences how a deal is structured. Projects using the 9% credit typically require less external financing, making them more straightforward to fund. In contrast, projects relying on the 4% credit often need to seek additional sources of capital to cover costs, which can complicate the financing structure.

One critical element of most LIHTC deals is the role of the syndicator. A syndicator is a firm that helps developers secure financing by pooling investor capital, typically from institutional investors such as banks, insurance companies, or real estate investment trusts (REITs). The syndicator's primary function is to raise the equity necessary for the project, in exchange for a portion of the tax credits over the 10-year compliance period. Syndicators also assist with structuring the financial aspects of the deal, ensuring that the distribution of tax credits is properly managed and that the project adheres to all regulatory requirements.

Syndicators are essential because they help navigate the complexities of LIHTC financing. They often act as intermediaries, connecting developers with investors and ensuring the deal is structured to attract capital. A well-structured syndication can reduce risks for both developers and investors by ensuring that the project meets the compliance requirements set by the LIHTC program, including the need to maintain affordable rents for low-income tenants for at least 15 years.

One of the most important aspects of the LIHTC program is the 15-year compliance period. Developers must agree to keep the property affordable for a minimum of 15 years, during which time they must adhere to income and rent restrictions set by the program. This ensures that the housing remains available to low-income tenants, even after the initial tax credits have been allocated. Compliance is closely monitored by state housing agencies, and developers must provide regular documentation to verify that they are meeting the program’s requirements. If the developer fails to maintain the necessary affordability levels or violates other program rules, they risk losing the tax credits or facing penalties. After the 15-year compliance period, the developer may have more flexibility with the property, but the long-term affordability restrictions help ensure that the public benefit of affordable housing remains intact.

A typical LIHTC deal is structured as a partnership, usually a limited partnership, where the developer acts as the general partner (GP) and the investors as limited partners (LPs). The developer manages the day-to-day operations of the project, while the investors provide the equity needed to finance construction or renovation. The return on investment for the investors comes primarily through the tax credits, which are allocated over the course of 10 years. In exchange for their capital, investors receive a share of the credits, which they can use to offset their federal tax liabilities.

In summary, the LIHTC program provides a vital source of financing for affordable housing development in the United States. The 4% and 9% credits offer different levels of financial support, with the 9% credit being more competitive and providing a larger equity boost, while the 4% credit is typically used for the acquisition or rehabilitation of existing properties. Developers often work with syndicators to raise capital from investors and structure deals that comply with the program’s requirements. Through this combination of tax incentives and private investment, LIHTC plays a crucial role in the creation and preservation of affordable housing for low-income communities.