The Low Income Housing Tax Credit (LIHTC) program is the nation’s longest-running and most successful program for affordable housing production and preservation. However, recent developments have called into question the ultimate ownership and stability of promised long term affordability of some of these properties. These new challenges stem directly from the program’s unique structure that relies on a joint effort and partnership between housing developers and investors. This article outlines these issues and discusses an important pending legislative response in the Build Back Better legislation. A companion note identifies what else must be done by states to ensure the preservation of these important affordable housing communities.
For perspective, it’s important to note three key program features:
- nonprofit developers are permitted to have a specialized right of first refusal (ROFR) to purchase the property on below-market terms after the investor’s tax benefits have been achieved. [1]
- LIHTC properties are required to maintain affordability for at least 30 years, through a so-called Extended Use Agreement.
- in the fifteenth year after project completion, an owner may be permitted to offer a so-called Qualified Contract[2] to sell the property to the state allocating agency for a formula-based price; if the agency declines, the property would be deregulated.
Since the creation of the Section 42 ROFR, implementation of the transfer of full ownership to nonprofit sponsors has typically been a relatively smooth process, based on a common understanding of the source of the investor’s return and the ultimate goal of nonprofit ownership. Further, Qualified Contracts have not until recently been a major threat to the affordable inventory. Finally, long-term use restrictions have been effective in protecting affordability.
Recently, however, challenges have arisen to these basic premises.
- disputes between nonprofit sponsors and some investors over terms for exercising the Section 42 ROFR. These disputes typically involve replacement investors who claim novel interpretations of a property’s governing legal documents, contrary to longstanding understandings and practice:
- increased efforts toward early termination of LIHTC extended use restrictions through the Qualified Contract process, driven by rapidly increasing market values; and
- the looming outright expiration of some long-term use restrictions.
Some dissenting investors are objecting to the right to exercise the Section 42 ROFR or refusing to agree to Fair Market Value determination in the case of a Sponsor-held Option. Actions include:
- withholding consent for normal transactions such as refinancing;
- invoking provisions for forced sale or Qualified Contracts;
- claiming Sponsor violation of fiduciary duty;
- or asserting rights to remove a developer-sponsor from the ownership entity.
Some nonprofits have settled lawsuits they deem frivolous but they feel forced to extricate themselves given the risk, delay and cost of defending them. Dissenting investors challenging a ROFR may claim that these actions won’t affect long-term affordability covenants, including those required by state and local government independently of Section 42. However, unanticipated equity-stripping by investors renders future recapitalizations unnecessarily more expensive. Also, given the racial composition served by the program (reflecting overall income and wealth inequities), extraction of equity from this portfolio adversely affects communities of color, even if the letter of low-income use restrictions will continue to be met.
Finally, these challenges, if successful, can result in the loss of long-anticipated full control of the property by a mission-driven or grass-roots owner and hamper or reduce the related programs that serve residents. This would place long-term affordability at risk when extended use agreements expire.
These issues are playing out in a variety of venues, including state and federal courts, state legislatures and state and local agencies (see the attached for my further recommendations).
Ultimately, federal legislation created both the Qualified Contract problem and the ROFR opportunity, so it is natural to look to that arena for a solution. The pending Build Back Better bill in the United States Congress contains a number of key provisions expanding and improving the LIHTC program and includes two measures that would (1) replace the ROFR with a purchase option for new transactions and (2) eliminate the Qualified Contract deregulation process. Procedures for exercising a ROFR or option would be clarified for new and existing properties (to the extent not prohibited by project agreements in the latter). This is a step in the right direction and could be complemented by parallel state legislation that addresses common law interpretations of the meaning of a ROFR contract, in the context of Section 42.
We’re in a critical time right now with these issues. Collective action by housing stakeholders with a common interest is needed for a satisfactory resolution, as it has in the past.
POAH Senior Advisor Vince O’Donnell is the former Vice President of Preservation at LISC and Director of Development at Community Economic Development Assistance Corporation.
[1] To distinguish the right of first refusal discussed here from its ordinary common law meaning, the term “Section 42 ROFR” will be used, as shorthand for Section 42(i)(7) of the IRS Code where this right is codified.
[2] Sections 42(h)(6)(E) and (F) of the IRS Code create an opportunity for an owner to deregulate a LIHTC property before the expiration of the Extended Use Agreement by offering it for sale under specified terms and conditions.
