Can Anyone Explain Section 42 Financing To Me In A Simple Way?
I understand the LIHTC/Tax Credit/Section 42 program in a general sense, but have trouble understanding how these deals are structured financially.
Can anyone either explain it to me or point me in the direction of anything that can in simple english.
Thank you
Well, the one thing I know about anything having to do with the IRS is that it ain't gonna happen in simple English.
The last residential project I did was a LIHTC project back in 1996 when these things were still relatively new and relatively undocumented. I have a manual from that time which is probably 150 pages in a three ring binder which the City of Chicago put together which is probably as close to understandable as anything I've seen. Someplace I've also got my notebook of photocopies of the appropriate legislation and everything else I could find on the subject as of 1995 or 1996 when I was doing them.
Back in those ancient times this was a relatively workable program exactly because it was so difficult to understand. This difficulty kept the number of applications down. I remember attending a LIHTC seminar in the early 1990's and at the end of the seminar the housing development guy from Urbana Illinois came up to me and offered me a project there simply because he had determined from my questions at the seminar that I was a developer and understood how this program worked. He complained that he couldn't get any local developers to even look at this project the City of Urbana wanted to do because as soon as they saw the manual for the LIHTC they turned and ran saying there were easier ways to make money across the street in Champaign.
Over time, of course this has changed and now there are lots of people who have figured out how to do these projects.
In essence each state is granted a limited number of Tax Credit dollars (based on the population of the state). Now back in the 1990's many states (including Illinois) would not recieve applications for as many tax credits as they had available so essentially every project that applied got funded.
About the time I got out of the residential business that equation tipped in all the places I'm aware of and the states started getting more applications than they had dollars. Last I heard in Illinois the ratio was about 4 to 1. This means that unless your project levers the tax credits to make something happen in addition to the low income housing or the developer (you) has political pull the odds of your application getting serious consideration are pretty slim.
Before I even thought about doing a LHITC project these days I would call your State Housing Development Agency and check on the volume of applications as a ratio to the dollars available to fund them. In the City of Chicago (which gets a seperate allocation) I'm sure this number is up to 8 to 1 now. Unless your cousin's last name is Dailey or you have very deep pockets I wouldn't even think about trying to break into the business here. But your local situation might be different.
ComKing...thank you very much for the information. A few questions for you if you don't mind.
1. If I want to buy a 100 unit current HUD property nd use tax credits to pay for the needed rehab work, what do I get on the acquisition cost? Is that where the 4% credits come into play?
2. Assuming that I would sell the credit to a syndicate or other party, am I receiving flay cash back each year for them that can be applied to the mortgage?
3. Is it safe assumption that if the deal makes sense financially on its own, the tax credits are just an added benefit to help pay for improvements? In other words, the deal needs to be able to pay its mortgage whether the tax credits come through or not....don't bank on the credits to make a bad deal good? Just because it might be a good candidate for tax credit usage doesn't mean you should py anything over what you would if it was not a tax credit candidate?
4. How does the developer fee work? Where does the $$ come from to pay this?
5. In the end do you have a traditional mortgage for the purchase of the property and a construction loan for the rehab (I'm assuming the yearly credit "sale" pays most of the down or t least 90% of it)?
Thanks for the time and help
1) Generally tax credits do not apply to the purchase price of existing buildings. Only rehab money applies. Especially if you are going to syndicate the credits there are substantial expenses associated with them. Therefore most ot these deals tend do to be new construction in order to maximize the credits.
2) Again, generally (which gives you some idea of how complicated these things are there are alternative methods of structuring this) the way this is done is that the tax credit buyer signs a note to pay for the credits anually about the time they'd otherwise have to pay their tax bill. Those notes are then pledged and you get all the money in year one. This you use for the downpayment.
3) No, this is not a good assumption. Generally tax credit granting authorities will not give credits unless they get convinced that the project will not go forward otherwise, "making a bad deal good" is exactly what the TC is supposed to accomplish.
4) Developer fees generally get paid when certain milestones are reached. Exactly how much and for which milestones is a matter of negotiation with the lender(s) and the tax credit authority.
5) Most of the time you have one purchase/construction loan which roles out into a permanent mortgage when construction is complete. But there is nothing to stop you from doing it that way.
thank you King....I may have some other questions for you as I get farther down the road if you don't mind.
Not at all, anytime.