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LURAs: Land Use Restrictive Agreements and the LIHTC Program
If you’re a multifamily investor/developer interested in using Low Income Housing Tax Credits (LIHTCs) to fund the construction or rehabilitation of a multifamily property, you will need to agree to limit rents for a certain period of time, as well as to abide by other restrictions. All of these stipulations will be put forth in a contract called a Land Use Restrictive Agreement, or LURA.
What is a Land Use Restrictive Agreement and How Does It Work?
If you’re a multifamily investor/developer interested in using Low Income Housing Tax Credits (LIHTCs) to fund the construction or rehabilitation of a multifamily property, you will need to agree to limit rents for a certain period of time, as well as to abide by other restrictions. All of these stipulations will be put forth in a contract called a Land Use Restrictive Agreement, or LURA. While LIHTC funds are allocated to states by the federal government, they are disbursed by state housing finance agencies to individual projects. Therefore, the exact nature of a LURA may vary greatly between individual states, and sometimes, even between individual projects. However, there are quite a few aspects that are common between all LURAs.
LURA Rent Restrictions for LIHTC Properties
All LURAs will contain the standard LIHTC rental restrictions, which include an owner setting aside a minimum 40% of a project’s units to residents earning less than or equal to 60% of the area median income (AMI), or setting aside at least 20% of the project’s units to residents earning less than 50% of the area median income. These are respectively referred to as the 40/60 test and the 20/50 test. These restrictions generally must last for at least 15 years.
However, since competition for Low-Income Housing Tax Credits is often fierce (and because states want to maximize the ability of the program to house low-income families), LURAs will sometimes require project owners to allocate more affordable units for low-income tenants. For instance, a LURA might require an owner to set aside 60-70% of a project's units for residents earning less than 50% of the area median income.
LURA Timelines for LIHTC Owner/Operators
Along with the basic requirement that a property meets the 40/60 test or the 20/50 test and keeps rents at these levels for at least 15-years, LURA agreements also involve an extended use period, which is often 15 years but is sometimes longer or shorter, depending on the state. It’s important to realize that if an owner sells a property and the LURA is still active, the new buyer will still have to abide by all of its rules.
What is a Land Use Restrictive Agreement (LURA)?
A Land Use Restrictive Agreement (LURA) is an agreement between an owner/developer and a government entity that documents the restrictions placed upon a property in order to receive tax credits in the future. The LURA typically helps guarantee that the project receives a specific number of Low-Income Housing Tax Credits (LIHTC) credits over a specific time period. Along with the basic requirement that a property meets the 40/60 test or the 20/50 test and is able to maintain rents at these levels for at least 15-years, LURA agreements typically involve an "extended use period". The extended use period is often 15 years but can sometimes be longer or shorter, depending on the state of origin. It’s important for any investors to realize that if an owner sells a property and the LURA is still active, the new buyer will still have to abide by all of its rules.
How does the Low-Income Housing Tax Credit (LIHTC) program work?
The Low-Income Housing Tax Credit (LIHTC) program is a federal government tax credit that helps facilitate the construction and rehabilitation of affordable housing units throughout the U.S. The program functions as follows: The federal government grants state and territorial governments authority over a predetermined budget. State housing agencies can then award tax credits to private developers through a competitive process. Developers awarded low-income housing tax credits typically sell credits to private investors in order to obtain funding for a project.
Though technically a federal program, the LIHTC program is executed by individual state Housing Finance Authorities (HFAs), which are responsible for approving LIHTCs to investors and developers on a project-by-project basis. Each state has a Qualified Allocation Plan (QAP), created to detail specific eligibility requirements for LIHTC projects, which are typically stricter than at the federal level.
LIHTCs don’t provide a tax deduction, which would reduce a borrower’s taxable income. Instead, the credit provides a tax discount of a specific dollar amount that can be applied to the investor or developer’s tax bill. Once the housing project is made available to tenants, investors are then able to claim the LIHTC over a 10-year period.
LIHTCs help fund the new construction and rehabilitation of a variety of different property types, including traditional apartments, single-family homes, and two- to four-unit multifamily properties (think duplexes or triplexes). In addition, LIHTCs can fund the conversion of structures like schools, warehouses, and motels into multifamily properties. Properties using these credits must generally cap rents for some or all of the units at a certain percentage of a location’s Area Median Income (AMI).
What are the benefits of using the LIHTC program for multifamily financing?
The Low-Income Housing Tax Credit (LIHTC) program offers a number of benefits for multifamily financing. HUD multifamily loans like the HUD 221(d)(4) and HUD 223(f) permit LTVs of up to 87% for affordable properties, with LTVs up to 90% for properties with 90% or more low-income units. They also offer a discounted 0.45% annual MIP for LIHTC or Section 8 properties (market rate properties pay 0.65% annually).
In addition, Fannie Mae and Freddie Mac also offer a wide swath of loan options for affordable properties, including some financing options specifically geared towards the LIHTC program. For instance, the Freddie Mac Bond Credit Enhancement with 4% LITHC is designed to provide forward commitments both new construction and substantial rehabilitation of LIHTC properties which are able to maintain at least 90% occupancy for 90 days. It also provides preservation rehabilitation funds for projects undergoing moderate rehab with tenants in place.
In addition, the traditional Freddie Mac LIHTC Enhancement provides a degree of protection for LIHTC investors in the case that an owner/operator defaults on their loan, which can make it substantially easier to attract LIHTC investors to a project. And, Freddie Mac Tax Exempt Loans provide up to 30 years of financing for 4% LIHTC projects. If your LIHTC property is also part of the HUD Section 8 program, as some are, you may wish to make use of Freddie Mac HUD Section 8 Financing, which permits LTVs up to 90% and DSCRs as low as 1.15x for LIHTC properties.
In comparison, Fannie Mae offers LIHTC-focused products including Fannie Mae MBS as Tax-Exempt Bond Collateral (M.TEB), which can be utilized for existing bond refunding and new issues for 4% LIHTC properties. This financing product allows LTVs up to 90%, and even permits interest-only financing for eligible borrowers. Another similar option is the Fannie Mae Credit Enhancement of Variable Rate Tax-Exempt Bonds (Index Bonds), which provides a degree of protection for LIHTC investors in the case that an owner/operator defaults on their loan.
What are the risks associated with LURAs and the LIHTC program?
The risks associated with LURAs and the LIHTC program include the potential for reduced cash flow due to the requirement to keep rents at a certain level for a certain period of time. Additionally, if an owner sells a property and the LURA is still active, the new buyer will still have to abide by all of its rules. This could potentially limit the pool of potential buyers and reduce the sale price of the property. Finally, if the owner fails to comply with the terms of the LURA, they could be subject to fines or other penalties.
What are the requirements for a property to qualify for the LIHTC program?
In order for a property to be considered eligible for the LIHTC program, it must pass at least one of these three affordability tests:
- 20% or more of the units are occupied by (or reserved for) tenants with an income of 50% or less of the area median income (AMI).
- 40% or more of the units are occupied by (or reserved for) tenants with an income of 60% or less of the AMI.
- 40% or more of the units are occupied by (or reserved for) tenants with an income of no more than 60% of the AMI, and the property has no units occupied by tenants with an income greater than 80% of the AMI.
In addition to the above, a gross rent test must also be passed. This test requires that rents for the property do not exceed 30% of either 50% or 60% of AMI (the exact percentage depends on the number of rental units set aside for the credit). LIHTC properties are required to pass these income and rent tests for a period of no less than 15 years — or risk having the tax credits recaptured by the local housing authority.
For more information, please see Low-Income Housing Tax Credit and LIHTC: Low Income Housing Tax Credits in Commercial Real Estate.
How can investors maximize their return on investment with the LIHTC program?
Investors can maximize their return on investment with the LIHTC program by investing in a LIHTC syndication. A syndicator pools multiple real estate projects into one LIHTC fund and sells these tax credits to investors, which reduces risk for individual investors that a single project will go out of compliance. Additionally, investment into LIHTCs is popular due to the fact that LIHTC properties have foreclosure rates significantly lower than the average rate for multifamily properties. This article and this article provide more information about the LIHTC program and how investors can maximize their return on investment.