The Low-Income Housing Tax Credit (LIHTC) program, established under the Tax Reform Act of 1986, is one of the most significant tools for encouraging the development of affordable housing in the U.S. It allows investors to reduce their federal tax liability in exchange for financing or purchasing affordable housing developments.
For real estate investors, especially those seeking long-term investments with consistent returns and tax advantages, investing in existing LIHTC buildings is an attractive strategy.
Understanding LIHTC
The LIHTC program provides tax credits to property owners who invest in the development, acquisition, or rehabilitation of affordable housing. Credits are available over a 10-year period, with an obligation to comply with rent restrictions for 15-30 years, based on the percentage of low-income housing units in the building. There are two types of LIHTCs:
The 9% Credit: Available for new construction and substantial rehabilitation projects without any other federal subsidies.
The 4% Credit: Used in projects that involve other federal subsidies, such as tax-exempt bonds or existing affordable housing needing substantial rehabilitation.
Initially, many LIHTC properties are developed through a partnership between a funding partner, frequently a financial institution, and a developer who builds the property.
Once the building is complete, the funding partner receives tax credits over a 10-year period, with a compliance period spanning 15 years total. After the first 15 years, there’s a second 15-year window governed by extended use agreements, during which the housing must remain affordable or go through a relief process to move to the market-rate market. Typically, these properties don’t trade hands until after the initial 15-year compliance period.
Why Invest in Existing LIHTC Buildings?
1. Tax Benefits
Investors who purchase LIHTC properties after the initial compliance period may elect to pursue additional tax credits for rehabilitation or capital improvements, which help maintain the building’s affordability for a longer time frame. These credits function as a dollar-for-dollar offset against income.
2. Long-Term Cash Flow
Investing in existing LIHTC buildings offers the potential for steady, long-term cash flow. Since the properties are typically stabilized and already operational, investors can begin receiving rental income immediately after acquisition. Because rent prices are regulated and tenants typically have high occupancy rates due to demand for affordable housing, these properties often generate consistent income — historically, LIHTC portfolios have maintained physical occupancy well above 95% for most of the past decade, according to industry performance tracking.
3. Stable Investment With Lower Risk
Affordable housing is generally less susceptible to economic downturns than market-rate housing, because demand for affordable rental units remains high even during recessions — a dynamic that echoes what we see with Section 8 housing voucher properties. This makes LIHTC properties a relatively low-risk segment of real estate.
Because rents are determined from median incomes, income tends to be very predictable. Default rates on LIHTC properties are among the lowest in the industry, making them a more stable credit risk to lenders.
4. Community and Social Impact
LIHTC properties provide much-needed affordable housing to underserved populations, including low-income families, seniors, and individuals with disabilities. Investors in these properties are helping solve a significant social issue while potentially benefiting from community goodwill, positive public relations, and incentives from local governments.
How to Invest in Existing LIHTC Buildings
1. Direct Acquisition
Real estate investors can purchase existing LIHTC properties outright from developers or current owners. These properties have already been placed in service and have tenants who qualify under affordable housing guidelines. The investor takes over management and operation of the property, including adherence to rent restrictions and tenant income qualifications.
Acquiring an existing LIHTC property can provide a quicker return on investment compared to new development, since the property is already stabilized. Investors must ensure the property complies with LIHTC regulations, or seek release under an extended use agreement. Typically, about 15 years after a new development is placed in service, the property will be positioned for a recapitalization event — a sale in which the original equity investors, who received the benefit of the initial tax credits, exit — not unlike the exit dynamics investors weigh under HUD versus agency financing more broadly.
2. Private Equity Funds Specializing in LIHTC
Another way to invest in LIHTC properties is through private equity funds focused on affordable housing. These funds pool capital from multiple investors to acquire LIHTC properties, offering diversification across properties and markets and a more hands-off approach, since fund managers handle asset management and regulatory compliance.
3. Debt Funds: Tax-Exempt
Section 142 of the IRC allows for tax-exempt bonds invested into specific community-enhancing projects, with LIHTC projects being one use case. Returns that are tax-exempt at the federal level, and potentially at the state level too, can offer a meaningful increase in yield that’s not often seen on the debt side of the equation.
What to Consider in Due Diligence
1. Compliance With LIHTC Regulations
Investing in LIHTC properties requires a clear understanding of compliance requirements. The property must maintain its affordability status for a minimum of 30 years, or seek relief from the state housing authority to move to market rate. This includes adhering to tenant income limits, rent restrictions, and proper property maintenance. Investors should work with experienced property managers who understand LIHTC regulations to ensure compliance.
2. Limited Market for LIHTC Resale
Selling a LIHTC property can be more challenging than selling market-rate real estate. Restrictions on rent and tenant income levels limit the pool of potential buyers, and the property may only appeal to other LIHTC-focused investors. Some properties may also carry restrictions on transfer of ownership, depending on the initial financing structure.
3. Potential for Lower Initial Returns
Compared to market-rate properties, LIHTC investments may have lower initial cash-on-cash returns due to rent restrictions. With stable income streams, though, these properties can provide steady, long-term cash flow. Investors should carefully evaluate a property’s financial performance, including operating expenses and potential rent increases, to ensure it meets their investment goals, and safeguard against substantial cost increases to maintain positive cash flow.
Conclusion
Investing in existing LIHTC buildings offers a unique opportunity for real estate investors to combine financial returns with social impact. The tax benefits, steady cash flow, and lower risk associated with affordable housing make it an attractive option for investors looking for stable, long-term investments.
Why not invest and do good for your community at the same time?
Many investors we work with appreciate the niche ways we help expand their investments and make an impact. Contact us for a strategy call to plan your next move.
