HOME Written Agreements and Legal Documents
When underwriting is complete and environmental clearance is secured, the PJ is ready to execute a HOME written agreement and other legal documents that detail the HOME requirements and enable the project to proceed. In addition to the HOME written agreement and other legal documents required by the HOME Program, in a HOME-LIHTC project, the PJ also should review a set of project agreements and documents related to the LIHTC transaction. This is critically important so that the PJ can understand the structure of the LIHTC deal and ensure protection of HOME Program interests. Tax credit projects tend to be complex deals with multiple legal agreements.
PJs will need to analyze the following agreements:
- Use restrictions imposed by the allocating agency and perhaps other lenders
- Joint venture agreement, if the project involves multiple development partners
- Partnership (or syndication) agreement between the developer and the investors
- Inter-creditor agreement(s) between the lenders, including the PJ.
The PJ’s legal counsel with expertise in both real estate law and tax law should be involved in the review of these documents.
HOME Written Agreement
HOME requires the PJ to execute a written agreement with all recipients of HOME funds. Mortgage and loan documents are not sufficient to meet this requirement. The HOME written agreement must convey HOME requirements and impose enforcement provisions; it can also be a vehicle for the PJ to clarify roles and responsibilities, and establish terms and conditions that will enhance its asset management during the affordability period.
The HOME written agreement is the basis of making a commitment of funds. It precedes other legal documents that are recorded at closing, including the note and mortgage (or deed of trust) and the required deed restrictions. PJs may have different terms to refer to the commitment document for rental projects. The most common terms are the “loan commitment” or “project funding agreement.”
Provisions in a HOME Written Agreement with a Developer
The written agreement should describe all of the requirements of the HOME Program with which the developer must comply. Certain required provisions of the HOME written agreement with owners, developers, and sponsors of HOME-assisted housing are specified in the HOME Rule at 24 CFR 92.504(c)(3), as follows:
- Use of HOME funds
- Affordability requirements
- Project requirements (rental and tenant provisions)
- Property standards
- Other program requirements (such as affirmative marketing, relocation, etc.)
- Records and reports
- Enforcement of the agreement
- Disbursement of funds provisions
- Duration (affordability period)
- If a CHDO project, CHDO provisions.
In addition to these required provisions, the PJ should incorporate additional provisions that facilitate monitoring and asset management, including:
- Definition of roles and responsibilities
- Performance standards
- Project audit or cost certification
- Buyout provisions (discussed in more detail in Chapter 6).
It is very important that the PJ have a clear understanding of how the owner will meet the HOME requirements. The written agreement should include strong enforcement provisions, to ensure that the PJ can enforce the HOME affordability requirements for the duration of the affordability period. In a HOME-LIHTC project, if the HOME affordability period is longer than the 15-year LIHTC compliance period, the PJ should evaluate whether it needs to tailor its enforcement provisions to the specific project. Chapter 6 of this guide discusses exit strategies LIHTC investors might use upon expiration of the LIHTC compliance period, and how these might impact HOME compliance. The PJ should become familiar with the investor’s exit strategy and determine if it needs to document any mitigating strategy in the HOME written agreement.
More information about developing HOME written agreements with owners, developers, and sponsors of HOME-assisted housing is forthcoming from HUD. When available, these guidebooks will be posted at https://www.hud.gov/program_offices/comm_planning/affordablehousing/programs/home/.
HOME Deed Restriction or Covenant
In addition to requirements and restrictions in the HOME written agreement, the HOME Rule at 24 CFR 92.252(e) requires the PJ to impose a deed restriction or covenant running with the land (or some other legal mechanism approved by HUD) that places specific use or other restrictions on the property. This use restriction is needed to impose HOME requirements throughout the period of affordability, even in the event the HOME loan is repaid. The deed restriction or covenant should be a stand-alone document that is properly recorded as part of the closing package and is received by the PJ after recording. Do not put the use restrictions in the mortgage or loan documents.
Recording the HOME Covenant
It is imperative that PJ staff verify that this legal mechanism is duly recorded to preserve its rights.
The PJ should also require that the HOME restrictive covenants be recorded before mortgage documents are recorded to ensure their enforceability and survivability.
For a HOME rental project, the deed restriction or covenant imposes the following requirements:
- Designation of HOME-assisted units (24 CFR 92.252(j))
- Occupancy of assisted units (24 CFR 92.216(a) and 92.252(a) and (b))
- Initial and ongoing rent restrictions (24 CFR 92.252(a) through (c) and (f))
- Tenant eligibility (24 CFR 92.203 and 92.252(h) and (i))
- Period of affordability (24 CFR 92.252(e)).
Some PJs also incorporate property standards under 24 CFR 92.251 in this document. The PJ may also choose to incorporate its authority under zoning ordinances and local and state building codes to condemn a unit or building, fine an owner, or take possession of a property.
Note and Mortgage
Typically, a note and mortgage (or a deed of trust in some states) and other loan documents are signed at closing and recorded. The note (also known as a promissory note) sets out the specific terms of the loan (interest rate, term, payment schedule); and the mortgage provides the lender a security interest in the property.
For HOME rental projects, a note and mortgage are not sufficient to meet regulatory requirements for a written agreement or to convey the HOME requirements. The HOME Program requires the use of a deed restriction to secure the HOME affordability requirements throughout the affordability period, as discussed in the previous section.
Nevertheless, a note and mortgage (or deed of trust) may be important and valuable tools for the PJ to secure its lien position to claim repayment of the HOME funds in the event of foreclosure, noncompliance, or other outcomes. Therefore, while not required by regulation, a note and mortgage should be considered by PJs in discussion with legal counsel.
If such documents are used, the PJ should ensure that they are recorded, and that copies of all closing documents, including agreements between other lenders and the owner/sponsor, are received after recording.
Locally-Imposed Affordability Period
The PJ can opt to establish a longer period of affordability than that required by HUD. If the PJ does this, it is prudent to record two deed restrictions or covenants— the first to secure the HOME requirements and the second to establish the additional time period that is locally-imposed. Using two agreements ensures that the PJ does not inadvertently extend the period during which it might be subject to repay HOME funds to HUD in the event of noncompliance. After the end of the affordability period required by the HOME Rule, the local PJ specifies what requirements apply.
In a foreclosure, the HOME Rule allows the affordability restrictions required by the HOME Rule to be removed before the primary lender takes the property. This is a way of permitting lenders to maximize the amount of investment recouped in the event of a default and can remove concerns private lenders may have about participating in the HOME Program. Notwithstanding the termination of affordability restrictions conveyed to a lender due to foreclosure or transfer in lieu of foreclosure, the PJ must repay the HOME account because the project has not met the affordability requirements for the full affordability period.
The PJ may wish to include in its agreement with the owner, a right of purchase, right of first refusal, or other preemptive rights to help it reclaim the property in the event the property defaults to avoid foreclosure and loss of the affordable units.
For a complete discussion of this issue, see HUD’s HOMEfires, Vol. 5 No. 2, issued June 2003. This is available on the HOME Program website at https://www.hud.gov/program_offices/comm_planning/affordablehousing/programs/home/.
Other Use Restrictions
The LIHTC program, and potentially other public funding sources, also imposes use restrictions. These may be slightly different from those imposed by HOME. The PJ should review the LIHTC use restrictions to:
- Determine if there are any possible conflicts with the use restrictions imposed by HOME. The key differences between the affordability requirements of HOME and LIHTC are discussed throughout this guide. PJs should be aware of differences in income levels, rent limits, property standards, and over-income requirements.
- Identify any priority of these use restrictions over HOME, and possible compliance conflicts. PJs should also determine if there are opportunities for the various enforcement entities to cooperate in enforcing restrictions and doing workouts. These should be addressed in the inter-creditor agreements discussed below.
It is prudent to record separate deed restrictions or use agreements to impose the affordability requirements of each program , so that the PJ does not inadvertently extend the requirements of both programs throughout the period of compliance of the other program.
Development Entity Agreements
By nature, LIHTC ownership entities are complex. At a minimum, there is likely to be an agreement between the general partner (the developer) and limited partners (the investors). This is usually called the “Partnership Agreement.” Sometimes, there are multiple general partners, especially in cases where CHDOs and other nonprofits team with for-profit developers.
While it is not the responsibility of the PJ to review the legality of these agreements, it is important that the PJ review these agreements to identify issues that may affect the ability of the project to comply with HOME requirements, to remain viable for the HOME affordability period, and to repay the HOME investment under various circumstances.
Partnership or syndication agreements are executed between the general partner(s) and the investors; they document the terms under which the limited partner investments will be made. Some of the key items to review are:
- Performance obligations and guarantees of the developer
- Residual interests and buyout provisions at the end of the partnership. These are discussed in more detail in Chapter 6.
CHDO Joint Venture Negotiation Tips
See Tool 5 in the CHDO Survivor Kit in the HOME Model Guide series for some tips on negotiating joint ventures and executing joint venture agreements. This guide is available on the HOME Program website at https://www.hud.gov/program_offices/comm_planning/affordablehousing/programs/home/.
In projects where there are multiple general partners, there is typically a joint venture agreement or other legal agreement between the partners. This agreement governs how the roles, responsibilities, risks, and fees are to be divided. This is important because it specifies how the entity will implement the project. It should be reviewed by the PJ to determine if everything is clearly laid out.
PJs need to review carefully those joint venture agreements that involve CHDOs. 24 CFR 92.300(a)(1) specifies that CHDO set-aside funding may only be provided to projects in which the CHDO is the managing general partner. HUD’s requirement is that the CHDO must have 51 percent interest in this joint venture entity, and be in control of the key development decisions. PJs need to review the joint venture agreement to determine if the CHDO has the controlling interest and control of the decision-making process.
CHDO Joint Venture Negotiation Tips
See Tool 5 in the CHDO Survivor Kit in the HOME Model Guide series for some tips on negotiating joint ventures and executing joint venture agreements. This guide is available on the HOME Program website at http://www.hud.gov/homeprogram/.
Some CHDOs and nonprofits are inexperienced with tax credit projects, and may not negotiate agreements that adequately protect their interests or controlling rights. While the primary focus of PJ review should be on the regulatory compliance issue, PJs may want to use this opportunity to provide technical assistance to these organizations to help them negotiate better partnerships in the future.
Many LIHTC projects involve multiple lenders, both public and private. Typically, a private lender provides a first mortgage, and one or more public lenders or intermediaries provide gap financing – construction, bridge, and permanent. With multiple lenders involved, there is a need to determine issues that arise among and between the creditors. These are documented in an Inter-Creditor Agreement.
Some of the key inter-creditor issues are:
- Lien priority. The lien position is critically important to PJs because of the requirement to repay the HOME funds in the event the project is foreclosed upon or otherwise fails to achieve completion and compliance (see 24 CFR 92.503(b)). If there is a foreclosure, lien holders are paid in order of lien priority, so the lower the PJ’s lien position, the greater the risk it will not recover all of its HOME funds. The PJ should negotiate the highest lien position possible, particularly when there are multiple subsidy lenders involved in a project. An emerging trend is for multiple subsidy lenders to agree to a pari passu lien structure, where the lien position and rights are shared to simplify legal negotiations and documents. Exhibit 3-1 provides an example of this.
Exhibit 3-1: Example of Pari Passu
Consider a project where the HOME PJ and a CDBG grantee share a second lien position behind the private 1st mortgage lender on a deal that has outstanding balances on the mortgages at the time of foreclosure as follows:
$2,500,000 - 1st mortgage private lender shared 2nd mortgage
$ 500,000 - shared 2nd mortgage HOME PJ
$ 500,000 - shared 2nd mortgage CDBG grantee
The 1st mortgage lender forecloses and sells the property at auction for $3,000,000. The 1st mortgage holder gets the first $2,500,000, reflecting its first lien position. The remaining $500,000 is split on a pro rata basis between the HOME PJ and the CDBG grantee, providing each with $250,000.
- Disbursement order and procedures. Most lenders and developers assume that public funds like HOME should be the first disbursed to a project, as these funds usually have the lowest interest rates. However, the first dollars disbursed are the riskiest dollars in the project. The PJ has a number of competing needs to balance when negotiating this point. To equally share risk with the other investors, the PJs may want to seek pro-rata distribution from the various sources. By investing HOME funds early in the construction process, however, the PJ may be able to reduce the need for construction financing, thereby reducing the cost of the project, and reducing the overall need for HOME funds. Additionally, if the PJ funds are invested early and the contribution of equity from the LIHTC investor is delayed, this may result in a higher price for the tax credits (as discussed in Chapter 2).
- Enforcement of provisions. The PJ needs to be able to enforce all HOME rules, both during construction and in occupancy. Typical subordination requirements limit a junior lien holder’s ability to enforce provisions without the consent of the senior lien holder. This needs to be resolved in advance. Senior lenders will need assurance that rule enforcement will not jeopardize the viability of the project.
- Foreclosure rights and procedures. In the event of default and foreclosure, the senior lender usually wants to reserve all rights to itself, and to be able to proceed as necessary toward foreclosure, unfettered by junior lien holders. However, PJs need to communicate their repayment risk in the event of foreclosure, and secure agreement with the senior lien holder to give the PJ rights to prevent foreclosure or take action in lieu of foreclosure to ensure continued affordability. Senior lien holders cannot be expected to have endless patience, but may accept terms which provide for a notification of delinquency to the PJ and forbearance on foreclosure for a short period of time to allow the PJ to intervene, correct the default, and even assume or assign control.
These and other issues are usually contained in an inter-creditor agreement, which must be negotiated among the lien holders. PJs should not assume that the other lenders understand the repayment risk of the PJ. PJs need to communicate this issue to the lenders, and negotiate for the rights the PJ needs to protect its interest.
Inter-creditor negotiations also might address longer-term control issues, including balloon debt, partnership buyouts, and other long-term strategies. This is important to a PJ. A newly constructed tax credit project has a HOME compliance period of 20 years, while the partners can be bought out in 15 years, and the senior debt might be structured to this term. This issue is explored in more detail in Chapter 6 of this guide.
Chapter 3: Commit to Project and Construct Units 100
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