Typical Investor Exit Strategies
Investor Exit Strategies
The tax credits are realized by the investor in the first ten years of the project. The Code permits investors to request to be bought out after the initial 15-year compliance period, and allow a successor owner to complete the extended use period. Therefore, most investors view their position in the project as a 15-year investment. An investor determines on the front end of the investment what exit strategy makes economic sense to optimize its return on its investment. At the end of the 15-year compliance period, the investor might have two options:
- Continue ownership and re-capitalize the project
- Exit its ownership interest.
Some investors may choose to continue ownership, but may require additional capital investment to address refinancing needs (on balloon mortgages) and additional capital investment to make improvements to the aging project.
However, most investors can be expected to opt to exit the ownership, as their tax credits have been used up. Under the Code, the state’s allocating authority attempts to identify a successor owner. If it fails to find a successor, there are provisions to phase out the affordability restrictions.
PJs with affordability requirements that extend beyond the IRS compliance requirement, especially in the case of new construction where the HOME affordability is a minimum of 20 years, should understand the options available to an investor and how they may affect a HOME-assisted project.
Up-front, and before negotiating the terms of the HOME investment, the PJs should know what exit strategy the LIHTC investor has selected. Information on the exit strategy may be contained in the partnership agreement (discussed in Chapter 3), or it may include options to be exercised later. PJs should assume that investors will wish to exit after 15 years unless otherwise committed in the partnership agreement, and negotiate appropriate protections in the HOME written agreement to ensure that the PJ will be able to enforce the HOME affordability requirements even if the investor exits the partnership.
In either case – recapitalization or exit – PJs need to keep in mind that HOME rules restrict the ability of the PJ to invest additional HOME funds in the project during the HOME affordability period.
If the PJ is unable to protect its affordability period beyond the expiring use of the LIHTC period or foreclosure, and the property does not continue to meet the HOME affordability requirements, the PJ is at risk of repaying the HOME funds invested in the project, whether or not those funds are recovered from the project.
Effects of Exit Strategy on Pricing of Credits
The type of exit strategy affects the price investors are willing to pay for the credits. The investor calculates an anticipated rate of return on its investment, including the financial and tax effects of the exit strategy. If the PJ negotiates or requires a different exit strategy than what the investors plan, this might impact the syndication yield.
For a full understanding of the model used for a particular project, PJs should consult with the owners of the project and the owner’s or PJ’s tax and/or legal counsel. However, some of the investor’s financial considerations related to its exit strategy are:
- Capital gains resulting from a sale
- Distribution of partnership assets other than the real estate
- Transaction costs related to a sale or transfer of title
- Potential tax benefits if the investor’s interest is donated to a 501(c)(3) nonprofit organization
- Exit taxes.
PJs need to find the appropriate balance between the investor’s economic interests and the PJ’s interest to preserve affordability. If the requirements of the PJ restrict the economic benefits to the investor, the PJ may need to provide more HOME funds to provide a better product.
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