Lease-up Deficit Guarantee for LIHTC Projects

Syndicators/investors typically require a lease-up deficit guarantee from the sponsor as a condition of making an equity investment in a LIHTC project. This is listed as a separate guarantee or is made part of the Completion Guarantee in the Limited Partnership Agreement.

But, search what does that actually mean?

Lease-up Deficits for LIHTC Projects

For a LIHTC project, medications the Sponsor agrees to fund any costs of operating the building in excess of the budgeted lease-up expenses until the project reaches Stabilization. Shortfalls are incurred because the building leases slower than anticipated or expenses exceed projections.

The definition of Stabilization varies, but generally means when income and expenses meet projected values for at least a continuous 3-month period. This is a typically an unlimited guarantee.

It is important to note the exact definition of both Income and Expenses in the limited partnership agreement. Sometimes the definition of Income excludes parts of rental subsidy payments and the definition of Expenses can be the greater of underwritten or actual expenses on a line item basis. It is important to communicate with property management on the Stabilization budget to make sure targets are being met.

Typically, the construction debt is repaid and the Permanent / Term debt begins once Stabilization occurs. A delay in reaching Stabilization can put both construction and term debt into default. Should ongoing income be less or expenses more than anticipated, the amount of permanent debt may be reduced, creating a budget imbalance.

As with all items that don’t happen as plan, constant and open communication with lenders and your syndicator is critical.

Developer & Investor Perspective

It is critical for the project to convert to its Permanent / Term debt at the completion of construction to keep the project in good standing. A delay in converting to permanent debt could put the project in default and increase the risk of foreclosure, which would wipe out the tax credits. This is why the investor requires an unlimited guarantee from the Sponsor to handle this risk.

Scenarios for this Guarantee

Here are some fictional scenarios in which the lease-up deficit guarantee would be called upon within a LIHTC project.

Scenario 1:

Construction is delayed by three months and a senior (55 years and older) property opens on November 15th. With the holidays and extreme cold weather, the lease-up is delayed and there are few occupancies until March. As a result of heating and operating the elevator building with below projected occupancy, the building has operating losses in excess of projected values. Fortunately, there were development cost savings to pay for these additional lease-up operating costs.

Scenario 2:

The city raises the property tax rate by 25% while the building is under construction. Thus, the actual property taxes are significantly higher than projected and it is not possible to raise the rents. Thus, the stabilized operating costs are higher and the amount of debt that can be supported is reduced by the difference. The developer defers part of their developer fee in order to offset a reduction in the first mortgage debt.

With proper underwriting (proper rents, expenses and lease-up schedule)- ideally with some cushion built in, and a good property management team, lease-up guarantees can be minimized or avoided.

LIHTC Project Success

While navigating the intricacies of a LIHTC project, you need an experienced LIHTC consulting team who works alongside you as a partner. Contact us today.