Long Term Operating Deficit Guarantee for Low Income Housing Tax Credit Projects

Syndicators/investors typically require a long term operating deficit guarantee from the sponsor as a condition of making an equity investment in a LIHTC project.

But, sick what does that actually mean?

Long Term Operating Deficit for LIHTC Projects

For a LIHTC project, this this means the Sponsor agrees to fund any operating losses of the building until the project has at least three full calendar years where the project either maintains a debt coverage ratio of 1.15 to 1.20; or, link if there are no scheduled debt payments, where the project maintains some defined amount of cash flow. This guarantee may be limited to the amount of the developer fee or some other defined amount.

In some circumstances, the investor will require a 15-year unlimited operating deficit guarantee. This may happen when there is substantial overhang (i.e. rental assistance payments in excess of LIHTC allowed rents) or there is significant income from market rate apartments or commercial space.

Most LIHTC transactions include an Operating Deficit Reserve, generally sized to equal six months of operating and debt service costs. The partnership agreement will detail if this Reserve can be used first to cover operating deficits before the Sponsor must fund the difference. It is important to negotiate the reserve drawdown as many investors have flexibility on this point (but you have to ask to get it).

Scenarios for Long Term Operating Deficit Guarantee

This guarantee is required by the investor because they want to make sure that the property is in good financial health, so that it will maintain compliance with LIHTC requirements. This guaranty comes into play when either income is less than projected or expenses higher than projected. Debt service is rarely a factor since it is fixed prior to closing at a 15-year fixed rate.

Scenario 1: In this project’s rural community, the major company closed its production facility, which accounted for a large percentage of jobs in the community. As a result, many people moved away and the demand for apartments declined. Even after reducing rents, the project had difficulty maintaining full occupancy. As a result of the lower income, the project experienced long term operating deficits. The sponsor and investor worked together to keep the project operational through the 15-year initial compliance period.

Scenario 2: This elevator building was operating within anticipated parameters. Over two years, though, the property taxes increased by 30% and the utility rates also increased significantly. Unfortunately, the LIHTC rents remained the same. As a result of stagnant income (although fully occupied) and increased expenses, the property did not have positive operating cash flow.

LIHTC Project Success

In order to confidently navigate the complexities of a LIHTC project, you need an experienced LIHTC consulting team who works alongside you as a guide and counselor. With expert guidance, you can get out of the details and back into the big-picture thinking your project requires.

We’d love to help. Contact us today.