Spring 2014 issue of Horizons

REAL ESTATE

∙ Investor’s Capital: Safe harbor requires the investor’s capital to now be at risk more than what the HTC industry was accustomed to in pre-safe harbor transactions. This is achieved by requiring the investor to contribute at least 20% of its total expected capital contributions as of the date the building is placed in service. The investor must maintain the minimum contribution throughout its ownership in the partnership and the contributions cannot be conditional. Additionally, at least 75% of the investor’s expected capital contributions must be fixed before the building is placed in service. ∙ Elimination of Call Option: Safe harbor eliminates the developer’s right to have a call option to remove the investor, but the guidance still allows for the investor to have a put option for exit as long as the put doesn’t exceed fair market value of its ownership interest. ∙ Guarantees: Safe harbor also addresses guarantees – both permissible and impermissible. Again, this is an effort to ensure that the investor has sufficient downside risk in the investment. Traditional developer guarantees such as developer performance, construction completion, environmental/operating deficits are permissible so long as they are unfunded. One exception, operating deficit reserves can be funded for a maximum of one year to cover operating and debt service requirements. All other guarantees must be unfunded. Guarantees such as tax credit recapture, tax structure risk are deemed impermissible and risk is placed solely on the investor. While tax credit insurance is permissible, it is clear that the costs for such must be solely paid by the investor and not by any party involved in the partnership project.

partnership’s allocation of HTCs to its partners without challenge from the IRS.

Safe Harbor Highlights ∙ Interest: Safe harbor requires that, at all times, the developer must have a minimum of a 1% interest in each material item of partnership gain, loss, deduction and credit. The investor must have, at all times, a minimum interest of at least 5% in each of those same items. This allows for a “flip” of partnership interests where the developer has an initial 1% and the investor has a 99% interest respectively. After 5 years from placed in service, the investment flips whereby the investor has 5% and the developer has 95% of the partnership interest. a bona fide equity investment with a reasonably anticipated value commensurate with the investor’s overall percentage interest in the partnership. This provision is certainly more complicated but has been widely interpreted to mean that the investor will need to reasonably expect to share in the value of the project irrespective of the tax benefits. This is essentially achieved with the aforementioned flip whereby the investor is sharing in 99% of the cash flow during the first 5 years and 5% post-flip. It is, however, important to note that the safe harbor does not allow for the value of the investor’s interest to be reduced through fees, leases or other similar arrangements which would be deemed unreasonable compared to other real estate transactions that do not utilize HTCs. Simply put, the investor’s return cannot be fixed and must share in the project’s economics while invested in the partnership. This will require much more analysis during the underwriting stage of the investment than the HTC industry was accustomed to prior to the safe harbor. ∙ Equity Investment: Safe harbor requires that an investor’s interest must constitute

page 56 | horizons Spring 2014