The Valuation Process For LIHTC Projects In Financial Distress: Part I

Note: This post is part of a continuing series on the Credit Report Blog on the subject of workouts and bankruptcies involving low-income housing tax credit (LIHTC) projects.

In a previous post, we wrote about the importance of a secured lender understanding the value of its collateral in a workout or bankruptcy involving a low-income housing tax credit (LIHTC) project. In this post and a subsequent Part II post, we'll delve into the subject of valuation in greater depth.

Why is valuation important?

In any workout or bankruptcy, it is important to understand the value of a lender's collateral, because the value of the collateral will largely determine the amount of the lender's recovery. This is particularly true in a workout or bankruptcy involving an LIHTC project because under the federal LIHTC program, once a project is placed into service, all senior debt of the project owner must be non-recourse to the partnership and its partners. In other words, the lender's only recourse will be to the project itself.

If the project is in bankruptcy, the valuation of a lender's collateral can be even more important. Under Section 506(a) of the Bankruptcy Code, a lender's claim is bifurcated into (i) a secured claim in an amount equal to the value of the lender's interest in its collateral, and (ii) an unsecured claim for the balance of the debt owed to the lender. A borrower/debtor may "cram-down" a plan of reorganization on the lender if it pays the lender the full amount of its secured claim, with interest, over a reasonable period of time and satisfies various other requirements set forth in the bankruptcy code (which, in most cases, do not require the payment in full of the lender's unsecured claim). In short, the amount that a lender receives in a bankruptcy is also largely determined by the value of its collateral.

What is unique about the valuation of an LIHTC project?

There are four unique aspects of an LIHTC project that impact valuation when compared to the valuation of a typical real estate project.

An LIHTC property is burdened by rent and occupancy restrictions of a Land Use Restriction Agreement (LURA), which limit to whom units in the project may be rented and the amount of rent that may be charged. An LIHTC project benefits from federal (and in some cases state) tax credits that can be used to reduce the tax liability of the owner on a dollar-for-dollar basis, provided the property remains in compliance with the rent and occupancy...