Sign Up For Novogradac Industry Alert Emails

The Importance of Compliance in Asset Management

Published by Kimberly Taylor on Sunday, December 1, 2013

Journal cover December 2013   Download PDF

As the affordable housing portfolio in the United States grows, so does the responsibility to maintain compliance at the property level. Every year it seems to get a bit more difficult to find all of the funding sources needed to put a deal together. Gone are the days when tax credit equity was all that was needed to build or rehabilitate a property. Layered funding is really the only option for affordable housing developers – and with more funding sources come the need for adequate and comprehensive compliance monitoring and staff who understand the requirements and implications of non-compliance. Many sponsor organizations wonder where this responsibility should fall. For many, this monitoring is done by the asset manager. There is a direct relationship between compliance and asset management – both areas of focus need the other to maintain a healthy property.

Compliance within Asset Management
The asset management role within an organization may look very different from one owner to the next. But ultimately, wherever the position falls, an asset manager is responsible for monitoring the long-term viability of a property (and portfolio). This is accomplished through thoughtful cash management, capital needs and reserve analysis, property goal-setting with property management staff and refinance/restructure management. Compliance plays a role in each of these important areas. The actual definition of compliance is the act of meeting the requirements and conditions specified under the law and specific regulations for each funding source, like the Low-Income Housing Tax Credit (LIHTC) program. For LIHTCs, there are both federal and state regulations that must be followed, the state’s regulations usually being the more restrictive of the two. Program noncompliance can result in a loss of dollars or tax credits, which can mean the owner returns any investment or the investor could withdraw its capital. Because the asset manager’s role is to analyze the long-term viability of a property, noncompliance would most certainly affect financial viability.

Compliance and Cash Management
An asset manager’s financial analysis of a property would most certainly start with the revenue side. In the LIHTC compliance world, maximum rent schedules are a common area of discussion and monitoring, especially in the last several years when, in many areas, maximum rent limits have not increased. For properties that are maximizing their rents, this can create a revenue problem. An asset manager makes certain assumptions from year to year and if rents can’t be increased, this will negatively affect cash flow at the property. Staying in compliance with the specific rent requirements is crucial, especially if it has multiple funding sources. Asset managers need to understand that funding sources may require the use of different maximum rent limit schedules. It can affect the cash flow projections if the wrong limits are used and/or if the limits are not increasing. Charging a household rent above the maximum limit is considered noncompliance and can cost the property tremendously.

Asset managers also monitor net cash flow, especially any cash that can go back to the owner. Compliance plays a role here as well in that partnership/operating agreements outlined in the cash flow waterfall (or distribution of net cash) clause determine how cash flow is to be distributed and, in some cases, limits the amount of cash flow back to the owner. For any asset manager forecasting cash back to the parent organization, they would need to know the correct cash flow distribution order to know whether the parent organization can pay itself and, if so, how much.

Compliance and Capital Needs & Reserve Analysis
Many tax credit investors are now requiring capital needs assessments (CNAs) to be completed on properties every five years and when exiting the partnership. An asset manager is responsible for knowing the physical condition of a property. These CNAs give a solid picture of what those capital needs are and how much they are going to cost over time. Compliance comes into play with the specific reserve requirements for a property. Tax credit properties usually have at least one reserve which requires annual deposits, the capital replacement reserve being the most common. An asset manager’s job is to analyze the gap between what the capital needs on the property are and the amount of reserves the property has (or will have) for those needs. Unfortunately, the required annual deposits rarely add up to the amount of capital needs of an aging property. A reserve analysis will tell an asset manager what the adequate annual deposits must be in order to cover all of the capital needs costs at a property but they must also know the annual required deposit amount in order to determine the deficit. For a property to be in compliance, the required annual reserve deposit must be monitored and met. If there is a gap in the needs and reserve balance, it’s up to the asset manager to determine how to address those needs financially, all while staying in compliance with existing requirements.

Compliance and Property Management Goals
Property management is typically responsible for the day-to-day compliance on a property. But the owner/asset manager needs to know what the specific requirements are on a property in regards to tenant eligibility. The most common are the required income restrictions for the households who apply to live at the property. If property management is not properly verifying an applicant’s income, and they move applicants with income over the required income limit into the property, this could result in loss of tax credits, which could cost the property (and owner) greatly. There may also be stipulations in a property’s regulatory agreement, which outlines a required target population, such as formerly homeless families or seniors. Staying in compliance with these requirements is just as important and requires a special attention to marketing and outreach on the property management side. Again, if the property is not in compliance with target population requirements, it can result in a loss of tax credits, which affects the property’s financial viability. Other areas of compliance to consider when an asset manager is working with property management are the length of affordability periods, occupancy requirements, such as “good cause” evictions only, specific LIHTC lease provisions, record-keeping requirements and reporting.

Conclusion
No matter where asset management exists in an organization, there’s no doubt that compliance plays an important role in a property’s long-term viability. For owners who use third-party property management, it’s crucial for them to understand all of the compliance requirements on every property in the portfolio. The responsibility ultimately falls on the owner to maintain compliance. Asset manager is increasingly becoming a more necessary role within owner organizations. Asset managers need to understand that to do their jobs effectively, compliance is critical. Take compliance very seriously – it’s only going to become more restrictive from this point on.

Learn more about Novogradac's expertise and many services