Year 15 Considerations for RAD Conversions

Published by Teresa Garcia on Friday, February 7, 2020
Thumbnail Cover February 2020

About 40 percent of Rental Assistance Demonstration (RAD) conversions use low-income housing tax credit (LIHTC) equity, making it critical for partners in a RAD transaction to understand and prepare for the end of the LIHTC 15-year compliance period, which is when a vast majority of investors choose to exit.

Panelists at the Novogradac 2020 RAD Public Housing Conference in Fort Lauderdale, Fla., in January discussed the following considerations when negotiating Year 15 strategies to sell or transfer a property or an interest in the property, or to rehabilitate the property through re-syndication or refinancing.

Early, Long-Term Planning

Panelists emphasized the importance of early planning for Year 15. “You should start thinking about Year 15 when you start looking at a RAD deal with LIHTC,” said Tanya Dempsey, a principal at CSG Advisors. “Everyone thinks, ‘Year 15 is going to be down the road and I’m not going to be around then,’ but in most cases, you are going to be around and you have to confront the mistakes you made 15 years ago. Avoid that by thinking about Year 15 at the beginning.” Dempsey said CSG Advisors typically discusses Year 15 at the letter of intent (LOI) stage, when parties tend to be more willing to negotiate.

Matt Lockhart, CPA and a Novogradac principal, added that it is important to plan for the future of a property even beyond Year 15. “We talk about Year 15 because of the low-income housing tax credit compliance period, but you should also think about what’s the plan for the property in 20, 30, 40 years,” said Lockhart. “Building that into your partnership agreement and regulatory agreement is really important to think about before you actually get to doing any renovations.”

For situations in which Year 15 was not negotiated in advance or in which a party inherited the deal from someone else, leverage for negotiations can be limited.  “If you waited to negotiate your exit at Year 14 or if you poorly negotiated your exit in your partnership agreement, you might have some leverage if you’re going to do future business with your investor,” said Jill Cromartie, division director of housing and finance development for the Georgia Department of Community Affairs. “The only leverage that you have in working out a deal with your investor may be giving up something on your next deal.”

Right of First Refusal

The right of first refusal is a key element of LIHTC-RAD transactions that varies from deal to deal, investor to investor. A qualified nonprofit organization or governmental agency in a LIHTC transaction—in most RAD cases, the public housing authority—has a right of first refusal, based on the terms of the partnership agreement, under which the nonprofit organization or government agency has the ability purchase the property from the LIHTC partnership. In some cases, there may also be agreements by the parties to structure a purchase of the limited partner’s interest in the LIHTC partnership. Pinoli said the right of first refusal should not be confused with an outright option to purchase the property.

“The right of first refusal is something built into the tax code and it’s available for every deal, but you don’t have to put it into every deal,” said Lockhart. “It’s usually a good idea to do so because it’s a way you can try to get your property back. It’s generally a function of the exit taxes that the investor partner would pay plus the debt that’s on the property.”

Drafting a detailed and clear right of first refusal can help avoid ambiguity or disagreement down the road. “A part of the fun of the right of first refusal is that usually it’s drafted up front when you close the deal, but it doesn’t actually become active until 15-17 years later when the compliance period is over, if you figure a year or two for construction, plus 15 years of compliance,” said Nicolo Pinoli, CPA and a Novogradac partner, who moderated the panel. “Memories can fade [by Year 15], and not only that, but people [involved in the closing] may no longer be around. That’s why the agreement needs to be as clear as possible.”

“My advice is to dig into that right of first refusal and understand how it gets triggered and who needs to approve it, if anyone,” said Pinoli. “I’m seeing that as deals get to Year 15, when you have a right of first refusal that was poorly written or the details were not fleshed out, that creates the opportunity for disagreement, contention and lawsuits.”

Exit Taxes

Exit taxes are an important component of the right of first refusal. Lockhart said important questions to ask are where does the investor’s capital account end up after 15 years and how much tax will the investor owe if they get bought out of the partnership.

“You need to do your underwriting for the deal not only to know what the cash flow for the deal is, but you need to know where the capital account is going to be,” said Lockhart. “If the capital account is negative, the investor is going to owe a lot of money to pay the exit taxes and you’re going to have to pay them that amount to get your property back.”

Purchase Price

LIHTC partners typically negotiate a sales price for the property in Year 15, which will determine each party’s share of the sales proceeds, based on the limited partnership agreement. A common challenge is that a property’s value changes over the course of the 15-year compliance period due to market changes, occupancy problems, tax credit compliance issues, significant maintenance needs and other issues. Conference panelists emphasized the importance of running an updated financial projection of the property that includes actual performance and estimated future income and expenses so that each partner understands the potential cash available in the event of a sale.

An upward trend in property values has made LIHTC exits more complicated than in previous years. “Exits were a lot easier because deals weren’t that valuable,” said Pinoli. “Over time, real estate values improved and the economy has done well. Year 15 over the last five to 10 years now has tremendous value in these properties. In some cases, it’s well exceeding debt. If you go back 20 years ago, often the properties weren’t even worth the debt. There was no value there, so there was nothing to argue about. The economy has driven a lot of the excitement around Year 15, around who gets the residual, how it gets shared among various parties… and how you document those agreements when you sign that LOI and that partnership agreement.”

Dempsey urged housing authorities to be cautious about doing a RAD conversion for a mixed-finance transaction before an exit. “When you add RAD vouchers into mixed-finance deals you convert, you add value,” said Dempsey. “The reason is because rents are higher. So you’ve increased the value at exit just by converting to RAD. That’s a pretty powerful thing that housing authorities control.” Dempsey gave an example of a housing authority that pursued a RAD conversion for 500 units before an exit and ended up paying an additional $10 million in the exit because the doubled rent increased the property’s value.


Resyndication is one tool available in Year 15 to finance rehabilitation work on an aging RAD property. “You need to have enough work to do to do the re-syndication possible,” said Lockhart. “You need to have some rehab you have to do otherwise the underwriting doesn’t work because you don’t have enough credits. It’s a way to address that deferred maintenance problem before you have significant deferred maintenance.”

“From Georgia’s perspective, our biggest concern with re-syndication is making sure that the caliber of rehab is good enough so that the property can stay affordable for the next 30 years,” said Cromartie. “I know we keep talking about 15 years, but in Georgia it’s a 30-year affordability commitment. We want to make sure that you’re spending enough money so that this property will withstand normal wear and tear for at least 15-30 years. For us, that requires spending at least $25,000 per unit.” Cromartie said the state agency works with public housing authorities to help aging properties compete with new construction developments.

Further Reading

More information on Year 15 strategies and considerations can be found in the Novogradac LIHTC Year 15 Handbook.