If you’re set to rehabilitate or construct a multifamily property that will exist as low-income housing, you’ll need to adhere to some guidelines that are set out in land use restriction agreements. These agreements state that you must limit rents for a set period of time on the multifamily properties you develop.
The main benefit of making a land use restriction agreement is that you’ll gain access to low-income housing tax credits (LIHTCs). If development on your project has only just begun, you should understand what these agreements entail and how you can protect your property. In the following guide, you’ll learn about land use restriction agreements and if they apply to your property.
Land Use Restriction Agreements: Understanding the Basics
A land use restriction agreement (LURA) is a type of legal document that involves the property owner giving away some of the rights they had to the land use. The property owner will then receive future tax credits for giving up these rights. Additional restrictions that the owner must agree to include tenant income restrictions and affordability restrictions. The owner must also set aside a substantial portion of the property for lower-income tenants.
The LURA document details all land use restrictions and is placed in the public record. Even if a change in ownership occurs, the land use restriction agreement will pass to the new owner. This agreement is important because it gives property owners access to tax credits in the future that can substantially reduce the amount of money they owe to the IRS.
How Land Use Restriction Agreements Work
The main purpose of land use restriction agreements is to deliver affordable housing that low-income households can gain access to. The low-income housing tax credits that developers and real estate investors can take advantage of are allocated to states through the federal government. Once states have control of these funds, they are sent to state housing finance agencies for further disbursal to individual projects.
Because of how much individual states are involved in this process, LURA agreements can differ substantially between each state. However, there are some aspects of these agreements that are the same regardless of where a property is being developed. The agreement will highlight all restrictions that have been placed on a property and guarantee that the project receives low-income housing tax credits over a set period of time. These tax credits are meant to push private businesses to make investments in affordable housing.
The availability of low-income housing tax credits depends on the project providing at least 40% of the units to tenants who make less than 60% of the median income for the area. It’s also possible to obtain these credits by allotting around 20% of units to tenants who make less than 50% of the median income for the surrounding area.
In the event that a potential buyer wants to develop this type of project, the LIHTCs could be too restrictive. However, there are steps you can take to navigate this issue and still receive the tax credits.
One option is to make a master lease where the developer signs the lease to take control of the commercial space. In this scenario, the developer would become a tenant and pay a set amount of rent under the aforementioned income restrictions. The developer can then rent out the space to individuals or businesses to make a profit from this situation.
It’s also possible for a buyer to separate the project into individual pieces, which could involve having different condominium units be owned by different people. The developer would be the only person who owns the commercial portion of the project. However, it would remain separated from the residential aspect, which is where LIHTCs apply. The 40/60 and 20/50 restrictions mentioned above must be kept in place by the property owner for a period of at least 15 years.
Keep in mind that there are some exceptions to the standard LURA rules. The competition for LIHTCs can be strong, which is why LURAs sometimes require owners to allocate additional units to low-income tenants. Depending on the project, a LURA could require the owner to set aside as much as 70% of the units for residents who earn less than 50% of the median income.
Reasons for Using Land Use Restriction Agreements
There are numerous reasons why land use restriction agreements are put into place, the primary of which is the need to create more affordable housing. Additional reasons include the:
- Protection of endangered species
- Promotion of sustainable development
- Prevention of nuisance activities
- Preservation of natural resources
Compliance Period of Land Use Restriction Agreements
Once a land use restriction agreement is made with a developer or property owner, there will be a compliance period and extended use period. The compliance period lasts for 15 years, during which the property owner must abide by all of the income restrictions that are specified in the document. However, the extended use period is also 15 years.
The main difference between the initial compliance period and the extended use period involves how they are regulated. The compliance period is enforced directly by IRS regulations as well as the HUD. Extended use periods are enforced by the state housing authority.
There are three ways that LURA restrictions on a property can be terminated. The first option is to terminate these restrictions through the qualified termination process, which differs with each state. These restrictions will also become null and void if the lender completes foreclosure proceedings.
The third option occurs when the consecutive 15-year periods expire, which means that the restrictions would no longer be in place after 30 years. As mentioned previously, the LURA agreement will transfer to the buyer in the event that the property is sold.
Specifics of Land Use Restriction Agreements
If you’re a developer or investor who wants to obtain LIHTCs to effectively fund the construction of a new multifamily property, you must agree to place restrictions on rents for a set period of time. All of the stipulations regarding these restrictions will be placed in the land use restriction agreement contract. The housing authority in your state will enforce the guidelines and make sure that your property meets the restrictions before providing the LIHTCs.
Each state can have much different guidelines on how land use restriction agreements are made. Properties that consist of a LURA will be taken through different underwriting processes, which means that the interest rates, loan terms, and costs can differ from the ones available with market rate properties. All properties with this agreement are processed through affordable housing programs.
Once the owner of the property agrees to the land use restrictions, they will receive tax credits that provide reductions in federal income taxes. These tax credits are given annually in the first 10 years following the agreement. They are provided to the owner based entirely on their ownership of the property, which means that owners can’t sell these credits. Since these credits are attached to the property, it’s possible for them to be transferred to the buyer if the property is sold after the agreement is made.
There are many benefits associated with using land use restriction agreements, the primary of which is that developers and property owners gain access to more loans that help them pay for the property. For instance, HUD multifamily loans that cover as much as 87% of the property costs are available. If at least 90% of the units in your property are set to be low-income units, you can benefit from a loan-to-value ratio of as much as 90%, which means that you would only need to make a down payment of 10%.
Freddie Mac and Fannie Mae also offer numerous loan options for these affordable properties. Some of these options are specifically focused on the LIHTC program. As an example, the Freddie Mac Bond Credit Enhancement offers 4% LIHTC and is designed to promote new construction and rehabilitation of various LIHTC properties.
The standard Freddie Mac LIHTC Enhancement also provides investors with some protection in the event that the owner defaults on their loan, which is meant to make these properties more appealing to investors. Fannie Mae offers LIHTC products that allow a loan-to-value ratio of up to 90% and provide interest-only financing to eligible borrowers.
Before you enter into one of these agreements, it’s highly recommended that you seek legal assistance. Since these agreements transfer from owner to owner, selling a property that comes with a LURA can be difficult if the market conditions aren’t perfect. A lawyer who’s well-versed in real estate law should help you understand the legal implications of this deal and if this option is right for you.
Jason Somers, President & Founder of Crest Real Estate
With over 15 years of professional experience in the Los Angeles luxury real estate market, Jason Somers has the background, judgement and track record to provide an unparalleled level of real estate services. His widespread knowledge helps clients identify and acquire income producing properties and value-ad development opportunities.