Maximizing loan proceeds with tax abatements

With the current market rate environment, most loans are rate-sensitive. Many of our Walker & Dunlop clients are looking for alternative ways to maximize loan proceeds as deals transact, and tax abatements are playing a role in these conversations.

Tax abatements allow borrowers to reduce or eliminate taxes on a transaction for a specific period of time. They can be issued by states, cities or counties as a way to financially incentivize developers or investors to build new housing or rehabilitate existing properties.

We are seeing an uptick in clients obtaining tax abatements in an effort to maximize loan proceeds while also allowing housing production to move forward. It’s a win/win for developers, investors, and states, cities and counties.

However, taking advantage of the full benefits on a tax abatement isn’t a simple or direct path. Abatements have unique structures and can be difficult to obtain or structure in a way that maximizes the benefit. Let’s explore the complexities of tax abatements and see how you can use them to maximize loan proceeds.

Challenges with using tax abatements

Local and state governments use a variety of tax-based tools to encourage development, typically in the form of an abatement. However, the unique structure of abatements and the high level of variability provide challenges for developers and investors.

Underwriting requirements will vary

With FHA financing, borrowers benefit from a comprehensive FHA underwriting guide that explains what abatements are and when tax abatements are eligible for FHA financing. There’s a lot of flexibility in this framework, but this also opens the door to lots of questions and “what-ifs.”

Each municipality tends to have some form of affordability restriction or component tied to receiving an abatement. It’s important to start that conversation early in the process to avoid situations where its structure might not fit into FHA requirements.

Abatements won’t always apply to FHA financing

Not all tax abatements will apply to FHA financing for generating additional loan proceeds. When you’re contemplating FHA financing, you’re looking at a long-term loan product, and long-term loans come with certain responsibilities.

HUD loans are fully amortizing and assumable 35-40-year mortgages. HUD wants reassurance that any additional loan proceeds generated from tax savings are reliable regardless of whether there is a change in ownership (voluntary or involuntary) with a few exceptions.

Fixed and variable abatements follow unique structures

Abatements can range from long-term or short-term, fixed or variable. They can run with the land or run with the Sponsor.

Generally speaking, abatements that run with the land and are long-term can be underwritten for both value and debt service purposes. Abatements that run with the land but are short-term can be underwritten as a B-piece loan for debt service but not value purposes. Abatements that run with the Sponsor could potentially be underwritten if there is an affordability component (either LIHTC or 90+ percent Section 8 or a governmental lease).

The abatements that run with the land and are fixed in nature tend to be sources of savings that can be relied upon for underwriting. It’s easier to understand and quantify what those savings will be.

Variable abatements are more complicated, and the savings can vary year over year.  A more in-depth stress test may be necessary to assess the reliability of the savings and whether HUD would permit additional loan proceeds from these savings.

Understanding how you may qualify for a tax abatement

Our team uses a basic questionnaire to jumpstart the tax abatement process. Answering key questions early on helps our clients prepare and verify their potential eligibility before getting in the weeds of the process.

Examples of questions we explore include:

• Does the abatement run with the land? If yes, how?
• Does the abatement run with the Sponsorship? If yes, how?
• Is the abatement revocable by either party?
• What is the history of the party granting the tax abatement revoking or otherwise disallowing an abatement?  Under what circumstances?
• Does the abatement survive foreclosure?
• Is the abatement transferable in a purchase and sale?
• Is the abatement subject to any sort of annual renewal and/or certification?
• Is the property subject to LIHTC or similar covenants to maintain affordability or 90%+ of the units covered by Section 8?
• Is the property leased from a governmental body (for-profit or non-profit)?
• Is the abatement tied to any affordability restrictions?
• Does the abatement require annual approvals?

This isn’t a complete list, but it illustrates the level of due diligence we conduct to help our clients save time and explore their options from every angle.

How to find the tax abatement structure for your transaction

Tax abatements are state or local-specific, which requires local knowledge to successfully navigate this process. Working with Walker & Dunlop’s experienced team allows you to anticipate requirements, questions, and challenges that will arise in the process and improve your chances of an optimal outcome.

Our team has in-depth experience in analyzing and assisting with structuring tax abatements to maximize loan proceeds for our clients. One example comes from a transaction where HUD was uncomfortable about underwriting an abatement because it was variable in nature. When we analyzed and assessed what those savings would be over time, they would not be lower than what we had underwritten. We were able to obtain a waiver to treat it as a fixed abatement and generate more proceeds for the client.

The analysis piece is key to the tax abatement process. Showing your assessment for the term of your loan will help you demonstrate the feasibility of the abatement.

Walker and Dunlop can assist you in understanding what structures work and don't work with FHA financing. We guide you in working with the city or county to structure the abatement so that we can underwrite to those savings, generate more loan proceeds, and help with your returns. Contact us today to learn more.