Introduction

As a leader in the low-income housing tax credit industry, the National Association of State and Local Equity Funds (NASLEF) has developed the following "Best Practices" for Asset Management and Compliance Monitoring. Adherence to the "Best Practices" will lead to better quality tax credit projects, preserve and protect the interests of investors, and assure compliance with Section 42 of the Internal Revenue Code. These "Best Practices" are guidelines and not a set of criteria. NASLEF recognizes that there may be circumstances where the "Best Practices" will need to be modified by individual equity funds to meet certain needs.

NASLEF is a professional, nonprofit association formed in 1994 to promote the efficient management of state and local equity funds. Collectively, its 30 member funds have created or rehabilitated 33,000 units of affordable housing and have raised $1.3 billion in equity capital for rental housing developments throughout the United States.



Underwriting Review

Best Practice: Asset managers and compliance specialists should begin working with projects during the underwriting process to ensure that they will, to the greatest extent possible, perform in accordance with projected operating budgets, achieve occupancy goals, and deliver the amount of projected tax credits.

Asset management and compliance monitoring "Best Practices" should be incorporated in project level legal documents, i.e. reporting requirements, adherence to the management plan, segregating bank accounts, etc.

During the underwriting process, underwriters and asset managers should hold technical review sessions, during which the following items might be reviewed: market studies including market comparables, projected operating budgets, selection of property managers, asset management and compliance matters to be incorporated in legal documents, site plans, specifications, and other construction factors related to the long-term marketability and management of the property.

Asset managers should establish management criteria for vetoing property managers and accounting firms (e. g. prior experience, ongoing training, staffing, etc.).

Discussion: Asset managers and compliance specialists bring a unique perspective to tax credit projects. They are the ones responsible for working with projects throughout the compliance period; thus, their participation during the underwriting process strengthens projects and lessens the likelihood of financial, occupancy, and compliance problems later.



Equity Disbursements

Best Practice: Equity funds should follow sound business practices when making equity disbursements to projects.

A percentage of equity as well as a percentage of developer's fees should be withheld prior to reaching certain milestones such as construction completion, issuance of certificates of occupancy for all units (or placed in service date for rehabs), achieving stabilized occupancy and/or break-even operations for specified period of time, final cost certification, submission of 8609's, permanent financing, etc.

Requests for disbursements of equity during construction should be accompanied with the following documentation:

A signed copy of the general contractor's draw request containing (i) the amount of money being requested; (ii) a statement indicating the percentage of construction completed to date; (iii) a copy of itemized invoices for which payment is being sought; and (iv) AIA Form G703 signed by both the architect and the contractor; and, (v) an independent construction inspection report certifying the percentage of work completed to date and a statement indicating the work has been conducted in accordance with the plan and specification in a workmanlike manner.

An explanation of any cost overruns or change orders.

Certification from either the inspecting architect or engineer stating that the work to date has been accomplished according to the plans and specifications in a workmanlike manner.

A Developer's Certification stating that the equity disbursement will be used solely to pay agreed upon project expenses and that there are no liens or claims pending.

Some equity providers may consider holding back a portion of equity until the property has undergone its one-year warranty inspection.

Some equity providers may consider utilizing an independent disbursing agent, such as a title company.

Discussion: Even though developers typically ask for as much equity as they can get at the earliest possible date, equity providers should structure pay-in schedules that reflect sound business principles. In doing so equity providers must take into account the financing needs of projects as well as competitive market conditions. Equity funds might also consider imposing credit adjusters for those projects not delivering credits as projected.



Restriction of Funds

Best Practice: Equity providers should impose restrictions on the uses of construction contingency monies and dedicated reserve accounts (Operating Reserve, Replacement Reserve, etc.). Additionally, developers should have the consent of equity providers in order to access reserve account funds.

Project developers should be required to notify their equity provider of the use of construction contingency funds in cases where the amount is $5,000 or greater for a single occurrence.

Operating Reserves should be limited to paying operating expenses in cases where there are inadequate gross receipts to cover such expenses.

Replacement Reserve monies should be used solely for the purpose of paying for substantial repairs, capital expenditures, and/or replacement of capital assets of projects.

Use of the Rent-Up Reserves should be limited to payment of operating expenses during the lease-up period in cases where there are inadequate gross receipts to cover such expenses.

Projects should have segregated reserve and security deposit accounts, and a separate Taxes & Insurance Escrow Account.

Discussion: Expenditures of funds from the various reserve accounts, other than the Rent-up Reserve Account, should be allowed only with prior approval of the equity provider. The degree to which an equity provider chooses to limit access to the various reserve accounts of a particular project should be based on the reputation and experience of the property developer and manager. With respect to Replacement Reserves, equity funds might consider setting a threshold for a maximum withdrawal without equity provider consent as opposed to having the equity provider approve all withdrawals. However, for Operating Reserves, it is appropriate to have the equity provider approve all withdrawals. Equity funds may also consider making it the General Partner's responsibility to fund any deficits during the rent-up period when the Rent-up Reserve is depleted, thereby, avoiding using the Operating Reserve to cover deficits until a certain occupancy has been achieved.



Minimum Reserve and Account Requirements

Best Practice: Equity providers should establish Operating, Replacement, and Rent-up Reserve requirements that consider, the project location, site specifics such as: single location vs. scattered, construction type, population served, projected vacancies, duration of reserves, design features, and security.

All reasonable efforts should be made to maintain Minimum Operating Reserves equal to four to six months of projected operating expenses plus: (i) "must pay" debt service payments; and (ii) annual Replacement Reserve payments. In general, Operating Reserves should be sufficient to pay for short-term net operating income shortfalls.

All reasonable efforts should be made to maintain Replacement Reserves sufficient to pay foreseeable capital expenditures. As a guideline, it is recommended that a minimum of $250 per unit per year be held in the Replacement Reserve for new construction and a higher amount be set aside for rehabilitation projects. Exceptions may be made for certain special needs developments, such as senior developments, which may suffer less wear and tear than other properties.

The amount of money allocated to Rent-up Reserves should be sufficient to offset the potential loss of rental income.

Projects should be required to establish a Taxes and Insurance Escrow Account (unless included in the permanent loan financing). However, some small deals might not need and escrow for reasons such as the abatement of taxes or minimal debt service.

Equity providers should consider establishing an asset management reserve for the project in order to cover the cost of fifteen years of asset management.

Discussion: Adequate funding of reserve accounts is essential to the long-term financial and physical viability of rental developments. This is particularly important in tax credit projects because rents are restricted and may not keep pace with operating, maintenance, and replacement costs. Asset managers should routinely verify the balances of all reserve accounts. In projecting the amounts of funding for Operating and Replacement Reserve Accounts over the compliance period, a realistic inflation rate, conditions for refunding reserve accounts over the life of the project, and a mid-life capital needs assessment should be addressed.



Insurance Coverage

Best Practice: Projects should be required to carry the following types and minimum amounts of insurance coverage, which should be stated in the project Operating Agreements. Insurance companies should have an AM Best ratings of A+.

Projects should have a minimum of $2,000,000 of General Liability Insurance; where possible, larger projects should be covered by a greater amount.

All Risk Casualty Insurance: amount of coverage should equal the replacement value of all improvements (review for hazardous materials and soft costs)

Title Insurance with appropriate coverage

Flood Insurance where a project is located in a flood plain

Equity funds should conduct earthquake risk analysis where geographically reasonable to do so. Earthquake insurance should or should not be retained based on analysis results.

Rental Interruption Insurance: amount of coverage should equal six to twelve months gross rental income

Additional named insured: Operating Entity, Equity Fund, Equity Syndicator, and Management Agent

Discussion: The above types and amounts of insurance coverage are designed to serve as a general guideline. Where appropriate, equity providers should incorporate the insurance requirements of a project's lenders. Additional types and different amounts of coverage may be required in some cases. Asset managers should routinely verify the types and amounts of insurance coverage in force, develop a tracking system to ensure renewal of policies, and confirm that commercial space located in the project is separately and appropriately insured. In addition, property managers should have the following insurance: Liability of operations, Fidelity bond, Errors and omissions (if feasible).



Reporting Requirements

Best Practice: Equity funds should establish specific project reporting requirements, which should be incorporated in project Operating Agreements.

Developers and property managers should be required to submit reports on a timely basis. Project Operating Agreements may provide for penalties, including a condition of default, for developers and property managers who fail to comply with these provisions.

Developers should submit to equity providers monthly reports comparing actual development costs as compared to projected costs during construction.

Equity providers should receive copies of the third party construction progress reports and/or similar reports.

If construction is delayed, the developer should be required to submit a revised construction and leasing schedule to the equity provider.

During lease-up developers and/or property managers should submit monthly reports to the equity provider including, but not limited to: occupancy, income and expenses, balance sheet, reserve accounts, and other bank statements. Asset managers should be aware of the lease-up schedule being used by underwriters as the project first year credits.

During lease-up, property managers could be required to submit bi-weekly or monthly leasing activity reports to the equity provider.

During lease-up, equity funds will make a reasonable attempt to review initial tenant files before the tenant has signed the lease, as long as such efforts are not being duplicated with those of the respective State Housing Finance Agency or other independent third parties.

For the first six to twelve months after projects achieve 100% qualified occupancy, the equity provider should review financial and occupancy reports on a monthly basis; thereafter, if projects are performing appropriately, reviews may occur on a quarterly basis.

Equity providers should:

Review the following monthly/quarterly financial information: income and expense statement, explanation of significant out-of-budget revenues and expenses, balance sheet, reserve account balances, bank statements. Reports should include an explanation of unexpected expenses, failure to maintain debt coverage ratios, and the use of reserves.

Review the following monthly/quarterly occupancy reports: rent roll reflecting current vacancies and unit turnover, tenant aged accounts receivable. Reports should monitor such items as: vacancy issues, large tenant accounts receivables. Where possible, reporting formats should be consistent with that of state housing agencies.

Review and approve projected operating budgets annually and the state compliance certification report when applicable.

Receive copies of documents concerning the partnership provided to the government or any other financial authority.

File reminder notices (or default notices where applicable) if reports are not received on a timely basis.

Review drafts and final copies of tax returns and audits.

Request other reports as reasonably requested.

Where permitted by the state housing agency, equity providers should request to be included on the mailing list for all correspondence generated by the state housing agency about the equity provider's projects.

Where possible, reporting documents required by the asset manager should mirror the reporting documents required by the state housing agency for a given property. Although seemingly a small issue, uniform-reporting documents will help identify weaknesses in record keeping. Failure to follow Section 42 record-keeping requirements causes many 8823's.

Lower tier project reporting requirements should reflect upper tier investor reporting requirements.

Where possible, equity providers should request an annual certification from its General Partners certifying that the project has not received any notice or violation from any governmental entity of which if uncured would result in a violation of any statute, code, ordinance, rule, regulation, etc. Once all of the equity has been disbursed, there typically is not a mechanism in place that would allow the equity provider to be informed of these types of violations; therefore, having a certification process in place may serve as an early warning device.

Discussion: Requiring project sponsors to provide appropriate reports on a timely basis is the only effective means equity providers have for tracking the performance and compliance of tax credit projects. Thus, it is essential that a reporting system be established that will ensure that equity providers receive information they need throughout the compliance period. Equity providers may consider providing a standardized reporting package to each project in order to have consistency among the projects in each portfolio. (Equity providers should be mindful of General Partners who certify that their property is in 100% compliance on their annual certification; if a state monitoring agency discovers otherwise, the General Partner's misrepresentation is indicated on the 8823.)



Training

Best Practice: In order to insure that asset managers, compliance specialists, developers, and property managers keep abreast of current compliance related matters, they should undergo annual compliance training in order to ensure the long-term viability of their projects and comply with provisions of Section 42 of the Internal Revenue Code.

All equity fund compliance specialists and asset managers should be nationally certified or receive adequate training on a local level.

Upon admitting a project to an equity fund, the equity provider might conduct an orientation meeting with the developer, property manager, and accountant (if applicable), and familiarize them with reporting requirements, matters relating to asset management, and compliance issues. If possible, an asset management policies and procedures manual with forms should be given to all project sponsors.

Discussion: There are several nationally recognized compliance certification programs. Two of the better-known programs are offered by Elizabeth Moreland and Spectrum Seminars. On the local level, state housing finance agencies and several property management associations offer training. Additionally, a number of state and local equity funds provide compliance training. All of the programs are worthwhile. Asset managers and compliance specialists should be taking advantage of them. NASLEF also encourages equity providers to focus on building asset management capacity at the project level. Consortium for Housing and Asset Management (CHAM), a non-profit organization, offers LIHTC asset management training for General Partners and property managers. NASLEF is currently working on developing a standardized asset management and compliance monitoring training package to be used by equity providers when training their General Partners and property managers.



Asset Management and Compliance Reviews

Best Practice: Asset managers and compliance specialists should regularly inspect projects in which their equity funds have made investments to ensure they are meeting performance standards and complying with provisions of Section 42 of the Internal Revenue Code.

After an initial orientation meeting designed to acquaint project developers and property managers with reporting requirements and compliance, there should be a second meeting to review the material discussed in the initial meeting. Additionally, this meeting might include a review of the following:

All forms and documents related to qualifying tenants for occupancy such as application forms, verification forms, lease, income certification forms, etc.,

The organization and completeness of tenant files,
Marketing programs, including any issues addressing changes in market conditions,
Maintenance schedules,
Initial operating budget,
Bookkeeping system and establishment of bank accounts, (describe purpose and restrictions of each bank account),
Inspection of premises,
Tenant selection plan,
Watch list criteria and other financial benchmarks, and
First year lease-up schedule and consequences of not meeting the schedule.

After a property has reached 100% Qualified Occupancy, the equity provider should perform a site inspection and review the initial tenant files within 90 days. Setting a reasonable time limit on the timing of the inspection will allow errors in the files to be found sooner and most likely easier to correct. Tenant file reviews might include:

Proper completion of tenant applications including a review of student status,
Verification of all income and assets of tenants, including proper timing,
Verification of income and rent limits, compliance of the income certification, including proper timing,
Proper timing and completion of leases, and
Other special requirements, such as verification of the age of elderly tenants, checking for the student status of all household members, and performing asset testing.
Equity providers might conduct annual site visits to review:
Physical management of site,
Condition of the neighborhood,
Comparable properties,
Services available for the tenants,
A percentage of tenant files,
Use of common spaces,
Verifications of insurance coverage amounts and payment of insurance policy premiums, property taxes, Asset Management Fee,
Verifications of utility allowances and LIHTC median income limits,
The following reports: income and expense, expenditures commentary, reserve account statements, and occupancy.
Quarterly or more frequent site visits should be conducted if projects are not performing satisfactorily, properties are not being properly maintained, etc.

Discussion: To help ensure that projects perform as expected and are in compliance with Section 42 of the Internal Revenue Code, it is important that asset managers/compliance specialists work with project developers/property managers to ensure that they have a thorough understanding of reporting requirements and compliance issues. Similarly, it is important that asset managers/compliance specialists conduct regular on-site visits to projects in order to verify how well projects are being managed.



Independent Reviews

Best Practice: Equity providers should require independent third party construction inspection reports and financial information pertaining to projects in which they invest.

A qualified independent construction inspector or inspecting architect/engineers should inspect projects and review construction draw requests on a monthly basis during the construction period. Additionally, equity providers should consider receiving copies of inspection reports from the construction lender.

Equity providers should review significant change orders and approve significant changes in construction specifications.

Plans, specifications and the construction budget should be reviewed by the construction inspector prior to starting construction.

Equity providers should require annual independent audits of all projects in which they have made investments and which have sufficient revenues to cover the cost of the audit. (For small deals, which cannot support audit costs, equity providers should retain documents supporting the financial stability and condition of the project.) In working with accountants, asset managers should check the lease-up schedule to ensure that the amount of tax credits claimed is appropriate.

Discussion: Unless equity providers have their own construction inspectors, using outside independent construction inspectors is the only way they can be certain that projects are constructed in accordance with plans and specifications and that they are constructed in a workmanlike manner. Relying on certified public accountants to perform independent audits is one of the best ways to ensure that project finances are in order.



Document Retention

Best Practice: Recognizing the importance of retaining certain key project files, the following recommendation lists documents that should be retained:

Initial tenant files and all subsequent new income certifications should be retained at the management company or general partner. A copy of the files should be retained in the office of the equity provider in fireproof filing cabinets for 21 years.

Copies of the following project documents should be retained by the general partner and in the office of the equity provider:

Tax credit application,
Qualified allocation plan,
All loan agreements,
All legal documents including partnership agreements and related documents,
Reservation letter from allocating agency,
Extended use agreement,
Certificate(s) of occupancy,
8609s,
10% carryover cost certification,
Carryover allocation from the state housing agency,
Final cost certification,
Project tax returns,
Project audits,
Annual reports to the state housing agency,
Rent increase documentation for each year,
Utility allowance documentation for each year,
Income limits and maximum housing expenses for each year,
Rent rolls listing every unit and date each unit was initially qualified,
List of vacant units and documentation of compliance with the next available unit rule (if applicable),
Any 8823's or other notices of noncompliance and documentation of corrections if applicable, and
Sign-in sheets and documentation of supportive services.

Discussion: Should a project be audited by the IRS, project records provide the only proof it has been in compliance; therefore, it is vital that key project records be maintained in a safe place. Maintaining duplicate copies of records provides an added measure of insurance.



Workout Plans and Watch Lists

Best Practice: Equity funds should establish watch list criteria and specific workout plans formats for dealing with development problems before they arise. NASLEF has used the AHIC watchlist criteria as a model for NASLEF guidelines.

Establish policies for dealing with significant project issues such as: construction delays, market condition changes, poor construction quality affecting the long-term viability of projects, mismanagement, poor performance, etc.

Establish project watch list indicators such as delinquency, failure to maintain debt coverage ratios, and vacancy.

The following represents suggested guidelines for watch list criteria:

CODE	CATEGORY	COMMENTS
Development Phase
D1	Construction delays	Over 3 months behind schedule
D2	Construction cost overruns	Exceeds 15% of original contract Contingency reserves spent
D3	Leasing delays Qualified occupancy	Over 3 months behind schedule
D4*	Leasing delays All units	Over 4 months behind schedule
D5	Mechanics liens	Filed lien not covered by indemnity and not cured within 3 months
D6	Sources/Uses of Funds	Uses greater than sources by 3% of total development costs or $100,000 whichever is less
D7	Change in qualifying units	Any change
D8	Other litigation	Any action
* If a project is 100% LIHTC units use D3

CODE	CATEGORY	COMMENTS
Operation Phase
O1	Rental delinquency	Greater than 7% of Effective Gross Income (60 or more days lag)
O2	High vacancies	Greater than 8% of all units
O3	Negative coverage	Income after payment of operating expenses and of "must pay" or scheduled debt service is negative Any draws on debt service reserve not replaced within 30 days of draw down
O4	Unpaid taxes	Property taxes more than 3 months past due (indicate whether there is a tax escrow held by first mortgage)
O5	Insurance	Expired property insurance
O6	Mortgage delinquency	"Must pay" debt pmts. more than 30 days late
O7	Mortgage default	Default on first mortgage or any subordinated debt
O8	Deferred Maintenance Extraordinary Repairs	Any repairs not budgeted in excess of 3% of EGI or $25,000, whichever is less or any deferred maintenance in excess of $5,000/unit or $100,000, whichever is less
O9	Physical Deterioration Natural Disasters	Draws on replacement reserves not refunded in 6 months Material change in property physical condition based on last inspection by Fund General Partner
O10	Debt Coverage	Less than 1.10 on mandatory "must pay" debt service
O11	Unauthorized debt	Any unauthorized liens or unauthorized subordinate debt

CODE	CATEGORY	COMMENTS
Other Compliance Issues
C1	Loss of LIHTC	Non-compliance with 10% or more of qualified units
C2	Sponsor Reporting	Monthly report more than 30 days delinquent Fees outstanding for delinquent reports
C3	Site Visit	Project not visited in 12 months or more
C4	State Certification	Notice of non-compliance with NIFA (8823)
C5	IRS Compliance	Notice of IRS claim or audit
C6	Transfers of ownership and/or reorganization of Project Sponsor	Any Change
C7	Unscheduled capital call	Any amount above scheduled dollar amount
C8	Unit Non-Compliance	Any qualified units in a project out of LIHTC rent compliance for more than 60 days

CHRONIC WATCH LIST:

Report on any project having any of the above problems for more than one quarter

The Watch List should include for any project which meets the above criteria:

1. Project Name
2. Location
3. Purpose of watch list
4. Narrative of problem
5. Workout plan
   

Discussion: Having a series of well defined watch list criteria and guidelines for workout plan procedures in place prior to having to deal with projects having difficulty, alerts equity providers to problems and better prepares them to handle problems as they arise.