CAPITAL MARKETS: TAX CREDIT EQUITY

APARTMENT FINANCE TODAY • July/August 2008

Good LIHTC Deals Get Passed Over

The housing tax credit market struggles to find the right point for both investors and developers.

By DONNA KIMURA

Pat Nash’s phone has been ringing off the hook. The longtime low-income housing tax credit (LIHTC) investor has had a hectic 2008, with an unprecedented number of requests coming from developers and tax credit syndicators.

With several investors sitting on the sidelines this year, those who have been active, like Nash, are very popular.

“We’ve turned away hundreds of millions of dollars of deals this year,” said Nash, managing director of JPMorgan Capital Corp., explaining that there wasn’t enough time and staff resources to close more transactions. His team also turned down transactions that did not meet the firm’s yield expectations and other economic metrics.

Nash and other investors are concerned that some good affordable housing deals might not get done in today’s market.

JPMorgan Capital has consistently invested in LIHTCs since 1994. Nash declined to say how much business the firm has done so far in 2008.

A national investor, JPMorgan Capital focuses on proprietary funds and direct investments. It has also participated in multi-investor funds on a select basis. (AFFORDABLE HOUSING FINANCE is published by Hanley Wood, LLC, a company owned by affiliates of JPMorgan Partners, LLC.)

One area that has changed this year is the length of time that the firm will leave open an offer to invest, said Bill Pelletier, who manages the firm’s proprietary and direct investment products.

“We have shorter fuses on deals,” he said, explaining that they like to keep an offer open for 60 to 90 days. “We are no longer able to make a commitment to invest and let it sit there for an extended period of time.”

The firm doesn’t want to get locked into a price and yield at a time when yields to investors have been rising.

Yields had inched up to 7 percent, sources said recently. When investor yields rise that means prices paid to developers for their tax credits decline. The market is struggling to find the right balance of having strong enough yields to attract investors and high enough prices for developers to do their deals.

Not enough equity

Several investors have stepped out of the market over the past year for a variety of reasons, including low yields, which were in the 5 percent range about a year ago. Banks and other companies that have experienced recent losses also have a reduced need for tax credits. It’s made for a tough and interesting year.

“The obvious difference was the lack of available equity. That sums up everything,” said Christoph Gabler, senior director of AEGON USA Realty Advisors, Inc., which invested approximately $300 million in LIHTCs last year and plans to invest a similar amount in 2008. The firm recently surpassed the $2 billion mark in its overall investments.

The overall dearth of equity leads to one of Gabler’s concerns: good deals not getting done this year.

“In a perfect working market, bad deals won’t get done or will be priced accordingly,” he said. “But in the first half, some perfectly good deals weren’t getting done.”

That’s bad news for affordable housing developers who rely on LIHTC equity to finance their projects. That also leaves a broader issue of potentially fewer affordable housing units being built.

Gabler believes this is a shortterm problem. The initial panic that was felt by many in the industry at the start of 2008 has eased as the market has started to settle, he said in late May.

It used to be that yields were the main point of discussion for many investors, but that has changed, added Gabler, who has focused on direct investments but has also invested in syndicated funds. “We talk about yields after deal terms and deal structure,” he said, citing strong guarantees and larger reserves as key considerations.

Deal terms are being looked at in conjunction with yields and risk, he said.

Gabler said the lack of equity is the result of some investors sitting on the sidelines. If they start to come back, the second half should see more activity.

Historically, the second half of the year is busier as states make their reservations and investors try to close deals before the end of the year.

To cope in these times, developers should be conservative in their LIHTC pricing expectations, said several LIHTC industry veterans. It would be great if prices come in higher, but planning for lower numbers lets developers know that their deals will still work if prices are down. It pays not to be too optimistic in these times.

Another recommendation for developers is to update their construction loan, permanent loan, and equity terms to make sure they still want to do the deal in today’s market.

In addition, developers need a complete package of materials that saves investors and lenders time and effort. It is no longer enough to just have a LIHTC allocation letter, said one developer, explaining that more of the construction costs needs to be bid out and more soft money needs to be committed.

Being cautious

One investor who took a waitand- see approach in the first half of the year was GE Real Estate. “We’ve been slow and cautious,” said Jim Mendelson, managing director of the firm’s affordable housing group. “2007 was a big year for us, and we’re digesting that at the moment.”

The firm also wanted to be patient and assess market conditions, which Mendelson described as “choppy.”

He anticipates making some investments in the second half of the year and thinks the market will eventually settle down. “The tax credit bus has been too strong for people to not migrate back,” he said.