CAPITAL MARKETS: TAX CREDIT EQUITY

APARTMENT FINANCE TODAY • MARCH 2008

Turbulent Tax Credit Market Searches for Balance

Syndicators warn developers to brace for lower tax credit prices.

By Donna Kimura

It has been a cold winter for low-income housing tax credit (LIHTC) developers. The usually sunny market has been clouded in uncertainty this year, with the market struggling to find the right balance between prices and yields.

The price per dollar of tax credit for developers has been falling, and yields to investors have been rising over the last several months. The hope is that higher returns will combat the sagging demand of investors and push new ones to buy tax credits, but the lower pricing hurts developers who need every penny to make their deals work. That ultimately may mean fewer affordable housing developments are built.

It is anticipated that Fannie Mae and Freddie Mac will either sit out or reduce their LIHTC investing this year, and banks are facing losses because of the turmoil in the mortgage market, which could reduce their need for tax credits.

“It’s all about equity in 2008 … Will there be enough? Will the market diversify so that deals in non-Community Reinvestment Act (CRA)-rich areas can still attract investors? How will risk-based pricing impact different kinds of deals in different kinds of markets?” said Joe Hagan, president and CEO of the National Equity Fund, Inc. (NEF). “There is an awful lot of uncertainty within financial and housing markets generally. We will most certainly feel that in the LIHTC [market] as well.”

The price per dollar of credit averaged about 93 cents in the fourth quarter of 2007, according to an AFFORDABLE HOUSING FINANCE survey of LIHTC syndicators. That’s a notable fall from the nearly 97 cents average reported a year earlier, and prices were expected to drop further. Yields were in the 5.3 percent range in the fourth quarter and climbing.

Syndicators practically formed their own Greek chorus, sounding a warning of what may lie ahead and offering similar advice for LIHTC developers in January:

“Be prepared for lower pricing,” said Carl Wise, senior vice president at Alliant Capital.

“Developers should expect a lower price per credit and more stringent deal terms, particularly around guarantees and reserves,” said Michael Riechman, director of investor relations at Apollo Equity Partners, a division within RBC Capital Markets.

“Expect lower tax credit pricing than in years past … This time it’s for real,” said Ryan Sfreddo, managing director of Centerline Capital Group, which raised more than $1.1 billion in tax credit equity in 2007.

“Be conservative on pricing expectations and be prepared to improve the underwriting presentation of the deal as this will be necessary to ultimately place the deal in a scarce equity market,” said Paul Cummings, senior vice president of tax credit syndication at Enterprise Community Investment, Inc.

In non-CRA markets or in deals with challenging underwriting issues, LIHTC prices could drop as much as 10 cents or more from where they were a year ago, said Enterprise officials.

“Developers need to be realistic both in their project planning and in managing key relationships related to their deals. There are just fewer dollars to go around, and most syndicators and investors will be focusing on their key customers and critical markets over the next 12 months. Given that, developers should focus on good real estate deals,” said NEF’s Hagan.

“Plan for lower pricing in applications, and hopefully syndicators can exceed that, but if not, at least projects will work,” said Steve Kropf, senior vice president and director of investments for Raymond James Tax Credit Funds, Inc.

Coming changes

It’s not just pricing. Syndicators expect 2008 to be unlike all prior years in other ways.

“There is a ‘flight-to-quality’ element of the current market, which means investors are looking for the highest of quality; from the qualifications of the development team to the strength of the rental market and the structure of the deals,” said Riechman.

He said several state allocating agencies have initiated discussions with LIHTC syndicators about the current market, resulting in some good ideas. For example, some states are considering changing their application processes to accept soft commitment letters for tax credit equity.

Other ideas that may be explored include raising the cap on the amount of credits that a project can receive and removing or adjusting deep targeting requirements.

State housing agencies are also trying to figure out how to deal with projects that received a 2007 reservation of credits. Some of those deals were underwritten at earlier pricing and may now need an adjustment.

Bob Moss, senior vice president and director of originations at Boston Capital, said at the end of January that the market has been changing and shifting every day. As a result, market corrections and moves have been difficult to forecast.

The market is going to be more CRA-driven than in the past, added NEF’s Hagan, who said banks that invest in LIHTCs will focus very specifically on their footprints or target regions. “That’s bad news for parts of the country that have few national banks in their marketplace and for those deals perceived to be more risky or difficult than others might be,” he said. “2008 is definitely a buyer’s market.”

Silver linings

Despite the gloomy forecast, syndicators see some potential bright spots on the horizon.

“With internal rates of return rising, we may see nonbank investors return to take a look at LIHTCs in a way that they haven’t for many years,” Hagan said.

Some syndicators estimate that yields would need to approach 7 percent to entice new corporate investors.

Although some investors are expected to pull back from the market, other existing investors may increase their projected volumes, said Alliant’s Wise, adding that he anticipates the volume of secondary-market activity to decrease.

Until then, the forecast remains cloudy.