CAPITAL MARKETS: TAX CREDIT EQUITY

APARTMENT FINANCE TODAY • MAY 2008

Affordable Housing Faces Tough Conditions

A retreat of low-income housing tax credit investors and a drop in credit prices are making it tough for affordable housing developers.

By Donna Kimura

It’s not just market-rate housing that has been hit by the credit crisis this year. Affordable housing deals being financed with low-income housing tax credits (LIHTCs) are struggling in the wake of sinking equity prices as several finance companies have reduced their tax credit investing.

That’s meant some recent deals have been left searching for new tax credit syndicators or additional funding sources to fill a gap in their budgets.

“There’s no question that the market has been changed substantially by the withdrawal of Fannie Mae and Freddie Mac and large banks,” said Deborah VanAmerongen, commissioner of the New York State Division of Housing and Community Renewal (DHCR), which allocates tax credits to developers.

VanAmerongen estimated that there is about a 10-cent difference between what sponsors expected to get from syndicators from when the agency reserved credits and what they will receive.

The housing finance agency is not backing away from the standards placed on its LIHTC deals, but it is considering establishing criteria under which it would accept requests for additional financing, either in the form of more tax credits or other subsidy, she said.

DHCR would ask sponsors several questions to determine what help, if any, it could offer. For example, the agency would want to know how much of a developer fee has been deferred. In addition, DHCR would want to know how strong the market is and how the deal was originally underwritten.

VanAmerongen added that there was a time not long ago when there were other investors besides Fannie, Freddie, and major banks. “It’s incumbent on syndicators to get aggressive and bring other investors back into the market,” she said.

Syndicators are the link between affordable housing developers and tax credit investors. States award LIHTCs to developers for their affordable housing deals. The developers then sell the tax credits to syndicators who sell them to investors.

State and local funds

Like the national syndicators, state and local equity funds are figuring out ways to adapt and raise capital. Fund executives also say that the lower prices, combined with the reduced amount of capital in the market, will mean that some affordable housing deals just won’t get done.

It could also mean that some states will not be able to reserve their entire LIHTC allocation this year. “It will be interesting to see what happens with the national pool,” said Hal Keller, president of the nonprofit Ohio Capital Corporation for Housing (OCCH), referring to the pot of unused housing credits that gets distributed to other qualified states to use. In 2007, about $6.4 million in unused credit authority was parceled out from the national pool.

Mark McDaniel, president and CEO of the Great Lakes Capital Fund, and other LIHTC syndicators say 2008 is even more challenging than last year, as the market remains unsettled. Participants are searching for the magical point where prices to developers will allow projects to be built and yields to investors will be high enough to attract tax credit buyers. The Great Lakes Capital Fund has repriced its latest fund three times, with yields moving up to about 6.5 percent, said McDaniel.

For some developers, deals are simply falling apart at the last minute. McDaniel’s group has recently been contacted by several developers with projects in Michigan and Indiana. The developers are looking for help because their original syndicators have come back and said they can’t do the deal, according to McDaniel, who said his group has so far been more of an adviser than a new syndicator.

Falling tax credit prices

In general, LIHTC market experts say prices have fallen about 10 percent since last year.

Despite the tough conditions, Great Lakes raised a record $220 million in tax credit equity in 2007. McDaniel attributes his fund’s success to the decision to offer its first guaranteed fund last year. That fund had a return rate of 4.15 percent and raised $130 million. Historically, the group has raised one large multiinvestor fund of about $180 million each year. This year, it is planning to have a couple of small multi-investor funds, a guaranteed fund, and a few single-investor funds. This gives Great Lakes, which operates in Michigan, Illinois, Indiana, and Wisconsin, several different ways to raise equity.

In Ohio, OCCH closed a $160 million fund in December, providing capital for a good portion of the year, said Keller. He estimates that his next fund will have a yield that’s between 6.5 percent and 7 percent, giving it a return roughly 1 to 1.5 percentage points higher than recent funds.

In 2007, OCCH raised about $223 million in LIHTC equity. Keller isn’t certain how much he will raise this year for LIHTC deals, but he expects it will be less.

It will likely be a few more months before clarity is seen in the market, according to syndicators. “With Fannie and Freddie on the sideline, we have a concern,” Keller said. “It’s not clear what the subprime effect will [be] on Community Reinvestment Act (CRA) banks. I think it will be mixed.”

Keller said the state and local equity funds might be in a better position than some national funds. This is because the regional funds depended on Fannie and Freddie to a lesser degree. “[The retreat of Fannie and Freddie] certainly hurts, but maybe not as much as it did the national syndicators,” he said. Second, CRA-motivated investors may first look to the local funds because they target specific regions more than a national fund.

Developers urged

Keller has warned developers not to expect more than 85 cents per dollar of credit. He said he is paying more than that but wants developers to budget conservatively.

Like McDaniel, Keller has also heard of LIHTC projects that are in trouble. In one case, a syndicator pulled out of a deal four days before closing. OCCH ended up funding the project.

Merritt Community Capital Corp., headquartered in Oakland, Calif., closed 2007 with a $42 million fund. Like other fund leaders, Merritt President Bernard Deasy anticipates raising less capital this year. Just how much less is uncertain.

In California, LIHTC prices were still on average in the low 90-cent range per tax credit dollar, said Deasy in late March. California remains a preferred market because the overall rental market is so strong.

Deasy noted that it’s not just lower tax credit prices that are making it tough to do deals. “Other sources are not plentiful either,” he said. “There are budget pressures at local governments, making other sources of financing harder to line up as well.”