New study examines the Low Income Housing Tax Credit

Effectiveness, efficiency, and recent market developments

by David A. Smith

By most common measures the most successful affordable housing financial resource of the last thirty years, the Low Income Housing Tax Credit (the Credit):

• Is essentially a revenue-shared block grant of a tax expenditure that is then factored into equity used to develop or acquire property.
• Represents roughly $4.1 billion annual net-present-cost tax expenditure, roughly 40-50% of the total Federal affordable housing resource expenditures.
• Supports or facilitates production of 60-80,000 new affordable apartments a year, about 50-70% of all new affordable housing production or preservation, distributed nationwide across an extraordinary and impressive variety of apartment and income types.
• Is legislatively countercyclical, residing in the tax code rather than via authorized/ appropriated vehicles, so it tends to be immune to annual budget/ funding fights, to be modified independent of other housing-related initiatives, to change less frequently, and to lack the normal statutory/ regulatory/ administrative guidance hierarchy common in appropriated programs.
• Is in many respects a mature and successful industry that has demonstrated several important virtuous-circle feedback mechanisms leading to greater effectiveness and efficiency.

Of the five main types of financing (grants, soft debt, hard debt, soft equity, and hard equity), four of them are like fingers of a hand – similar to one another and working in parallel. Compared with these, the Credit (soft equity) is metaphorically an opposable thumb:

• It works only in concert with one or more of them.
• It works with them individually or in combination.
• Without it, the others are suddenly much less effective.
• It is more flexible than any of them individually or even in combination.
• It has an importance roughly equal to all of them put together.
• It and its colleagues have from time to time co-evolved toward greater harmony and efficiency with one another.

All of this has made the Credit an almost indispensable tool from the perspective of Federal multifamily affordable housing policy – if it did not exist, Congress would find it necessary either to replace the lost equity by direct Federal grant or to reinvent an equivalent soft equity investment mechanism.

At the same time, the Credit is today facing new challenges, some of them consequences of its own success:

• Uncertainty over the pricing impact of the cap increase (from $1.25 in 2000 to $1.75 in 2002).
• A backwash of secondary-market resales (estimated at $1.0 billion of equity in play).
• The rapidly approaching affordability expiration of the first cohort of existing properties (developed between 1987 and 1993 and comprising about 330,000 apartments, of which perhaps 60,000 may be at risk of market conversion).
• The possible introduction of a new single-family homeownership tax credit that would not only double the volume of tax credits but is in some ways more appealing from an investment perspective.

These are among the observations contained in a new report we authored, The Low Income Housing Tax Credit, Effectiveness and Efficiency: A Presentation of the Issues, commissioned by and presented as a circulation draft to the Millennial Housing Commission. Recap's 25,000-word report is a comprehensive exposition of the Credit — its origins, evolution, practical mechanics, current market dynamics, policy impacts, place among affordable housing resources — as well as a platform for informed discussion.

The report identifies five categories of changes to the Credit or complementary programs, and provides both historical examples and current stakeholder proposals in each category:

• Technical. Correct or modify targeted specific parts of IR Code §42.
• Administrative. Leave program goals unaffected but smooth administrative interface.
• Devolutionary. Remove Federal strictures and place greater reliance on state-level allocation and compliance mechanisms.
• Exogenous. Change other programs to work better with the Credit. Creative/ complementary. Invent new programs that will target resources to places that are a stretch for the Credit.

The report is particularly timely in view of an unexpected development: the Bush Administration has proposed a new single-family housing tax credit (the "SF Credit"). As proposed, the SF Credit borrows many features from the current credit (same per capita amount, state-level allocation and administrative mechanics).

If enacted as proposed, the SF Credit would at a stroke double the potential volume of credits requiring syndication, with the new entrant more attractive in three important ways: (1) homeownership rather than rental, (2) 5-year rather than 10-year delivery, and (3) eligible households at 80% rather than 60% of median income.

Although it is far too early to predict specifics, enactment of an SF Credit would be a major event for the equity markets of Credits. Its consequences should be thoughtfully considered.

Where to find the paper

The paper is accessible in either of two locations:

• The full text is at the Millennial Housing Commission's Web site: http://www.mhc.gov/lihtc.doc.
• The same text, with hypertext internal links for easy navigation, is on Recap's Web site, http://www.recapadvisors.com under News and Analysis, select the first item, then click on download the report

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