AHF Live: The 2005 Tax Credit Developers' Summit
Industry leaders debate ways to improve LIHTC program
Transcript of Affordable Housing Finance's Editorial Advisory Board roundtable meeting

PAT SHERIDAN: I think that certainly we see out there on the preservation side that there just aren't enough developers around that actually preserve. What is coming out right now is expiring-use and RHS and HUD properties. We could use more for-profit or nonprofit developers. From that standpoint, I would like to see probably an expansion even though it might hurt our own personal business if we're getting more deals in a state. But on the other side, I think there is certainly a lot to be said for the experience angle and trying to build more in a team. Maybe it is a failure on the part of the agencies or the syndicators and lenders if they're letting these deals getting to the point where they're funding them without just plain turning them down. I think in many cases, where we're getting involved is we're being asked to partner with a less-experienced nonprofit. Particularly, we've done some with for-profits that have been asked to step in, in one case by the attorneys. Those have actually gone quite well. It gives us an opportunity in some cases to get into a new area or new state where we weren't. Also, it gives the inexperienced developer time to work with somebody else. In many cases, we're putting up the guarantees or whatever. It gives them the experience that next time they may be able to do it by themselves. What we've seen is that the state agencies are then giving the co-developer that had the less experience points for having participated with us. So, I think more partnering is probably a good ideak.

DAVID REZNICK: You know, it's interesting. What Jana was saying in response to what David was saying, really you weren't saying too many different things. What David was truly saying is that states should come in and look at what these folks promised and score them as to whether they delivered what they promised. That then flows right back to what you were saying, which is the quality of the product that is being developed, that just because somebody may have done 15 properties or more, or 18 properties, does not mean necessarily that those 18 properties are all developed well. So, you really weren't saying different things.

DAVID PEREL: I agree. I was actually saying the same thing as Patrick in my notes here. I think the way to get around this is joint ventures. That's a great way to pair up a qualified developer with someone who is new to the industry.

CORINE SHERIDAN: I totally agree with what you are saying. To speak to what Jana was saying, the lack of guarantees is not something that we're doing at Boston Capital. I don't think we have any deals where there are no guarantees. But we are excited when we can pair up a relatively new developer with someone like you guys. The other issue that is really important, I think, in looking at deals is if you couple a relatively inexperienced developer with one that has done a couple of deals with the type of deal they've never done before, that is also sometimes a disaster. If you are a new construction developer and you all of the sudden are going to take on a really hairy, tricky rehab with historic credits, or it's part market and part affordable ... Forget it. It usually doesn't work very well. So, there are ways to get around that. I agree with you that it's pretty scary to do a deal with a really inexperienced developer who also does not have a balance sheet. Even in a highly competitive syndication world, we just sometimes have to say no.

JEANNE PETERSON: As someone else who ran a tax credit agency, I think the first important thing that Judy said that everybody should remember is that NCSHA's recommended practices are that state agencies should take into consideration the experience of the entire development team. I think that there are issues between what is a quantitative assessment and what is a qualitative assessment. As somebody who ran a state credit agency, I could tell you who the good developers were. That didn't necessarily correspond with who had done the most deals. Nevertheless, I think that some of your concerns are important. I mean, it's inexcusable if states aren't monitoring for everything that developers have promised. That really should be a given. Other things that some states have employed are getting information from the varying states that developers are and/or have developed in, not just their own state asking for the sharing of information. The joint-venture thing, of course, is kind of a no-brainer idea. Most states now do include some kind of experience points or advantage. Another thing – I don't necessarily agree that the state should be looking at the guarantees that are given. I think that sometimes it's premature. Sometimes it is impossible to do that if you look at the point at which the applications are coming in and judged and scored. One of the things that we did was not only to look at this quantitative measure, which like I say is not necessarily the best one, of how many deals have you done. But how many deals have you been a general partner in, not just a consultant or some other extraneous development-team member. But also requiring the financial statements (the latest financial statements) of those deals. In our case, we require that there be positive cash flow or some really good explanation for why there wasn't positive cash flow for those deals. I think those are some other things that might be helpful. But I don't think – and people may disagree with this – in this area of experience, as in some other areas, that necessarily all of the burden should fall on the states. That's why, for example, I would say that the guarantees is something that there are a lot of other eyes on.

TERRI PRESTON-KOENIG: I'm Terri Preston-Koenig I work with Virchow Krause. Jeanne very rightly pointed out that NCSHA talks about development teams holistically. One of the things that hasn't been brought up is management capacity. Once you get over the hill with putting this deal together, you have to run it. You have to make it go. A lot of these deals are gong to have mixed, different types of financing. You have to be able to make those be compliant, as well as all the other stuff compliant. You have to be able to understand those and make those work. It's important. Linking people joint venture-wise back to a quality management partner is also important. So, I would say when Corine is linking people back, she's probably looking for a management partner that works, too.

STAN HERSKOVITZ: I'm Stan Herskovitz. Let's get a priority of what we want. At the end of the day, this is a real estate project. What you want to deliver first and foremost is affordable housing. If you can add on top of that a social program, if you can add on top of that some of the other things we're talking about here, I think that's great. But at the end of the day, Fairfield focuses on 50% and 60% of area median rents as to what we do, where we go, and how we do it. The reality is that when people look at who we are and look at our management, look at our operations, and look at our track record, obviously we're going to stack up pretty well. But at the end of the day, if you want to make us go rent to households earning no more than 20% of area median income, if you want to add social programs, if you want to do this or that, that all impacts economics. I think mixed-use is a great idea where rents are inordinately high. But if there's even a $150 or $200 difference in rents, the management of 20% at $200 more than 80% at affordable rent levels becomes very complicated, not in Year 1 or Year 2 or Year 3. We've got to run this thing for the next 30, 40, 50 years. When you're tied into these kinds of requirements, how is that going to look?

I would suggest to you if you can find the best possible project and you provide good-quality housing where families have an opportunity to send their kids to good schools and get a good education and change their lifestyle in a positive way, you've done a whole lot more than you're really being asked to do. To go on and do these other things is great. This isn't a social project at the end of the day. It's a project that has to pay its mortgages. It has to do its maintenance. It has to do its operations. Those are the things you need to look to first. Jeanne and I have done a lot of business together, and I would suggest to you I continue to believe the most important thing and more points should be awarded to the guy that runs a good, quality project year after year after year as opposed to some of the other things we'd all like to see.

DAVID REZNICK: Chris, why don't you move into the next one so that we can keep ourselves on schedule?

CHRIS TAWA: That was the perfect segue into my remarks. I want to talk about some of the issues that I've observed in terms of the deep income-skewing that is mandated by some of the state plans and the impact that has on project feasibility as well as on operational risk. Interestingly, so far most of the comments have related to mixed-income, which is the idea of generating greater income at the project level, assuming it makes sense to do mixed-income, so as to generate greater net revenue, more debt, and a better pro forma. Our concern is that we have seen a trend, especially in the 9% allocation plans, to requiring a greater percentage of units be highly stratified at certain income tiers. The classic example of this is the deal that shows up with 20% of the units reserved at 30% median, 20% at 40%, 20% at 50% and 20% at 60%. When you see those deals, you know that the reason it's formatted in that manner is to address a point system with the credit-allocating agency. But, it reveals to me a certain level of naiveté about how this business works. Unfortunately, we, as others in the industry, have funded these projects.

I think I'd like to call out just a couple of issues in this. This is maybe within the category of things we do to ourselves in terms of administering these programs versus some of the solutions you started to identify in the discussion, Andre, that I call technical solutions to how we might better stretch our resources and make the program work better. But within this area of how we really hurt ourselves, we've had a portfolio that up until now has done pretty well for the past 10 or more years because we've had, generally, rising incomes every year and thus rising rents, and relatively stable operating expenses with relatively moderate increases over time because inflation has been substantially in check. Well, when we have projects that are launched with deep income-skewing so that we cannot really get at any reasonable increase in rents, and indeed, the utility allowances are about to be dramatically changed as we see changes in energy costs, we're going in the reverse mode. We're stressing this portfolio and we're seeing this in our own numbers. The revenue side of our ledger is flat or declining while our operating expenses are going up. Projects that have deep skewing do commonly have funded reserves, but those reserves are finite.

My concern is that over time, we're creating properties that will physically deteriorate and generate what would be called a slum. I hate to use that word in connection with this wonderful program that has done so well, but I'm very concerned about the long-term deterioration of housing as it's financially stressed operationally. When we launch these projects, we do generate the debt level that we think works for the project with the very low incomes. The challenge is, of course, project feasibility because you need to pull together tax abatements, soft money, etc. But if we can pull that off, then I do think we encounter operational risk without deep subsidies, as really would be appropriate for some of the very low income populations in these tax credit properties.

So what to do? I think that this creates, potentially, some very long-term risks for how the portfolio will be seen politically. I think that we're on the verge of a greater stress test for these portfolios than we've ever seen before as expenses associated with inflationary pressures really increase. This is going to link, then, into some of the sponsorship issues that David called out because very often we find that the projects that are done with the deepest income-skewing are the developers that will come to the table with the most social purpose and legitimately seek to serve populations that are most in need. But the reverse side of this is that sometimes these are not the most financially strong and secure developers and sponsors that we work with. So, it seems to feed on itself: Projects that are stressed to put together, projects then are stressed to operate, and projects that have sponsorship that doesn't have the capacity to sustain this kind of stress. I wanted to just bring out this whole issue of the deep skewing. It's a real counterpart to the issue of mixed-income, which really is a buzzword for “get me some more revenue on my pro forma.” So, this is something that has been very troubling and I wanted to put that on the table.

JUDY CALOGERO: I'd love to see the IRS give us greater flexibility to use the 9% credit for income bands above 60% of the median, in part to do what Christopher talks about, but also the IRS strengthened the part of the program that requires us to be determining need based on market condition established within a market study. Some of these market studies truly demonstrate that there isn't a need. I also think that it is not just the point system that skews these projects toward lower-income groups, but it is the market that drives that. The developer is not able to put together a market plan to the state that establishes anything other than that.

ANDRE SHASHATY: Let me try to crystallize what Chris said just a tiny bit. I think the key point is that the deep income-targeting that has been present in QAPs for some time is becoming increasingly hard to fulfill without putting projects at risk. He is sounding an alarm saying that it really can't continue and that states really should not continue to prioritize deeper targeting as they have been given the fact that costs are going up so fast. Could you elaborate? When you said costs are going up, are you sounding an alarm? Are you saying that costs are exploding?

CHRIS TAWA: I think the market is changing quickly and dramatically on the operational side of projects. We're seeing this most obviously in energy expense, in utility expense, and in taxes and insurance. The tax legislation that was recently, or is about to be, passed and signed into law in New York will at least rationalize this for that state and base taxes on an income analysis of the project. But we have incredible variants on tax burden and how taxes are assessed across the country. And yes, I think we're seeing fast rises, Andre. We have not seen these types of line items accelerate so quickly, in my memory, in the past. It's not a trend that one has a lot of comfort will change in the near future.

JACK MARKOWSKI: I have a number of thoughts on this. One of the things is that I sympathize with is the difficulty in delivering housing to very low income people under 50% of the median. But also we have to recognize where the housing need is. To be blunt about it, in the city of Chicago, and I'm sure markets are different across the country, we don't particularly need more rental housing production at 60% or at 70% or at 80% of median income. In fact, the tax credit projects that have been developed have largely been priced to serve people as low as 40% of median income, but generally 50%-60% of median income. The fact of the matter is in our market there are not enough households with money to afford the rents that are being charged by the tax credit projects. As Judy was talking about, it's a market question. We don't have to say that we're targeting people at the lower-income levels to make it a reality in Chicago. You have to target those people at the lower-income levels, and you've got to figure it out. We need a new resource. It's got to do with rental subsidies. You've got to figure out how to get to that lower level. There is tremendous need. In Chicago, we've got about 220,000 rental households with incomes under $20,000 a year. Of those 220,000, about 60,000 of those are served by affordable housing of some kind. That leaves about 160,000 not served by what we call affordable housing. At the same time, our tax credit projects are suffering from high vacancy rates because they can't find enough people with the resources to pay the rent. So, you have to deal with this issue. Oddly enough, in our projects where we see trouble, we don't see trouble in our SROs or in supportive-housing projects. Across the board, I don't have a single one of them in trouble. Why are they not in trouble? Because in fact the rental subsides or the supportive services, but primarily the rental subsidies, have been thought about and figured out ahead of time. Now, you just can't make people do it without providing the resources. You have to have the resources there from the beginning. That's clearly where we have to target.

DAVID REZNICK: What you're really pointing out is something similar to what Chris is saying. You've recognized in Chicago that the same issue you have in Chicago, you have in many rural areas. That is, people who really can't afford to pay 60% of the area median, but you're coming up with a gap that isn't fillable with Sec. 8 and vouchers, being pressured and going down, there being no money. So, it may be that it may have to come from this state, from the city, because the developer can't develop what has the gap, the investor can't invest in what doesn't make sense. Tony, you had some thoughts.

TONY FREEDMAN: Yeah. I'd like to take Jack's point a step farther, and that is that we've got to look not only at the need but at the inventory. The affordable inventory in this country is by and large 20 to 25 years old. Half, at least half, of the deals that every single one of us is doing is preservation deals, with Sec. 236 decouplings/Sec. 202 conversions, Hope VI projects, Mark-to-Market. We are turning over this old subsidized inventory. We can't ignore it. It's not going anywhere. It's just sitting there and getting more vulnerable. Chris is absolutely right. It's incredibly vulnerable. It's vulnerable to taxes. It's vulnerable to utility costs. But the agencies that are dealing with it are not simply responding to competition as they were maybe five years ago, saying, "Look, if so-and-so will target a lower-income level, I'll go with so-and-so rather than you." We're now dealing with an entire inventory that is demanding recapitalization. It's a great creative challenge for all of us. It's a great deal of fun to deal with. That inventory is what is soaking up resources. It's soaking up not simply the tax credits, it's soaking up all the rest of those subsidies, which are declining. That has to be dealt with.

BRIAN HUDSON: Brian Hudson from Pennsylvania Housing. Just one point I want to add to that. From a state where we have the second highest elderly population and also some of the oldest housing stock, when the tax credit program was created in 1986 we realized that right off the bat there was going to be a subsidy needed. We started using our reserve to that point. Since 1986, we've dedicated $175 million of soft seconds to make these projects work, but I have to touch base that yes, you have to reach the entire population, meaning that we have a lot of elderly on fixed income. We recognize that need and we're trying to fill that gap.

JEROME RUSSELL: We have a sizable HUD portfolio throughout Georgia, a mix between rural and in the city. What we're seeing with our rural portfolio is this HUD Mark-to-Market program, which we don't like. We think it's just a band-aid. The rents in these rural areas just can't support the actual operational costs. We're struggling with what we do. We just took one and we did a 9% tax credit deal. This is an 80-unit deal. Total development cost was about $7-$8 million. We only could support a debt of $1.5 million. It will work. We're putting enough recapitalization in it to make it work. It barely met the threshold for our state to qualify. The rest of the portfolio, we don't think it's worth going through the challenge. If we can sell it and get what we have in it, we'll be happy. But that is how bad it is in the rural areas as it relates to this capitalization. On the other hand, we've taken a 100-unit development, actually near one the Atlanta Housing Authority's redeveloping, and going to raze it and do condos. The tax credit program, particularly for these rural programs, can come together. I think it's more on HUD's side to try to come up with some creative ways to get above this Mark-to-Market.

CHRIS FOSTER: I've got everything figured out. Tony, here's a solution to your problem. The first thing is on preservation projects – the state should allow a flip in the targeting requirements if they lose their project-based Sec. 8. So, if they lose their project-based Sec. 8, then it would go to 60% targeting when in fact they were able to underwrite originally down at 20% because they had the overhang on the Sec. 8. That helps the preservation issue.

Number two: To take care of Chicago's problem, what if you gave a higher credit basis for deeper targeting? Obviously, that has got to be offset with lesser basis for higher targeting, but that allows the lower-income deals to work (the deeper targeting).

The third thing is I think again that if you don't need more 60% housing in Chicago or other markets (and I think that is the case in some markets), then I think we (and I know this is not very popular) but we need to be looking at the homeownership credit because that is really where a lot of these people in that bracket want to go. So, let's not poo-poo the homeownership credit if we can. Let's do it, and let's do mixed-use projects that include all those elements.

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