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

RENEE GLOVER: On the whole issue of income-targeting, it's interesting because I think that we're talking about a couple of different concepts. On the one hand, the voucher can in fact serve families way down in the income spectrum provided that the rents support the operations of the project. On the other hand, if you limit the rents you can collect to only at 20% of area median income, then you're putting stress on the project because you're collecting less rent than you need to maintain the viability of the project. I would suggest two things: One, that targeting deeper in the income be achieved using the Sec. 8 voucher but allow the voucher to provide rents that are market-driven.

Second, if we're going to keep the focus on creating mixed-income communities, you can't just declare victory because the property is financed with tax credits but all of the residents at the property are way down in the income band because both the operations and the social and political engineering will fail. All services follow disposable income. You have to have it. One of the things that HUD has refused to do is actually break up the project-based subsidy. We have a lot of deals out there that are going to opt out because this Mark-to-Market process that Jerome talked about quite frankly doesn't work.

My point is that the project-based vouchers represent operating subsidies that if they could be split, could actually be used as a tool to do two things: Move away from concentrating 100% very low income families, but allow you to achieve some deep targeting without adversely impacting the credit deals.

PAT CLANCY: I think this is a huge issue, and I think as Renee was saying, it really needs to be dealt with in the context of the market for a community and the range of incomes that you are trying to serve. We've got housing authorities that will sometimes politically end up too exposed and in a bad place, and they make commitments to resident organizations that preclude them from making work requirements or other things. Then, in the same situation, you might have a state agency that says you have to have some market-rate units. All of the sudden, you've got a difficult low-income population and a capped market-rate population. The combination of what state agencies are doing and what local housing authorities are doing can create serious problems. I think that a fix would be if in fact the credit could be made more flexible, but as you go down to Jack's 30% band to make a development serve that, you could also go up to the 70%-75% band. You could create more of a range and have units be able to be tax credit units. To the extent you go lower you could also go higher. Mixed-income, and everything that we have been involved in for the last 20 years, is a much healthier environment if you can create it. That would be a vehicle to help the credit in response to Chris' problem.

DAVID REZNICK: You know, Pat, in some way all of you have said we have to take and think out how we're going to do it so it does not make the responsibility of the property manager so complex because we've created something that works on paper but then doesn't really work in actuality because of the complexities we've created.

PAT CLANCY: But working with three or four income levels is not that complex. We have to do it as an industry. We have to have a series of income levels that work in the marketplace and that work in the housing. Come on, it's just math and careful selection.

DAVID REZNICK: Judy, do you want to go on to your subject now?

JUDY CALOGERO: Thank you, David. You've heard it a couple of times here already today. On Oct. 12, Gov. Pataki did sign into law new, and I think landmark, legislation that will ensure uniformity, predictability, and fairness in the assessment of government subsidized affordable housing in New York state. We'd love to see this law be able to go beyond New York state and be something that other states and governments might be able to utilize. We'd be happy to talk to you about some of the details. If I have time, we'll talk about how this got done. The new law requires local assessors to establish the assessed value of the affordable housing property based upon the actual net operating income of the project. By standardizing the method for valuing subsidized housing development, the government agencies who administer housing subsidy programs will be better equipped to evaluate the operating expenses, and consequently the economic feasibility of, proposed developments. We think this income approach to valuing properties is commonly used to determine the value of unique properties when no other comparable properties exist or the replacement cost of the property does not relate to its actual value. The net operating income for a project is the rents collected less actual operating expenses required and deposits required for project reserves. In order for a property to qualify under the legislation, the property must be subject to a regulatory agreement with the municipality, the state, or the federal government, that limits occupancy of at least 20% of the residential units to an income test. The legislation is effective immediately and it applies taxable status dates occurring on or after the first of January 2006. I think that this legislation would not have been possible were it not for a statewide association that we work very closely with, the New York State Association for Affordable Housing.

ANDRE SHASHATY: Can you try to bring it down to concrete terms how it benefits a project?

JUDY CALOGERO: Yeah. It's going to require tax assessors to look at these projects uniformly across the state. They're not going to be able to just do whatever they want to do. In addition, the developer is going to know that upfront. Before the time that they submit their application to us, they're going to be able to plan what the property tax is going to be.

ANDRE SHASHATY: So it's not necessarily lower, it's just more uniform.

WALLY SCRUGGS: Putting aside any assumptions on what cap rate you might use – assuming you can come to a reasonable compromise on the appropriate cap rate – what this really does is instead of the assessors looking at the last 10 projects that sold and were recorded in land records, and they can see what the price per unit is, and say, "Oh, you have a 100-unit project and they're selling for $50,000/unit, and therefore using a market approach, we're going to value your project at $50,000 a unit." Well, based on its income stream, it may not support a value of $50,000 a unit. It might be $40,000 a unit. That is the biggest impact. By using the income method, it's going to set the real estate tax based on the project's ability to pay. We have this in Maryland. Corine and I are on a board of an affordable housing advocacy group in Maryland, and we just got very similar legislation through the Maryland state legislature. It sounds like a carbon copy almost. We're still arguing with the assessors over the cap rate.

LEE HARRIS: First of all, with respect to the cap rate, if we could include in the legislation, as more states get on the bandwagon here, a mandating band of investment method for calculating the cap rate, that would squeeze a lot of the air out of this equation. Obviously, band of investment is a component of debt and a component of equity. The debt component is easy to calculate based on whatever the loan constant is (theoretically). The equity side of it is where it gets hairy. I submit that a combination of the internal rate of return being achieved by the syndicator – which right now is pretty low, but everybody forgets that the risk premium that the developer is undertaking with respect to these guarantees – one could make an argument that whatever the percentage of the developer fee is of the total equity ought to be a piece of that equity component. While it sounds complicated, I believe that you can formulize band of investment and mandate that through legislation.

The other thing, David, is how do you make the assessors play ball? In Iowa, in Kansas, in several states where we've undertaken this legislation in years past, we still have rogue assessors running around deciding they will do whatever they want because they have no accountability. Again, if you want to legislate, you could build a penalty into the legislation whereby the assessor, if he doesn't play ball and it's appealed two or three times and he consistently isn't playing ball, somebody has got to write a check back to the developer.

DAVID REZNICK: We're not going to have all of the answers today, but we do understand that we have to get real estate taxes more uniformly treated, not just within the states, but outside of the states so that we can really get things under some form of uniformity. No question about that. Judy, any thought on that beyond what you've already done?

JUDY CALOGERO: Well, in New York and I think now in Maryland too, it's going to require the assessors. The other good part of this is it's going to get the assessors back to school to learn how to do this. I think it's going to open their eyes a little bit to some of the work that we do that they've closed their eyes to for so long.

DAVID REZNICK: Hopefully, the assessors won't be like umpires. There is going to only be so much that you are able to judge, but what you're saying is that having it read off financial statements makes an awful lot of sense. That's what they have been doing for years in some parts of the country.

JUDY CALOGERO: It forces the assessor to take into consideration our project reserve requirements, which are very needed for the developments.

DANIEL CUNNINGHAM: Changes that reflect on an increase in net operating income are good from a standard financial perspective on these deals. We're talking about the ability to do more leverage. What the financial community did on the tax-exempt bonds side several years ago was to make an adjustment to take into account the value of the tax-exempt financing by allowing for up to a 100-basis-point reduction in the cap rates. So, cap rates really are a key component of making sure the value is appropriate, but I still back up to the core issue of being able to enhance leverage.

DAVID REZNICK: The counties or the states will have to in some fashion understand where they can come up with replacement revenue. All of this doesn't go into the governor's salary. A lot of this goes into schools, police, and other services that are provided. We have to be open-minded as we come up with the solution, but we do need a solution. Jana, why don't you come into the last written one because we've got some write-ins that we want to bring in should we have more time.

JANA BLACKMAN: What's worrying me and what is keeping me up at night in terms of this industry, and not merely because we're writing legal opinions on structures now that push the envelope, although I like my house and I'd rather not lose it, is the various tensions that play in this industry. We've talked a lot today about the increased cost of getting projects built. That's the tension down here at the bottom tier, if you will, of these deals. There's also very real and very profound economic tension coming in this way. What you have is a market where yields have fallen dramatically and pricing has gone up. When I started in this business, like a lot of you, we used to pay 40 cents on the dollar per credit and yields were 18 on an after-tax basis. Now, we have clients paying in excess of $1 per credit, over $1 for a dollar of credit for yields of 5%. In the guaranteed market, we're seeing yields in the fours, low fours. We're seeing very little difference between guaranteed and unguaranteed spreads. So, we're seeing very real economic pressure. On top of that, which makes no sense, we still have more money chasing deals than we have deals. So, we have prices dropping and more money chasing deals than we have deals, and we have that pressure coming to bear down here on the increased costs coming up this way. Who gets squeezed in the middle? The syndicator.

Last year my focus was developers; this year the bane of my existence is the syndicator. But what is happening as a result of this is we're seeing shortcuts. We're seeing strain put on legal structures that cannot withstand the strain. It's being done at the lower tier to try and cut costs or increase revenue, and it's being done at the upper tier to try to boost yield to the investor or to get more money. In the past, this industry has enjoyed a “bye” for many years from the IRS that I fear it's going to lose. So, you've got the upper-tier pressure and you've got the lower-tier pressure squeezing down here. The first thing that happens is the syndicators' fees are being cut. One of my concerns is that this is playing out in reduced asset management. I fear the asset management, the first line of defense to make sure we're complying with Sec. 42, is being whittled down. That is fear number one: asset management. I've seen more projects fail this year than I have ever seen. We've made more money in legal fees this year from workouts than we've seen in all the time I've been in this business. Projects are failing. Asset management is being reduced. We could have caught the problem sooner. That is issue number one I'm seeing.

The second stage of this is what I will call the legal risk and the structural risk. It used to be the case that we required developer fees to be paid off in 10 years. Then it became 12 years. Then it became 13 years for no apparent reason. Now, most of us will allow developer fees to be paid off in 15 years. I cannot begin to tell you how many projects I now get that cross my desk that have developer fees being paid off through a capital contribution by the general partner in Year 16 or Year 17. They want that developer fee included in basis. I'm seeing it all the time. It's making me very nervous. That's example number one on the legal structure.

Next, debt that isn't real debt being included as debt in order to boost basis. Grants that are being funneled through as debt. I get sets of loan documents and they say this does not have to be repaid, like that is not going to make me crazy. Or I get projections that show there is no chance ever for this to ever be repaid. This is why lawyers and accountants don't get along. I see us stretching the limits of, let's say, the HOME program and the regulatory framework. I've seen deals cross my desk where one loan is artificially divided into two or three loans when the tax rules – and I'm not a tax lawyer – say effectively they're going to be consolidated because all of the loans were made on the same day and they all have the same interest rate. These are the kinds of structural risks I see us taking. My fear is that it takes a while for the IRS to catch up. Okay, it does. But once they catch up and they hone in on this, we potentially go the way of all those other real estate tax shelters and the other tax shelters that have not enjoyed the halo effect that this industry has enjoyed by virtue of serving people who need to be served.

That's the problem in a nutshell. I'm seeing reduced asset management. I'm seeing far too aggressive lower-tier structures and the lack of policing because there is still too much money chasing too few deals. So, deals are getting done that shouldn't get done because we need the deals. The checks and balances are gone and it can't be up to the lawyers to kill a deal. It is the worst possible answer for me to say this deal doesn't work and I won't issue a tax opinion. Before it gets to me, you should save yourself the legal fees and structure it in a way that works. In terms of solutions, one is do it right. Two is, could we please go back to contractual remedies? Contractual remedies in multi-investor funds, so the investors have real rights to look over the shoulder of the syndicator, to make sure the asset management is being done. Contractual remedies at the lower tier where developers stand behind their deals, and let's get back to the framework that we know works and be aggressive and creative legal ways as opposed to ways that in the end are going to kill us.

DAVID REZNICK: Jana, that all starts with the real estate deal itself. What it takes for a real estate deal to make sense and at what point early on something does really not make sense, it stops getting pushed up to your point. Tony?

TONY FREEDMAN: Just let me second it with a couple of examples. When you and I were doing the very first development agreements, we were very careful about what went in and what went out [of eligible basis], and what we could defer. The TAMs showed us that others were a lot less careful about what went in and what went out. Renee and I did the first Hope VI with Centennial Place. God, were we careful. We had half of the Hope VI loan go in at the applicable federal rate and half of it we excluded as a grant. Today, we see Hope VI loans which balloon at the 40th year and believe that a public housing project in the 40th year is going to pay off that Hope VI loan, that its value is going to be sufficient. We believe that's good debt. We see this across the board. We see it in cash flow splits. We have been living, Jana rightly points out, in a fool's paradise in this area. We've never had a 10% test challenge by the IRS. We've never had an allocation challenged by the IRS except when the state agency walked in because it had some invalid allocations. The administration of this program has been so benign by the Service that we are all protected, and yet the good money is in fact being driven out by the bad, so that we really do have to pay attention to this area so that we don't come back to you and explain why you have to pay us a great deal more in legal fees to bail you out.

WALLY SCRUGGS: Just a couple of points. First, on deferred developer fees, frankly from a developer's standpoint, and I know you developers here will agree with me, I think that should be un-American. It shouldn't be allowed. But all joking aside, we actually work in one state (and I'm not going to mention it because it is not so important to identify the state), but we're using one of their soft second programs and we're required to defer a portion of the development fee as a condition of being awarded that particular subsidy. If we of course need that subsidy, we had no choice. That subsidy was far greater than the portion of our developer fee that we had to defer, so that was forced on us. Frankly, if I could have figured out a way to bring more subsidy and more dollars into the projects and we wouldn't have to defer the fee, of course we would do that. There are some situations where it's being forced on the developers.

DAVID REZNICK: You know, you have an issue that the "fix" has to start somewhere because wherever a deal walks itself into a syndicator, when that syndicator says no, it walks to another one and another one and someone looks at their fund and says, "I need 7 million so I can close this one out. Harold, how can we make it work?" We're going to have to think about how we can police ourselves, because you're right, Tony, in that we have not really been looked at that hard by the IRS. The net result is that housing is being provided because equity is coming in without regard to, Jana, your sleeping habits and mine and so forth. But at the same time, we've got to figure a solution two ways. One is to get more equity in through some changes that would allow deals that don't otherwise work, that need some of the year's zip code depreciation or interest accrual in order to pump up the numbers. I've heard of those things before, but I think the fix within the same budget is a certain flexibility within the agencies to allocate more credits in some fashion, but we really have to think that out so it doesn't really get abused. Because every time you figure out something there comes to be an abuse on it. I need one more comment on this, Stan, and Ronne – two more comments. Then, what I'd really like to do, guys, you guys in the audience that think you've gotten away without contributing or having to make any kind of noise, we're going to ask you of what you've heard, which are those comments that you would like us, the magazine, to move forward with.

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