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[ continued ]

Larry Swank, The Sterling Group: I’m Larry Swank, and I’m a developer from South Bend, Ind. I would also echo quite a few of the remarks made here. One of the biggest things confronting us in the Midwest is the QAP and all the social engineering that’s taken place in the last few years, creating a process that leans far to the left. I’m not sure if we’re fortunate or unfortunate in Indiana to have selected Mitch Daniels, [President Bush’s] former director of budget, as governor. We are going to see a housecleaning and a change in the entire housing finance authority. We think this will move us back to the middle of the road.

I build on the comments that David mentioned about the Republican administration. I view this as an opportunity in the next four years. This administration has certainly been an advocate of the single-family housing tax credit as well as multifamily. I take that as a positive, and I hope that David and I are right about that.

The biggest item, next to QAPs, that confronts us in the Midwest is the soft market from unemployment. In many cases, what was a strong market three years ago is soft, not from overbuilding but from lost jobs and people moving out. So we found tremendously soft markets in many areas that were strong three years ago. I guess that’s the biggest challenge we face because the markets have really dwindled in the Midwest. We build in Ohio, Indiana, Illinois, and Michigan, so we pretty well take the center of the Midwest. All of those states are very similar. There are pockets that are strong, pockets that are very weak, and there are pockets that look like they’re gaining strength for six months and then they kind of lag. The QAPs are probably the single biggest issue confronting most of the developers we know in the Midwest. As Elizabeth mentioned, one thing that everyone across the country has had is [problems with] the compliance side and recertifications that are constantly coming at us, especially with 12/31 approaching; trying to keep everything in guidelines and not getting any 8823s. Those are the major challenges I see the developers having.

Jeanne Peterson, Reznick Group: I’m Jeanne Peterson. I’m glad to be sitting between these two optimistic people because I haven’t felt very optimistic for these last two weeks. I’ve been with the Reznick Group, a partner of Dave Reznick, for about three months. I left my prior life, which was all in public service, running the tax credit committee in California for about five-and-a-half years. Prior to that, in Michigan, I was general counsel to the state housing finance agency. I think escalating costs are a major issue. With respect to this, as California goes, we hope the rest of the nation does not go. With the implementation of a prevailing-wage requirement …, which raised costs that were already tremendously high in California for doing tax credit deals, considerably fewer units will be done. The land costs there, of course, are very high. We have other costs there such as subterranean parking and seismic things that you don’t have in a lot of other parts of the country.

I think I can understand why people are so concerned about the QAPs and the uncertainty they cause. You put a lot of money into putting in an application on the 9% side, and you have no certainty of getting an award. Also, as was mentioned, there are some compliance issues that relate not only to the myriad 8823s that states are being required to issue, but also what’s happening to them. Does it make a lot of sense to have to report something that has already been fixed? There are staffing and expertise issues that state agencies have. As the market is becoming more and more important, do states have ample market analysts? More and more states are hiring their own market studies rather than having them done separately. There are also some issues with the Internal Revenue Service [IRS], and I’m not sure how we should deal with them. Recent audit rulings have sown uncertainty among all of us.

Heller:  When I’m not working with the NAHB housing credit group, I’m a principal with The NRP Group. We’re located in Cleveland, Ohio, with developments that have both 4% and 9% credit. We’re active in Michigan, Ohio, North Carolina, Virginia, Texas, New Mexico, Indiana and Arizona. We see a lot of QAPs, and I think that that is definitely a large problem; I echo Ronne and Larry.

The thing that we see is the boxing out of the experienced developer. This is really a problem for our industry – when you give points and point chasing for a lot of the CHDOs [community housing development organizations] and less experienced nonprofits just because they feel they have a right to be at the table. I think it’s important that the nonprofits do play a role in affordable housing. We’ve partnered with them over the years, and they do have a distinct role to play in their area of expertise, supportive services and providing service to the residents. This should be applauded, but it shouldn’t be rewarded by turning them into housing development organizations when they don’t have the capital or the experience.

The state agencies, with their QAPs, need staff who can take more of a long-term perspective with affordable housing. They need to look into their crystal ball as best they can and take a look at those properties 10 or 15 years into the future. I think they would take a whole different approach with a long-term perspective. The members that sit on the boards of many state agencies are in appointed positions. When you sit down and talk QAP with some of them, you see their eyes glaze over, and that’s a real problem for our industry. They are very bright people, and they have every reason to be there. However, when it comes to the QAP, which determines where the housing will go in their communities, they have a lot of power but not a lot of expertise, and that’s a challenge.

Chris Foster, Hampstead Partners: I’m Chris Foster. I’m the president of Hampstead Partners, a San Diego-based, for-profit developer specializing in repositioning preservation properties nationwide. I also serve as president of the Institute for Responsible Housing Preservation, which is an industry group made up mostly of developers, housing finance organizations, and so on that are interested in preservation activities around the country.

I would echo a couple of things. One, David, I applaud you for taking the politically incorrect stance on the targeting toward nonprofits. I think that it is a gutsy move, and I think all us around the table need to be willing to take gutsy positions. For us, the toughest issues are uncertainty at HUD and uncertainty surrounding the credit. Finding properties that make sense at an affordable price in this extremely competitive real estate market is another major issue. Some people talked about the QAPs and their extremely deep targeting; this is a major concern. The uncertainty about HUD cost-cutting is causing us some heartburn along with some of our syndicators. With HUD, if we ask for a budget-based rent increase on a preservation property [Sec. 8], we’re not having that overhang any more that used to fund the cash flow and the transition reserves. They’re not underwriting – except on [Sec.] 236 projects – new debt anymore in budget-based rent increases. I wait for the time when they say they’re going to cut your developer fees and not underwrite those. This is a controversial thing that I’ll bring up, but I believe that the housing industry, if it is to survive in tough times, does have to respond to what the government wants and is looking for. Ultimately, as an industry, we have to think of how we’re going to provide services as part of our housing, not just providing a couple of computers in a learning center but really helping people get on their feet and find employment, and so on. I think we have to figure out how to integrate this and how to fund it. Right now, it doesn’t seem like there is a lot of effort being put into this integration.

R. Lee Harris, Cohen-Esrey: I’m Lee Harris with Cohen-Esrey Real Estate of Kansas City, a full-service real estate firm specializing in both commercial and multifamily properties. We have a development unit for affordable housing. We do some acquisition/rehab historic work and have a construction unit.

I’ve worked with HUD for 30 years. Our biggest concern is a nuts-and-bolts issue: the economic viability of existing projects, and are we going to continue making the same mistakes we’ve made for the last 15 years, when nearly 25% of the LIHTC market is underwater financially? The default rate is 1% so a lot of investors are shoveling a lot of money into these deals to keep them alive. I’m very concerned that if too many corporate investors shovel too much money into these deals and see their IRRs diminishing even further, are we going to have the investor market we need to make this industry work? It comes down to underwriting and lenders, developers, and syndicators being realistic. State agencies can’t play politics and have to look at deals from an economic standpoint as well as making the social applications they need to make.

David Perel, Preservation Properties:I’m Dave Perel with Preservation Properties. We do acquisition/rehab of HUD properties using bonds and credits in California. In California, there is just as much of a problem in strong markets with tax credits. Because of costs and rising rents, projects are very difficult to do without tons of subsidies, and there is intense competition for that. The state has a $15 billion deficit, so there won’t be more subsidy any time soon. In terms of the tax credit program changes, you have to find ways to better integrate it with market-rate projects. It may take some legal changes, but it’s better to do it with mixed-income projects. If you look at conventional projects in California, you can raise much more capital with market-rate rents than you can with credits. If you’re a credit developer and you have to compete to buy land and existing properties, competing against that and the costs you have to pay is just ridiculous. The credit becomes sort of an artificial program: there’s no cash flow and, in a kind of pyramid thing, the developer’s profit is their developer fee on the next deal rather than the ongoing cash flow. Our nonprofit partners have no income unless it’s on the next deal, and they’re always starving for cash. This is where the program has reached, and it’s time for some recasting of it.

Chris Tawa, MMA Financial:I’m Chris Tawa with MMA Financial. I’m co-managing director of our tax-exempt bond programs. My group operates programs for agency credit enhancement: Fannie, Freddie and FHA. MMA also buys bonds for private placement, so we have a wide array of financing tools.

I’d like to address two issues of concern. On the macro-political level, thank God for David Heller, the housing credit group, Herb Collins, and some others who are close to this administration. It’s crucial that we have advocates for these programs.

My concern is not their effectiveness. My greater concern is the macro-tax policy changes that are looming in the country and if they will undermine the program by substantial reductions in top corporate tax rates that make it less appealing for investors to invest in the credit as opposed to CRA-driven investors who will be required to. I’m also concerned about municipal bonds and if there is a continued movement toward a tax-free dividend distribution. What will that mean about what we pay for muni bonds and can we maintain a below-market yield on those bonds? Our advocates on the Hill and in the White House might be very effective in protecting the programs, but the programs could wither due to some more macro changes and some changes at HUD where the Sec. 8 program is never eliminated but could be regulated, interpreted and managed to a point where it is totally ineffective and can’t be used for the NRP and Hampstead types of preservation deals. So my concern is the backdoor way our programs might be affected rather than the front door, where our advocates could protect them. The second area I want to put on the table is the general lack of discipline in myself and so many of my colleagues in this industry in what I call the “help me before I invest again” problem. How many deals do we see that we say no to? We’re producers, and we try to do everything. My company doesn’t pay me for not doing deals.

Tony Freedman, Hawkins Delafield & Wood: I’m Tony Freedman of Hawkins, Delafield & Wood. I’m your friendly neighborhood housing lawyer wherever your neighborhood is located. I’ve probably closed deals for or with more than half the people at the table. Before that, I was with HUD.

I’d like to start where Chris ended. The most significant challenge today is simply getting an allocation. Once you’ve got an allocation, even the worst deal can close. The most unfinanceable deal will find financing. The weakest, shadiest developer will find equity at 85 to 90 cents on the dollar. I’ve been saying for 10 years that it can’t go on this way. It did go on, and we’ve been living in a fool’s paradise. We’ve been operating with incredibly low interest and default rates in high-demand rental markets. We’ve been proceeding apace and conditions have been getting better. Equity yields to developers are still going up, even 10 years after we declared that they couldn’t keep going up.

If we look at the reasons for this, we can see the dangers in the future. Part of the success of the tax credit program has been the poverty of its own ambitions. We do about 100,000 units a year in an environment in which, just to meet replacement needs in the rental sector, you probably need 200,000 to 300,000, aside from new demand coming on. We are way short of demand. We operate at the absolute middle of the rental market, and we put everything into it. We spend half of our resources redoing old HUD deals. We look at the tax credit program over the last 16 years and say it produced about 1.5 million units. In four years at HUD, I funded 1.5 million deep-subsidy units. A million hard units: we’re still playing with that inventory 15, 16, 20 years later. Let’s understand how limited the ambitions of the program are.

Second, we’re operating in an environment of the most benign administration. Sure, we complain about the IRS, state agencies and HUD, but the truth is that even HUD has behaved well in this program. As far as the Internal Revenue Service in its administration of the tax credit program, as they say in another context, “even when it’s bad it’s good.” When you look at the non-eviction ruling, they were really trying to do something useful and to put it out in a way that the states would have time to administer it. Yes, I believe they’re wrong in the substance of the ruling and that it’s not a good idea in this context, but if that’s the worst they can do, it’s not so bad. With HUD’s new rule on effective dates for difficult development areas, HUD did something that made the program work better. Overall, we’ve had an incredibly benign administration. We’ve also had one program for 16 years, which is four times as long as the half-life of any housing program.

Finally, a word about the incredibly good and steadily improving market circumstances in which we’ve been operating. It is in those good factors that we see the threats for the future. What are they?

First, we’re getting to the end of the first round of use restrictions on these projects, and that means several things: one, bad publicity as projects convert to market uses; second, efforts by the state agencies to put more new allocations of credits into keeping old properties from converting; and third, increased complaints to the Congress as Congress begins to consider whether the 15 years that it first gave us as a compliance period, and the 30-year extended use period that it gave us, are all enough in exchange for this very generous benefit of the low-income housing tax credit.

Second, other people have mentioned tax reform. Tax reform is a real threat. It’s going to make 1984 look nice.

Third, increasing pressures at the low end of the inventory. We can’t count on the Sec. 8 renewals, we can’t count on the vouchers being there. Budgetary pressures are going to make the housing assistance harder to come by.

Fourth, we don’t know what’s going to happen in the compliance area. Yes, we’re getting 8823s, but there is no suggestion that the Service is reading those 8823s. The [Internal Revenue] Service might actually start reading them, might audit and send deficiency notices. Moreover, if the Service begins to focus on compliance and auditing in this area, that’s going to increase pressure on inventories. There’s no indication yet that it’s happening, but it could happen. If the Service takes a more enforcement-oriented view toward the program, the pressures are going to increase.

Fifth, the equity prices have been so good because of high concentration but high competition among the very few players in the equity market. The big players, Fannie and Freddie, are under enormous regulatory pressure from Congress. They missed an opportunity to get a fairly benign regulatory structure a year ago. The next time through, for a change in the Fannie and Freddie regulatory structure, the GSE legislation is not going to be so benign, and we don’t know what impact that will have on their willingness to invest in tax credits. The equity market is very strong but very thin.

Finally, the inexperienced participants are sooner or later going to get in trouble. Sooner or later, they’re going to have defaults and challenges to legal opinions they can’t deal with. Sooner or later, they are going to have to defend accounting practices they can’t justify. Again, each of those is a threat so let’s keep walking out over that cliff like the Roadrunner – but things could change.

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Donna Bushore
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