FINANCE

TAX CREDIT EQUITY

LIHTC Investors Weigh Year Ahead

BY DONNA KIMURA

AFFORDABLE HOUSING FINANCE • JANUARY 2008

The big uncertainty going into 2008 is how active, if at all, the biggest low-income housing tax credit (LIHTC) investor will be in the market. Several affordable housing industry leaders have said that Fannie Mae, which has been the single-largest LIHTC investor in the recent past, will be out of the market or will significantly reduce its LIHTC investments this year.

The company has been cautious about what it says to the press.

“Fannie Mae has been a provider of liquidity for the low-income housing tax credit market for nearly 20 years and looks forward to continued participation in this important affordable housing market in the future,” said Ed Neill, vice president of tax-advantaged equity, in a written statement in October. “As with other investors in this market, we periodically adjust our levels of new investments and our levels of sales of LIHTC assets to correspond to our current corporate tax liability.”

Market participants have also raised concerns that Freddie Mac and Bank of America, two other big-time investors, may reduce their LIHTC activities.

Experts say that the loss of such major investors would translate to price declines and market volatility for developers.

Bank of America recently confirmed that its community development banking group will no longer be a separate division. Instead, it will be integrated into the commercial real estate banking division. Phyllis Caldwell, who had been president of community development banking, has also retired from the bank.

Bank of America spokesman Greg Barnard said the bank remains committed to the housing tax credit industry and will continue to be active.

AFFORDABLE HOUSING FINANCE asked other investors how cutbacks by major investors would affect them and the equity market.

Assuming that everything else stays the same, it should mean that there will be a significant reduction in demand, which will mean that prices for LIHTCs will drop and yields will rise, said Jim Mendelson, managing director of tax credit investor GE Real Estate. “However, if interest rates continue to decline, that should have the opposite effect,” he said. “Regardless, as a general rule, less competition for credits given a stable supply should mean a better environment for investors.”

In addition, the retreat of major investors could mean that more investing will be done through proprietary funds as syndicators shift placement efforts to reduce warehousing risk, he said.

“Clearly, there is concern in the market right now about a supply/demand imbalance,” said Cynthia Lacasse, president of John Hancock Realty Advisors, Inc. “If there is truly less demand currently and going forward, pricing will decrease. However, this has been a supply-constrained market. You don’t necessarily have to have a huge change in pricing to bring demand back into the market.”

“I don’t think it will be like what has gone on in the debt markets with spreads increasing by hundreds of basis points,” Lacasse said. “It remains to be seen where pricing will shake out in this market.”

Overall, the product line remains attractive to new entrants and some existing investors, added Beth Stohr, president and LIHTC director of U.S. Bancorp Community Development Corp. (CDC). Stohr is president of the Affordable Housing Investors Council in 2008.

“The impact of those investors leaving could be absorbed by some new investors and others increasing their investments, as occurred in 2007,” Stohr said. “However, this is not a certainty for 2008, and there may be some nailbiting moments at the project level as it pertains to equity pricing and amounts. I do think there will be a continued migration to high-profile and well-underwritten deals.”

When it comes to pricing, there may also be wider price variations between toptier markets and other areas, according to investors.

“My wish for the market is to stem any erosion in terms of underwriting,” Stohr said. “The collective market needs to be smarter at how we structure and underwrite deals. As an example, I am looking for more consistency in reserves at both the project level and the upper-tier level in funds, rainy day funds of sorts.”

While much of the industry talk centered on the potential pullback of some major investors, others quietly had their biggest years.

GE Real Estate was on track to finish 2007 with slightly more than $500 million in equity commitments, said Mendelson in November. That’s nearly twice as much as prior years.

He hopes for a similar year in 2008. “As long as we can find attractive investments with good clients, we intend to invest at least as much as 2007, if not more,” Mendelson said.

JPMorgan Capital Corp. also had its biggest year in LIHTC investing in 2007, according to Patrick Nash, managing director, who declined to reveal how much was invested.

Looking toward 2008, he said JPMorgan Capital, which has invested nationally with a focus on major metro markets, will continue to be active. “I see us having another good year,” Nash said, but cautioned that market conditions would be a factor in determining the volume. (AFFORDABLE HOUSING FINANCE is published by Hanley Wood, LLC, a company owned by affiliates of JPMorgan Partners, LLC.)

Citi Community Capital also had a big year. It was on pace to invest about $750 million in LIHTC multi-investor funds. In addition, Citi had an opportunity to invest approximately $1 billion in the secondary market, resulting in an approximate investment total of $1.7 billion for 2007.

The amount committed to multiinvestor funds was comparable to what Citi invested in those funds in 2006, according to Leila Ahmadifar, market director of the LIHTC investment group.

“The company’s secondary-market activity, however, grew significantly in 2007,” she said.

Citi has invested primarily in multiinvestor funds, and that will continue to be a focus in the future, Ahmadifar said.

She anticipates that Citi will be active in the LIHTC market in 2008, and that its early goal is to keep its multi-investor activity in 2008 on par with 2007 levels.

“I will be looking more closely at deal structure on the lower-tier level and possible erosion of deal terms,” Ahmadifar said. The deal terms that may be examined include early payment of development fees, developer and general partner obligations, construction contingencies, and underwriting assumptions.

“Another hot button for us is developers who are over-extended with respect to their development and management capacity,” Ahmadifar said.

The question for banks

Banks have been among the key LIHTC investors, and many now face financial trouble because of the turmoil in the credit markets. The concern for the affordable housing industry is that troubles would result in the banks having a smaller appetite for tax credits.

Ahmadifar pointed out that banks still have Community Reinvestment Act obligations.

U.S. Bancorp CDC invested north of $375 million in LIHTCs in 2007. The bank hopes to invest a similar amount in 2008. “The issue is whether we can get there or not,” Stohr said. “It’s going to depend on market conditions related to both the yield and underwriting on the individual investments.”

U.S. Bancorp CDC is a direct investor and also invests in multi-investor and guaranteed funds throughout the bank’s 24-state footprint.

As yields began to fall in 2005, U.S. Bancorp CDC invested more in guaranteed funds because yields between guaranteed and nonguaranteed deals were compressed. In 2007, the bank did fewer guaranteed yields and more direct investing.

When asked how the LIHTC market might be different in 2008, Stohr said there may be more growth in other tax credit investment classes. “To the extent there might be a limited amount of corporate dollars in tax credit investing, there may be more splintering into New Markets Tax Credits (NMTCs) and renewable credits,” she said.

The bank’s NMTC investing has outgrown its LIHTC investing in the last two years.

Key Community Development Corp. was on pace to invest about $100 million in LIHTCs in 2007. The firm had approved investing about $51 million in 10 directinvestment deals and another $29 million in investments in five multi-investor funds as of mid-November, said Roz Ciulla, senior vice president and manager of Key CDC. The group had additional deals in the works.

The investment volume was about the same as in 2006, but there were more direct-investment transactions in 2007 than in the past, according to Ciulla.

Key CDC also invests in NMTCs and historic rehabilitation tax credits.

Key CDC concentrates its investments in the bank’s 13-state footprint. It has invested in all types of LIHTC properties with the exception of assisted-living developments.

Ciulla said she anticipated that the group’s investment appetite would be about the same in 2008. Key Corp. has not had the subprime mortgage troubles that some other banking institutions have had.

One area that Ciulla will pay close attention to its project reserves, she said. Overall, she said she would like to see more money in both operating and replacement reserves. Another area of concern is property taxes and insurance costs.

Lacasse of John Hancock Realty Advisors said she expected her firm to finish 2007 with about $50 million in investments in state and federal housing tax credits, which is comparable to what it has done in the last few years. The firm’s LIHTC portfolio is about $750 million. A direct investor, the firm has been in the market consistently.

In November, Lacasse said it was still unclear what the firm’s target investment volume would be for 2008. “We will watch the market and see what happens,” Lacasse said. John Hancock Realty Advisors’ strategy, she said, has been very consistent, and that won’t change. “We continue to look for solid deals with very strong and experienced developers in good markets,” Lacasse said.