Affordable Housing Finance

FINANCE

TAX CREDIT EQUITY

Syndicators Predict Better But Still Restrained Second Half

AFFORDABLE HOUSING FINANCE • October 2008

BY DONNA KIMURA

Low-income housing tax credit (LIHTC) syndicators remain subdued about the second half of the year after a tough first six months marked by reduced investor equity and sagging prices to affordable housing developers. Although a few syndicators anticipate more money entering the market before the end of the year, their expectations are guarded.

"We expect to see investors that have been cautiously watching the market to step up somewhat in the second half of this year," said Joe Hagan, president and CEO of National Equity Fund, Inc. "It will be difficult for many of them to meet their goals otherwise. Beyond that, I wouldn't say that I necessarily anticipate a lot more equity, but I think there are signs for cautious optimism on that front, the housing legislation being the biggest reason."

Hagan said yields have jumped about 50 basis points since the beginning of the year, with pricing off by 3 to 4 cents from what it was in December. "Right now, the most important variable is where a project is located," he said. "If it's in a Community Reinvestment Act (CRA) market, it can find investors. On the other hand, projects in non-CRA markets are having a more difficult time attracting investor interest, even at a higher return. If this continues into 2009, it could fuel some significant disparities in where new affordable housing is being built across the country."

Other syndicators agree that activity will likely be restrained through the rest of the year.

"We know some previously inactive investors are now more engaged as yields have risen, but we generally expect activity to stay slow under current conditions," said Chris Grim, director of equity investments at Red Stone Equity Partners, which is in its first full year of syndicating tax credits. "Until financial markets stabilize, activity will continue to be muted."

There are no quick fixes on the horizon to entice additional capital into the tax credit market, added Todd Crow, director of institutional sales and portfolio management at PNC MultiFamily Capital, who said he expects to see some new investors enter the market later this year and in 2009, but they will likely just replace those who are sitting out. "To see a material increase in capital, I suspect we will either need to see a dramatic improvement in the fortunes of the financial-services sector or an increase in yields aimed at attracting capital from outside the financial-services sector. Or both."

Banks and other financial institutions have been key LIHTC investors.

The recent decline in available equity is due to investors pulling out of the market or severely reducing their investment activities. For example, Fannie Mae invested $10 million in tax credits in the first half of 2008, a sharp drop from the $620.5 million it invested in the first six months of 2007.

Fannie Mae leaders said they will look closely at the Housing and Economic Recovery Act of 2008 to see what the new bill might mean for their LIHTC business. The legislation includes several key changes to the LIHTC program, including repealing the alternative minimum tax limitations and other possible incentives for investors to return to the market. Signed by President Bush on July 30, the bill offers some hope for sparking renewed investor interest in the market.

Fannie Mae's participation, however, "will be a function of the overall earnings of the company," said Ken Bacon, executive vice president, just prior to the bill's signing.

That will be the case for other firms as well.

Second-half expectations

Going into the second half, there will be continued pressure on pricing and yields this year because of the drop in investor demand, said Carl Wise, senior vice president at Alliant Capital. "We are seeing pricing differentials between deals in the larger markets (New York metro area, Los Angeles, and San Francisco, for example) and deals in more secondary areas."

The overall economy needs to stabilize, and yields and pricing need to remain attractive to bring more capital into the market, Wise said.

Several syndicators noted the need to widen the LIHTC investor pool, but that's likely going to require stronger yields to investors. The challenge is finding the right balance between good investor yields and sufficient prices to developers to make their affordable housing projects work.

"The difficulties being experienced in the financial-services sector highlight the necessities for greater diversity in the LIHTC industry's investor base," Crow said. "At the moment, the need for more diversity among the investor base is my biggest concern."

To attract more LIHTC investors and bring more capital into the market, "yields will need to increase to bring in non-CRA investors, and real estate as an investment class needs to stabilize to give new investors the confidence to internally pitch future investments in real estate," said Paul Cummings, senior vice president of syndication at Enterprise Community Investment, Inc.

Greater market stability in terms of yields may also help to attract more investors, according to Steve Kropf, senior vice president at Raymond James Tax Credit Funds, Inc.

Looking at the second half of the year, he anticipates prices to developers being stable to declining and yields to investors being stable to increasing.

Others are also counting on a steadier ride.

"We expect yields to stabilize somewhere in the 6 to 7 percent range, depending upon perceived deal quality and location," said Mirko Jokanovic, manager at Credit Capital, LLC. "We also anticipate that investors will require more guarantees and protections from developers than had been commonplace during recent years, returning to levels similar to what had been typical prior to 2003."

Jokanovic said he sees more equity entering the market, but the amount is incremental. "New investors are poised to enter the market, but time is needed to educate them while existing investors are still in the process of consummating the deals that are currently before them. The new pricing is attracting greater investment, but it will take time to reap the benefits."

Red Stone's Grim also anticipates an increase in investor yields and price declines to developers in general in the second half. "However, we are seeing some stability in pricing for experienced LIHTC developers in top-tier urban markets," he said.

What to watch

Syndicators cited several trends that developers should watch in the next several months.

There may be more scrutiny of a developer's balance sheet as well as the potential exposure from the condominium and single-family home market, said Alliant Capital's Wise.

Developers should also watch for "issues that could impact deal timing, limited availability of soft or public financing, and rental markets that continue to be soft or weak," said Enterprise's Cummings.

PNC's Crow said an important trend for developers to watch relates to the health and well-being of investors and, to a lesser extent, syndicators. "Tax credit modernization legislation has now been enacted, and the federal government has done its part," he added. "Now, the burden has shifted to states that are charged with implementation. This would be a significant benefit to developers and to transaction feasibility generally. This is something that developers should monitor closely."

Developers should also keep in mind that this is an investors' market with a trend toward more conservative underwriting, particularly with regard to the need for reserves and guarantees, Hagan said.