Rising interest rates and the emergence of deals propelled by the Rental Assistance Demonstration (RAD) program will be two issues to watch in the coming year.
What likely won’t change is the heavy demand for low-income housing tax credits (LIHTCs) by banks and other investors.
“I’m projecting the market to remain relatively stable at the highly competitive level that we saw this year,” says David Leopold, senior vice president and tax credit executive at Bank of America Merrill Lynch. “The biggest variable will be what happens to interest rates.”
The word “competitive” is also used by Brian Coffee, manager of community investment capital at Regions Bank.
“We anticipate that equity pricing will remain very competitive,” he says. “Urban transactions continue to get more favorable terms and prices, but rural markets are surprisingly robust.”
The decline of yields
Strong investor demand for LIHTCs has kept prices high for developers with credits to sell. That’s meant investor returns have declined in the second half of 2014.
Heading into the new year, there’s going to be continued pressure on pricing and yields, according to Jeff Weiss, senior managing director and senior vice president at Hunt Capital Partners, a LIHTC syndicator.
“It started earlier in 2014,” he says. “Over the past year, sell yields have dropped 75 basis points, while buy yields have dropped almost double that amount. I think we’re going to see continued increases in pricing at the project level, with yields falling.”
As prices increase and yields decline, financial investors may exit the market or reduce the amount of their investments, Weiss says. That could result in prices leveling off in 2015.
About 15 percent of the market is made up of economic investors, estimates one industry observer. Although it's not a large segment, it's an important one that helps diversify and deepen an investor pool that's dominated by large banks.The banks continue to big investors because the credits also help them meet their Community Reinvestment Act (CRA) obligations.
Returns on national multi-investor funds had inched down to between 6.5 percent and 6.75 percent in the fourth quarter, according to dealmakers.
That’s significant because there’s been much speculation that yields need to remain at least 7 percent to satisfy economic investors and keep them in the market.
Despite the lower returns, funds were moving ahead at the offered yields in October, says Rick Floreani, a partner at Carlisle Tax Credit Advisors, a Boston-based firm that advises LIHTC investors.
“I think yields are getting to a place where, in the first part of next year, we’ll start to see a clear indication from the market of whether we’re hitting resistance in terms of a pricing barrier,” Floreani says.
Trends to watch
In addition to monitoring LIHTC prices and yields, investors will be keeping close tabs on rising interest rates. In early October, the 10-year Treasury was around 2.44 percent, up from the 52-week low of 2.31.
If returns on alternative investments increase, some may switch to those other investment vehicles, says Weiss.
Rising interest rates could also affect 4 percent LIHTC and bond deals, because they typically carry a higher level of debt.
Investors and syndicators also note the recent emergence of RAD deals in the market. The new federal program is central to the Department of Housing and Urban Development’s (HUD’s) rental housing preservation strategy. RAD allows public housing authorities and owners of HUD-assisted properties to convert units to project-based Sec. 8. The program opens the door for existing developments to preserve their affordability and finance needed renovations, often using LIHTCs.
“We were an early adopter of RAD,” says Leopold. “That’s an important trend in the industry. We have several clients that have redeveloped public housing as RAD deals.”
Bank of America Merrill Lynch will close approximately six investments in properties that will have RAD-assisted units this year, according to Leopold.
Others are also watching for more of these deals.
“That trend is going to increase,” Weiss says. “Many of the initial deals will come to fruition next year.”
Overall, Weiss says, there continues to be a growing focus on preservation by states in their qualified allocation plans, which is resulting in a large number of rehab deals.
In addition to RAD projects, there has also recently been a number of developments targeting veterans, according to dealmakers.
Another issue to keep an eye on is the possibility of new investors entering the market as a result of recent accounting changes.
At the end of 2013, the industry received good news when the Financial Accounting Standards Board (FASB) determined that LIHTCs should be classified as investments and not deferred tax assets. The board supported allowing qualifying investments to use the proportional amortization method, in which the costs as well as the tax credits and other tax benefits of the investment are reported in the income statement on a net basis as a component of income taxes.
The bottom line is this makes the accounting of LIHTC investments easier to understand. So far, the FASB ruling has been an emotional lift more than anything else. There hasn’t been any big effect on the market.
More will be learned about the impact of FASB in 2015. By then, new investors may begin to enter the scene.
This year, the market also saw the growth of funds with multiple shared classes for CRA investors.
This wasn’t new, but it increased in popularity, says Floreani.
These multi-investor funds typically have a CRA component, with tiered pricing for certain property locations. The tiers help bring different investors into a fund, and someone who wants to claim a property for CRA needs would pay more for that property. The higher price enables the fund and investor to win the tax credits on a desired property while the fund overall can still deliver a good yield.
“There’s been enough market acceptance that it seems a popular way to bring multiple investors together in a fund who might have nuances and differences in where they want their assets to be,” Floreani says.
Connect with Donna Kimura, deputy editor of Affordable Housing Finance, on Twitter @DKimura_AHF.