The specter of tax reform hangs over the low-income housing tax credit (LIHTC) market, threatening a slowdown in affordable housing production this year.
Even though tax reform may be a year or more away, it’s already triggered major shifts in the industry as LIHTC investors have pulled back since the November election, caused housing credit pricing to fall.
With Donald Trump in the White House and Republicans in control of the House and Senate, the prospects of tax reform have shot up significantly. Trump has called for slashing the business tax rate from 35% to 15% while members of Congress will likely be eyeing a rate in the 20% to 25% range.
“Within a two-week period (after the election), the LIHTC market experienced the most dramatic change this industry has ever seen,” says Mark McDaniel, president and CEO of Cinnaire. “Investors reacted immediately to the possibility of tax reform that would result in significantly lower corporate tax rates.”
Some investors pulled out of funds they had verbally committed, others stayed in but indicated that it would be their last investment assuming a 35% tax rate, and others modified their investment parameters, according to McDaniel, a veteran housing credit syndicator.
“The uncertainty as to what the tax plan will look like is the biggest driver of any hesitancy in the LIHTC market right now,” says Stacie Nekus, senior vice president, investor relations, at Alliant Capital. “Five points of corporate tax rate change translates to approximately 100 basis points of change in internal rate of return (IRR) (on average) which translates anywhere from 5 to 10 cents per credit, depending on the transaction and if it’s a 4% or 9% credit. Those are large fluctuations that make it difficult to adapt.”
Syndicators overwhelming expect pricing to developers to decrease in the first half of 2017, according to an Affordable Housing Finance magazine survey in January. Several market veterans estimate prices will be 10 to 15 cents less per dollar of credit compared with a year ago.
This could mean some deals will no longer pencil out and will need to find additional soft funds or be value engineered. It may be especially difficult for tax-exempt bond deals with 4% LIHTCs, which are more highly leveraged.
The LIHTC is the nation’s primary tool for creating affordable housing, and any drop in the production of housing credit developments is alarming.
“The need for affordable housing is at an all-time high, and the production of units will not come near to meeting demand,” says Tammy Thiessen, director of equity sales, at RBC Capital Markets. “The current market disruption only exacerbates this problem.”
The more than 20 syndicators surveyed by AHF paid an average of $1.02 per dollar of credit in the fourth quarter of 2016 compared with 99 cents a year earlier. Yields to investors averaged 4.47% in the fourth quarter, a drop from the 5.3% average at the end of 2015, according to the survey.
The recent fourth-quarter prices aren’t expected to last and have been coming down.
“Pricing for deals in 2017 will be much lower than deals in 2016,” says Jeff Weiss, president of Alden Capital Partners. “However, these deals will have adjusters to take into account differences in assumptions made at closing and actual tax reform legislation. LIHTC deals will also be envisioned with lesser amenities or the deletion of costs in excess of the amount necessary to support the allocation of credits.
Others agree that the developments themselves may begin to look different.
“Going forward, LIHTC projects will likely be scaled back with ‘no frills’ design elements and will include more cost-saving measures,” McDaniel says, adding that mixed-income projects in strong communities may become more popular because they can support more debt and are a little less dependent on LIHTC equity.
John Wiechmann, president and CEO of Midwest Housing Equity Group, also expects “a return to plain-vanilla transactions.”
What developers can do
While some syndicators expect investor apprehension to remain as long as tax reform remains unsettled, a few are optimistic that many of the concerns will begin to lift in the coming months for several reasons, including the strong bipartisan support that the program has built in Congress, Community Reinvestment Act investors’ continuation to invest in housing credits, and the creativity of the LIHTC industry.
In mid-January, housing finance agencies in Colorado, Illinois, North Carolina, Ohio, and other states were pursuing ways to assist struggling 2016 deals. The ideas include helping fill funding gaps with 2017 tax credits and rescheduling allocation rounds and extending deadlines.
Syndicators also recommend other steps to get through this turbulent time.
“Developers need to be cautious about acquisition prices of properties intended for LIHTC development,” says Todd Crow, executive vice president at PNC Real Estate. “With LIHTC prices decreasing, larger gaps in financing will be created and therefore some developments will have gaps too big to fill. Lowering acquisition prices of land and or existing properties will help to fill some of the gap.”
The next six months will be “choppy,” says Christine Cormier, senior vice president at WNC.
“To the extent deals are in the closing process, there is a high likelihood that they are being repriced based a tax rate of between 20% and 25%,” she says. “Adjusters are being agreed to that would adjust equity up or down based on where we finally land from a corporate tax rate perspective. The key for a developer that is looking to move forward will be to get a good understanding of the ultimate home for the deal and ensuring that there is committed equity to the deal from an end investor at a price point that works for the deal.”
Other syndicators also stress the importance of closing deals quickly, especially remaining 2016 transactions.
“Developers should focus on getting committed deals closed as soon as possible as investors appear to be honoring short-term commitments,” says Tony Bertoldi, executive vice president at CREA. “The outlook beyond the next couple of months and into the second quarter is less clear. Developers should remain in close contact with their syndicator partners and state allocating agencies over the next several months and obtain timing extensions, if possible, or seek additional soft dollars or additional credit awards on deals that have an immediate requirement to close.”
While investors may remain on the sidelines, clear guidance from the administration may result in an avalanche of demand for new deals, so the market could move very quickly. The economy appears to be very healthy, and once the dust settles, investors should continue to have a strong demand for credits, Bertoldi says.
“Do not delay in closing transactions to the extent a viable investor commitment is in hand,” says Stephen Daley, executive vice president at The Richman Group Affordable Housing Corp.
If you need to close soon, push hard to do so, adds Hal Keller, president of Ohio Capital Corporation for Housing. “If you can, wait until things calm down,” he says.
In addition, developers should be conservative when estimating LIHTC pricing.
“Expect lower prices regardless of tax reform clarity due to higher interest rates and looming threat of tax reform,” says Steve Kropf, president and CEO of Raymond James Tax Credit Funds.
Being cautious on pricing expectations in the 2017 allocation rounds, agrees Mark Gipner, manager, fund development, at Community Affordable Housing Equity Corp., often known as CAHEC. “The magnitude of the pricing reduction is unknown at this point,” he says.
Staying in touch with your financial partners will also be critical in the coming months.
“It’s going to be an uncomfortable adjustment period to adapt to this new pricing environment, especially given the unprecedented speed at which it has occurred,” says Ryan Sfreddo, managing director at Red Stone Equity Partners. “Now, more than ever, is the time to be communicating early and often with your financial partners and other project stakeholders.”
2016 Tax Credit Activity
|Company||Capital Closed (in $ millions)||LIHTC Projects Acquired|
|Alden Capital Partners||280||24|
|Boston Financial Investment Management||589.5||51|
|Community Affordable Housing Equity Corp.||178||33|
|Enterprise Community Investment||811||70|
|Hudson Housing Capital||367||30|
|Massachusetts Housing Investment Corp.||47.9||8|
|Midwest Housing Equity Group||190||42|
|National Equity Fund||947.6||88|
|Ohio Capital Corporation for Housing||376||45|
|PNC Real Estate||608.4||50|
|RBC Capital Markets—Tax Credit Equity Group||897||72|
|Raymond James Tax Credit Funds||1,007||104|
|Red Stone Equity Partners||556||46|
|The Richman Group Affordable Housing Corp.||810||59|
|Stratford Capital Group||286||31|