New low-income housing tax credit (LIHTC) deals are poised to benefit from a permanent 9% fixed rate recently established by Congress.
In some cases, the new minimum rate could result in 15% to 20% more credits, and ultimately equity, going to deals, according to LIHTC syndicators.
At a minimum, the fixed rate will bring a much-desired level of certainty to upcoming affordable housing developments. Prior to the change, the industry had been using a floating rate that had been about 7.5%.
“It’s important in that it provides certainty and clarity with regard to the underwriting of transactions and ensuring deals pencil,” says Christine Cormier, senior vice president at WNC. “The differential between the fixed 9% rate and what the floating rate would otherwise be was material enough to have the potential to seriously jeopardize deals without the fixing of the 9% rate.”
With more equity and less debt in the capital stack, the underwriting should be favorable, says Mark Gipner, senior fund manager at Community Affordable Housing Equity Corp.
However, syndicators will be watching to see if any unintended consequences emerge, such as larger deal sizes, which could reduce the number of projects allocated housing credits, notes Gipner and others.
“[The minimum rate] is good in that it will allow certain deals to pencil that would otherwise not be able to if they are in markets experiencing ever-increasing land and construction costs and ever-shrinking supplies of soft monies,” says Ryan Sfreddo, managing director at Red Stone Equity Partners.
“On the flip side, it means fewer awards, which means fewer deals done and fewer affordable housing units constructed and/or preserved,” he notes.
With deals potentially receiving more credits, it would mean less gap funding would be needed and deals would be stronger, adds Hal Keller, president of the Ohio Capital Corporation for Housing. “But much depends on what the housing finance agencies do with the fixed rate and basis boost underwriting.”
An overwhelming majority of syndicators (91%) polled in January by Affordable Housing Finance expect the recent strong LIHTC prices to hold steady in the first half of the year.
The more than 20 syndicators surveyed paid an average of 99 cents per dollar of credit in the fourth quarter of 2015, compared with 94 cents a year earlier. The high prices being paid to developers for their credits have meant a drop in yields to the investors buying the LIHTCs.
Investor yields averaged about 5.3%, a notable fall from 6.5% at the end of 2014, according to the survey.
“We’re expecting the LIHTC market to be the same or more competitive in 2016,” says Stacie Nekus, senior vice president at Alliant Capital. “While certain economic investors have put a floor of 5% for investments, Community Reinvestment Act (CRA) investors have shown no signs of slowing their interest and are either investing the same amounts or increasing their investments. Even the economic investors that want to remain in the market may determine that a sub-5% after-tax yield is better than alternatives that are currently available.”
It wasn’t long ago that many people were thinking 7% was a floor for economic investors. The low yields remain a concern.
It’s likely that funds will be rather slow to come out during the first quarter, with syndicators waiting to see how investors will react to proposed returns, says Mark McDaniel, president and CEO of Cinnaire.
“With returns as low as they were at the end of 2015, it is likely that return-driven investors such as insurance companies will stay on the sidelines or reduce their appetite,” he says. “Many banks have already indicated they’re searching for types of CRA investment opportunities other than LIHTCs. As such, this could result in a decrease in, or at least a stabilization of, the amount of equity in the market—which would result in lower-tier pricing stabilizing and even, perhaps, falling in the coming months.”
This year has the potential to be a transition year in the LIHTC market, adds Joseph Jones, director of equity funds at the Virginia Community Development Corp. (VCDC). “On the ground, it will probably look a lot like 2015 from the perspective of pricing and yield, but simply a leveling off would signal a market shift from the last five years of steadily escalating credit pricing,” he says. “Pressure from interest rates could finally cause the market to bump into a ceiling, with its future largely dictated by the fluctuations in those rates.”
The interest-rate factor
While the establishment of the 9% fixed rate was a big victory and will help deals, rising interest rates could create new wrinkles on the debt side.
“Higher interest rates mean smaller loans, resulting in larger financing gaps for LIHTC deals, and there’s less soft money to fill such gaps,” says McDaniel.
But Cinnaire officials don’t anticipate a significant rate hike this year. “Additionally, modest rate increases will likely be positive for banking profitability and could lead to more demand for housing credit investment,” McDaniel adds.
However, others are warier of rising rates.
Higher rates will affect deal structures and make deals tighter, according to Steve Kropf, president and CEO of Raymond James Tax Credit Funds. “Marginal deals won’t make sense,” he says.
They will impact bond transactions that aren’t as flush as most 9% deals, adds Joseph Macari, managing member at Hudson Housing Capital.
“However, it’s less of a concern than the general economic outlook and the fact there is already an expectation of higher rates,” he says. “It is of concern as it relates to equity investor expectation of returns. Syndicators warehousing product without equity commitments are subject to being squeezed if investment yields rise during warehouse periods.”
2015 Tax Credit Activity
|Company||Capital Closed (in $ millions)||LIHTC Projects Acquired|
|Alden Capital Partners||301.5||23|
|Boston Financial Investment Management||527||97|
|Cinnaire (formerly Great Lakes Capital Fund)||254.4||32|
|City Real Estate Advisors||500||56|
|Community Affordable Housing Equity Corp.||112.5||49|
|Enterprise Community Investment||685||66|
|Hudson Housing Capital||487.3||37|
|Massachusetts Housing Investment Corp.||89.3||10|
|Midwest Housing Equity Group||160||38|
|National Equity Fund||970||106|
|Ohio Capital Corporation for Housing||349||52|
|PNC Real Estate||562||63|
|RBC Capital Markets—Tax Credit Equity Group||722||62|
|Raymond James Tax Credit Funds||868||97|
|Red Stone Equity Partners||473||49|
|The Richman Group Affordable Housing Corp.||710||67|
|Stratford Capital Group||215||17|
|Virginia Community Development Corp.||53||10|