There is no place where the low-income housing tax credit (LIHTC) is more important than on the hurricane-damaged Gulf Coast.
Although every state receives an annual allocation of tax credits to award to affordable housing developers, Louisiana, Mississippi, and Alabama are getting considerably more credits than usual as part of a federally created Gulf Opportunity Zone (GO Zone) program to help rebuild the region.
In addition to their regular allocation of LIHTCs, Alabama is receiving $15.7 million in annual GO Zone credits in 2006, 2007, and 2008; Mississippi, $35.4 million; and Louisiana, $56.8 million. For Louisiana, that’s about seven times the amount of its regular tax credit authority.
This means that a lot of tax credit business is taking place on the Gulf Coast. It also means that there’s a huge opportunity for the LIHTC program to show what it can do.
“We’ve done a significant amount of equity in the GO Zone,” said Bob Moss, senior vice president and director of origination at Boston Capital, a national LIHTC syndicator. Moss estimated that his firm has invested more than $30 million in equity in the area so far and continues to be active.
Boston Capital, however, is far from being the only LIHTC company working in the region. Many national syndicators are busy doing deals in the GO Zone, where there is suddenly a big volume of tax credits to buy.
Some firms are syndicating GO Zone credits as part of their usual business, meaning the new credits are incorporated into their regular national LIHTC funds. Others like PNC MultiFamily Capital and The Richman Group Affordable Housing Corp. have created special hurricane funds for investors.
PNC has been very active in the area. Its work has included a $75 million tax credit fund for properties in the GO Zone, according to Todd Crow, executive vice president and director of institutional sales and portfolio management. Overall, the firm has more than $100 million in equity committed or in process in the region.
If the average price per dollar of tax credit overall is in the low- to mid-90 cents range, the price for GO Zone credits is a touch higher, running in the mid- to high-90s, estimated David Salzman, president of The Richman Group Affordable Housing Corp., which plans to invest about $200 million in Mississippi and Louisiana this year.
GO Zone differences
Unlike the regular LIHTC, the GO Zone credit has a unique depreciation feature. Developers can claim accelerated depreciation, called a “bonus depreciation,” allowing them to take 50 percent depreciation on eligible property in the first year.
This is an issue for some investors because it affects the loss ratio of a transaction. Some investors are more sensitive to losses than others.
“There is a reduced number of available investors, but sufficient interest, so there does not seem to be a significant price difference for GO Zone credits than for typical LIHTCs, with the exception that accelerated depreciation adds early tax benefits that some investors value,” said Dave Urban, vice president of acquisitions for RBC Capital Markets’ Apollo Equity Partners.
He estimated that GO Zone prices are three to five cents higher on average due to the depreciation benefit. Apollo has closed on three Alabama GO Zone properties and is also working on eight LIHTC developments with the Housing Authority of New Orleans that have approximately $50 million in equity.
Another firm active in the GO Zone is MMA Financial, which is working on 13 transactions in the region totaling about $180 million in tax credit equity and about $60 million in hard debt. MMA has been mixing its GO Zone transactions throughout its various investment funds, according to Greg Judge, senior vice president and chief investment officer. “We may create a GO Zone-specific fund later this year, but we are hearing risk-concentration concerns from some investors about this concept,” he said. “Another complicating factor in finding investors is the high percentage of market-rate units in some GO Zone transactions. Tax credit investors do not want to take market-rate risk and will tolerate somewhere in the neighborhood of 20 percent market-rate units. As the market-rate percentage increases, so does the risk profile, and the investor market becomes very thin. Consequently, the GO Zone transactions with a high percentage of market-rate units have very limited investor appeal.”
Despite the large volume of GO Zone credits hitting the market, there hasn’t been a glut in product.
Justin Ginsberg, senior managing director of affordable housing at Centerline Capital Group, formerly CharterMac Capital, said he has not seen the additional GO Zone credits impact the 9 percent LIHTC market overall. On the contrary, the increase of GO Zone credits has been balanced out by the decrease in 4 percent deals in Texas and Georgia, where there have been fewer bond deals than in the past.
Centerline has closed about $60 million in equity investments in the GO Zone in seven transactions. The firm has another 17 deals in the pipeline.
“The market shows that developers have a great appetite for GO Zone credits,” said Milton Bailey, president of the Louisiana Housing Finance Agency (LHFA), the state’s tax credit allocation agency. “Very few credits are being returned, and developers are seeing additional credit allocations.”
Freddie Mac is one of the investors in the region. Shortly after the 2005 storms hit, the company and the Freddie Mac Foundation donated $10 million in immediate assistance and have invested $1 billion in state and local mortgage revenue bonds. “On the tax credit equity side, we have a growing list of investments in this area, on both the fund level and project level,” said Chris Hobbs, affordable equity investment director. “Many of the fund sponsors that we work with have targeted this area, and we are beginning to see the results of their efforts. In addition to making an over $18 million investment in a fund dedicated to rebuilding in the GO Zone, we are investing in an increasing number of projects through the national LIHTC funds with whom we invest.”
Rebuilding the region is important work, Hobbs said, but it raises several underwriting challenges.
“Market studies, and determining insurance costs, project occupancy, and project expenses over a 15-year period are all important ingredients in underwriting LIHTC projects, but these issues are among the challenges when underwriting in the GO Zone,” she said.
One of the big concerns is the risk involved in rebuilding in an area that flooded and the viability of a project built in that area.
“Some investors are looking for properties that are greater than 100 miles from the Gulf, while others are accepting of some [deals] in coastal markets and New Orleans,” said Apollo Equity Partners’ Urban.
Syndicators said that while they have found good deals, they have passed on a number of others.
PNC’s Crow said his firm has been rigorous when it comes to reviewing construction and operating expenses, including insurance costs.
“The deals that we find that we like the most are with developers who have been historically active in the area and have done their homework as opposed to someone from out of state who has heard there are a lot of tax credits down there,” he said.
Syndicators are keeping in mind a number of issues.
“The market and demand for the units is very difficult to quantify, especially with so many units coming on line in the next few years,” said MMA Financial’s Judge. “Insurance costs are a moving target. Understanding the flood zones should another large storm hit is another concern.”
Centerline Capital Group sent a market analyst and an internal team made up of underwriting and acquisition specialists to the GO Zone early on to plan what its approach ought to be. “We studied every level of the market,” Ginsberg said. “Our intense focus helped us understand the dynamics of the deals.”
At Boston Capital, most, if not all, of the GO Zone business has been with developers that the company has worked with in the past.
Unknown environmental conditions and unknown issues with sewer and water connections do affect interest in a property, Moss said.
Salzman of The Richman Group cited the limitations of flood insurance. He said coverage is limited to about $250,000 per building. As a result, he likes to see projects that are made up of smaller buildings like duplexes.
Apollo Equity Partners’ Urban noted several other underwriting issues, including market demand, construction quality and costs, and experience or inexperience of contractors.
It’s been tough for developers to move forward on deals, and the tax credits are absolutely critical, said Charles Williams, vice president and manager of the South Central/GO Zone team for the National Equity Fund (NEF). He is located in Baton Rouge, La.
The Local Initiatives Support Corp. and NEF in April announced that they will spend an additional $100 million in Louisiana this year on 2,000 affordable housing units. The two organizations had already committed more than $50 million for investment in Louisiana.
Construction costs have increased approximately 30 percent since Hurricane Katrina, Williams said. In addition, insurance costs during construction and the operating period subsequent to construction have tripled or more on a per-unit basis.
The bottom line is that with the cost increases and projects having less debt, the tax credits have to carry more of the project costs, Williams said.
Under the GO Zone rules, projects funded with GO Zone credits need to receive their allocation and be placed in service by the end of 2008, a very ambitious timeline. There is an effort to extend the deadline to Dec. 31, 2010.