• Considering your tax risk
  • The appeal of guaranteed funds
  • What corporations want from LIHTC investments

Over the course of 2001, tax credit acquisition prices fell slightly while yields to investors rose to around 8% on average. Thanks in large part to declining interest rates and lower yield on alternative investments, that was enough to jump start corporate investment late in the year and keep the capital flowing right through the end of 2001.
There was no sign of a drop-off in corporate investment activity as the economy slowed in the last half of 2001. Even after the terrorist attacks of Sept. 11 and the resulting increase in pessimism about the economy, only a few investors backed away from tax credit investments, according to equity syndicators.

Nonetheless, the investment climate for tax credits was marked by uncertainty and transition in 2001. The overriding concern was that the universe of investors was shrinking. Manufacturing firms had largely left the tax credit world, leaving it to be dominated by financial services firms, especially banks. Fannie Mae was widely considered the single most dominant investor.

In addition, the industry saw an increase in the quantity of partnership interests offered for sale on the secondary market. In early 2001, this investment product coupled with an “overhang” of unsold partnerships combined for a very slow start to the investment year.

While manufacturing firms had stopped investing some time ago, 2001 saw the rapid financial decline of several utility companies which had invested in tax credits. For example, Edison Capital not only stopped investing in tax credits, it put its existing partnership holdings up for sale.

There was also an increasing awareness of the real estate risk involved in tax credit projects as federal limits on credit amounts were increased and the economy weakened. In the early part of the year, rising energy costs were a cause of uncertainty about project feasibility. This threat faded away as energy costs fell in the last half of the year.

Considering your tax risk

In addition, tax risk became more of a threat to investors after the Internal Revenue Service issued five Technical Advice Memoranda (TAMs) that drastically reduced costs that could be included in eligible basis for purposes of calculating the amount of tax credits a project could receive. The bulk of the excluded expenses were payment attributable to land preparation and impact fees, developer fees and organization/syndication costs.

The TAMs were issued in the fall of 2000, and the industry fought to have them modified by the Treasury Department and sought legislation to dampen their impact. However, they played a part in the investment decisionmaking process in 2001. For a large part of the year, the uncertainty about how the policies would be implemented was another reason for investors to stay on the sidelines. Later, investment began to flow again, and developers were forced to take the risk that some expenses would not count for purposes of calculating credit amounts.

Overall, greater concern with real estate and tax risk motivated investors to increase their level of scrutiny of individual investments, or due diligence. Syndicators reported that there was also an increasing difference in pricing based on the perceived risk of various project types.

Throughout the year, larger syndicators warned that smaller syndicators could not stay in business as they acquired projects at high prices using lines of credits, even as corporations were holding back on investment commitments or demanding higher yields. Nonetheless, only one syndication operation announced that it was leaving the business, and it was Lehman Housing Capital, not one of the small firms that was considered the most likely candidate to drop out. Another firm, Paramount Financial Group, was acquired by GMAC Commercial Mortgage, following in the footsteps of Boston Financial, which was acquired by Lend Lease earlier.

As yields on investments rose, many syndicators began looking at the possibility of offering guaranteed funds. Under this scenario, a very well capitalized firm (often an insurance company) provides a guarantee to investors in a tax credit fund of a minimum yield. The guaranteed return ranged from 5% to 5.75% in October 2001. This allows the fund to pay project sponsors more for their projects than unguaranteed funds by a margin of anywhere from one to four cents per dollar of tax credit.

The appeal of guaranteed funds

Guaranteed funds appeal to investors because they eliminate the risk from the deals, an important issue since investors began to show increased concern about risk in 2001, said Mike Fowler, president of SunAmerica Affordable Housing Partners, Inc. The Los Angeles firm has been offering guaranteed funds exclusively since it entered the business in 1992. It has closed $3.2 billion in equity investments over the years.

Guaranteed funds also reduce concerns about accounting for investments. In a guaranteed fund, the losses associated with depreciation may not have to be recognized against pre-tax income on corporate financial statements. In non-guaranteed funds, such losses generally are reported on financial statement, a fact that has deterred some investors from participating in tax credit projects with high levels of losses from interest costs and depreciation. This concern has made it harder to syndicate tax-exempt bond deals with 4% credits.

AMBAC Financial did a guaranteed fund with Lend Lease Real Estate Investments that closed in the summer of 2001. National Partnership Investment Corp. was planning to offer a guaranteed fund as well.

What corporations want from LIHTC investments

When the tax credit was first created in 1986, public partnerships were the primary source of equity investment in tax credit projects in the early years of the program, but sluggish sales have driven most syndicators out of the retail investment market. In recent years, the vast majority of equity has come from corporations, either investing directly or through private partnerships.

While the tax code limits the amount of tax credits and other passive loans that can be taken against ordinary income by individuals and certain types of corporations, it places no such limits on widely held C corporations. Corporations flush with profits and facing a lack of investment alternatives find tax credit projects very appealing.

Corporate investors fall into two categories: those who are very sophisticated and look for individual projects they can buy, and those who invest through diversified tax credit funds sponsored by syndicators and nonprofit equity funds.

They can also be categorized by their investment motives. Some corporations, particularly banks, have nonfinancial motivation for investing. A corporate investor may see a tax credit investment as a way to meet housing needs in its service area and gain positive publicity.

Banks often invest at least partly to meet their obligation under the Community Reinvestment Act to invest low-income parts of their service areas.

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