A new study by the Reznick Group has found no deterioration of low-income housing tax credit (LIHTC) property performance despite the economic turmoil of the past three years.
The findings come when there is increasing scrutiny on both federal programs and the nation’s banks, which play a huge role in the tax credit program as an investor.
“From the industry’s perspective, I think that the data in areas like occupancy, where we’re at 96.6 percent, prove yet one more time the enormous imbalance between the supply of affordable housing units and the demand for them,” said Fred Copeman, a principal at the firm and head of its Tax Credit Investors Services practice.
For investors and regulators, the study offers reassurance that LIHTC investments have not grown riskier in the last few years. Instead, property performance has improved.
Overall, the Reznick study estimates that every dollar of tax credit raises about $1.23 in equity and debt. “When you look at the fact that we are raising so much equity and private-sector debt from a dollar of tax credit, there is no way you can argue that this is not an efficient program,” Copeman said.
Reznick Group, an accounting and business advisory firm, requested the participation of 40 investment sponsors and institutional investors. Virtually every sponsor of LIHTC investments and some of the nation’s largest investors participated in the survey. In the end, data of more than 16,000 LIHTC properties was examined.
In one of the most positive findings, the study shows a dramatic drop in the number of projects reporting negative cash flow and/or negative debt coverage. The percentage of these underperforming properties has been as high as 35 percent in prior years, but that figure has steadily fallen in the last three years to 33.7 percent in 2008, 28.3 percent in 2009, and 25.2 percent in 2010.
LIHTC properties typically operate on a razor-thin cash flow margin because state credit agencies are required to allocate just enough housing credits for these projects to be financially viable. Reznick Group noted that the majority of properties slipping into the underperforming category do so for just a year and return to profitable operations in the following year.
The study also found that the closely watched foreclosure rate remains extremely low even though it has increased in small increments in recent years. Respondents to the survey reported that just 98 out of 16,399 properties experienced foreclosure, an aggregate rate of 0.62 percent.
This raises the question why is there such a low foreclosure rate when roughly 25 percent of the properties are still not breaking even. Copeman explained that developments with deficits often have very minor shortfalls, which can be easily overcome. For example, a developer can defer a fee payment, put off a capital expenditure, or make an advance to take care of the deficit.
As debt-coverage ratios continue to improve, housing tax credit properties will be better positioned to handle rainy days when they come, he said.
The reason that fewer properties are operating below break-even is likely due to several factors. First, fewer LIHTC renters appear to be moving these days. This is significant because every time a tenant moves, the property is not able collect rent from the vacant unit until the apartment is re-leased. In addition, when a family leaves, the owner will also have turnover costs to repaint the unit and make repairs. “We believe that those two things, the loss of revenue and turnover costs, have gone down because people have hunkered down and stopped moving so much,” said Copeman. “While physical occupancy can’t get much higher, we believe that economy occupancy has increased.”
Additional factors appear to include the age of the portfolio, more underwriting experience, and lower operating expenses. Copeman pointed out that the first generation of tax credit properties have cycled through their initial 15-year compliance period. “There was a disproportionate number of underwriting mistakes in those early years because it was a brand-new program, and people were still figuring it out,” he said, noting that some of those deals may have carried too much debt or been the victim of unrealistic operating expense assumptions.
More recent projects are benefitting from the experience developers and their financing partners have accumulated from older deals. This second generation of housing credit properties has also been the beneficiary of higher tax credit prices, which has lowered the amount of debt being carried by these projects.
“We don’t view this as a short-term phenomenon but as something that is likely to continue,” Copeman said.
Reznick Group expects to issue a second report before the end of year that will do a deeper dive into why operating results have improved, the extent to which the Community Reinvestment Act impacts the price of tax credits based on property location, and what the average development cost is for housing credit properties.
Other findings from the first report, “The Low-Income Housing Tax Credit Program at Year 25: A Current Look at Its Performance,” include:
- LIHTC properties typically require economic occupancy of at least 87 percent to 89 percent (or physical occupancy of about 89 percent to 91 percent) to attain break-even operations. In recent years, occupancy in housing credit properties has reliably averaged 96 percent. Occupancy averaged 96.4, 96.3, and 96.6 in 2008, 2009, and 2010, respectively.
- The debt-coverage ratio climbed to 1.24 in 2010. The ratio has typically been about 1.13 and 1.15.
- Annual net cash flow averaged $200 to $250 per apartment unit in recent years. Cash flow per apartment reached $246 in 2008, increased to $335 in 2009, and then rose to $412 in 2010. While this looks like a dramatic increase, Reznick Group notes that in practical terms cash flow per apartment increased by about $8 on a monthly basis in 2009 and an additional $6 per month last year.
- The percentage of underperforming properties reporting below 90 percent occupancy (on a net equity versus property count basis) was about 11.5 percent in 2008, increased slightly to 12.5 percent in 2009, and then fell to 9.3 percent in 2010. This is a favorable finding. Prior to 2008, the percentage ranged from 11.5 percent to 18 percent.
- Again, survey respondents reported that 98 of a total 16,399 properties (of which 15,868 were placed in service by the end of 2010) experienced foreclosure through the end of 2010. About half of the stated foreclosures occurred from 2008 to 2010. Reznick Group thinks that this data point may have been understated in the past, in part due to syndicators supporting troubled properties to avoid foreclosure. This practice became less common from 2002 to 2006 when equity was relatively easy to obtain, and the foreclosure rate increased in small increments. Reznick Group further notes that the recent increase in the incidence of foreclosures appears to have begun to dissipate and that the foreclosure rate in housing credit properties remains lower than other real estate asset groups.