Tax credit developers could find rough sailing ahead as rental income remains flat while operating expenses rise and the amount of equity investment in their deals shrinks even as construction costs rise.
That was the consensus among members of AFFORDABLE HOUSING FINANCE magazine’s Editorial Advisory Board, which held a public roundtable discussion to kick off AHF Live: The 2007 Tax Credit Developers’ Summit.
The panel started by discussing whether the industry was better or worse off than when the board met in the fall of 2006. “Everyone so far around the table has said that we are better off as an industry, and I would strongly disagree. I think that we are in a much worse place than we have been," said David Heller, a principal with The NRP Group. “You have flat rents and increasing expenses, and I think that the equity investor community, the syndicator community, everyone has looked at this and said, 'This is a real challenge to our industry, and soft dollars are not there to make up for this challenge.'"
Most board members agreed that yields on tax credit investments would have to rise to attract investors, which means the proceeds of such transactions, the price per dollar of tax credits, will decline. Several board members said this represents a step toward a healthier longterm balance of supply and demand.
"In the long run, I think the industry is moving in the right direction because the high prices and some of the other things that were going on in 2006 were clearly unsustainable and not good for the industry," said Cynthia Lacasse, who runs the tax credit and equity investment group at John Hancock and is president of the Affordable Housing Investors Council.
"In the short run, though, I think the industry is worse off because of the turmoil that is going on in the capital markets," she added. "Right now there is a lot of uncertainty about the availability and the cost of both equity and debt capital."
An attorney who represents investors agreed. "The price corrections that are going on were absolutely necessary. I think you cannot expect investors to invest in deals where their cost of funds is higher than their yield, and that’s what I think this industry has been expecting people to do for the last few years," said Jana Cohen Barbe of Sonnenschein Nath & Rosenthal, LLP. "The fact that Fannie and Freddie stepped back means that new investors will enter the marketplace, and they are."
Board members noted that equity will continue to be available on attractive terms for projects in hot markets and projects with certain characteristics. One of the most effective ways for most sponsors to win investors’ attention is to go green.
Many banks are motivated to invest in tax credit deals because of the Community Reinvestment Act (CRA). According to Bob Moss of Boston Capital, "The new CRA is green. Green is the new CRA.
"Several panelists suggested that state housing agencies were asking developers to achieve too many social goals with their projects, especially as project economics become tighter.
"The most challenged deals in this environment are the ones that suffer from the 'checking the box' scenario, where the developers are just checking too many boxes (on tax credit applications) to get the deals done," said Heller. "I think the other ones that are really going to suffer are the states with lotteries. Because you have incentivized developers to go out there and throw anything at the wall that will stick in order to get [in the lottery]. Those states, they are just not living in today’s environment."
Heller said state agencies should simplify their allocation plans and go back to focusing on good real estate fundamentals. Others agreed. "I think it is time to peel back the layers. The layers of the onion have not been peeled back to the basics of what we are trying to achieve with the program. Peel back the layers and try to simplify," said Moss.
Another concern is projects with a large amount of soft debt and rents so low that the owners can’t realistically project that they can repay any outstanding debt, which is required by the tax code, said Ronne Thielen of Centerline Capital Group. "If you can’t show that you can sell that property at a price that can pay off all of that soft debt, then you are going to have to start counting some of that soft debt as a grant, and that is going to reduce your basis. And that is very serious. We see it a lot now," she added.
Several panelists called on developers to fight for more state resources to help make deals feasible. One example of how to make the case was cited by R. Lee Harris, president of Cohen-Esrey Real Estate Services, Inc. He cited a study for the Missouri Housing Development Commission which showed that for every dollar of state tax credits awarded for the last several years in Missouri, gross state product increased $5.45, and the overall economic benefit was $9.60. Developers in other states could use similar data from their states to argue for more housing funding, Harris said, nothing that advocates in Kansas are using the Missouri study to argue for a state tax credit that is going to be introduced in the next legislative session.
Several panelists were concerned about "unfunded mandates," wherein state agencies steer federal housing credits to projects that agree to meet social and income targeting goals but don’t provide the soft funding to make it feasible.
That’s not a problem in New York state, said Deborah VanAmerongen, director of the New York State Division of Housing and Community Renewal, who is a new member of the board this year. She said her agency earmarks state tax credits and direct subsidies to help developers comply with its project preferences, like serving people with special needs.
Several panelists suggested Congress might pass a tax law this year that would make the tax credit more compatible with HUD programs and give states more flexibility in how much tax credit authority they allocate. "There is a very good chance they can have a draft bill out this fall," said Moss. The bill could allow state agencies to determine whether a transaction might need tax credits of up to 10 percent or 11 percent of basis, instead of the current limits of 4 percent for bond deals and 9 percent for other deals, to make the deals feasible. The bill has a chance of enactment because it is revenue neutral, said Moss.
As for positive changes in state tax credit allocation plans, the board heard praise for the state of Ohio, which is now making sure to send a staff person to look at the site for each proposed project. “Going out and looking at the real estate was the biggest positive change, and grading the deals on how good the land is, how good the development is, that is something that I would encourage all states to do,” said Heller.
In New York, the state agency puts a high priority on a project’s readiness to proceed. This created a problem for developers who were trying to work with municipalities where there was resistance to affordable housing, said VanAmerongen. To rectify that in 2008, if the developer is doing everything it can to try to move a project to approval and the municipality is getting in the way of affordable housing development, the agency will not penalize the project on its readiness scoring, she said.
A majority of the board agreed that the problem of community opposition to affordable housing is getting worse.
"We have to look at how we got to this point, too, and how community opposition got to the point of such fervor in our society," said Heller. “We have a president that for the past seven years has called this the ownership society, so mentally in our minds, we have said, 'Apartments are a bad thing, ownership is a good thing.'"
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