Throughout its 15-year history, the low-income housing tax credit program has enjoyed widespread consensus as being a highly effective rental housing development tool as well as a sound real estate investment.
Until now, however, few studies have assessed the performance of housing credit properties over the long term, and none have undertaken large-scale sampling to assess performance characteristics. This has left the housing credit industry at a disadvantage compared to other real estate asset classes, for which myriad performance data sources are available.
A consortium of the housing credit community’s leading investors and syndicators has changed that by participating in the most comprehensive study ever undertaken of the program’s performance in “Understanding the Dynamics: A Comprehensive Look at Affordable Housing Tax Credit Properties.” A joint undertaking by Ernst & Young’s Affordable Housing Services and Quantitative Economics Statistics groups, this effort has created the largest database of housing credit properties ever assembled, representing approximately half of all housing credit properties ever developed. More than 7,800 properties representing more than 500,000 apartment units were evaluated.
Data sources included 30 investors in and syndicators of housing credit properties, including direct and fund investors, guaranteed and unguaranteed investments, and for-profit and nonprofit syndicators, with a wide variety of portfolio sizes. This data was aggregated, error-checked and tabulated for the study, and all data sources were kept strictly confidential. Following are key observations regarding the property performance excerpted from the study.
Property Operating Performance
Data points covering the significant property operating performance characteristics were collected, including average occupancy, hard debt coverage, cash flow and cash flow per unit. Information was for calendar year 2000 and was based upon audited financial statements. A sampling of averages is shown on Figure 1 and suggests that the program is producing properties that in the aggregate, generate adequate levels of cash flow. Occupancy averages are high, and reported average hard-debt service coverage ratios are reasonable. We note, in this context, that cash flow and debt coverage data were calculated prior to required replacement reserve deposits.
Several observations emerged from our analysis, including some that may be at odds with conventional wisdom about housing credit properties. First, high occupancy does not guarantee strong financial performance. As evidenced by Figure 1, there is clearly not a linear relationship between the two. Moreover, our analysis indicates that of those properties experiencing operating difficulties (which we defined as either operating below 90% occupancy or below 1.0 hard-debt service coverage), half had strong occupancy rates despite having below break-even operations.
Study data also indicated that older properties did not report higher debt service coverage ratios than recently developed properties (see Figure 2). This may contradict the conventional wisdom that debt coverage ratios (DCR) rise over time, or it may indicate that changes in property underwriting may have occurred over the life of the program. The study did not address this question because it did not follow the performance of individual properties over multiple years.
The relative performance of properties targeted to families vs. seniors poses a perennial question for many in the housing credit industry. Study data indicate that occupancy averages were substantially the same at 96.2% and 96.7% for family and senior properties, respectively. Properties restricted to senior tenants had the upper hand, however, in the matter of hard-debt coverage ratio averages, with an average DCR of 1.47 compared to 1.34 for family properties.
The study also found that urban properties tend to have a larger debt coverage margin than those in other areas. The average hard-debt coverage ratio for urban properties was 1.84, compared to ratios of 1.28 for suburban and 1.30 for rural properties.
This difference represents an advantage greater than 40% for urban properties and presumably reflects the prevalence of so-called “soft debt” disproportionately available to urban projects. And while occupancy averages for urban properties were high at 95.4%, the average for suburban properties was extremely high at 99.5%.
Surprisingly, the study discovered that on average, properties financed through the RD/FmHA program (which finances rural properties) operate well above break-even. These properties were generally underwritten with the expectation that they would operate at break-even, yet they reported an average 1.34 debt coverage ratio.
One of the most significant data points analyzed was the incidence of foreclosure in housing credit properties. Foreclosure of a housing credit property by its lender represents a tax credit recapture event for investors and thus is widely perceived as an investment risk.
Though foreclosures in housing tax credit properties were thought to be rare, no published data was available to support this belief. The survey indicates that only 10 of the surveyed properties had been foreclosed upon, or tendered a deed in lieu of foreclosure, since the program’s inception. This represents 0.14% of the properties since the program’s inception, or an annual foreclosure rate of 0.01%. Figure 3 compares this statistic with publicly available foreclosure rates for other real estate asset classes, showing that housing tax credit properties have a statistically insignificant foreclosure risk compared to other types of real estate.
While property foreclosures are exceedingly rare, the survey indicates that a material number of housing credit properties reported negative cash flow from operations in 2000. The prevalence of negative cash flow, particularly in certain markets and project types, would appear to contradict the reported incidence of foreclosure in housing credit projects. The E&Y report looks at the materiality of the cash flow deficits but suggests that further study will be needed in this area.
Tax Credit Issues
Participants in the study were also asked to report information unique to housing tax credit properties, including the incidence of Internal Revenue Service audits, the incidence of a reduction of tax credits as a result of those audits, and the frequency of 15-year credits due to delays in placing units in service. Only 70 properties, representing 0.9% of properties surveyed, reported IRS examinations. Of these properties, only 8% reported reduced tax credits as a result of those audits. This data would appear to support the widely held notion that the incidence of IRS examination of housing credit developments is very low.
Survey participants were also asked to report properties that have experienced deferred housing credit delivery due to delays in placing properties in service. Housing tax credits are generally claimed over 10 years; however, if a portion of a property’s units are not placed in service within 24 months after the end of the year in which they receive a credit allocation, the tax credits associated with those units must be claimed over a 15-year period. When a project’s housing credits are deferred, their present value to investors is lower. Because housing credit properties are underwritten with a 10-year credit stream, significant deferrals will have an adverse impact on investment yield. Of the properties surveyed, 132 (or 1.7%) reported that a portion of their credits are being realized over 15 years.
This information represents a small sampling of the data presented in the study. For more information, visit the Ernst & Young Affordable Housing Services library by searching for “tax credit” at www.ey.com. To order a copy of the study, call (617) 570-8454.
Richard Floreani is a manager with Ernst & Young's Affordable Housing Services group. E&Y is the leading advisor to investors in low-income housing and historic rehabilitation credit transactions, providing due diligence, capital markets and organizational development services.