The massive $787 billion American Recovery and Reinvestment Act (ARRA) included funding and program changes aimed at jump-starting the stalled low-income housing tax credit (LIHTC) market this year.
A panel of leading affordable housing developers and experts tells Affordable Housing Finance the prospects for the market in the wake of the legislation.
The participants weigh in on what they like about the bill, what else needs to be done to encourage LIHTC investments, and whether more deals will be done in 2009 than last year. The panel is made up of members of Affordable Housing Finance’s Editorial Advisory Board.
Q: What impact will the stimulus bill have on the LIHTC market?
Sister Lillian Murphy: Hopefully, it will enable developers who have projects in the pipeline for 2009 but have LIHTC investment gaps to move forward. Mercy Housing has 20 deals pending for ’09 representing $150 million of investment. We also need to be concerned about the long-term effects of this market chaos on the LIHTC pipeline in 2010 and 2011. If the usual investors do not return because of depressed profit margins, we need to start a conversation with the Feds about what will replace this source of capital, which has been the primary rental housing production program for the last 20 years.
J. David Heller: It will have a positive short-term effect on the production of affordable housing. It should jump-start the industry.
Patrick Sheridan: That remains to be seen. Certainly both the gap HOME funds and the tax credit refund provisions should help, but it is not clear at this stage if they will create more investment dollars for credits. There are too few large investors remaining, and it appears the few that are left are not looking for economic deals, but CRA [Community Reinvestment Act] deals. If you have a credit project in a community that no investor has CRA needs, you may not be able to close on a credit investment with anyone no matter how sweet the deal gets with the incentives.
Rob Hoskins: We are hopeful that the bill will assist in the gap sourcing that currently exists due to the lower tax credit pricing and higher spreads on permanent debt.
R. Lee Harris: It is hard to say at this point because the states will still need to create their own rules and policies concerning the application of the stimulus bill provisions. This could take weeks or even months.
Bill Kelly: I believe that the bill will have relatively little effect on investor appetite for credits. By providing gap funding that overcomes reduced credit prices in the market, ARRA will enable some of the modest number of deals with strong investor interest to proceed to closing.
Chris Tawa: There won't be much impact on investor participation in the tax credit market since using federal funds as gap-filler loans in lieu of LIHTC equity will only help those specific projects that get a gap loan. The bill did not adopt other approaches that may have stimulated the equity market, such as shortening the credit period to five years, buying Fannie and Freddie's tax credit portfolios, and directing them to use the funds to make new investments, etc. Plus the big financial institutions that have been our primary investors now have other tax credit incentives available to them (such as loss carryback to prior years), which makes the LIHTC with all of its regulatory restrictions even less appealing compared to their credit alternatives.
Sean Thomas: With the new subsidy sources (Tax Credit Assistance Program and Monetized Tax Credits) provided with this bill along with the assistance from last year’s bill Neighborhood Stabilization Program (NSP), higher credit rate, basis boost, and additional credits), state housing finance agencies now have the tools to help facilitate the completion of projects in the pipeline and create new deals in 2009. We will be able to provide enough gap financing to encourage investors to participate in projects at higher yields and still meet our public policy goals. For those projects that are financially viable, meet certain guidelines, and are located in areas not attractive to investors, states will now be able to fund them directly. These temporary measures will help ensure that projects are still developed until the investor market rebounds.
Steven N. Fayne: [It’s] to been seen how individual states will participate in the federal credit exchange program. The bill could have had more in it, but it remains to be seen if projects move forward.
Q: What do you like and dislike about the signed bill?
Murphy: It gives us some tools to get through 2009, but [it] could have been more help getting investors to the table by changing some of the tax credit rules to push yields higher.
Heller: I like the gap funding available for making more projects feasible. I do not like the refreshing of the credits. It eliminates one of the most important checks and balances in the industry provided by the investor community.
Sheridan: There are several good aspects of the bill—the gap HOME funds, the credit refund, the full funding of Sec. 8 contracts, a new “green” program for Sec. 8 projects, and increased funding for homeless assistance and Community Development Block Grants. Affordable housing developers should be able to take advantage of each of these programs. What I don’t like about the bill is its lack of tax credit improvements, such as accelerated credits and the carryback provision, each of which may have brought more investor dollars to deals.
Hoskins: We like that the bill gives the state authorities greater flexibility in assisting deals to get done. We are disappointed that the bill did not address tax-exempt bond/4 percent LIHTC transactions, which are needed for the expiring tax credits.
Harris: Because the states are left to their own devices with respect to establishing the rules and policies to administer the stimulus bill provisions, there is a strong chance that there will be little consistency from state to state. I think it’s unfortunate that the bill only addresses LIHTC for 2008 and 2009. I’m very disappointed that the House and Senate conference did not agree to accelerate the credits, which would have had a real positive and long-term impact on tax credit equity.
Kelly: ARRA does a reasonable job of providing grant resources to address the sharp decline in the tax credit market, but it fails to take any steps to rebuild that market.
Tawa: The bill only provides a finite amount of new resources through the gap loan program and will only help a limited number of deals get done, until the federal funds are spent. The bill requires that projects that get a gap loan must pay Davis-Bacon wage rates, so that will push up labor costs for many projects and will result in fewer projects getting done than would otherwise have been the case. The bill does nothing to stimulate investor interest in the tax credit market. It's great that a number of projects that have been in limbo will now get completed. But, it will have very little, if any, long-term impact on reviving the tax credit equity market or investor interest.
Thomas: Generally, we are pleased with the bill and appreciate the significant resources given to the states. As with any legislation, there are some provisions that will need further clarification from the Department of Housing and Urban Development and the Internal Revenue Service. We were disappointed that some of the technical changes to the housing tax credit program, such as the acceleration of the credit period, were not included in the final compromise language. In addition, we would have liked to have seen more flexibility for use of NSP funds required to serve households with incomes at or below 50 percent of the area median gross income so that we can use these funds more easily with the housing credit and other programs.
Fayne: Needed the carryback loss provisions.
Q: What else needs to be done to bring investors back into the market?
Murphy: One thing that could be done is to allow individuals back in.
Heller: I think states will need to eliminate the caps they have imposed on the most experienced developers, because the investment community has indicated that they are only willing to work with the most experienced developers. In addition, an expansion of CRA requirements, particularly for institutions participating in TARP [Troubled Assets Relief Program] rescue plan, should be considered.
Sheridan: What seems to be driving investors right now is CRA and good community relations. Without profits, many investors don’t need economic deals. However, without strengthening CRA requirements or finding an alternative incentive to nudge investors into all areas of the country, I don’t see many small rural or Rust Belt state deals getting done. Government direction to the government-sponsored enterprises to buy credits along with direction to continue funding affordable rental housing loans would increase the ability to close more credit projects.
Hoskins: Companies have got to become profitable and have a tax liability. Bottom line, until that occurs, the program will not work as it needs to.
Harris: The tax credit benefits period needs to be shortened to five years. Credits should be available for use by any taxpayer for taxes generated by active and passive income alike. Allow a five-year carryback for the tax benefits.
Kelly: In the short term, we need to address the effect of the financial meltdown on the tax liability of long-term investors by allowing a five-year carryback of tax credits or refundability for investors that are not related to developers. Unless we make it possible for these knowledgeable investors to continue their pattern of investment, we risk losing them not only for this year but forever as they shed staff and dump their investments in the secondary market. As a second priority, accelerating the credit would increase yields and over time improve our prospects for attracting new investors.
Tawa: The LIHTC program needs a variety of structural changes to re-ignite investor interest, such as reducing the tax credit period, fixing the credit percentages, modernizing various program requirements that unnecessarily put projects and investors at risk (such as carryover and placed-in-service rules, arcane rules for what's includable in basis, lack of standardization of legal forms that helps drive up soft costs, bizarre accounting rules, etc.), allowing easier resale of tax credit investments so they are not illiquid for the 15 years, creating ways that high-income individuals could invest in tax credit equity through a mutual fund structure, resume enforcement of banks' CRA obligations and extend CRA to the insurance industry, etc.
Thomas: The president and Congress should reconsider many of the technical changes proposed by the industry in order to encourage more investors to the program. However, the key to success of the housing credit program ultimately hinges on the success of the economy. We can only put so much soft subsidy in deals and raise investor yields so high without raising questions regarding the viability of the program. Investors must have profits in order to have a need for tax credits.
Fayne: Like to see Fannie and Freddie guarantee the credits. Credit acceleration would help.
Q: Will more deals get financed in 2009 than 2008? Why or why not?
Murphy: No, too much uncertainty in the capital markets.
Heller: More deals will get financed in 2009 than 2008 due to the stimulus bill. However, 2011 could be a real challenge for the industry.
Sheridan: I suggest that far fewer deals will be financed in 2009. In some ways, 2008 was a busy year. Our organization had one of its most active years ever in 2008, but we project a substantial reduction in the number of deals we will close in 2009. The problem is twofold, and also well known. Fewer lenders exist now; their underwriting standards have gotten substantially tighter, so coupled with higher rates, fewer deals pencil out successfully. Secondly, even if a deal can find a lender for the debt portion, the credit investors are scarce; so many deals are languishing for lack of a tax credit investor.
Hoskins: I think the 2008 deals will get assistance through the stimulus package. 2009 will be interesting, unless the economic cycle runs its course and businesses become profitable again, I think less deals will get done.
Harris: This all depends upon how forward-thinking the state agencies are with respect to deploying the applicable elements of the stimulus bill. If done properly, there is a chance that more deals can be done in 2009.
Kelly: Deal volume will drop overall in 2009, principally because the market was reasonably strong before August 2008. I do not foresee an economic recovery in 2009, nor do I believe that the ARRA credit exchange and HOME gap financing will compensate fully for the loss of investor capital.
Tawa: Fewer deals will get done in 2009 because many of the 2008 development deals that did close had equity and construction loan commitments in place before the industry slowed down appreciably later in 2008. 2009 was looking like a complete disaster before the stimulus bill was passed. But, only those development deals that get selected for the limited amount of federal gap financing will get done this year, along with small 9 percent deals in which banks are still investing directly. There are very few new development deals being done this year that rely on bonds and 4 percent tax credits because investors aren't interested in buying the losses that bond deals generate rather than the tax credits that 9 percent deals generate.
Thomas: Before the new housing bill passed, we were expecting to fund 30 to 40 percent fewer projects since we will be able to give more credit per project. Now we are projecting that we will fund at least as many projects as we funded in 2008 and perhaps a few more depending on the multifamily bond market. Our projections are dependent on the economy. If the investor pool continues to decrease, then we will not be able to stretch our resources and will be forced to fund fewer developments.
Fayne: Less because credit pricing stinks.
Q: Give us your outlook for the rest of the year.
Murphy: Continued uncertainty in the LIHTC and capital markets. If the stimulus dollars work, then we could see some improvement in the fourth quarter.
Heller: I think that 2009 will create opportunities for the developers of affordable housing. There will still be a flight to quality. The flight to quality will continue because the lending community will only work with well-capitalized, strong developers.
Sheridan: Frankly, it doesn’t bode well for the balance of 2009. I expect to see a reduction in the number of successful deals as the lack of tax credit investors and tight credit strangles deals that could have been done in past years. As a result, I see a number of nonprofit and for-profit developers going out of business or looking for other opportunities where they may not be dependent upon tax credits. Hopefully, that is not the case as the benefits from the ARRA come to the rescue and deals become more attractive to both investors and lenders, but the results likely won’t show up until the fourth quarter of 2009.
The bottom line is that affordable rental housing is still one of the few strong real estate investments out there. Sure it has seen declines in values, and depending on the market, variances in occupancy rates, but the fundamentals are strong, and the continued need for affordable rental housing, now more than ever, is undeniable.
Hoskins: I think the bigger equity investors will demand higher returns, creating financing gaps where fewer deals will get done. The pendulum has swung from equity to being a commodity to equity being a scarcity due to profitability.
Harris: There’s not a lot to be excited about for the rest of 2009. Congress had an opportunity to make some real positive changes to the LIHTC program but did not succeed in this respect. The fear in this country has frozen the investor market and will continue to do so until there is more confidence in the economy.
Kelly: The economy will continue in a deep recession throughout the year.
Tawa: It ain't pretty. Many deals have been delayed or have died due to the lack of investor interest or the lack of construction loans, and many planned projects' site control and local approvals have now lapsed. Permanent financing options have been reduced to just the loan programs run by Fannie, Freddie, and the Federal Housing Administration. The development pipeline will take a long time to get started back up, so the recovery in the affordable housing industry will lag the recovery in the overall economy and in the larger housing market. So, I think our industry will be in a deep funk for the remainder of this year and throughout at least 2010, as well.
Thomas: It is hard right now to make predictions for next week let alone a year. However, if the financial experts are correct and the economy begins to stabilize and starts to slowly improve later this year, we should be able to meet our goals for 2009 using the new resources given to us. Our hope is that the investor pool will grow in 2010, although it will likely not be as large as earlier this decade, and we can continue to fund deals that will succeed. We hope that the lessons we learn during this year as we implement new programs and develop new processes will make us more efficient and effective in the future.
Steven N. Fayne, managing director, Citi Community Capital
R. Lee Harris, president and CEO, Cohen-Esrey Real Estate Services, LLC
J. David Heller, principal, The NRP Group, LLC
Rob Hoskins, managing principal, The NuRock Cos.
Bill Kelly, president, Stewards of Affordable Housing for the Future
Sister Lillian Murphy, CEO, Mercy Housing, Inc.
Patrick Sheridan, senior vice president, housing development, Volunteers of America
Chris Tawa, senior vice president, MMA Financial
Sean Thomas, director, office of planning, preservation, and development, Ohio Housing Finance Agency