Surging insurance costs are making it difficult for affordable housing developments to pencil out.

The rising prices have been one of the biggest issues for the low-income housing tax credit (LIHTC) market this year, according to syndicators.

“The large increase in insurance costs throughout the portfolio has caused challenges both in new project underwriting and projects converting to permanent financing as well as eroding cash flow in the stabilized portfolio,” says Amy Dickerson, managing director, investor relations, at Hunt Capital Partners.

Other syndicators also point to swelling insurance bills as adding stress to developers and their projects.“Insurance costs are extremely volatile and have been hamstringing deals in coastal and fire-prone communities,” says Julie Sharp, executive vice president at Merchants Capital, noting that costs have surged 30% to 100% in some markets.

The challenge is further exacerbated by carriers pulling out of specific markets, limiting coverage options, adds Jason Gershwin, managing director at R4 Capital.

He says his firm is proactively addressing this issue by analyzing its portfolio to determine insurance cost increases by region. The data allows R4 Capital to run downside sensitivities to better understand what a property’s cash flow and debt-service coverage ratio will look like if insurance costs increase at the historical average for the region in which the property is located, according to Gershwin.

“We are also working with our development partners and their insurance carriers to understand the risk modeling the carrier is using to price coverage,” he says.

Property insurance costs have risen a staggering 26% on average for over the past year alone, reported the National Multifamily Housing Council’s recently released “2023 State of Multifamily Risk Survey and Report.”

Some apartment firms reported even higher spikes in property premiums and significant challenges across all other lines of coverage, such as liability, cyber, builders risk, and more.

The ability to secure project insurance at a price that a deal can support, especially in certain markets like California and Florida where some major providers have pulled away, remains a key concern heading into the second half of the year, says David Leopold, senior vice president and head of affordable housing at Berkadia, noting that the situation is further exacerbated by the recent wildfire in Hawaii.

Prices Hold Firm in Q2

Despite the notable headwinds, the average price paid per dollar of tax credit continues to be about 88.8 cents in the recent second quarter, according to an Affordable Housing Finance survey of syndicators. That’s right in line with the 88.9 cents reported in surveys covering the second and fourth quarters of 2022.

Yields to investors also held firm in the second quarter, averaging just under 5.5%.

Half of the firms surveyed say prices will decline in the second half of the year, while the other half believe they will remain unchanged. No one is anticipating prices to increase in the next several months.

“We expect the market to hold steady through the second half of 2023 as investors already have their allocations determined for the year,” says Catherine Cawthon, president and CEO of Ohio Capital Corporation for Housing. “Any decrease would more likely be for deals in 2024.”

The LIHTC supply continues to be constrained because of the recent expiration of the 12.5% allocation increase to the 9% credit program, and there continues to be strong demand from investors, notes Stephanie Kinsman, managing director, investor relations, at Red Stone Equity Partners.

She’s continuing to keep a close eye on the 10-year Treasury yield, which some housing credit investors use as a benchmark.

“While the 10-year Treasury held relatively steady in the first half of 2023, we are starting to see increases again, which may put some pressure on pricing and LIHTC yield targets,” she says.

Once the new year begins, there should be fewer and fewer deals that work given costs and interest rates, adds Philip Porter, senior vice president at Enterprise Housing Credit Investments.

“For the strongest sponsors in Community Reinvestment Act (CRA) locations, prices will be strong and perhaps higher than the second half of 2023,” he says. “But, for non-CRA locations, pricing may well further drop until interest rates decline.”

Deals in many higher-demand CRA markets have remained stable, but there has also been some evidence of pricing decreases in CRA markets impacted by the failure of several regional banks as well as in the broader market as some larger bank and economic investors adjusted their yield and upper-tier price targets heading into the second half of the year, according to Tammy Thiessen, managing director and co-head of originations and sales at RBC Community Investments.

The Loss of Key Investors

The collapse of three banks—Silicon Valley, Signature, and First Republic—has been another hit to the market this year. All were active LIHTC investors, according to syndicators.

“Between the aftermath of the three bank failures, the continued pressure from inflation and high interest rates, and the general pause we have seen from the economic investors, it has been very difficult to attract investor capital at the same levels we have seen in years past,” says Tony Bertoldi, co-president of CREA. “As a result, we are seeing smaller national funds in the market. Additionally, with the increased carry costs, syndicators are less willing to take down speculative product on their warehouse lines without certainty of a timely execution.”

The recent bank failures raised concerns from other investors about counter-party risk in deals and funds. While those worries seem to have subsided, “it is still on investors’ radar as something to monitor,” says Stephen M. Daley, executive vice president, at The Richman Group Affordable Housing Corp., about how the market is different compared with a year ago.

Other regional banks have a softening appetite for housing credits this year, report a few survey respondents.

Underwriting Changes

Syndicators were also asked about changes in underwriting, which has been impacted by both rising insurance costs and interest rates.

It’s been a “continuation of 2022 with the emphasis on ensuring deals have sufficient cushion in the capital stack to absorb cost overruns related to construction and interest expense,” says Steve Kropf, president and CEO of Raymond James Affordable Housing Investments.

Other syndicators are also focusing on the interest reserves and rate expectations in the sponsor’s budget.

“We are adjusting both in real time as rates move, and we are including cushions in case rates continue to increase,” says Robert Chiles, head of Regions Affordable Housing.

While including an appropriate cushion is critical, it currently is putting a lot of pressure on project budgets.

“We are discussing creative measures with our developer and investor clients such as higher insurance deductibles on policies not only to help manage costs but to also ensure a project can secure insurance coverage period,” says RBC Community Investments’ Thiessen.

Insurance, real estate taxes, and utility costs all continue to rise, impacting permanent debt sizing, adds Dickerson of Hunt Capital Partners. “Combined with increased interest rates, project feasibility is challenged,” she says. “Sponsors are having to spend additional time and resources to source gap funding, extending the underwriting period.”

CREA’s Bertoldi reports seeing more deals that have deferred development fees above 50%, including some over 75%. He’s being asked to approve lower terms such 1.15 debt-service coverage ratio on bond deals and operating deficit reserves sizes to less than six months of coverage.

“We are attempting to hold the line on these terms and only granting variances when there are other mitigants present,” he says.

In the second half of the year, syndicators will continue to closely watch interest rates, with hopes that they will begin to settle.

“As inflation stabilizes and rates come down, we are optimistic that closing timelines decrease and we see fewer deals fall out of balance,” says Bertoldi.

Dana Boole, president and CEO of CAHEC, is optimistic on several points—"a soft landing for the economy,” signs pointing to interest rate reductions in 2024, and hopefully no significant ramifications for the market caused by CRA reform.

Many market participants believe the Federal Reserve is moving close to the end of its tightening cycle, which will help stabilize interest rates.

“Projects have been able to absorb increases so far so any deceleration in tightening will be welcomed,” adds Chiles.

Alliant Capital $365.3 32
Berkadia $135.6 7
Boston Financial $291.8 20
CAHEC $47.0 8
CREA $416.0 25
Enterprise Housing Credit Investments $682.0 37
Evernorth $73.8 10
Hunt Capital Partners $119.0 11
Massachusetts Housing Investment Corp. $92.1 7
Merchants Capital $237.8 22
Merritt Community Capital Corp. $56.5 7
Ohio Capital Corporation for Housing $92.9 11
PNC Real Estate $630.0 29
Raymond James Affordable Housing Investments $780.5 42
RBC Community Investments $462.0 26
Red Stone Equity Partners $445.0 27
Regions Affordable Housing $237.0 14
R4 Capital $429.2 23
The Richman Group Affordable Housing Corp. $472.0 24
WNC $173.0 25
Source: AHF Survey, August 2023