Even though low-income housing tax credit (LIHTC) investors are feeling good about the market, they will be keeping careful watch on development costs in the year ahead.
Several leading investors list rising land and construction prices as their top concern heading into 2020.
“I’m worried about costs from two fronts. First is the impact on the number of units produced. The more a development costs, the more credits you need per unit so the fewer units you can build. That’s a real issue at a time when rents have risen much faster than incomes, and there is increasing demand for affordable housing,” says Beth Stohr, managing director of affordable housing at U.S. Bancorp Community Development Corp. (USBCDC). “The second aspect is the impact on the construction period. Uncertainty around labor and materials availability has developers and contractors building extra time into the contract in case they lose workers and have to reconfigure costs midstream.”
The challenges have created “a more laser focus around construction issues and whether we’re asking the right questions of our development partner and the contractor,” says Stohr. “There’s a heightened awareness about the construction issue. Developers have become smarter about this and are very focused to avoid getting caught with a contract that comes in 10%, 15%, or 20% higher.”
Increasing costs as well as labor and material shortages continue to be an issue, agrees Michael Lavine, executive vice president and head of the tax credit equity team at Wells Fargo, which expects to close between $2.1 billion and $2.2 billion in LIHTC equity in 2019. “The potential effects of these costs have been muted somewhat by low interest rates, but they remain a concern on an overall and transactional level," he says.
Lavine estimates that 90% of Wells Fargo’s investments will be direct investments in up to 114 separate investments. The remaining 10% will be placed in 13 separate multi-investor funds.
Investors also noted seeing more delays during the financial closing or construction process. These can be caused by local governments or housing finance agencies asking more questions or being involved in aspects of the deal where they were not before, long lead times in utility approvals, and other challenges.
Overall, LIHTC investors are hopeful that 2019’s stable market conditions will carry on into the new year.
“The market is working well at this point,” Stohr says. “There’s room for CRA [Community Reinvestment Act] investors as well as economic investors. That’s a plus. As we go into 2020, my hope is that we get clarification from Treasury around the income-averaging program, such that we see a lot more use of this new tool next year.”
Lavine also points to the prospects for the new LIHTC option in 2020. “One developing trend, not unexpectedly, is an increasing number of income-averaging deals,” he says. “I would expect this trend to continue especially if the service provides additional guidance about this set-aside.”
Bank of America is on track to have a record year of LIHTC investments in 2019 and expects 2020 to be another robust year, says Maria Barry, national executive, for the bank's Community Development Banking team.
“We expect to see sustained strong activity in RAD [Rental Assistance Demonstration] conversions, and we’ve seen wider use of historic tax credits in financing affordable housing,” she says.
Capital One leaders also expect investor demand and pricing to remain relatively unchanged. They plan to continue to be an active market participant and invest in LIHTCs through proprietary and multi-investor funds, says Desiree Francis, vice president of originations on the community finance team.
“We will continue to assess sponsors, location and community, and resident impact as we evaluate new opportunities, and we’ll seek opportunities to make social purpose investments and enhance the well-being of residents and surrounding communities,” Francis says.
While investors will be paying close attention to construction issues and costs, the key factors they look at to evaluate deals are expected to stay the same, including developer relationships and capacity.
“We want the sponsor or developer to have consistent experience and a proven track record in affordable housing. We strive for all the deals we finance to be successful, so it is important to ensure that projects have adequate reserves on hand,” says Barry, adding that
Bank of America also wants to have a broad banking relationship with developers to understand their needs and create solutions specific to each transaction.
USBCDC focuses on achieving successful outcomes for the housing resident, the developer, and return on its investment—“the triple bottom line that the industry refers to,” Stohr says. “And, while we want to ensure that the right product is being built in the market, we are driven by customer relationship and the character and capacity of the developer,” she says.
Stohr also notes that project impact is important. “Is the project a catalyst in the area or meeting an acute or unique need?” she says. “We’re not afraid of a deal that is complex if the impact is meaningful.”
U.S. Bank is placing an increased focus on economic opportunity and the role the bank can play to help, especially for historically disadvantaged groups. “USBCDC is reviewing how we can better use our financing tools to advance racial equity and maximize impact for affordable housing residents,” Stohr says. “We’ve put together a team dedicated to visioning and strategizing for how best to do this. We are also talking to our developer customers about how best for us to do this because we know many of them are also thinking about the same thing. The goal is to figure out how to build this into our 2020 investments.”