Low-income housing tax credit (LIHTC) deals continue to move forward, but investors are being very cautious as they weigh potential new risks brought on by the COVID-19 crisis and the economic downturn.
Deals that were agreed upon late last year or early this year have largely been closing under their original terms and pricing, according to market veterans.
“I think that’s the overwhelming sentiment of investors in the market right now,” says Jennifer Seamons, senior vice president and national equity sales manager at KeyBank Community Development Lending and Investment (CDLI). “For deals that were signed up pre-COVID, to the extent that they can be closed on their original terms, they are.”
KeyBank CDLI continues to move through a strong pipeline of deals this year, says Seamons, also president of the Affordable Housing Investors Council (AHIC).
Bank of America also had a big pipeline entering 2020 and continues to work on those deals, says Maria Barry, community development banking national executive.
“We feel really strongly about supporting communities, and communities will need us more than ever now,” she says. “We want to make sure that as we move forward with our clients who are developing affordable housing that we all have our eyes wide open and are looking at the potential health and economic risks in this COVID-19 crisis environment.”
The LIHTC market has had big ups and downs in recent years, including during the Great Recession in 2008 when prices plummeted and then during tax reform in 2017 when prices dropped again and many deals were suddenly retraded.
“This feels a lot different,” says Dan Kierce, president of the Texas Affiliation of Affordable Housing Providers (TAAHP) and managing director for the Central region at RBC Community Investments. “We haven’t seen that full-scale retrading. All the investors that we were working with circled their deals and said, ‘We’re still good. We may slow down or be cautious circling new deals, but we’re keeping the existing ones moving.’ That’s been very positive.”
However, the uncertainty created by COVID-19 has slowed activity, says Kierce.
Some investors have hit the pause button as they evaluate their balance sheets and assess their appetite for deals in the current market. In addition, there’s been a slowdown in getting building permits and other approvals because city and county offices have been closed and employees have been working remotely.
For those who are still in the market, there’s more enhanced due diligence. “First, they are evaluating the project’s construction process, policies, and procedures,” Kierce says. “How is the general contractor going to keep everybody safe? Will there be any issues getting materials?”
Second, they’re spending more time evaluating the project sponsor. “Investors have always spent a lot of time making sure the sponsor is strong,” he says. “There’s probably been more enhanced due diligence around their real estate-owned schedules and how those stand, how their portfolios are doing, and around their liquidity.”
Third, people are looking at sensitizing a deal. That means determining what happens if a project is delayed by several months. Is there enough cushion in the budget or cash developer fee to sustain the project?
Barry and her team are asking many of those questions. “We are also looking at the subsidies and making sure everything is still lined up,” she says. “We realize there is a need for subsidies in other areas now due to the health crisis, so we’re making sure everything is still as it was intended to be. So far, so good in that area.”
Bank of America has also been reviewing takeout schedules and encouraging where it’s possible to have more leeway on the permanent debt timing so if a developer needs a little more time they are not pushed up against deadlines.
Rehab projects have been among the most difficult during the health crisis because construction crews have no or limited access to buildings. Investors are asking how resident safety is being managed and looking at the different policies that need to be in place.
Like the others, Enterprise Housing Credit Investments has a strong pipeline of secured deals and is continuing to underwrite and close those transactions, says Scott Hoekman, president and CEO.
“In underwriting, we are asking additional questions in consideration of COVID, but so far we have not seen deals encounter insurmountable obstacles to closing,” he says. “For new deals we are structuring now, we are continuing our practice of working closely with our investors so that we can deliver what we promise. There is obviously greater uncertainty now, and housing credit investment is always subject to market fluctuations. Some investors are pausing a bit to see how things evolve, and that may affect developers who are looking for equity now, but so far this doesn’t feel like 2008-2009 when we experienced a meltdown.”
Investors and others are also trying to determine what the LIHTC market may look like months or even a year from now, but that’s challenging, says Seamons.
She also points out that area median income growth or contraction likely won’t be felt for a while because of a lag in the income limits that are set by federal officials. “The effects of this pandemic in terms of AMI and rent growth may not be felt for a couple of years, which could have an adverse effect on projects that are closing now that are anticipating rental increases to support debt sizing,” she says.
Positioning New Deals, Issues Ahead
The long-term impact of COVID-19 on the economy, affordable housing, and the housing credit market, which has seen some pricing compression since the beginning of the year, is a great unknown that hangs over everyone.
To best position deals at this time, developers and others should not be overly aggressive in their assumptions. They should go back to industry standards in terms of vacancy assumptions, reserves, and guarantee requirements, with a focus on operating reserves being shored up, says Seamons.
For example, the AHIC guidelines call for deals to have at least six months of operating reserves.
There’s more of a focus on reserves and guarantees, agrees Barry. “Try to keep deals as straightforward as possible as far as underwriting goes. I would say we are seeing fewer exceptions and in some cases stronger reserves and guarantees depending on the risks of a deal,” she says.
Rent collections is another area to watch, according to Kierce, noting that overall collections in April and May were better than people originally expected. “I think seeing that resiliency in the market is going to be helpful for investors and all stakeholders,” he says, noting that property managers and owners have been creative in working with residents to come up with payment plans.
There’s also concern around Community Reinvestment Act reform this year. Affordable housing leaders worry that a plan by the Office of the Comptroller of the Currency could diminish LIHTC investment and other key activities by banks.
Developers should also continue to pay attention to construction costs, Kierce says.
TAAHP and the Texas Department of Housing and Community Affairs (TDHCA), the state housing finance agency, regularly exchange information about construction costs, rent rate, collections, and other challenges, says Roger Arriaga, TAAHP executive director.
Communication will be “critical in placing housing as one of the key constructs in the upcoming recovery,” he says.
