Could low-income housing tax credit (LIHTC) prices reach an overall average of $1?
They’ve been inching pretty close to that lofty mark this year. A mid-year survey of 17 syndicators finds they paid an average of 97 cents per dollar of credit in the second quarter, up from 94 cents at the end of 2014.
“The competition for 9% deals, regardless of their location, has been fierce,” says Tony Bertoldi, executive vice president, syndication and investor relations, at City Real Estate Advisors. “Negotiations with developers have taken place over several rounds, and pricing is as high as we have experienced in recent history.”
The uptick is not just in the big Community Reinvestment Act (CRA) markets like New York City and San Francisco, which typically see the highest prices. What’s surprising is several syndicators report deals in secondary and tertiary markets commanding pricing at or near $1.
“To say that the market is moving quickly is an understatement,” says Stacie Nekus, senior vice president, investor relations, at Alliant Capital. “A year ago, a market shift reduction of 25 basis points in a quarter was a notable event. In this current environment, yields are dropping 100 basis points in a quarter. Deals in tertiary markets are hotly contested, and it’s rare to find a deal for less than $1 per dollar of credit.”
Pricing for credits continues to increase in all areas, agrees Joe Hagan, president and CEO of the National Equity Fund. “It’s definitely a developer market,” he says.
The rise in prices has meant a drop in investor yields, which averaged 5.6% in the second quarter, according to the survey. That’s down from 6.5% about six months ago.
“This time last year we were debating whether yields could be sustained if they fell below 7%,” says Chris Cormier, senior vice president at WNC. “Now, we are debating whether yields can be sustained if they fall below 5%.”
Looking ahead, 57% of the surveyed syndicators say they expect prices to hold steady in the second half while 43% predict prices to still go up because competition for deals will continue to be strong.
“From where pricing is now, resulting in LIHTC yields approaching all-time lows, it is difficult to think there will be further increases in pricing going forward,” says Stephen Daley, executive vice president at The Richman Group Affordable Housing Corp.
Jeffrey Goldstein, executive vice president and COO at Boston Capital, also thinks prices will hold steady. “With the anticipation of interest rates rising in the economy, this could signal a flattening or reversal of tax credit yields,” he says.
The surveyed firms report closing nearly $3.7 billion in LIHTC capital and acquiring 407 projects in the first six months of 2015. Several syndicators have multi-investment funds closing in the second half.
4% credit deals
Many firms also report seeing more 4% LIHTC and bond deals in the market.
The Massachusetts Housing Investment Corp. (MHIC) acquired seven 4% deals in the first half. “We are doing mostly 4% deals as they are preservation transactions,” says Peter Sargent, director of capital development. “That is the segment of the market where we see the most value of our activity.”
RBC Capital Markets—Tax Credit Equity Group closed 32 projects in the first half—21 9% deals and 11 4% projects. “We’re seeing more deals as pricing fundamentals work for 4% deals in this market,” says Tony Alfieri, managing director.
WNC closed 16 deals in the first half—half were 9% deals and half were 4% transactions. “Demand for 4% deals is higher than it was this time last year,” Cormier says. “The investor community is more accepting of these deals, assuming they are well structured (cushion in debt-service coverage, strongly capitalized developers) and given the substantial rise in demand for the 9% deals.”
Issues to watch
Syndicators want the market to have just the right balance—healthy prices that allow developers to make their affordable housing deals work and good yields that attract a deep and diverse group of investors. A further decline in yields raises several concerns.
“If returns continue to fall, developers should watch for yield-driven investors to leave the market, leaving only CRA investors,” explains Mark McDaniel, president and CEO of Great Lakes Capital Fund. “As such, only hot CRA deals will be in demand, leaving non-CRA deals with very low pricing.”
Deals could also be affected by rising construction costs, permitting delays, and labor shortages that potentially impact costs and schedules in some markets, adds Steve Kropf, president and CEO of Raymond James Tax Credit Funds.
Syndicators are worried that the high competition will lead to changes in deal terms and underwriting.
“I hope with the ‘frothy’ market and unprecedented investor demand that developers do not lower their underwriting standards and start developing riskier deals,” says Raoul Moore, senior vice president, syndicator, at Enterprise Community Investment.
Ryan Sfreddo, managing director at Red Stone Equity Partners, cites the “breakneck pace” at which pricing has increased and yields have decreased as the most significant change in the first half.
In places where there was already limited room for price increases, like the highly priced CRA markets of New York, Boston, Florida, and California, there has been some accelerated term erosion at the deal level, he says.
“While this trend may be perceived as good news for the development community, it is a concern in the investment community,” Sfreddo says.
That’s not all. There are plenty of other issues that developers should watch and plan for in the second half, according to surveyed syndicators.
With such heated competition for deals, developers should ask themselves “can syndicators deliver on the prices offered?” says Hal Keller, president of the Ohio Capital Corporation for Housing.
“At some point, there will likely be a pricing correction (albeit maybe muted because of the overall demand dynamics in the market) as yields continue to drop in the market,” adds Mark Gipner, senior fund development manager at Community Affordable Housing Equity Corp. “We are encouraging developers to get their deals signed up quickly and move to close in a timely manner to safeguard against any market upset or pullback.”
That’s the strongest advice coming from syndicators at this time.
“Developers should be cautious about using high pricing in tax credit applications as the market is at an all-time high in pricing and may not sustain until such time as the deal is allocated and begins construction,” agrees Todd Crow, executive vice president and manager of tax credit capital at PNC Real Estate.
John Wiechmann, president and CEO of Midwest Housing Equity Group, points out the cyclical nature of real estate assets, including LIHTCs.
“While pricing seems likely to remain aggressive in the near term, I encourage developers to model later pipeline deals at lower prices to ensure they stay viable when things shift,” he says. “And, as always, minimize leverage—it’s the best way to make it through a downturn.”