The affordable housing industry entered 2021 with a major victory—the establishment of a minimum 4% low-income housing tax credit (LIHTC) rate.
The long-desired 4% floor—a change from a rate that recently hovered around 3.07%—was included in a fiscal 2021 spending bill that was approved by Congress at the end of December.
“We expect the 4% rate fix to have a material impact on the market,” says Steve Kropf, president and CEO of Raymond James Tax Credit Funds. “Deals will now pencil out in markets that previously didn’t support 4% transactions due to lower rent levels or lack of subsidy. Supply will increase, and we could see an impact on pricing that could result in new investors entering the market.”
While the long-term prospects are great, there are some early unknowns and market adjustments that will likely take place.
“Deal equity increased by almost 30% overnight, but available investor equity did not,” says Jason Gershwin, executive vice president at R4 Capital. “It will take some time to absorb the increased available credits that flooded the market, and, as a result, we are seeing tremendous deal flow.”
The new minimum rate results in more 4% deals penciling out, with many, if not most, boasting more attractive investment metrics, including lower price and lower leverage than originally anticipated, according to Gershwin.
“The increased attractiveness of many 4% deals may, at least for some period of time, impact the pricing on 9% deals that are in the marketplace,” he says. “In the long term, once the short-term impacts shake out, the fixed 4% credit will help finance more than 100,000 desperately needed affordable homes over the next 10 years.”
In the near term, syndicators are watching to see how the market reacts to the rate change and the latest deals.
The additional 4% credit deals coming up could allow investors to be more selective. They will “have more choices so quality, structure, partner strength, and ultimately location could all be important to place 4% deals,” says Lori Little, president and CEO of the National Affordable Housing Trust.
There’s also been an early dip in prices that’s attributed to the rate change. However, even with the recent decline, the credits should still provide a higher value than before.
“We have already begun to see pricing on bond deals drop 2 to 5 pennies on account of the 4% fix,” says Tony Bertoldi, co-president of CREA. “The additional proceeds generated by the change in law have created more cushion in development budgets and allowed both developers and investors to share in the upside.”
Bertoldi also says it’s uncertain whether the investor market will be able to fully absorb the additional supply of credits at first, and, if it cannot, further price reductions may be possible.
The recent spending bill also provided about an additional $1.1 billion in LIHTCs for 11 states and Puerto Rico that have recently experienced major disasters, bringing even more credits into the market.
Matt Reilein, president and CEO of the National Equity Fund, agrees that pricing has declined about 2 to 5 cents. “We would expect this downward pricing trend to even out by the end of the second quarter as the industry gets a feel for whether the 4% floor results in larger or additional deals,” he says.
Together, the 21 firms in Affordable Housing Finance's survey closed about $12.4 billion in LIHTC capital and acquired 1,084 housing credit properties last year.
The average price paid for credits was about 90 cents per dollar of credit in the fourth quarter of 2020, down from 93 cents the prior year. Yields to investors averaged about 4.86%, up from 4.65% during the same period the year before.
COVID-19 and Other Issues
The other big issue continues to be the far-reaching effects of the COVID-19 pandemic. In response to the uncertainties caused by the global health crisis, many investors have become more cautious.
“Investors were understandably focused on COVID-related underwriting,” says Scott Hoekman, president of Enterprise Housing Credit Investments. “We will continue to address these concerns in 2021.”
In 2020, the investor community placed significant emphasis on several areas, including working with repeat developer partners and pursuing deals set aside for seniors and/or benefiting from project-based rental assistance, “the prevailing thought being that these deal types are better insulated than unsubsidized family properties against the massive job loss and economic dislocation brought about by the pandemic,” says Stephanie Kinsman, managing director, investor relations, at Red Stone Equity Partners.
“We also saw heightened focus and attention on deal terms, including operating reserve levels, guarantees, and guarantors, from the investor community,” she says. “We see all of these trends continuing in 2021.”
Hunt Capital Partners’ core underwriting values remained firm and didn’t change, but additional sensitivities were incorporated early on, according to Amy Dickerson, managing director, investor relations. “Investors required more sensitivities and a higher net worth and liquidity in some cases than in previous years,” she says.
The LIHTC program’s income-averaging, or average income, option is another area that is being scrutinized at this time. Several syndicators reported that investors are holding off or being very cautious on these deals until the Internal Revenue Service provides guidance on proposed regulations that have raised alarms. Developers and others want clarification on several points, including whether unit designations can change and how nonqualified units may impact a project.
|2020 TAX CREDIT ACTIVITY|
|COMPANY||CAPITAL CLOSED (IN $ MILLIONS)||LIHTC PROJECTS ACQUIRED|
|Aegon Asset Management||475||28|
|Boston Financial Investment Management||620.2||51|
|Enterprise Housing Credit Investments||1,060||80|
|Hudson Housing Capital||601.8||40|
|Hunt Capital Partners||306||28|
|Merritt Community Capital Corp.||76.5||8|
|National Affordable Housing Trust||106||22|
|National Equity Fund||1,060||90|
|Ohio Capital Corporation for Housing||388||48|
|Raymond James Tax Credit Funds||1,371||125|
|RBC Community Investments||1,303||94|
|Red Stone Equity Partners||779||73|
|Regions Affordable Housing||361.4||37|
|The Richman Group Affordable Housing Corp.||650||56|
|Source: AHF Survey, February 2021|
Still, nearly all the syndicators surveyed in February say the LIHTC market will be stronger in 2021.
“People are gaining a better sense of what the new normal will look like with the [COVID-19] vaccine rollout underway. New stimulus packages are moving forward to accelerate the economic recovery, and investors are re-evaluating positions this year to reduce loan loss reserves as unemployment rates come down,” says Todd Jones, senior vice president, equity syndications, at Boston Financial Investment Management.
He adds that there is continued demand from Community Reinvestment Act (CRA) investors, and a potential corporate tax credit increase could even strengthen the demand for LIHTCs later this year.
Others also are watching for potential changes to the tax rate that could push corporate investors to buy more credits.“We think the market will be about the same as 2020 during the first half of the year, and then it may strengthen in the second half of the year,” says Robert Chiles, head of Regions Affordable Housing. “Banks are coming back into the market, and the increased potential for tax reform should also help increase demand.”
Stephen Daley, executive vice president of The Richman Group Affordable Housing Corp., also thinks that market will remain strong this year. “Increases as a result of the 4% fixed might see better pricing on bond deals,” he says. “Investors demand will be strong, but yield expectations are increasing.”
Several syndicators also cite the significant support for affordable housing in the new Biden administration as well as at the state and local level. “We are seeing a number of opportunities in all regions within the U.S. as states/municipalities are looking to expand as well as preserve their existing affordable housing stock for all tenant populations,” says Andrew Anania, managing director, investor relations, at Berkadia Affordable Housing.
While there are still big uncertainties ahead for the LIHTC industry, developers can take steps to better position their deals for syndicators and investors this year.
“Developers still need to have a thoughtful plan in place to manage through the impact of COVID on rehabs,” says Tammy Thiessen, managing director and co-head of originations and sales at RBC Community Investments. “At closing, the plan needs to be detailed, but investors want to know early on, even during the LOI [letter of intent] stage, what the developer’s overall thoughts and plan are on mitigating this new risk.”
This includes a plan to eliminate potential COVID exposure during rehab and have the construction schedule and costs contemplate tenant exposure considerations, she says.
Ari Beliak, president and CEO of Merritt Community Capital Corp., expects the LIHTC market to be stronger as CRA investors, who took a pause last year, will work to catch up in 2021.
He says developers should work with investors and syndicators early on in their deals. “Equity is still more constrained than pre-COVID so lining up investors early is critical. In addition, relationship-based partnerships will be key to securing investment.”
“Investors will quickly fill their appetite with the amount of deals and credits in the market,” adds Jen Erixon, senior vice president, originations, at Alliant Capital. “Getting your sources identified early in the process will increase the opportunity to get to the closing table on your desired timeline.”