After being rocked by the prospect of tax reform, the low-income housing tax credit (LIHTC) market has regained its footing in time for the busy second half of the year.
The flow of deals has picked up, and most syndicators believe that pricing will hold steady through the end of the year.
“After two to three months of almost no activity, the LIHTC market has seemingly reached a new equilibrium as investors have demonstrated a willingness to close on investments that assume a 25% corporate tax rate with no upward and downward tax rate adjusters contemplated,” says Tony Bertoldi, executive vice president at CREA.
The use of a 25% rate assumption has been key in financing deals and helping the market stabilize, agree other syndicators.
“While the level of uncertainty of tax reform continues, the thing that has changed is that the LIHTC industry has come up with a mechanism for addressing the uncertainty—the market has settled in at a 25% tax rate with no adjusters—and deals need to be structured to work under these assumptions,” says Mark McDaniel, president and CEO of Cinnaire, adding that housing finance agencies (HFAs) also have been helpful in providing additional resources to fill funding gaps.
General agreement on an assumed 25% tax rate has allowed the HFAs that are awarding credits and underwriting deals to move forward and most investors to approve transactions under that assumption, adds Tammy Thiessen, director of equity sales at RBC Capital Markets.
The market stalled after the 2016 election when tax reform appeared to take a big step forward with Republicans in control of the White House and both houses of Congress. President Donald Trump has called for slashing the business rate from 35% to 15%, a level that many people say is unlikely, if not impossible. Members of Congress likely will be eyeing a rate in the 20% to 25% range.
The possibility of tax reform shook the industry as wary LIHTC investors pulled back. This caused deals to be restructured at lower prices.
“Equity pricing had dropped by as much as 20% on certain types of deals, and there was a scramble by developers to procure additional gap funding sources and by syndicators to close funds for which they had committed capital,” Bertoldi says. “Many of these deals had complicated structures, which included tax rate adjusters or something more creative to make the deals profitable if rates remained at 35%, a concept that was not well received by the investor market.”
However, most of these restructured deals have closed, and state agencies have factored current market pricing into their new allocations. “The result is a new generation of deals that work under the assumption of a 25% tax rate with no further complications and even some potential upside for investors,” Bertoldi says.
The recent uptick in the market also came as some economic buyers entered the scene, according to Stephen M. Daley, executive vice president at The Richman Group Affordable Housing Corp. “I believe they view opportunistically the more favorable pricing due to corporate tax rate uncertainty,” he says.
Bank investors also still must meet their Community Reinvestment Act (CRA) needs, adds Peter Sargent, director of capital development at the Massachusetts Housing Investment Corp.
While the market has perked up, it’s not to the point where it was a year ago. The average price per dollar of credit was about 95 cents in the recent second quarter, according to an Affordable Housing Finance survey of syndicators. Yields to investors averaged about 5.4%.
In comparison, prices were averaging $1.03 and investor yields were about 4.6% a year ago, according to AHF’s 2016 survey.
It's also worth noting that syndicators have acquired fewer projects so far this year. There was about a 16% drop in the number of projects acquired in the first six months of this year compared to the same period last year among firms completing midyear surveys in both 2016 and 2017.
Looking ahead, about 54% of the syndicators polled expect prices to hold steady in the second half while 31% think they will increase. “A number of large investors were not that active in the first six months of the year, and very likely these investors will be much more active in the last six months of the year, especially as the threat of comprehensive corporate tax reform seems to diminish over time,” says Steve Kropf, president and CEO of Raymond James Tax Credit Funds.
There is much more scrutiny on each investment, adds Stacie Nekus, senior vice president at Alliant Capital. “While investors are continuing to invest in LIHTCs, they are taking a more measured approach,” she says, explaining that yields need to be higher than they were prior to the election and CRA investing needs to be more specified.
Most syndicators also anticipate seeing fewer deals with complicated tax rate adjusters in the second half. Never popular, adjusters likely won’t be used as long as investors feel good about the market and remain comfortable with deal assumptions.
“We did incorporate tax rate adjusters into a few deals immediately following the election, but for the most part we have shied away from them in more recent months as the investment market has begun to coalesce around a middle-ground corporate tax rate assumption in pricing new deals,” says Ryan Sfreddo, principal and managing director, investor relations, at Red Stone Equity Partners.
Even though the LIHTC market has calmed, the possibility of tax reform continues to cast a cloud over the industry as it enters the critical second half. The third and fourth quarters are typically a busy time as HFAs make their LIHTC reservations and investors and developers hustle to close deals before the end of the year.
Syndicators worry that any news, even just gossip, about tax reform could trigger another market disruption.
“While we do expect the LIHTC market to heat up during the second half of the year, rumors or announcements out of Washington, D.C., about potential tax reform about anything other than a tax rate of 25% or higher could come at any time and could temper investors’ demand, particularly the economic investors,” says Jason Gershwin, senior vice president at R4 Capital.
Striking an appropriate balance with developers receiving adequate credit prices and investors receiving their desired risk-adjusted returns is paramount to ensuring that the greatest number of quality projects get financed and the greatest number of affordable housing units are delivered, he says.
“Lack of clarity on tax reform, continued political fighting, new tax proposals all lead to uncertainty, which causes investor discontent, waiting out the volatility, and perhaps temporary withdrawal from the market,” adds Jeffrey Goldstein, executive vice president and COO at Boston Capital.
The prospect of comprehensive tax reform continues to be at the forefront of our concerns, says Ben Mottola, president of Stratford Capital Group. “Even if meaningful tax reform isn’t imminent, it’s likely to remain the keystone of most political discussions along with health-care reform,” he says.
Beyond tax reform, several other issues are weighing on syndicators, including rising interest rates and construction costs, which make deals even tougher to pencil out.
Kenn Sassorossi, vice president for partner relations at Housing Vermont, adds another concern—funding for rental assistance and other housing programs that are often part of LIHTC deals. Significant cuts have been proposed to the Department of Housing and Urban Development's 2018 budget.
With these different issues hanging over the industry, developers need to be mindful going into their next deals.
They need to know how their syndicators and other financial partners will perform during unsettled times as well as what HFAs will do in a lower-price environment, stresses Hal Keller, president of Ohio Capital Corporation for Housing, and other LIHTC leaders.
“To the extent developers are either working through closing deals or are about to be executing a commitment with a syndicator to move forward on a deal in the next six months, the key would be to fully understand the syndicator’s ability to place the deal,” says Christine Cormier, senior vice president, investor relations, at WNC. “Developers should be asking questions regarding whether capital has already been identified so that assuming the project underwrites, capital is committed at the price point agreed to by the syndicator.”
Syndicators bidding on projects that will be supported by future investment funds may include language in their letters of intent (LOIs) enabling them to reprice if tax reform legislation appears to become more likely and if it appears the corporate tax rate might land below 25%, according to Cinnaire’s McDaniel. LOIs will likely include a short window for developers to act, he says.
“Developers should continue to price credits conservatively for applications and when valuing acquisition-rehab opportunities that are likely to use 4% credits,” says Gayle Manganello Ellis, senior vice president, manager of originations, at PNC Real Estate. “Developers also need to be involved with the state agencies and keep their eyes on completion deadlines and the potential need for a new allocation of credits, given delays caused by market disruption.”
2017 MIDYEAR TAX CREDIT ACTIVITY
|$ Closed in First Half (in millions)
|LIHTC Projects Acquired in First Half
|Aegon USA Realty Advisors
|Boston Financial Investment Management
|Massachusetts Housing Investment Corp.
|Ohio Capital Corporation for Housing
|PNC Real Estate
|Raymond James Tax Credit Funds
|RBC Capital Markets
|Red Stone Equity Partners
|The Richman Group Affordable Housing Corp.
|Stratford Capital Group