“Welcome to disruption 2.0.”
That was the greeting from Mark Siranovic, senior vice president for multi-investor fund markets at the National Equity Fund and one of the panelists on the Tax Credit Equity Outlook Power Panel at AHF Live in Chicago.
Siranovic and other low-income housing tax credit (LIHTC) syndicators and investors detailed the changing dynamics of the market as Congress works to overhaul the tax system. The market was jolted by the 2016 election, which gave Republicans control of the White House and both houses of Congress and increased the prospects for tax reform.
“Last year, you had the three-month blowup of the market, and then we found equilibrium again,” Siranovic said. “A couple of weeks ago, you started phase two of that. I think the market will quickly adjust once somebody can give us an accurate and final set of guidelines and rules to play by.”
Until there’s a resolution on a final tax reform package, a cloud of uncertainty hangs over the industry.
The tax bill passed by the House repeals private-activity bonds (PABs), which are used in conjunction with the 4% LIHTC program and help finance roughly half of all LIHTC homes annually. Losing the bonds could mean roughly 60,000 fewer affordable units are built or rehabilitated each year. In addition, the House repeals the New Markets Tax Credit (NMTC) and historic tax credit.
The Senate’s initial version is much more favorable for affordable housing and community development, retaining PABs, keeping the NMTC through 2019, and retaining the historic tax credit although it would be claimed over a five-year period.
Both bills seeks to reduce the corporate tax rate from 35% to 20% without making provisions to sustain LIHTC production.
“The positive takeaway is that the tax credit is here to stay,” said Stephen Daley, executive vice president at The Richman Group Affordable Housing Corp. “There are questions on the 4% side, but generally the credit is here. A year ago, there was a lot of concern. We worked through it.”
Despite concerns—especially with the House bill, which was unveiled at the beginning of November—there has not been any repricing on deals so far, according to panelists. The industry coalesced around using a 25% tax rate on deals earlier this year, and that has continued as tax reform efforts heated up in recent weeks.
However, if legislation passes that reduces the corporate tax rate to 20%, there will have to be another adjustment, said Marge Novak, executive vice president, capital group, at Cinnaire. “I do not anticipate us underwriting to a 35% tax rate again any time soon,” she said. “I just don’t think the investors will want to go there.”
On average, a drop from 25% to 20% could mean about a 4 to 5 cents per dollar of credit reduction in deals, estimate industry leaders.
There is a lot of desire for the 35% rate, but everyone needs to get used to the idea that tax reform is going to happen at some point, said Fred Copeman, senior vice president, equity production, at Boston Financial Investment Management. “It’s just a matter of time,” he said. “If it doesn’t happen this year, it will happen next year,” he said. “I think we can wave a fond farewell to 35%.”
It will be important for the industry to not only get clarity about the fate of PABs but also the transition rules for bond deals that have recently closed or are about to close, said Beth Stohr, director of new production, affordable housing tax credit investments, at U.S. Bancorp Community Development Corp., a leading LIHTC investor.
There needs to be a lot of conversations happening among developers, lenders, investors, and syndicators if they have a 4% bond deal on the table, according to Stohr.
Project partners need to come together and examine the different issues that they may face, including when to fully draw down the bonds.
While the outcome and timing of tax reform remains unknown, it looks certain that interest rates will rise in the next two years. The Federal Reserve has predicted about nine interest rate hikes between now and the end of 2019 that will total roughly 150 basis points, according to Copeman.
That will likely make some deals difficult to pencil out and require restructuring, he said, noting that the good news is that Community Reinvestment Act–motivated investors will remain in the market. “The key is we don’t want an interest rate shock,” Copeman said, explaining that a gradual increase would be much more workable than a sudden spike in the rate.
The deals that are potentially most exposed in a rising interest rate environment are bond projects, said Ryan Sfreddo, managing director, investor relations, Red Stone Equity Partners. This is because developers of bond deals will have higher debt costs and also face getting hit on the equity side with higher costs.
Advice for developers
During this period of unrest, panelists said developers should consider more than the best price offered for their housing credits.
“That extra penny or two or three may not be worth as much as committing to an investor that will stand by their deal and is ready and able to close,” said Susan Moro, senior vice president and community development executive at Bank of America Merrill Lynch, another leading LIHTC investor.
Stay nimble and stay in touch, added Stohr. “One thing that’s great about this industry is that even in choppy times, we’re a very collaborative industry. We work to get things done, and I think this is a time for communication.”
Developers should sign their letters of intent as soon as possible, said Novak. “Get a spot and get a partner who is going to work with you to get your deal done.”
