As the unrelenting COVID-19 pandemic moves into the second half of the year and foreseeable future, developers need to be increasingly conservative in planning their deals, according to low-income housing tax credit (LIHTC) syndicators.

“Make your deals as resilient as possible by structuring them with healthy reserves, additional cushion built into the construction and conversion timelines, and enlist a best-in-class general contractor with longstanding subcontractor relationships,” says Ryan Sfreddo, president of Red Stone Equity Partners.

Developers should also structure their deals to meet traditional underwriting terms because the fewer exceptions to guidelines, the more likely a deal is to attract investment, adds Jen Erixon, senior vice president, originations, at Alliant Capital.

Others stress the importance of working with strong and reliable partners, getting deals to the syndicator originator as soon as possible, and being conservative when underwriting area median income (AMI) growth.“Also, have your policies and procedures related to COVID up to date, handy, and thorough,” says Matt Reilein, president and CEO of National Equity Fund. “Investors are asking us to get that information from developers, and it can be time consuming to generate information and data quickly. Documentation should include COVID-related plans for tenant-in-place rehabs.”

Investors want to know early on, even during the letter-of-intent stage, what the developer’s plans are for mitigating risk. For example, how will the firm reduce tenant and work interaction and potential COVID exposure during a rehab and have the construction schedule and costs taken into account for different exposure considerations, says Tammy Thiessen, managing director of equity sales at RBC Community Investments.

Reilein adds that if developers are planning a large 4% credit tenant-in-place renovation and have the ability to postpone, they might even consider holding off. “Let us recover from the pandemic a bit longer as investors are saying, ‘Hey, that’s a great deal, but the rehab of a 250-unit senior high-rise just isn’t something we want to bite off right now,’” he says.

In addition to setting realistic closing timeframes and planning for longer construction periods to allow for delays, developers should “draft budgets with realistic ‘post-COVID’ LIHTC pricing,” adds David Leopold, senior vice president and head of affordable housing at Berkadia.

“Seek gap dollars where necessary as investors and lenders want to see sufficient cash fee in budgets to address cost overruns and/or loan-sizing issues,” he says.

A Conservative Approach

A good majority, 73%, of the syndicators surveyed by Affordable Housing Finance in July expect LIHTC prices to decrease in the second half of the year while the remaining 27% think prices will remain steady. No one is foreseeing an increase.

The average price paid per dollar of credit in the second quarter was 89 cents, down from 92.3 cents the year before. Yields to investors averaged about 5% in the recent second quarter, up from 4.8% reported during the same time in 2019, according to the survey.

“Pricing on deals was adversely impacted to the tune of two to four pennies dependent on property locations,” says Anil Advani, executive vice president of originations and finance at WNC. “The drop in price was a function of a drop in investor demand as some investors decided to take a wait-and-see approach based on the pandemic.”

The good news was that many deals, especially those that had commitments in place at the beginning of the year, moved forward despite the uncertainties around COVID-19. However, there were delays because local approvals and site inspections slowed down.

The 23 surveyed syndicators reported closing a combined $5.4 billion in capital and acquiring 502 projects in the first six months of the year.

It’s clear that conditions and procedures have changed from a year ago. Major concerns about the COVID-19 health crisis as well as the impact on the economy have pushed syndicators and investors to increase their scrutiny and tighten their underwriting.

Fewer waivers to underwriting standards are being granted, says Mark McDaniel, president and CEO of Cinnaire. In addition, Cinnaire is “stress-testing deals to ensure they will deliver credits and absorb the impact of delays in construction and tax credit adjusters should there be additional waves of COVID-19.”

At CREA, officials have been building in an additional three-month cushion to construction schedules. “We are now paying very close attention to the permitting and inspection processes as the pandemic has made it more difficult for projects to meet their readiness-to-proceed and placed-in-serve deadlines,” says Tony Bertoldi, executive vice president, syndication and investor relations. “We are also making sure additional cost containment measures are in place to isolate investors from the effects of cost overruns and are running sensitivities such as 10% first-year revenue reductions or flat AMI growth throughout the initial five years to demonstrate whether the project could sustain in a continued downturn.”

Others syndicators are also being conservative with deal assumptions, including potential AMI changes.

“We have been stressing new deals with flat AMI growth for the initial years and longer construction and lease-up period,” says Gayle Manganello, senior vice president at PNC Real Estate.

The Ohio Capital Corporation for Housing has also taken “a closer look at AMI trending over the 15-year compliance period and sensitized income over various scenarios to ensure adequate rental income through a sustained economic downturn,” adds Peg Moertl, president and CEO.

Hunt Capital Partners reports modifying its practices to include additional sensitivities around construction delays and costs as well as economic vacancy. “All projects in our most recent multi-investor funds were able to pass those sensitivities based on developer fee holdback and operating reserves,” says Amy Dickerson, managing director. “As we go forward, we continue to run those same sensitivities to make sure projects are well equipped for the COVID environment.”

To keep deals moving forward, “developers need to build in a cushion in terms of time and finance resources,” says Jeffrey Goldstein, executive vice president and COO at Boston Capital.

Plan for additional resources within each deal, agrees Joseph Macari, managing member at Hudson Housing Capital.

Developers should also “be open to additional scrutiny on their financial strength and their development assumptions as there could be a flight to quality if the economy or pandemic worsens,” says Robert Chiles, head of Regions Affordable Housing.

In many communities, government agencies are still experiencing layoffs or furloughs, so developers will need to “apply the appropriate amount of pressure” to receive the permits and approvals needed to keep their projects on schedule, adds Jason Gershwin, executive vice president at R4 Capital.

“Additionally, we are watching many of our successful developer partners get ahead of potential construction and supply-chain challenges, especially if there is a second wave of COVID-19 in the fall as many predict,” he says.

If developers can get an investor or syndicator to submit a reasonable letter of intent, they should sign it and move forward, says Peter Sargent, director of capital development at Massachusetts Housing Investment Corp. They should also stick with partners they know. “Now is not the time to try something different,” Sargent says.

In-Place Rehabs

While COVID-19’s impact on all deals is being examined, tenant-in-place rehabs are receiving the most scrutiny, according to Scott Hoekman, president and CEO of Enterprise Housing Credit Investments.

The National Affordable Housing Trust cites the importance of “rehab construction and relocation plans to address keeping residents safe from potential COVID exposure.” “These plans must be reviewed and vetted by both the syndicator and the investors,” says Lori Little, president and CEO.

In addition, as the pandemic continues, some state agencies are requiring tenants to be relocated during construction, according to Stephen M. Daley, executive vice president at The Richman Group Affordable Housing Corp.

Overall, developers must really know the specifics of their new construction or rehab deals and plan for delays to keep them moving. “Key is for them to push forward with the eye on the committed closing date,” Little says.

Long-Term Effects

At this time, most of the focus is on the short term as syndicators work to navigate the market and close deals. However, if COVID-19 remains a threat and the economy continues to suffer, there could be longer-term impacts on the housing credit market.

“There is no doubt that the pandemic will increase the need for affordable housing, however, that could be more than offset by the economic implications resulting from a decrease in the amount of LIHTC being purchased by investors from a muted economy,” says Todd Jones, senior vice president, institutional sales, at Boston Financial Investment Management. “We anticipate that investors will continue to be conservative about underwriting markets, vacancy, operating expenses, operating reserves, and sponsor qualifications (guarantees, liquidity, and net worth).”

The demand for affordable housing will continue, and if there is a drawn out recession, the demand for affordable housing may increase even further, agrees Cinnaire’s McDaniel. “If AMI is flat or even decreases, there will be downward pressure on income that will stress deals and their ability to cash flow,” he says. “This may put strain on deal reserves and may require adjustments in operations at the deal level.”

Depending upon the recovery of the economy and employment market, there could be reduced demand for LIHTCs from investors and stress on occupancy rates if the rebound takes several years, notes Mark Gipner, manager of fund development, at CAHEC (Community Affordable Housing Equity Corp.).

There are other factors to consider when it comes to the supply of equity, including Community Reinvestment Act (CRA) reform and the presidential election in November, says Steve Kropf, president and CEO of Raymond James Tax Credit Funds.

“The longer and deeper a recession, the more it will affect investor demand, but at this point I’m not really anticipating a significant long-term effect on the market from the pandemic,” says Enterprise’s Hoekman. “Current CRA regulations will remain in effect for at least several more years, the need for affordable housing will only increase, and housing credit investments will remain attractive to investors.”

The pandemic’s long-term effect on the market remains unclear at this time, says Sfreddo of Red Stone Equity Partners. “Q2 bank earnings were mixed, with the biggest concern being the record amounts of loan loss provisions banks are building to hunker down as they anticipate the coronavirus crisis will deal a blow to borrowers in the coming months,” he says. “If COVID-19 cases continue to rise and the economy and labor market continue to sputter, then tax capacity among larger LIHTC investors could become a real concern. On a positive note, with interest rates at historic lows and expected to remain so for the foreseeable future, LIHTC investments continue to offer a compelling value to investors compared to alternative investments. This dynamic has helped to counterbalance uncertainty and lower tax capacity that some LIHTC investors are projecting.”

Concerns Ahead

LIHTC investors and syndicators like stability, and the unpredictability of the months ahead is what worries many in the industry.

Concerns include “the unknowns, ranging from the election to legislative actions to overall corporate tax liability,” says Lynn Ambrosy, managing director at Aegon Asset Management.

“There are multiple external factors that could have a significant impact on the LIHTC market over the next six months, including but not limited to the 2020 election, the ongoing COVID-19 pandemic and related strain on our economy, and CRA reform,” says R4 Capital’s Gershwin. “It is impossible to predict exactly how each of these external factors will play out, which makes it difficult to accurately assess exactly how such factors will impact the LIHTC market. Though the impacts of these factors and others may wind up being positive in the long term, the unpredictable nature of the coming six months is a concern.”