Low-income housing tax credit (LIHTC) prices are expected to drop in the first half of the year as the market adjusts to the sweeping changes made under the recent tax reform legislation.

While the market may eventually regain its strength by the end of the year, it’s going to have to first reset at a lower corporate tax rate. This adjustment period will likely mean a cautious first half, according to multiple LIHTC syndicators.

“For the better part of 2017, the vast majority of LIHTC equity investors were using 25% as a hypothetical tax rate to price LIHTC assets and funds,” says Ryan Sfreddo, managing director at Red Stone Equity Partners. “With the marginal corporate tax rate having settled at 21% for 2018 and the foreseeable future, we expect pricing to be at least 3 to 5 cents lower than where things were trading for most of last year.”

Other syndicators agree that prices will fall or, at best, hold steady in the first half of 2018, which will squeeze affordable housing deals.

“The 21% rate will mean less equity into each deal (yield being held constant),” says Jeff Goldstein, executive vice president and COO at Boston Capital. “This will require developers to fill a larger gap either through more debt, more deferral of development fee, or outside soft sources.”

The conclusion of tax reform brings certainty to the tax rate, but it creates other levels of uncertainty, adds Mark McDaniel, president and CEO of Cinnaire.

“First, many of the deals previously underwritten to a 25% tax rate may now be infeasible or may need to be reworked at the 21% tax rate,” he says. “There is also a great amount of uncertainty as to how the investor community will respond to the new 21% tax rate—initially and then long term.”

That may mean that funds that were set to close at the end of 2017 will be delayed as the underlying deals are re-underwritten to the new tax rate. Investors will need time to assess their LIHTC appetite going forward—both in the short term and long term,” McDaniel says.

At the new rate, deals will be stressed, and some may not be feasible with reduced pricing, agrees Steve Kropf, president and CEO of Raymond James Tax Credit Funds (RJTCF), which reported closing nearly $1.2 billion in LIHTC capital last year.

Affordable Housing Finance magazine surveyed RJTCF and 19 other syndicators in January. In all, the firms closed more than $9.5 billion in LIHTC capital and acquired 971 projects in 2017.

They paid an average of just under 94 cents per dollar of credit in the fourth quarter of 2017, down from an average of $1.02 a year earlier. Yields to investors averaged 5.1%, up from 4.47% in the fourth quarter of 2016.

What’s next after tax reform?

Overall, the tax bill provided good news by maintaining the LIHTC program as well as tax-exempt private-activity bonds. However, the reduction in the corporate tax rate and other changes are still a big blow for affordable housing production and preservation.

Novogradac & Co. has estimated that the future supply of affordable housing could be reduced by about 232,300 units over 10 years.

There are still questions about several provisions in the Tax Cuts and Jobs Act that was passed in December, including the effects of the Base Erosion and Anti-Abuse Tax (BEAT) provision that could put some tax credit investors with foreign parent organizations or U.S.-based investors with significant foreign operations out of the market. The final bill mitigated industry concerns by allowing 80% of the housing credit to be used against the BEAT, but uncertainty remains.

Syndicators are hopeful that these issues will be resolved and that the LIHTC market will be stronger than in 2017.

“We have ongoing concerns about project feasibility and overall production levels as investors sort out the effect of the tax rate reduction and the BEAT on their existing and new investments,” says Raoul Moore, senior vice president, syndication, at Enterprise Community Investment. “We are hopeful that the market won’t suffer any significant further disruption in 2018, but many investors will need some additional time to assess the changes.”

If fewer deals get done this year, that will mean more competition for those projects, especially in Community Reinvestment Act (CRA) hot markets, says Matthew Haas, director, investor relations and fund management, at Merritt Community Capital.

Now that a tax bill has been signed, it will have to be “reviewed with a fine-tooth comb to determine the impacts to LIHTC,” he says.

Although the first half of the year may be a bit choppy as investors assess their credit needs, CRA, and other changes, Mark Gipner, manager, fund development, at the Community Affordable Housing Equity Corp., expects the market to stabilize as it advances throughout the year. “The implications of BEAT will be felt, but the addition of the GSEs (government-sponsored enterprises) should also make for a stronger equity market,” he says.

Fannie Mae and Freddie Mac were given the go-ahead to return to the LIHTC market as investors late last year. Each enterprise will have an annual investment limit of $500 million, less than a 5% market share for each. Within this funding cap, any investments above $300 million in a given year are required to be in areas that have been identified by the Federal Housing Finance Agency as markets that have difficulty attracting investors.

The return of the GSEs would help bolster the LIHTC market, especially if other investors cut back on their participation.

Looking beyond tax reform, other issues may surface this year.

“There have been some early reports about a revamping of CRA, which we as an industry will have to keep a careful eye on,” says Jason Gershwin, senior vice president at R4 Capital. “As we continue to hear from our bank investor partners, LIHTC investing is very highly regarded as a means of satisfying bank CRA requirements. Therefore, the way in which CRA is currently administered has led to a healthy LIHTC investment appetite among banks nationwide. Any potential changes to CRA warrant monitoring.”

Other issues on the horizon include the Department of Housing and Urban Development’s direction, rising interest rates and the effect on financing costs for deals, potential rising insurance costs in all parts of the country, and difficulty getting contractors in Florida and Texas, adds Joe Hagan, president and CEO of the National Equity Fund.

2017 Tax Credit Activity

Company Capital Closed (in $ millions) LIHTC Projects Acquired
Alliant Capital 380 33
Boston Capital 554 65
Boston Financial Investment Management 411.4 34
Cinnaire 164.5 36
Community Affordable Housing Equity Corp. 148 38
CREA 634 75
Enterprise Community Investment 896.9 77
Hudson Housing Capital 525 37
Massachusetts Housing Investment Corp. 85.3 9
Merritt Community Capital 58 5
National Affordable Housing Trust 76 7
National Equity Fund 833 76
Ohio Capital Corporation for Housing 260 35
PNC Bank 535.9 59
Raymond James Tax Credit Funds 1,175 104
RBC Capital Markets—Tax Credit Equity Group 826 71
Red Stone Equity Partners 641 49
R4 Capital 435 53
The Richman Group Affordable Housing Corp. 670 66
WNC 236 42
Source: Affordable Housing Finance survey, January 2018