A little more than a year after “income averaging” was introduced into the low-income housing tax credit (LIHTC) program, the option is being pursued in a number of projects.

Syndicators reported closing on more than 65 income-averaging deals around the country, with more coming down the pipeline.

The option expands the reach of the LIHTC program to more families by allowing LIHTC-qualified units to serve households earning as much as 80% of the area median income (AMI) as long as the average income limit at the overall property is no more than 60% of the AMI, but these deals require additional scrutiny and underwriting.

Several syndicators are stressing the need for a buffer to make sure projects stay within the AMI requirements.

“We underwrite to ensure a sufficient cushion, such that an error in tenant-income qualification would not cause the average AMI served of remaining units to go above 60%,” says Kari Downes, executive vice president at Enterprise Housing Credit Investments. “We are also focused on the property management entity’s history and capacity for thorough tenant-income screening. Finally, we work with our third-party market analysts to determine whether appropriate demand appears to exist for units at 80% AMI.”

Previously, housing credit units were restricted to households earning no more than 60% of the AMI.

Every income-limit category must be carefully analyzed, and clear policies need to be provided by the sponsor or property manager to show how they will track compliance, says Peter Sargent, director of capital development at Massachusetts Housing Investment Corp.

Other syndicators agree that the new option puts property management in the spotlight.

“We are also extremely focused on property management functions and the property manager’s ability to successfully navigate the nuances of income averaging throughout the compliance period,” says Tammy Thiessen, managing director of equity sales at RBC Capital Markets–Tax Credit Equity Group.

For each deal with income averaging, RBC makes certain to have a compliance plan that is reviewed and approved by its compliance team and a deal that fully supports the use of income averaging, according to Thiessen.

In addition to making sure there’s a sufficient pool of eligible tenants at 80% of the AMI, it’s important to underwrite with a continued focus on market-rent advantage. “We look to ensure that the gap between high-end LIHTC rents at 70% and 80% AMI is providing sufficient value compared to market rents,” says Jason Gershwin, executive vice president at R4 Capital.

These deals will continue to be scrutinized, and there may be increased costs associated with monitoring their compliance.

Several syndicators noted they are very cautious about the inclusion of market-rate units in deals seeking to utilize the income-averaging option.

“Overall, there is currently not acceptance in the market for deals combining income-averaged units and market units,” says Stacie Nekus, senior vice president, investor relations, at Alliant Capital. “There is a concern the next-available-unit rule could force a property into converting a vacant market unit into a LIHTC unit for the rest of the compliance period.”

Fannie Mae, Freddie Mac in the Market

Another change has been the return of Fannie Mae and Freddie Mac as housing credit investors after being out of the market for roughly a decade.

The government-sponsored enterprises (GSEs) had been two of the nation’s largest LIHTC investors, representing an estimated 35% to 40% of the market before being placed into conservatorship by the Federal Housing Finance Agency (FHFA) in 2008. The enterprises’ financial condition deteriorated during the housing market crash, requiring government intervention.

They were given the go-ahead to reenter the LIHTC market on a limited basis by the FHFA in late 2017 and have since partnered with several syndicators to invest in affordable housing developments.

On one hand, their return has increased competition for some deals. On the other, it has added diversity to the investor pool, according to several syndicators.

“We view Fannie Mae and Freddie Mac’s return to the market as a strong positive for the industry,” says Mark McDaniel, president and CEO of Cinnaire, which recently partnered with Fannie Mae on a fund. “Their presence helps balance the demand between Community Reinvestment Act (CRA) and economic investors. They are providing capital to locations and deals that are not CRA focused. Bringing non-CRA dollars into the LIHTC market provides more demand for deals with pricing at the lower end of the market and does not add to the competitiveness among the hot CRA deals.”

Since their return, the price per credit on rural deals has increased between 1 and 3 cents, adds RBC’s Thiessen, whose firm recently closed a fund with Freddie Mac.

“We have definitely seen an increase in pricing in some of the more rural communities, which would most definitely appear to be a result of their returning to the market, and with a specific mandate to invest in more rural communities,” says Anil Advani, executive vice president, originations and finance, at WNC.

Prices Expected to Hold Firm

After the disruption seen in recent years, the housing credit market was pretty calm in the first six months of 2019.

The 18 syndicators survey by Affordable Housing Finance reported raising a combined $4.6 billion in capital and acquiring more than 400 developments in the first six months of 2019.

“LIHTC market conditions were both liquid and stable for the first half of 2019,” says Ryan Sfreddo, principal and managing director of investor relations at Red Stone Equity Partners. “LIHTC pricing was steady, and declining interest rates helped to make LIHTC investments attractive to investors relative to alternative investment products and ease the stress on project development budgets given the lower cost of debt.”

The market has proven again to be resilient as investors remain committed to the asset class despite some looming economic uncertainty, according to Tony Bertoldi executive vice president, syndication and investor relations, at CREA.

“While there are concerns that the global market may soon show signs of tightening, those concerns have fortunately not yet impacted the LIHTC market,” he says. “We are optimistic that the current market will endure through year-end as investors continue to report positive earnings, and the lower interest rates will make the asset class even more attractive.”

The average price paid for a dollar of credit in the second quarter was 92.3 cents, just about the same as the 92.5 cents reported the year before, according to the survey.

Yields to investor averaged 4.8% in the second quarter, similar to the 4.7% average in the same quarter in 2018.A big majority of the syndicators (90%) expect prices to hold study in the second half of the year.

Despite the forecast, syndicators are wary of several issues that can upset the market or put increased pressure on deals.

“We are most concerned about the direction of the economy given the longevity of the expansion during this cycle,” says Robert Chiles, president of Regions Affordable Housing. “The economy has slowed and will continue to be slow for the balance of the year. Changes in interest rates, both up and down, affect investor appetite and the economics of property transactions, so reduced interest rates are helpful. Higher rates could soften demand from economic investors.”

Chiles adds that if the economy tips into a recession that would cause uncertainty. He would also be concerned if the economy started to grow faster because that would likely lead to higher interest rates.

The biggest concern is when will the strains that are out in the market start impacting the ability to get deals done, adds Matt Reilein, president and CEO of National Equity Fund.

“Construction costs are high, and many areas have labor shortages,” he says. “Some of the larger institutional investors will be entering a new CRA cycle, which gives them the ability to wait and see if there are shifts in the market since they have a few years to meet their CRA needs.”

In addition to seeing more states committing to the income-averaging option, NEF has seen more deals “twinning” 9% and 4% credits, according to Reilein.

Although the market has stabilized from the tumult caused by the threat of tax reform in 2016 and 2017, affordable housing firms still need to be cautious when putting together their next deals.

“Developers should watch for runaway costs without corresponding sources of funds,” says Jeffrey Goldstein, executive vice president and COO of Boston Capital.

Gayle Manganello, senior vice president, manager of originations, at PNC Bank, adds, “Developers should be conservative when assuming LIHTC pricing in tax credit applications as market conditions can change by the time the credits are awarded and the development is ready to close.”

Others agree that the market can shift. There are early signs that investor yield requirements are increasing, says Todd Jones, senior vice president, institutional sales, at Boston Financial Investment Management.

“Investor sentiment and needs can change quickly in this environment, so it will be important for developers to stay close to their capital partners to understand real-time investor demand and changes to yield objectives as the year unfolds,” he says. “In addition, construction costs and labor shortages are something for developers to consider when evaluating potential projects.”

Alliant Capital 145 18
Boston Capital 344 27
Boston Financial Investment Management 242 21
Cinnaire 20.2 17
Community Affordable Housing Equity Corp. (CAHEC) 101.5 23
CREA 255 29
Enterprise Housing Credit Investments 331.1 25
Hudson Housing Capital 168 11
Massachusetts Housing Investment Corp. 36.3 3
National Equity Fund 433 41
Ohio Capital Corporation for Housing 221.7 24
PNC Bank 248 17
Raymond James Tax Credit Funds 561 56
RBC Capital Markets-Tax Credit Equity Group 514 29
Red Stone Equity Partners 491 32
Regions Affordable Housing 214 14
R4 Capital 244 15
WNC 109 20
Source: AHF Survey, July 2019