After a year of tough adjustments, low-income housing tax credit (LIHTC) prices will likely remain flat in the first half of 2019, according to a strong majority of syndicators surveyed by Affordable Housing Finance.

The expectations come after the market adapted and found its footing following the changes brought on by tax reform legislation in late 2017.

“We expect pricing to generally hold steady,” says Tony Bertoldi, executive vice president, syndication and investor relations, of CREA. “Rising interest rates had pushed yield targets up for economic investors in 2018, however recent market turbulence and concerns about an economic slowdown have since tampered expectations of future rate hikes.”

He’ll be paying close attention to first-quarter earnings reports in the financial sector, and if growth begins to stall, interest rates may remain where they are or possibly even decrease.

“That being said, we expect Community Reinvestment Act (CRA)–motivated investors to continue to aggressively pursue product in their key markets, particularly on deals that bear additional lending and depository opportunities,” Bertoldi says.

Nearly 90% of the syndicators surveyed in January expect LIHTC prices to hold firm in the coming months.

“Investors will want to see returns increase, but deals won’t work unless they have the current pricing, so pricing will likely stay the same,” says Reena Bramblett, senior vice president, equity placement, at National Equity Fund. “Developers put in (LIHTC) applications at certain pricing with interest rates and construction costs assumed, meaning deals are getting stretched, resulting in the concentration in the first half of the year going to make existing deals work.”

Any changes in pricing will probably be more evident toward the end of the first half or into the second half, according to Jeff Goldstein, executive vice president and COO of Boston Capital, noting that yields have adjusted to the latest conditions.

Twenty syndicators took part in the AHF survey. Together, they closed more than $10 billion in LIHTC capital and acquired 939 projects last year. Two firms, Raymond James Tax Credit Funds (RJTCF) and RBC Capital Markets—Tax Credit Equity Group, each reported raising more than $1 billion last year.

Both the average price paid for credits and yields to investors were down in the fourth quarter of 2018 compared with the same period a year earlier.

During the fourt quarter, the surveyed syndicators paid an average of about 91 cents per dollar of credit, a drop from the 94 cents reported in 2017. Yields to investors averaged 4.6%, down from the 5.1% seen in late 2017, according to the poll.

In the new year, syndicators will still be looking for that sweet spot between what developers want for their housing credits and what investors are willing to pay.

Overall, the LIHTC market should be a little stronger than last year, says Hal Keller, president of the Ohio Capital Corporation for Housing.

“A lot of project closings slipped at year’s end because of early 2018 post-tax reform delays,” he says. “Those deals will close in Q1 2019, and everybody will be caught up. Plus Fannie and Freddie will continue to fully deploy their dollars as their investment strategies are refined.”

New moves

In 2018, affordable housing developers began to use the new income-averaging option, which allows LIHTC-qualified units to serve households earning up to 80% of the area median income (AMI) as long as the average income limit at the property is no more than 60% of the AMI.

Ten syndicators reported closing deals on projects that utilize the option, with a handful of other syndicators to soon follow, as they reported having income-averaging projects in their pipelines.

“We look at each income-averaging deal on a case-by-case basis,” says Steve Kropf, president and CEO of RJTCF, which reported closing on several projects that are using income averaging. “From a market standpoint, we must confirm the rents are achievable at the higher set-asides and that demand exists for these units. From a compliance standpoint, we analyze the proposed unit mix and strongly prefer the overall average be less than 60%, with some cushion to minimize any potential credit loss should any noncompliance occur.”

His team also assesses the credit delivery schedule to ensure the project average is maintained and ensures that the management company is capable of the additional oversight necessary for income-averaging deals.

Syndicators are also spending quite a bit of time thinking about the new federal Opportunity Zone (OZ) program.

“We firmly believe that OZs will have a positive impact on our distressed communities,” says Mark McDaniel, president and CEO of Cinnaire. “Combining OZ funds with LIHTC deals will work well for some deal structures, but not all. There are many complimentary aspects of LIHTC and OZs, like the holding period, however, the investment strategies may be different.”

For example, much of the OZ benefit will come from the appreciation in value and the forgiveness of future capital gains earned on the sale of the asset after the tax credit compliance period.

“We’re not seeing many LIHTC investments that have a large appreciation of value to substantiate or warrant a favorable placement of OZ investor equity, with the exception of those LIHTC deals that may have a large negative tax capital account, whereby an OZ investment would be favorable,” McDaniel says.

Officials at CREA think certain types of LIHTC projects in OZs could deliver substantial tax benefits to certain types of investors.

“Specifically, 4% new construction projects appear to be the greatest candidates, given their large projected negative capital accounts and the ‘original use’ requirement of the OZ program,” Bertoldi says. “We also believe economic investors such as insurance companies will be the primary investors for these deals as they typically have more capital gains tax to offset than banks.

Economic buyers usually have higher yield requirements than CRA–motivated buyers, so the deals claimed by economic investors typically start at a lower price per credit than those claimed by banks.

“For that reason, we are not anticipating a dramatic price premium on all OZ deals like some in the industry had originally suspected,” Bertoldi says. “That being said, some deals will certainly become more valuable than others, and the market will incorporate that demand.”

Other syndicators agree that marrying LIHTCs and OZs will likely be limited.

“We expect to see some pairing of the housing credit and OZ tax benefits, but we don’t expect it to have a major impact on the market,” says Scott Hoekman, president and CEO of Enterprise Housing Credit Investments. “We believe the effect of CRA on the market will outweigh that of OZ.”

OZs are designed to spur economic development in underserved communities by providing tax benefits to investors. First, investors can defer tax on any prior capital gains invested in a Qualified Opportunity Fund (QOF) until the earlier of the date on which the investment in a QOF is sold or exchanged, or Dec. 31, 2026, according to the IRS. If the QOF investment is held for longer than five years, there’s a 10% exclusion of the deferred gain. If the investment is held for more than seven years, the 10% then becomes 15%. Second, if the investor holds the investment in the QOF for at least 10 years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value on the date the QOF investment is sold or exchanged.

“A small percent of the LIHTC investors have capital gains they can invest—some on a one-time basis,” says Karen Przypyszny, managing director of special initiatives at NEF. “Therefore, some projects will get funded with OZ dollars and may benefit from slightly enhanced pricing. There might be a short-term impact on a small number of projects, but we don’t think it will materially affect the LIHTC marketplace. If anything, it could bring insurance companies back into the LIHTC investor mix for a short time.”

There’s still much uncertainty around whether OZs and LIHTCs will work well together, adds Lynn Ambrosy, managing director of Aegon Real Assets U.S.

At this time, it doesn’t look like most investors will increase their pricing just because a project is located in an OZ, especially since housing tax credits don’t typically have much or any appreciation over time, Ambrosy says.

R4 has also spent considerable time analyzing the impact OZs may have on its LIHTC offerings.

“The materiality of any potential yield increase for a project in an OZ is dependent on the investor and whether they have realized and recognized capital gains and such investor’s ability to predict future realized and recognized capital gains,” says Jason Gershwin, executive vice president at R4. “Taking advantage of coupling OZs with LIHTCs is more likely for certain insurance company investors, and variable factors from one LIHTC deal to another will determine the materiality of the benefit received. While we expect select investors to benefit from LIHTC projects in OZs, we do not expect OZs (as the legislation is currently drafted) to have a dramatic industrywide effect on LIHTC pricing in 2019. We hope that there will be further guidance on OZs from Treasury and the IRS in 2019, which may significantly alter this answer.”

2019 Watch List

LIHTC syndicators are largely upbeat about this year but remain wary of potential roadblocks. The possibility of CRA reform, changes at the Federal Housing Finance Agency (FHFA) that could affect Fannie Mae and Freddie Mac, rising construction costs, and higher interest rates are among the issues on their watch lists. The recent government shutdown also delayed some first-quarter deals.

“The prospect of being on somewhat of a roller coaster ride with the economy could cause some investors to sit on the sidelines,” says Cinnaire’s McDaniel. “We could see similar delays in investor decision making, thereby impacting timing of closings, as we saw in 2018 or, worse, see an overall reduction in investor interest in LIHTC investments resulting from uncertainty with the economy, less appetite due to negative impact on existing LIHTC portfolio investments due to tax reform, or LIHTC returns not being able to compete with alternative forms of investments as interest rates continue to rise.”

On the other hand, if financial institutions are projecting to be more profitable in 2019 due to tax reform, they may develop an increased appetite for LIHTC, he adds.

Cinnaire leaders will also be keeping an eye on projects outside of the big CRA areas.

While bank investors will continue to seek CRA investment opportunities, projects located in small towns and rural areas could be at a disadvantage. Fannie Mae and Freddie Mac’s re-entry into the LIHTC market could alleviate some of this, but their investment level is not currently large enough to have a significant impact, and it’s unclear whether their participation will be modified by the FHFA in 2019, McDaniel says.

“Impacts of increased short-term interest rates have been felt throughout the LIHTC industry, and the potential for further increases is a concern for 2019,” says R4 Capital’s Gershwin. “We have also seen significant increases in construction costs, which have impacted our market and are likely to continue to have an effect throughout the next 12 months.”

Finally, the potential for CRA reform is something that the industry must continue to keep a careful eye on, he says.

“The theme for 2019 is diversity, demand, and innovation,” says Stacie Nekus, senior vice president, investor relations, at Alliant Capital. “The demand for affordable housing is greater than ever, something that has been highlighted by the government shutdown. Many working families are living at or below the poverty line and are surviving paycheck to paycheck. The LIHTC industry needs a fixed 4% credit rate, which would significantly increase the production of affordable housing. The demand is there from the investor community and the population.”

Aegon Real Assets US $437 27
Alliant Capital 325 30
Boston Capital 667 65
Boston Financial Investment Management 638 47
Cinnaire 241.7 26
CREA 809 73
Enterprise Housing Credit Investments 804 68
Hudson Housing Capital 613 42
Massachusetts Housing Investment Corp. 86.3 12
Merritt Community Capital Corp. 42 3
National Affordable Housing Trust 60.5 5
National Equity Fund 963 86
Ohio Capital Corporation for Housing 277.8 40
Raymond James Tax Credit Funds 1,046 103
RBC Capital Markets-Tax Credit Equity Group 1,053 74
Red Stone Equity Partners 492 52
Regions Affordable Housing 400 31
R4 Capital 648 39
The Richman Group Affordable Housing Corp. 450 47
WNC 455 69
Source: AHF Survey, January 2019