Strong low-income housing tax credit (LIHTC) prices. Check.
Low-cost debt options. Check.
A seemingly endless demand for affordable housing. Check.
Despite all these favorable conditions, it could be much tougher to get deals done in 2016. The momentum that has helped developers over the past year could begin to slow. What could play the part of spoiler? For one, rising development costs.
Cost climb
One of the main reasons for escalating costs is a shortage in construction workers. A survey last summer by the Associated General Contractors of America revealed that 86% of construction firms reported difficulty filling hourly craft or salaried positions. In particular, 73% of firms that employ carpenters had trouble finding workers, but the problem was across all 21 crafts covered by the survey.
The growing competition to find workers is prompting companies to increase wages, which is leading to higher construction costs.
The shortage of skilled workers is not going to be solved in a year or two, said Mark McDaniel, president and CEO of Cinnaire, formerly Great Lakes Capital Fund. “I think this is so deep, so systemic,” he said at AHF Live: The Affordable Housing Developers Summit in November.
McDaniel spoke on the Tax Credit Equity Outlook Power Panel that featured several leading LIHTC syndicators and investors.
The worker shortage has become an increasing problem at job sites, agreed Joe Hagan, president and CEO of the National Equity Fund (NEF). He reported hearing a number of unusual stories from the field, including framers walking off one job to work at another site and developers luring workers to return the next day with the promise of a $50 bill.
A recent Supreme Court decision could also trigger higher costs for many projects. In a 5-4 ruling, the court determined that actions with a discriminatory effect are unlawful under Fair Housing Act, regardless of intent.
The case began several years ago when a fair housing organization brought a disparate-impact claim against the Texas Department of Housing & Community Affairs, alleging the department had caused continued segregated housing patterns by allocating too many housing tax credits to developments in predominantly black inner-city neighborhoods and too few in predominantly white suburban neighborhoods.
“This is something a lot of people should be concerned about because you’re going to see some significant changes,” Hagan said, explaining that state housing finance agencies are going to be forced to look at their qualified allocation plans to make sure they are in line with fair housing regulations.
While the intentions of the Supreme Court ruling and the state housing agencies may be good, their actions could have big consequences.
“Trying to put decent, safe affordable into these areas of opportunities is a lot more expensive,” said Corine Sheridan, vice president and director of origination at Boston Capital. “We’re not going to cut costs with this.”
Developers are working with a fixed amount of subsidies, so the higher costs will make deals tougher to do, added Todd Crow, executive vice president and manager of tax credit capital for PNC Real Estate.
“I worry this is a situation where good is becoming the enemy of great,” he said. “Everybody would like to see great opportunities, access to retail, better schools. That’s a terrific outcome. I don’t think anybody is opposed to that, but I think how it’s implemented is a concern. As a matter of public policy, cost is an issue for our industry.”
If there is a push to build LIHTC developments in high-opportunity zones and costs increase, Crow worries that “the next shoe to drop is going to be criticism of the increased cost.”
Affordable housing often costs more than other housing to develop for a variety of reasons, including having to meet different design and program requirements. However, developers and housing leaders have had difficulty explaining why affordable housing costs what it does.
The growing concern about development costs comes at a time when the Government Accountability Office is examining multiple aspects of the LIHTC program. Developers should be prepared for any increased attention that may be coming to the program.
“I don’t hear us have a consolidated, succinct explanation of costs,” said moderator Michelle Norris, president of National Church Residences Development Corp. “… That maybe something as an industry we should be thinking about.”
Market changes
The market has seen extremely high prices for housing tax credits during the past year.
Hagan noted that NEF’s average pricing has risen to north of $1 per dollar of tax credit. He said one of the reasons for the high-flying market is that the Office of the Comptroller of the Currency (OCC) and federal regulators taking a tough stance on all the banks, both large and small.
“We’ve seen a whole new bunch of banks come into the market, saying I’ve got to do CRA (Community Reinvestment Act),” he said.
There's been no shortage of demand for credits and strong pricing in many areas of the country. “What’s surprised me the most in the last year is the narrowing of that spread between top CRA pricing and the outer markets,” said Susan Moro, senior vice president at Bank of America Merrill Lynch.
When bidding on deals, the outcome has become more difficult to predict. Moro and others reported seeing top bids come in as much as 4 or 6 cents higher than the next offer.
KeyBank’s pricing is based on a sponsor-based approach, said Kevin Nowak, vice president, national equity investment manager, at KeyBank. “If there’s a sponsor we’re working with and we want to continue to work with, there may be a pricing premium in that,” he said.
He urged developers to think about the investors they want to partner with and who will be there for them when the market isn’t as strong. “I think the best position for a developer is something that’s a relationship with someone who can provide that capital both in this time but also in the downturns,” Nowak said.
Although the CRA-motivated banks make up the bulk of the LIHTC equity in the market, the industry needs to keep a close eye on economic investors, according to Tony Bertoldi, executive vice president of syndication and investor relations at City Real Estate Advisors.
“If they pull out significantly, that could be 25% to 30% of the equity retracting or expecting higher returns,” he said. “We should all listen to what they are doing next year (2016).”
Throughout 2015, the competition for housing credits was huge. Those market conditions are likely not sustainable, according to speakers.
“I think we’re going to see some moderation in 2016, driven in part by interest rates,” said PNC’s Crow. A developer who has a feasible project that pencils out with a willing equity provider, lender, and contractor should make the deal, he said.
Advice for the new year
Other investors and syndicators also stressed that the bullish market will not last.
“There’s going to be cycles,” said Vihar Sheth, senior vice president and director of business development—affordable housing tax credit investments, at U.S. Bancorp Community Development Corp. “I fear that people are stretching too thin to make it work today and then planning for the future in an unsustainable way.” He urged developers to work with their partners to take a hard look at how they are projecting out as well as their long-term strategies.
“To the extent possible, I know that as builders, owners, and developers you already do this, but if there’s a possibility to build in a cushion into your models, do it,” Sheridan said. “There’s so much unpredictability right now with rates, pricing. We’ve been solving to make deals work with high pricing and low interest rates. We don’t know how sustainable that is.”
Bank of America’s Moro agreed on the importance of building in a cushion. “All these deals that I’m seeing now are getting to be so tight,” she said. “The first thing I’m seeing going away now is operating reserves, which we used to consistently get at six months, and now we’re seeing deals coming in at three months and in some cases two-and-a-half months. I don’t think that’s good for anybody.”
