The National Multifamily Housing Council (NMHC) counts 45 affordable housing units for every 100 very low-income renter households, while the organization’s recently commissioned research suggests the U.S. needs 4.6 million new apartment units by 2030 to meet demand. Both of these statistics underscore the rental housing shortage’s depth.
“I think it was a big win for the industry that we were able to protect and preserve tax credits as part of tax reform,” remarked NMHC Vice President of Tax Matthew Berger. “(But) it’s unfortunate that the lower corporate rate reduces the amount of equity that the 9 percent tax credit can raise, and that’s why we’re very supportive of increasing tax credit allocations, generally.”
In late March, Congress made progress in this area by enacting an omnibus spending bill that includes some features of the Affordable Housing Credit Improvement Act introduced in 2017 by Sen. Maria Cantwell (D-Wash.) and Senate Finance Committee Chairman Orrin Hatch (R-Utah), to bipartisan support. One such provision increases LIHTC allocations by 12.5 percent from 2018-2021. While significantly below the 50 percent initially proposed by Cantwell and Hatch, the revised allocation cap will augment production of affordable rental homes by approximately 28,400 units over 10 years, forecasted accounting firm Novogradac & Co.
At the same time, Congress also authorized income averaging—another Cantwell-Hatch measure—to serve a wider range of households and entice developers to build in more markets. This measure replaces the 60 percent AMI maximum eligible income for LIHTC properties with 80 percent for apartments where the propertywide average does not exceed 60 percent.
Although it is a nascent concept, Novogradac & Co. Partner Dirk Wallace observed that “developers are exploring the use of income averaging to support more permanent debt on properties and fill that (financing gap),” which continues to widen amid increasing capital costs. And in light of dwindling affordability, NMHC holds that the legislation falls short of the nationwide need for low-income housing. “The states themselves are implementing income averaging on a prospective basis, which is good,” Berger put forth. “But that’s not really being implemented by the (federal government) at the moment, so we’re looking to enact further legislation to enhance tax credits.”
Prior to tax reform, all transactions were priced at a corporate tax rate of 35 percent. Once it became clear that tax reform was likely to happen, and given that transactions are structured months to years in advance, the market began preparing itself by adjusting for a potential new corporate tax rate of 25 percent. For the two months subsequent to tax reform being passed, all transactions were adjusted to fit the final, new corporate tax rate of 21 percent.
Over the past six months, the market has had time to adjust to the new legislation. “Tax credit prices have somewhat stabilized in the high-80- to low-90-cent range for most transactions,” observed Phil Melton, executive vice president & national director of affordable housing & FHA lending for Bellwether Enterprise, with the lower-priced deals concentrated primarily in rural areas.
The developer’s dilemma
The significant fluctuations in equity prices following the passage of tax reform have put pressure on developers and sponsors to make certain deals pencil out. One way that developers have confronted this issue is by upping their deferred developer fees, noted Melton. Previously, these fees hovered around 50 percent of total cost, he approximated, but more recently they have inched up into the 60 to 65 percent range.
“The developer’s perspective is, ‘If I have to defer my fee, income averaging allows me to collect higher rents and have the cash flow to pay the deferred portion of the fee (once the property stabilizes),” Wallace stated. The reduced corporate tax rate impacted pricing, with an average reduction of 10 to 15 cents per credit, calling for all market players to work together to maintain transaction feasibility. Once tax reform passed, both developers and syndicators reduced their fees and investors lowered their yields as an adjustment in order to offset the reduction in funds available.
“Every penny makes a big difference in getting these (deals) done, so developers are continuing to scramble in trying to figure out how to make transactions work in that changing credit environment, also in conjunction with rising construction and overall development costs,” added Melton.
Fortunately, developers have been tossed a life raft in the form of a new community development tool: opportunity zones. Included in tax reform, the law offers tax incentives for investing in underserved communities. Investors that use the mechanism are able to defer capital gains taxes for as many as nine years, provided they invest the gains in a Qualified Opportunity Fund. The fund, which exists at the state level, then uses that capital to support economic development in the low-income communities identified as opportunity zones by governors. By placing capital within these long-term funds, investors are able to earn higher returns than they would otherwise. As such, opportunity zones represent another growth option for LIHTC.
The uptick in rates, against the backdrop of compressing yields, has pushed investors to seek alternatives to generate returns, such as bridge lending. Despite the segment’s growing popularity among LIHTC investors, “right now, there’s not enough (gap financing) to put into transactions,” Melton explained.
Luckily, LIHTC expansion under tax reform has been beneficial for investors seeking late-cycle opportunities to deploy capital. Pooling contributions from five repeat investors and one new investor, WNC closed a $150 million LIHTC fund in August that will be used to build and preserve more than 1,950 affordable housing units nationwide. Among the 26 properties included in the fund is the Hotel Maytag in Des Moines, Iowa: The 1926-built asset will be converted into 45 affordable rental housing units.
A study released in June by the NMHC and the National Association of Homebuilders (NAHB) shows that regulations from all levels of government—including land entitlement and zoning—comprise an average of 32.1 percent of multifamily development costs, and in around 25 percent of cases, as much as 42.6 percent. Although some of these regulations are necessary, “each one should be looked at from a cost-benefit perspective,” Berger recommended, “because (every regulation) adds to the cost and the rents you have to charge to make the deal work. To the degree that you can get rid of some burdensome regulations that don’t make sense, (you’re better able to) provide safe and decent housing at a lower price point.” To that end, NMHC prescribes a layering of solutions, rather than a singular panacea, to address these cost-additive measures.
Despite much of the conversation focusing on the most distressed income groups, diminishing housing affordability “is not just a 60-percent-AMI-or-less problem,” Berger described, citing the Middle-Income Housing Tax Credit (MIHTC) bill proposed by Sen. Ron Wyden (D-Ore.) in August. Wyden’s proposal would establish a 15-year tax credit covering 50 percent of qualifying project costs—or a minimum of 5 percent annually—with varying per-capita allocations for rural areas and small states.
So where does that leave LIHTC? “There is tremendous demand for these credits,” Berger encouraged. However, increasing interest rates have cast a dark shadow on the segment. “As rates start to rise,” Melton prognosticated, “I think you’re going to see more pressure on credit pricing.”
You’ll find more on this topic in the October 2018 issue of MHN.