Extra Credit for Affordable Housing Finance

A new fixed rate promises to help sponsors raise equity, but its impact will be more complicated.

The challenging year of 2020 was one of affirmation and progress for the affordable housing sector. Despite massive job losses across the country, steady occupancy rates and rent collections at properties financed by the federal low-income housing tax credit program illustrated resiliency.

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Site plan for NHP Foundation’s $100 million redevelopment in Baltimore’s Park Heights, made possible by 4 percent LIHTC financing.
Site plan for NHP Foundation’s $100 million redevelopment in Baltimore’s Park Heights, made possible by 4 percent LIHTC financing.

Just as promising, as part of the $1.4 trillion omnibus bill passed at the end of 2020, Congress reset the LIHTC rate to a fixed 4 percent, which is allowing developers to raise more equity and reduce the debt and gap financing needed for projects. Before that step, the rate varied and had dropped to a historic low of 3.07 percent in 2020, according to the Pillsbury Winthrop Shaw Pittman law firm.

Given those highlights, affordable housing is attracting attention, said Dudley Benoit, executive vice president at Alliant Capital, a LIHTC syndicator based in Woodland Hills, Calif. The company reported average occupancy of 94 percent throughout 2020 across its portfolio of more than 105,000 subsidized and unsubsidized units.

“Now that we’re toward the end of the pandemic, folks are going through their metrics and analysis and can see that, even during the pandemic, affordable housing assets performed well,” Benoit said. “So investors are saying, ‘Let’s get as much as we can.’”

Indeed, National Equity Fund (NEF), a Chicago-based affordable housing tax credit syndicator and lender, invested $1.5 billion in primarily new development and preservation projects in 2020, the largest total in the firm’s 33-year history.

“We’re seeing a lot of opportunities from prospective developers and interest from investors coming into the market,” said Matt Reilein, NEF’s president & CEO. “I think there’s a focus on the social need for affordable housing, but investors also see it as a solid investment above and beyond the positive social outcomes.”

Rendering of Park Heights multifamily communities. Image courtesy of Torti Gallas + Partners.
Rendering of Park Heights multifamily communities. Image courtesy of Torti Gallas + Partners.

Feeling the squeeze

Despite the steady performance and the favorable action on the 4 percent tax credit—one that affordable housing advocates spent years lobbying for—these favorable trends have not entirely removed the stresses on affordable development finance. A chronic housing shortage continues at a time when construction prices are rising. Even before COVID-19, 30 percent of U.S. households were spending more than 30 percent of their income on housing, according to the latest report by the Harvard Joint Center for Housing Studies. Of those cost-burdened households, about half were devoting more than 50 percent of their income to housing.

Meanwhile, extremely low-income renters—those earning 30 percent or less of the area median income—face a shortage of 6.8 million affordable units, according to the annual survey by the National Low Income Housing Coalition.

Melissa Marcolini-Quinn, a senior vice president & managing director at NorthMarq in Orlando, Fla., witnessed firsthand how the disequilibrium is playing out. Marcolini-Quinn secured a $4.25 million forward commitment from Freddie Mac for a permanent loan on Brownsville Manor, a new 88-unit, 9 percent LIHTC development in Pensacola reserved for renters 55 and older. The community opened in November 2020 and was fully leased one month later, she said.

“It’s impressive that it leased that fast,” she said. “But at the same time, it’s sad and speaks to the need for affordable housing out there.”

Pricing based on equity Letter of Intents (LOIs) provided by market participants. Data reflects average equity pricing for LOIs issued in each month. No adjustments made for timing of capital contributions or other consideration. Source: Novogradac
Pricing based on equity Letters of Intent (LOIs) provided by market participants. Data reflects average equity pricing for LOIs issued in each month. No adjustments made for timing of capital contributions or other consideration. Source: Novogradac

Price drop

Additionally, developers have yet to see the full benefit of the 4 percent LIHTC. For a $10 million deal, the adjustment would ideally yield about $1 million more in equity than when the rate was in the 3 percent range, Marcolini-Quinn said.

But investors have dropped the prices they’re willing to pay by as much as 5 cents, to about 88 cents per credit, observers say. While the fixed rate may provide investors looking to reduce their tax liability with more credits, the extra dollars they’re paying don’t provide the same yield as before. The reason: Depreciation and other items that were also used to offset income remain unchanged, noted Mansur Abdul-Malik, vice president of development at NHP Foundation, a New York City-based affordable housing developer that owns properties in 15 states and Washington, D.C.

“In order to maintain the balance between the tax credits and fixed losses, investors need to reduce the amount of money they’re putting out per tax credit,” he said. “It’s a phenomenon that developers are still wrapping their minds around as they see the prices for equity drop.”

Still, the fixed rate provides an opportunity to raise more equity in the aggregate. Among other benefits, developers can more easily rework deals that weren’t eligible for 9 percent LIHTCs, Abdul-Malik added. While 9 percent tax credit projects typically target renters in very low-income brackets, he said, 4 percent tax credits allow for a broader mix of incomes, which can provide more revenue to support the project.  

NHP recently experienced that situation in Baltimore, where it is overseeing the redevelopment of 17 vacant acres in the Park Heights neighborhood. The $100 million project calls for new apartments, senior housing and single-family homes in two phases. After NHP failed to win 9 percent LIHTCs to help fund the first phase, it was able to secure 4 percent tax credit funding.

“We went back and sharpened our pencils, and boom—it’s working as a 4 percent deal,” Abdul-Malik said. “But it wouldn’t have worked if the 4 percent rate wasn’t fixed.”

Rendering of Park Heights senior housing. Image courtesy of Torti Gallas + Partners
Rendering of Park Heights senior housing. Image courtesy of Torti Gallas + Partners.

Adjustment period

Affordable housing observers are optimistic that pricing will improve as the market adjusts to the new rate, which has effectively increased the supply of tax credits on the market. What’s more, in addition to fixing the rate at 4 percent, the end-of-the-year omnibus bill authorized $1.2 billion worth of disaster LIHTCs for 11 states and Puerto Rico. Together, those two steps have likely added some $3.5 billion in tax credits to the market, Reilein noted.

“We don’t think the softening in pricing is because of any underlying perception of risk in the market,” Reilein said. “We think it’s tied to this bit of disruption from the 4 percent credit fix and the added layer of disaster credits. That’s a material move in supply.”

One catalyst to reverse the pricing pullback could come by way of a tax increase sought by the Biden Administration. The average price of LIHTCs fell from about $1.05 per credit in 2016 to below 95 cents in 2017 and has largely remained there, according to Novogradac, a diversified consulting and advisory services firm. That decline stemmed from the 2017 tax cuts, which sliced the corporate rate from 35 percent to 21 percent , thereby reducing the need to offset income with losses.

“That was a dramatic decrease in the corporate tax rate,” said Dirk Wallace, a partner in the firm’s Dover, Ohio, office. “Our anticipation is that an increase in the rate will fuel stronger demand for credits, and pricing should increase.”

Read the May 2021 issue of MHN.