Rising Demand Boosts LIHTC Credits

Much like the rest of the multifamily sector, the Low Income Housing Tax Credit (LIHTC) niche has seen a revival in the last two years.

Washington, D.C.—Much like the rest of the multifamily sector, the Low Income Housing Tax Credit (LIHTC) niche has seen a revival in the last two years. Back in 2008, the tax credits were being sold at a discount due to a lack of investor interest. Considering that banks were more focused on cutting down their losses, rather than looking for tax credits to offset profits, these traditional tax credit buyers were not active in the market.

In the last two years, the pendulum has swung the other way. In fact, Joe Hagan, president of the Affordable Housing Tax Credit Coalition (AHTCC), says, “I’ve never seen a shift so quick in the 25 years I’ve been in this business. There is so much buying interest in the LIHTC credits that they are sometimes going for a premium price of greater than $1 for $1 worth of tax credits.”

There is interest from banks that have to satisfy their Community Reinvestment Act (CRA) mandates and are making up for their lost ground from the last couple of years. These banks are primarily interested in the major coastal cities, such as New York and San Francisco, and have driven up the prices of the credits in those areas. As well, newer investors have become interested in the market. The latter group includes insurance companies such as State Farm and corporate investors such as Google and Verizon.

According to Hagan, “Any developer that has an allocation of credits in a deal that’s worth doing has three or four investors willing to take that deal. That’s a huge shift in the market. What’s more remarkable is the pricing, and how that’s changed.”

He points out that this shift is not just confined to metropolitan pockets such as New York, Los Angeles and San Francisco, but is in evidence all across the country.

Indeed, Brian Coate, a Columbus, Ohio-based vice president with Lancaster Pollard, notes that 12 to 18 months ago, tax credit deals were not getting done in Ohio. Today, with the rising demand for the credits, these deals are getting done.

“With a rising tide, all boats float. It’s really been a benefit for the smaller markets,” according to Coate. He says he’s seeing more of an emphasis on rehabilitation deals, rather than on new construction, considering that some markets continue to have high vacancies.

Hagan, who is also president of National Equity Fund, a syndicator of LIHTC credits, notes that in 2010 the firm handled $815 million worth of deals, with an average pricing at the deal level of $0.70. As of the second quarter of 2011, the average pricing for the credits was $0.88. Thus, investors are willing to pay more for the credits, thereby benefiting LIHTC developers.

Attracting a broader investor interest

Mary Pat McKeown, a portfolio manager with Allstate Investments, managing its LIHTC portfolio of about $500 million, says that the insurance company has been focusing its investments on multi-investor, multi-property funds, rather than on individual investments through proprietary funds. While Allstate, which has been active in this market off and on since the late 1990s, does not face the CRA pressure that banks do, the firm still prefers larger metro areas.

The multi-investor funds that Allstate has invested in tend to have a mix of properties located in rural, urban and suburban areas, though. Allstate is not overly particular about the location, as long as the properties are well-underwritten and don’t overemphasize rural or suburban markets. While Allstate invests in both the 4 percent LIHTC credits and the 9 percent credits, McKeown has a preference for the 9 percent deals because they use less debt funding.

Allstate plans to maintain a steady presence in the LIHTC area. McKeown expects that the insurance company’s interest in this market will continue, as long as the yields in the LIHTC asset class continue to be attractive relative to the yields Allstate might get in other areas. She expects that yields will be in the range of 6 percent to 6.5 percent this year, and that non-bank investors are likely to pull back from the LIHTC investments when yields dip below 6 percent.

McKeown sees the current yields in this niche, in the 6 percent to 6.5 percent range, as being very attractive. According to her, “There is more money pursuing these types of investments. More insurance companies are coming in because they see these as attractive returns, and they can also use the tax credits. Over the last couple of years, the void that was created by Fannie and Freddie’s departure from the market filled very rapidly, more rapidly than anybody expected.”

Fannie and Freddie departure

Fannie Mae and Freddie Mac used to be major investors in tax credits, accounting for about 40 percent of the market before they went into government receivership during the financial crisis. And they continue to hold a portfolio of tax credits that they bought in previous years.

Market participants do expect that there could be a disruptive effect to the LIHTC market if these GSEs try to unload this portfolio at some point.
A proposal to do this last year did not move forward, though.

“The risk to the industry is that they could, at some point, be a seller of that portfolio. In the future, it could impact pricing and yield if they were to start selling the product on a secondary basis, points out Robert Levy, president of Centerline Capital Group.

It is unclear if Fannie Mae and Freddie Mac will continue to invest in this niche going forward. Levy, for one, doesn’t expect that tax credits will remain a part of their business model. If so, there is likely to be a void in the market after the newer investors back off as yields dip.

Hagan expects that when the returns on their tax credit investments dip and newer investors step out of the market, there will be more of an impact in the geographic areas where banks have less of a CRA mandate to invest. “If insurance companies step out because they have go-anywhere money, it will create a geographic division again. The middle part of the country does not have a lot of major banks that have a huge CRA need, so those states will be affected,” he notes.

Outlook

While it is likely that the non-traditional investors will back off when yields start to dip, McKeown expects that it will be more of a gradual departure. And a decline in investor demand means that the yields are likely to go back up again, attracting investors back.

Indeed, Hagan has noticed such shifts in the market over the LIHTC program’s 25-year history. Between 1996 and 2001, for instance, investors were getting a stable yield of about 7.5 percent on the credits. As this attracted more investors into the market, yields started going down. “What’s interesting is that we’re back to the days when it was kind of crazy, go-go stuff,” according to Hagan.

Are LIHTCs at Risk?

With government now focused on its need to cut costs in a bid to tackle the federal budget deficit issue, one recent proposal put forth was to do away with the LIHTC program. While the proposal, backed by Tom Coburn, an Oklahoma Senator, did not go through, it did elicit some concern in the industry.

Hagan says that the proposal, which was trying to do away with almost every type of tax credit, was based on a study of the Missouri state housing tax credit program, which is not a proper basis of comparison for the national LIHTC program. However, he is still concerned about any possible impact on the credits as a result of tax reform. Considering that the annual cost of the LIHTC credits is $4.5 billion, he expects the program will not avoid scrutiny as long as the budget deficit needs to be tackled.

Centerline’s Levy also sees this as a risk to the industry. “Congress will be forced to look under every stone for new money to reduce the deficit. Certainly the LIHTC tax credit is something they will discuss.”

AHTCC, too, is focusing on making legislators understand how the program benefits their states. Hagan says that they have been pushing developers to do ribbon-cutting ceremonies and talk about the number of jobs the program generates through construction activity. Another indication of the program’s success, according to AHTCC, is the low level of foreclosure activity associated with LIHTC-funded projects, which is less than 0.1 percent nationwide.