LIHTC’s Bizarro CRA
By Caitlin Jones
5 min read
Tax Credit Advisor, March 2010: With the 2010 low-income housing tax credit equity market just getting underway, a pattern of sorts is emerging. Properties located in some major metropolitan areas are having no trouble attracting multiple bids, even trading at a “premium” in some markets. Some of this we can ascribe to the natural hesitancy of earning-battered equity investors to move quickly to reinvest in an asset type that has a long delivery (ten years) and questionable liquidity. Some is natural prioritizing by strength of real estate market – better markets will attract capital earlier in the year at higher prices. Some can be put down to seasonality; after December, January is always slow.
Dig a little deeper, though, and the picture is troubling. Overlay the properties with multiple bids with the Community Reinvestment Act assessment areas of the major banks, and I think the pattern will pop out with devastating clarity: inside the CRA assessment areas, properties have no trouble raising LIHTC equity, while outside, demand falls rapidly, almost to nothing.
So if you’d like something to blame for the current separation in LIHTC pricing, blame the CRA, and its Seventies-era fixation with fixed-boundary capital evaluations.
Think back a third of a century, to 1977 when CRA was enacted. No internet. No fax machine. No cell phone. More to our points, no securitization. No global capital market. No national banks – repeat, no national banks. No internet banking. Something called North Carolina National Bank was dreaming of massive expansion (whatever happened to them, anyway?). No corporate investors; for that matter, no low-income housing tax credit.
Congress believed that banks had large wall maps where the urban core was bounded in red. The bank would take deposits from inside the red line and invest them solely outside it. That, to Congress, was economic bigotry and it had to be stopped. Under the CRA, banks were to be arm-twisted into plowing back into communities at least as much as they took out, via evaluation of their community service, lending, and investing.
LIHTC’s 1986 arrival was a godsend for CRA-regulated institutions. The agencies charged with enforcing CRA compliance – OCC, OTS, FDIC, and the Federal Reserve – soon grasped its utility, moving from a deeply skeptical posture (requiring advance approval), through a safe-harbor endorsement (blanket approval) into becoming virtual hucksters, sponsoring LIHTC investment seminars. Why take genuine equity-loss risk when you meet that test simply by buying a fixed-income security with a debt-like yield? LIHTC soon filled the equity-test void – indeed, so successfully that it crowded out virtually every other form of CRA equity investment.
This worked fine – for us, anyway, if not necessarily for CRA’s original purpose – when the financial sector was profitable, and when we had Fannie Mae and Freddie Mac were there to soak up all the excess demand. Now, with the GSEs out of our market, probably for good, we currently have precious few takers for LIHTC investments that lie outside the CRA maps of major national banks. Redlining has completely reversed its polarity. Ironic, isn’t it, that a statute designed to compel capital to flow in to some undercapitalized areas is now having the effect of flowing LIHTC capital out of all the other areas?
The consequences of the Bizarro CRA are anything but esoteric; they are economic and politically program-threatening. Remember, when a state reserves housing credits for a property outside the CRA hot spots, the state can’t go back to Treasury and Exchange 100% of those credits for cash, only 40%. The state must find someone to buy the 60% Unexchangeable. If not, the state will watch that money get “lost,” flowing via the national pool outside of the state entirely and into the CRA hot spots – large urban areas. In crude terms, Unexchanged Red LIHTC may migrate into Blue markets, creating a massive political risk to what has been a remarkably bipartisan program.
There are only two ways out of this dilemma: create substantial new non-CRA demand, or reform CRA.
New non-CRA demand has to come at levels attractive to economic investors – traditional-industry CFOs uninterested in CRA – and that will mean LIHTC prices in the 60-65¢ range at best. My desperate colleagues bushbeating for new investors are showing progress – as much as $2.0 billion of largely CRA-blind capital appears poised to enter, but this will take time to work through the pipeline, and even when it does, CRA investors will be driving the bus.
CRA regulators could make an immediate impact by allowing (say) any property, regardless of location relative to the assessment area, to qualify for the equity test if the rent-cap covenanted income level was low enough (e.g. below 50% AMI), or giving banks investing outside their CRA areas to count the investment as “innovative,” qualifying them for CRA bonus points. As far as I know, such fixes will not require any statutory changes – just new direction (in the form of amended regulations) from the OCC and the other CRA agencies.
Remember, folks, investors don’t need LIHTC; LIHTC needs investors. The CRA rules won’t change just because we wish them to – somebody must take up the cause. Are we worried enough about our industry’s future to make the ask? If we don’t, when 2010 closes with much of the nation’s LIHTC unsold, we’ll have no one to blame but ourselves.
Got a question you’re burning to have answered? Email it to [email protected].
David A. Smith is CEO of CAS Financial Advisory Services, a Boston-based firm that optimizes the value of clients’ financial assets in multifamily residential properties, particularly affordable housing. He also writes CAS Financial’s free monthly essay State of the Market, available by emailing [email protected].
