The Tax Credit Crystal Ball: Where Are the Industries Headed?
By Caitlin Jones
10 min read
Tax Credit Advisor, October 2009: The Tax Credit Crystal Ball: Where Are the Industries Headed?
What’s ahead for the federal housing, historic, and new markets tax credit industries in the next year? The next five years?
Will they have different investors, new project characteristics? Will they still exist?
In recent interviews, industry participants and observers offered their predictions for the future of these sectors.
Low-Income Housing Tax Credit
Participants were divided in their predictions for the low-income housing tax credit (LIHTC) industry over the next year. Some anticipate a significant inflow of additional equity, while others predict a continuation of current conditions.
Participants, though, generally concurred that longer-term prospects will heavily depend on whether certain key actions occur within the next year or two.
“We’re in a period of potential structural change,” says David Smith, CEO of Boston-based CAS Financial Advisory Services.
He noted the LIHTC industry has been rocked by gut-wrenching, rapid changes since the end of 2007 that have caused a precipitous decline in credit prices and in the supply of tax credit equity, and a rise in yields to investors. This is a marked change from 1993-2007, when the equity and credit supply were in balance and economic and financial conditions were favorable. At the end of 2007, everything went out of whack. Hyper inflated credit pricing and the global credit crunch combined to devastate an LIHTC “value chain” that Smith says had become “over-engineered and fault intolerant.” The result is the market’s current woes.
“It’s by no means clear that we should repair the [system] in exactly the way that we put it together,” Smith says. “If we’re going to have LIHTC as the principal resource prospectively by which we finance affordable housing, the value chain à the QAP and award process, and the equity-raising process à have to become more robust and responsive.” This means shorter time frames, more cushion built into original underwriting, and the ability to make adjustments at project completion to handle variances.
Smith expects housing credit pricing to stabilize in the next 12 months, but not to return to prior lofty levels. He also expects pricing to be differentiated by market types (e.g., CRA versus non-CRA markets, demographics).
Investor Patrick Nash, managing director of JPMorgan Capital Corporation, and current president of the Affordable Housing Investors Council, anticipates the status quo over the next 12 months. “I think we’re going to see much of the same as what we’ve seen over the last couple of years.”
Syndicator Stephen Daley, of The Richman Group, suggested that there is likely to be increased demand for credit investments from some big banks that have gone through mergers and now have large LIHTC investment mandates. “Are we going to get back to where we were three years ago? I’d say those days are long over. Are things going to get worse than they are? Or are yields going to go much higher? I don’t think so.”
Syndicator Jeffrey Goldstein, of Boston Capital, expects an “influx of new investors and new equity” into the LIHTC market in the next 6-12 months, both investors new to credits and returning investors. Beyond 12 months, he anticipates that the equilibrium resulting from the equity influx will probably cause yields to peak and perhaps even fall a bit, depending on prevailing yield levels on alternative investments.
Goldstein and several others predict fewer syndicators and LIHTC developers over the new year or few years, as the industry consolidates and goes through a shake-out.
Participants indicated that the longer-term outlook will heavily depend on whether the LIHTC industry can successfully broaden the investor base and return to a self-sustaining condition. Much of the answer will depend on whether Congress enacts legislative changes like those proposed by a national coalition of LIHTC supporters. These proposed tax law changes are designed to make the housing credit more attractive to new and existing investors. They include a five-year “carryback” proposal; removing barriers to entry to certain types of businesses; and extending the federal low-income housing credit exchange program for one year. (For details, see Tax Credit Advisor, September 2009, p. 4.)
“Unless we get some congressional relief in the form that we’re looking for, or some other form that works, I don’t see that we’re going to have enough equity to fulfill the needs in the market for the next several years,” says syndicator Ronne Thielen of Centerline Capital Group, and current president of the Affordable Housing Tax Credit Coalition.
“However,” she continued, “if we get congressional relief in some way to make the credit more enticing to investors, to new investors, then I think that we can build this equity industry back up to a point where it can be self-sustaining within two years, by 2011.”
Smith suggested that the LIHTC program is in a precarious political position. Because equity is scarce or non-existent for projects in many parts of the U.S., the LIHTC could be seen as no longer a national program, which could undermine the program’s traditional strong and bipartisan support in Congress unless the equity demand problem is remedied.
Smith noted Congress might also decide to choose which one of two “parallel” and competing funding systems à the LIHTC program and the credit exchange program à to continue, and which one to end. He noted both programs have the same purpose, target the same projects and developers, and are run by the same state housing credit agencies.
Syndicator Joe Hagan, of National Equity Fund, Inc., believes that if state agencies are flexible and effective in their use of credit exchange funds and of Tax Credit Assistance Program (TCAP) funds, there will be enough equity to supply good deals in 2009. Furthermore, a one-year extension of the exchange program would mean “a good climb back up” for the market, he said. But Hagan warned, “By 2011, this market has got to be able to sustain itself – or we’ve got to get new jobs.”
He predicted that by 2011 projected after-tax yields on new LIHTC investments will settle back between 9.0% and 9.5% Ã maybe lower if the carryback proposal is enacted.
Another question mark for the industry is what Fannie Mae and Freddie Mac do with the billions of dollars of existing LIHTC investments they hold but cannot fully utilize. The two “GSEs,” which once accounted for as much as 40% of the total annual LIHTC equity raised, are said to be exploring ways to sell some of their holdings without disrupting the LIHTC market. Reportedly possibilities include carving up some credit investments into “strips” of a few years in duration, possibly wrapped by a GSE guarantee. “I think it’s a very poorly held secret that there’s going to be some dispositions in the very immediate future,” said one source.
Spokespersons for Fannie Mae and Freddie Mac declined comment.
While some industry officials worry that GSE sales of existing LIHTC product might provide unwanted additional competition for existing investors for new LIHTC investments offered by syndicators, another view is that limited sales of existing GSE product might attract first-time investors. Depending on the yield level, short-term strips might attract prospective new investors because companies would only need to anticipate their tax shelter need for the next few years, rather than 10 years as with standard LIHTC investments. Additionally, new guaranteed tax credit investments, now generally unavailable, might attract investors that prefer or will only invest in this type of housing credit product.
Participants envision an even greater emphasis on energy efficiency in projects selected by state housing agencies for housing credit awards. John McIlwain, a senior fellow at the Urban Land Institute, says the green building trend is long term and may ramp up even faster as more local governments adopt energy-saving requirements, and if a national energy code is established.
He also sees increased governmental incentives for urban and suburban infill developments.
Several participants expect state housing credit agencies to make lasting changes to their LIHTC underwriting and project selection policies as a result of the current market upheaval.
“Now the state agencies really have to look much more closely at their underwriting, and look at the long term,” says Thielen, once head of California’s housing credit allocating agency. She suggested that state agencies will be looking at deals more conservatively now that they will be truly at risk in some projects funded with TCAP or exchange dollars, particularly deals without an equity investor.
“There’s a good chance that we [state agencies] are in a state of transition,” says Mark Shelburne, of the North Carolina Housing Finance Agency. “State agencies are going to learn a lot of lessons in the near future about what [project] is going to be able to secure equity, and what won’t. The frustrating part is that I don’t know that those lessons will be instructive for whatever is the equity situation in the following year.”
Shelburne also expects state agencies to award credits to a fewer number of projects each year going forward, because of the need to provide larger credit awards to make deals feasible.
Historic Tax Credits
Participants were generally positive about the near- and long-term prospects for the federal historic rehabilitation tax credit industry, despite some current challenges. (See p. 11 for article on snapshot of industry.)
Participants would be particularly optimistic if Congress approves a package of proposed legislative changes to the historic tax credit developed by an industry coalition. These changes would encourage smaller projects, permit the historic credit for moderate rehabilitation projects, and provide incentives for energy-saving improvements in historic buildings. Supporters hope that Congress will attach the proposals to tax legislation enacted this year. (For details on proposals, see Tax Credit Advisor, July 2009, p. 23.)
“The industry will recover as soon as the economy does,” says Eric Darling, of Carlisle Tax Credit Advisors. “A lot of people are just waiting to go.”
Washington, DC attorney Jerry Breed, a partner in the law firm of Bryan Cave LLP, anticipates a slow, gradual recovery from the recession rather than a sharp, rapid one, and for a continuation of difficult real estate markets in 2010.
Marc Hirshman, of US Bancorp Community Development Corporation, a major investor in federal historic credits, expects a slowdown in the delivery of historic credits in 2010 and 2011, because of the difficulty in getting new projects off the ground.
Syndicator John Leith-Tetrault, of the National Trust Community Investment Corporation, expects an eventual broadening of the corporate investor base for historic credits, though smaller appetites by individual companies. There may also be more historic credit developers. Leith-Tetrault is getting more calls than ever from developers seeking equity for projects, including many who’ve never done an historic credit deal before.
New Markets Tax Credit
The fate of the new markets tax credit is in the hands of Congress. Unlike the LIHTC and historic tax credit, which are permanent, the NMTC program will expire on 12/31/09 unless Congress passes an extension. Legislation to extend the program for five years with annual funding of $5 billion is pending.
Claudia Robinson, of Bank of America, a major investor in new markets credits, says the NMTC has been a successful and wildly popular program. But unless it’s extended for at least four years, the program’s success will be hampered, she says. “Investors don’t want to go into a program that could be sunset the next year.”
Darling suggested that a substantially higher credit supply is needed for the program to reach its full potential. The typical annual credit authority level has been around $3.5 billion.
Speakers also said the program needs legislative improvements to put the NMTC on par with other federal tax credits, such as an exemption from the federal alternative minimum tax, which the low-income housing and historic tax credits already enjoy.
