Some, But Not All, Syndicators See A Peak Reached in Tax Credit Prices
By A. J. Johnson & Caitlin Jones
11 min read
Tax Credit Advisor February, 2006: Investor resistance has taken the steam out of tax-credit equity price increases, according to syndicators interviewed in late January. Some syndicators said this was evidence that a peak has at last been reached in prices after more than a year of sharp increases. Others disagreed.
“Investors are taking a tough line [on tax credit price increases], and this has stabilized things,” said Bryan Sfreddo, Senior Vice President of Related Capital LLC, a subsidiary of CharterMac.
“It looks like prices have finally leveled off,” added Stephen Daley, Senior Vice President for Equity Transactions at Paramount Financial Group. Daley said that a peak was reached at the end of 2005, as investors began to balk at the lower fund yields prompted by the rise in prices. “The impact didn’t really hit home until then,” he said.
But other syndicators insisted that tax credit equity prices are still rising, fueled by intense competition between syndicators for a limited supply of these credits. “I wish I could say that prices aren’t continuing to go up, but what we are seeing is offers that are off the charts,” said Will Cooper Jr., President of WNC & Associates Inc.
Greg Judge, Senior Vice President at MMA Financial, shared this view. “People are hoping that prices will slow down,” he said, “but right now it seems that there are still buyers willing to step up and pay whatever it takes to secure a transaction.”
Judge also said, however, that an end to rising tax credit equity levels is near: “We are in the last leg of a pricing increase, and investors are saying loudly that this is as low [in terms of fund yields] as they will go.”
Most investment in Low Income Housing Tax Credits (LIHTCs) is now made through funds sponsored by syndicators who buy the credits directly from developers. Investors in the funds receive a specified yield in addition to the tax benefits of the credits. As tax credit equity prices rise, funds contain less tax credits per dollar of credits purchased, and yields decline.
Reviewing 2005
The price that the syndicators paid for tax credits now averages in the mid $.90s per $1.00 of credit (See Ernst & Young’s Corporate Tax Credit Fund Watch, page 5), an increase of as much as $.10 per dollar of credit from prices at the beginning of 2005. In a number of markets, they said, pricing now averages over $1.00 per $1 of credit, and is particularly elevated in California, where many properties fetch between $1.05 and $1.10.
Over the past year, yields on national non-guaranteed funds have dropped by about 100 basis points, from an average of about 5.5 percent to about 4.5 percent. Guaranteed funds, meanwhile, have dipped to the mid-3 percent level.
Reviewing 2005, the syndicators said there are two main reasons for the record increase in tax credit equity prices.
The first is the unprecedented buying of tax credit equity by “non economic” investors, including banks, insurance companies, and government-sponsored enterprises like Fannie Mae and Freddie Mac. These investors bought shares of housing tax credit funds largely to fulfill community investment goals specified by state regulators or the federal government, or to fulfill a mission. In 2005, they bought about half of the approximately $9 billion in tax credit equity raised by syndicators, with Fannie Mae and Freddie Mac together purchasing about $3 billion, or a third of the total.
But “yield” investors – those whose primarily interest was the rate of return offered by the funds – were also aggressive buyers through much of 2005, as strong economic growth helped them generate more taxable income to shelter than any time since the late 1990s. Given the low level of interest rates and a lackluster stock market, these investors had few other investment options last year that offered comparable after-tax returns.
Forecast for 2006
Support from both of these types of investors may well fall off in 2006, the syndicators predicted.
With tax credit fund yields dropping, some yield investors have already begun to seek other investments, the syndicators said. The pace of this could quicken, if the stock market gains strength, or interest rates increase. Investors could also fall off if the economy loses steam.
At the present time, the syndicators appeared to be most concerned about the prospects of an economic slowdown reducing the taxable income of the yield investors – and with it any interest from these investors in funds filled with credits near or over $1.00 in price.
“A big question for us is the economy and whether the yield investors are really making money,” said WNC’s Cooper. “If they’re not, the current [fund] yield levels don’t make any sense,” he said.
Cooper said he is also monitoring interest rates closely, but with longterm rates remaining stable, “this is less of a worry than it was six months ago,” he said.
A falloff in “non-economic” investors also looms in 2006, the syndicators said. In 2005, both Freddie Mac and Fannie Mae indicated that they were not likely to increase investments beyond 2004 levels. For Fannie May, this has been borne out in 2005 tax credit investment level of $1.3 billion reported in Tax Credit Advisor, which for the first time in 13 years did not increase. (See TCA, January 2006, “Freddie Mac’s Investment in LIHTCs Levels Off.”)
Although the syndicators said that it is unlikely that the GSEs would substantially decrease investments in housing tax credits on their own, they may be forced to do so by legislation currently pending in Congress that could restrict their investments in housing projects. Whether banks and insurance companies will continue to be strong buyers of housing tax credits funds is also a wild card, the syndicators said.
Complicating Factors
As the market reaches for a definitive turning point, syndicators said that at least four additional factors are complicating matters.
Syndicator Competition
Even as fund investors are balking at lower yields, the large syndicators continue to be engaged in a spirited competition for market share, and are focused on buying tax credits from well-known, experienced developers.
“If you are buying at these levels, you don’t want to be paying for inexperienced, thinly capitalized developers – you want to do business with those who are in it for the long haul,” said Related Capital’s Sfreddo. The problem with this, he said, is that a limited number of developers fit this bill, and they are very sought-after by syndicators.
Market Polarization
Another complicating issue is the extreme polarization of the market, with credits in California, New York, and Florida priced well above those in the rest of the country.
“What is happening is that pricing is getting stabilized in some of the second-tier markets, but is still rising in California and New York,” said WNC’s Cooper.
Cooper said this is could lead to a marketplace where tax credit equity price continue to increase in the high-flying states – even as prices level off in the rest of the country.
Delayed Impact of Price Increases
Another issue is the delayed impact of tax credit equity price increases on fund yields, said Paramount’s Daley.
Fund sponsors can take up to six months to assemble their product, delaying the impact that rising tax credit prices has on yields. Funds offered to investors in the Fall of 2005, for example, reflected a blending of lower-priced tax credits from early 2005 and higher-priced ones added after mid-year, Daley said. But funds brought out towards the end of the year suddenly began to reflect a preponderance of higher-priced credits.
“Only now are the full effects of these high-priced tax credits being felt in terms of lowered yield,” he said. “This will only get worse as fewer lower price credits are included in funds.”
New Supply from GO Zone Credits
The introduction of new LIHTCs added as a result of legislation following the Gulf Coast hurricanes also complicates matters.
All syndicators interviewed expressed interest in investing in the LIHTCs newly allocated as part of the legislation setting up the Gulf Opportunity Zones. The legislation, which became law in December, provides for additional LIHTC authority in 2006 through 2008 of $18 per person in the Gulf Opportunity Zone located in those parts of Louisiana and Mississippi hit earlier this year by Hurricanes Katrina and Rita.
The syndicators said that pricing of these credits is apt to be particularly competitive. The GO Zone credits “will be part investment, part charity – and competition for them could be the greatest ever seen in our market,” said MMA’s Judge. He said these credits will strongly impact pricing of all housing tax credits in the Gulf region.
But do not look for the syndicators to rush into these credits, said Related Capital’s Sfreddo. “Everybody is still trying to figure out their credit structure,” he said.
2006 Outlook
All of these uncertainties for tax credit equity prices add up to a “very unpredictable market” in 2006, said Daley. He said that one scenario is for prices to stay relatively stable for most of 2006 until some sharp change in market climate – such as a significant rise in interest rates or an economic slowdown – initiates a slow decline in prices.
“The bottom line is that we view the [tax credit equity] market as healthy, and I think we’ll see a good equilibrium reached between supply and demand,” Daley said.
E&Y reported that syndicators continued to set new records in 2005 in terms of the amount of tax credit equity raised in a single year, and look to repeat this in 2006 (See Corporate Tax Credit Fund Watch, page 5).
MMA Financial ended 2005 with $1.3 billion in equity raised, eclipsing the previous record, $1.1 billion, which it shared with Related Capital for 2004. For 2005, Related matched its previous-year figure by raising $1.1 billion in tax credit equity. Another syndicator, the Richman Group, was just shy of the $1 billion mark for 2005, raising $910 million. Richman was the biggest gainer in tax credit equity in 2005, climbing 46 percent from the $652 million it raised in 2004.
Together, these three syndicators raised a total of $3.3 billion in tax credit equity, accounting for almost 40 percent of the housing tax credit equity market.
Some other firms also gained ground in terms of tax credit equity, with PNC Multifamily Capital increasing from $395 million in 2004 to $425 million in 2005; Apollo Housing Capital from $310 million to $330 million; and WNC Associates from $175 million to $183 million.
Meanwhile, a number of firms lost ground in 2005 from 2004 levels. The biggest change occurred at Paramount Capital Corportion, which raised $530 million in 2005 down from $765 million in $2004. Boston Capital, with $425 million in tax credit equity in 2005, was slightly below the $461 million it raised in 2004.
None of the syndicators interviewed said that their firms expect to raise less tax credit equity in 2006 than in 2005. MMA Financial’s Judge said that in 2006 his firm hopes to raise slightly more than the record $1.3 billion in tax credit equity it raised in 2005. “Each year we try to grab a little more market share,” he said. Related Capital said it anticipates $1.2 billion in tax credit equity in 2006, an increase over 2005.
Paramount’s Daley, who said that his firm’s volume has was hurt in 2005 by a pending ownership change, said it plans to regain its previous volume levels and has targeted raising $770 million in tax credit equity this year. General Motors Corp. is expected to soon complete its sale of a subsidiary of General Motors Acceptance Corp., which includes Paramount as one of its units, to an investor group.
E&Y: Price Increases Slow After Huge Run-up
Using data collected in late January, E&Y’s Corporate Tax Credit Fund Watch (See page 5), seemed to bear out a leveling off of prices. Average tax credit equity prices paid to developers in recent syndicator fund purchases ranged from $.90 per dollar of tax credit to $.98. This compares with pricing ranging from $.90 to $.96 in November, when E&Y last surveyed syndicators. The median for January was 94, the same as that for November.
Four of the eight syndicators reporting tax credit equity prices for the latest Fund Watch had the same numbers in November. Only two of the eight reported increases from November, both two cents on the dollar: Apollo Housing Capital an increase from 90 to 92, and the Richman Group an increase from 96 to 98. The Richman Group’s figure is the highest average tax credit equity price from a syndicator that E&Y has ever reported to Tax Credit Advisor.
Two other syndicators that reported tax credit equity prices for the current report had not done so in November. Boston Capital, which had reported tax credit equity pricing of 90 in September 2005, weighed in at 94 in the latest report, and Related Capital reported an increase from 88 in July to 94.
“Over the past several months, tax credit equity prices have been finding a top,” said E&Y’s Richard Floreani, senior manager at E&Y’s Tax Credit Investment Advisory Services. “Investors are forcing syndicators to stand pat.”
