On the Cusp of Further Growth: LIHTC Industry Hopeful for Boost in Equity Volume from Accounting Change

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Syndicators are getting positive feedback as they talk to companies to try to get them to start investing in low-income housing tax credits, while nervously trying to keep the after-tax yield on new national multi-investor funds at or above 7%, a tough challenge given persistently strong credit pricing to developers.

“With the new accounting treatment a lot of investors are looking at [LIHTC investments],” says Marc Schnitzer of R4 Capital, Inc. “I can’t tell you that the floodgates have opened as of yet. But I do know that a lot of people are considering it.”

“But it takes time,” he added. “It takes time for big organizations to decide to get involved in something that is outside their core business.”

In December, the Financial Accounting Standards Board (FASB) ratified the use by public companies of a new, more favorable “proportional amortization” method of accounting for LIHTC investments.

“We’re meeting with a lot of companies to explain it,” says Jack Casey of Meridian Investments, Inc., a broker of tax credit investments. “And they’re reciprocating by saying, ‘Here’s the business process that takes place here.’”

“The yields now are probably in the right place at 7%, 7½% on an after-tax basis,” said Casey. “That’s fairly attractive in a low interest rate environment. So I think you’ll get a lot of companies that will test the product, approve the asset class, and see what happens.”

Casey expected a couple large investors to come into the market in September. But he cautioned that the sales process for new investors is lengthy, generally requiring meetings and sign-offs at different levels in a company before the board of directors gives final approval and authorizes an initial budget.

LIHTC industry officials are optimistic that the accounting rule change will bring some new investors into the LIHTC market, lure back some prior investors that had been on the sidelines, and perhaps motivate some current investors to increase their volume.

Syndicators and brokers said they have been meeting with a variety of prospective new investors, including financial services firms not already in the market as well as tech, consumer products, manufacturing, and retail companies. But they cautioned that projected-after tax yields on national multi-investor LIHTC funds must be at attractive levels to bring in new investors; that the accounting rule change itself isn’t a sufficient carrot.

Another positive development is an indication that Google may be preparing to increase and diversify its volume of housing credit investment. The company, which so far has done limited investment in guaranteed product, recently sent a request for qualifications to a number of for-profit and nonprofit syndicators, asking for responses by March 28. “There’s a beauty contest going on to compete for Google’s business,” said Fred Copeman of CohnReznick LLP.

It’s unclear how many current LIHTC investors – nearly all banks and insurance companies – will decide to switch from the less favorable equity method of accounting to the proportional amortization method, as permitted by the FASB guidance. “The benefit is not as clear in some cases as it is in others,” says Copeman. But he added, “In my experience most of them have made a decision to switch. But implementation is taking longer than they thought it would.”

“Informally it appears that around 50% of our investors have elected to become early adopters of the proportional amortization method,” said Ben Mottola of Stratford Capital Group.

“We do know that some of our long-time investors are making the switch,” said Raoul Moore of Enterprise Community Investment, Inc. “We’ll have to wait and see if this has a long-term effect on the market.”

Bank of America Merrill Lynch hasn’t decided yet whether or not to change from the equity method to the proportional amortization method for its LIHTC investments, said executive David Leopold. He anticipated that the bank if it makes the election probably wouldn’t do so until near year end. Leopold said the bank continues to be active in making new LIHTC investments, and hopes in 2014 to match its 2013 housing credit investment volume of $1.038 billion.

Strong Investor Demand

Investor demand for LIHTC product remains robust, syndicators reported.

“Demand from both the major CRA investors and economic investors continues to be very strong,” said Steve Kropf of Raymond James Tax Credit Funds.

“The market right now is completely opposite from what we saw in the first half of 2013,” said Tony Bertoldi of City Real Estate Advisors, Inc. “Last year it seemed that investors had a wait and see attitude and our first fund of the year was smaller than expected. This year we have had to turn some dollars away as we cannot find enough product and investor interest appears to be increasing.”

“Investor demand is strong,” said Tammy Thiessen of RBC Capital Markets’ Tax Credit Equity Group. “Our challenge is winning good deals at pricing that balances the yield to investors and profitability to syndicators.”

Richard Floreani of Carlisle Tax Credit Advisors LLC, a Boston-based firm whose clients include investors and syndicators, said projected after-tax yields on current national multi-investor funds are “pretty tightly clustered” in the 7% to 7¼% range.

In the current issue of CohnReznick’s Housing Tax Credit Monitor (see p. 26), projected yields on 12 national funds range from 7% to 7.85%, with 9 of the funds between 7% and 71/4%.

Yields on most new national multi investor funds tend to be dropping slightly. Syndicators with new national multi-investor funds that have a projected yield lower than the yield on their prior national fund include Boston Capital, Boston Financial, CREA (for two

of the investment classes), and RBC Capital Markets’ Tax Credit Equity Group. Meanwhile, National Equity Fund, Raymond James, The Richman Group, and Stratford Capital Group are planning to roll out new national funds with a yield below that on their prior national fund.

Boston Capital’s Jeff Goldstein explained the reason for the lower yield on its new national fund – 7% compared to 71/4% on its prior one. “It’s more and more difficult to find deals even at 7s,” he said. “It’s an extremely competitive marketplace…We can’t find enough product at 7¼%. There’s not enough product at 7¼% or 7½%.”

Floreani called a 7% yield a “strong psychological barrier” among syndicators, noting that when national multi-investor fund yields fell below 7% at a point in 2013, “a number of investors pulled back from the market. I think syndicators are quite mindful of that and are very nervous about breaking the 7% level on a national fund.”

“I think the industry generally feels that that 7% mark is sort of the sweet spot for keeping both economic and CRA investors engaged,” said Beth Stohr of U.S. Bancorp Community Development Corporation, a major investor in housing, historic, and new markets tax credits.

 

Credit Pricing Robust

Most syndicators felt that housing credit pricing to developers has generally held steady at robust levels, both for deals in strong CRA markets such as New York City as well as in “non-CRA” markets, though with wide variations.

“There is a large variation between CRA and non-CRA pricing,” said Michael Gaber of WNC,” with pricing anywhere from as low as the mid-80s [in cents per credit dollar]

to a high of a dollar in the highly concentrated CRA markets. Nine percent deals are still in very strong demand as well, and we are certainly seeing such deals in non-CRA markets still being extremely competitively priced.”

Several syndicators said pricing for some deals in the strongest CRA markets can still range up to above one dollar per dollar of tax credit.

“The lowest tax credit price that we’re seeing right now is about 83 cents and probably the highest is about $1.02,” said Schnitzer.

“We’re seeing very aggressive CRA pricing in what might not be considered hot CRA areas like several markets in the Midwest,” said CREA’s Tony Bertoldi. “For national funds, the average price per credit is now above 90 cents, whereas six to nine months ago it was in the mid-80s.”

Marge Novak of Great Lakes Capital Fund, which sponsors an annual regional multi-investor fund, said, “Within our footprint, current lower tier pricing is in the 83 to 89 cent range for rural deals and in the 86 to 93 cent range for urban deals, with some hot CRA market deals outside this range.”

“We’re experiencing strong competition everywhere, including secondary or tertiary and non-CRA markets,” said U.S. Bancorp CDC’s Beth Stohr, which makes LIHTC investments both directly and through multi-investor funds.

She said the positive result from the higher pricing to developers is the greater amount of equity generated that allows the housing projects to get built, offsetting headwinds such as the floating rather than fixed rate for the 9% credit, the rise in mortgage rates, and declining gap sources.

Jim Silverwood, president and CEO of San Diego-based Affirmed Housing Group, which develops LIHTC properties in California, is one of those enjoying the benefit of the lofty credit pricing in the strong CRA markets his company operates in. “We’re currently getting quotes on 4% acquisition/rehab deals at about $1, and getting quotes on 9% new construction deals at about $1.05, $1.06” he said.

One positive factor for syndicators is that state housing credit agencies still have a lot more 9% housing credits to award this year, which could ease credit pricing in the future. According to Boston Capital, as of the end of March, only 21% of all anticipated 2014 housing credits had been reserved by state agencies.

Legislative Proposals

Officials said they haven’t seen any impact so far on investor demand from the provisions to modify the LIHTC program contained in the tax reform “discussion draft” recently released by House Ways and Means Committee Chairman Dave Camp (R-Mich.). While the housing credit industry has concerns about some of the proposed changes, overall the reaction has been that the draft’s retention of LIHTC is a positive endorsement of the program.          Industry officials also hope that Congress will find a way this year to renew the minimum 9% rate for the 70% present value housing credit that lapsed at year-end 2013 and perhaps also establish a minimum 4% rate for the 30% present value credit for non-bond financed acquisition costs. Both provisions are in the tax extenders bill recently approved by the Senate Finance Committee. “We’re feeling pretty good about that and cautiously optimistic,” said Boston Capital’s Jeff Goldstein.

In the meantime, syndicators generally believe that 2014 will turn out to be another good year for the LIHTC equity market.

“Right now the market is working pretty well by and large,” says Floreani. “Deals are getting done. Deals are finding equity. And investors are getting returns they’re happy with.”