Equity Market Rife With Uncertainties; Higher Yields, Lower Prices Seen in 2008
By Caitlin Jones & A. J. Johnson
13 min read
DEVELOPERS SHOULD PREPARE FOR reduced low-income housing tax credit (LIHTC) prices in 2008, because of various factors that have created uncertainty in the equity market, according to participants interviewed by the Tax Credit Advisor.
This uncertainty is largely due to expectations of reduced investment, possibly substantial, by at least some current corporate investors. If this happens, syndicators expect projected yields to investors to rise on new tax credit funds in 2008, and credit pricing to developers to fall. Credit pricing below 90 cents per dollar of housing credit could become commonplace.
“The market is going through an upheaval it has never gone through in the past,” said Patrick Nash, a managing director of JP Morgan Capital Corp., Chicago, IL, a corporate investor in LIHTCs through funds and direct investments.
Many LIHTC developers in recent weeks have been warned by their regular syndicators about likely lower credit pricing ahead.
Developer Bob Greer, president of Michaels Development Co., Marlton, NJ, told TCA he is seeing a “transition” in pricing. “We’re receiving kind of advance advice from our set of syndicators who are working with us as we put new deals together that maybe we shouldn’t even expect to be in the 90s, depending upon where in the country we’re building,” he noted. Greer indicated his firm was getting prices of $1 and above on some of its projects earlier in 2007, then the prices fell to the high 90s, and then to the mid 90s. Greer’s firm now has LIHTC projects under or about to start construction, or about to close, in 16 states.
Developer Steve Lawson, of The Lawson Companies, Virginia Beach, VA, also said he’s been warned by his regular syndicator of likely lower prices in 2008, and noted other developers he has talked to have indicated the same. Lawson, current chairman of the National Association of Home Builder’s Housing Credit Group, told TCA he last obtained equity commitments three months ago at prices in the low- to mid-90s. “If I was pricing now,” he noted. “what I would probably get from [syndicators] now is in the mid-80s.”
Trend in Yields, Prices
“I think clearly yields [to investors] will be going up, and I think prices [to developers] will be coming down. The question is, how much; that I just don’t know,” said syndicator Shawn Horwitz, president and CEO of Alliant Capital, Ltd., Woodland Hills, CA. “We’re offering less for projects that we expect to close next year” because his firms expects it will need to offer higher yields to investors in 2008 on its new tax credit funds. Alliant Capital raises LIHTC equity through singleand multi-investor tax credit funds and, for the first time in 2007, a guaranteed fund.
Much of the current uncertainty in the LIHTC equity market, which is driving expectations for higher yields and lower prices in 2008, is from widespread concern that Fannie Mae may significantly curtail its new investment in housing credits in 2007, and that Freddie Mac may as well. Fannie Mae has traditionally been the largest single corporate investor in housing credits ““$2 billion in new investment commitments in 2006. Freddie Mac has been a major player, too — $500 million in 2006, $1.3 billion in 2005. One syndicator estimated the two government sponsored enterprises (GSEs) together have probably accounted for 30% -40% of the total LIHTC equity raised each year; the combined market share from the two GSEs and from the major commercial banks that invest in LIHTCs is probably 80%-90%, the sponsor estimated.
Neither GSE has disclosed the amount of its new LIHTC investment commitments in the first half of 2007.
The need and appetite by Fannie Mae and Freddie Mac for additional tax shelter like housing credits is determined by each firm’s annual profitability, which depends on the size of their mortgage portfolios, which varies daily and is limited by federal caps. Both GSEs have sustained certain write-offs in 2007, reducing their taxable profits and need for tax shelter. Lower profitability than in past years is probably likely in 2008 as well. In addition, Fannie Mae is now subject to the corporate alternative minimum tax (AMT), which means that the company can’t reduce its annual federal tax liability by the purchase of additional LIHTC investments. A proposal to amend federal tax law to exempt housing credits from the corporate AMT might be considered by Congress in 2008.
Fannie Mae and Freddie Mac invest in housing credit funds through a stable of specific syndicators that each traditionally invests with.
In response to an inquiry by TCA about Fannie Mae’s plans for LIHTC investment in 2008, Fannie Mae’s Edwin Neill said in a statement, “Fannie Mae has been a provider of liquidity for the Low Income Housing Tax Credit market for nearly 20 years and looks forward to continued participation in this important affordable housing market in the future. As with other investors in this market, we periodically adjust our levels of new investments and our levels of sales of LIHTC assets to correspond to our current corporate tax liability.”
Freddie Mac, through a spokesperson, told TCA in early December the company hasn’t yet closed its 2007 activity yet, hasn’t finished planning for 2008, and probably won’t until after the company’s fourth quarter earnings go out.
Additional new LIHTC investment by Fannie Mae and Freddie Mac in 2008 isn’t out of the question. Moreover, either GSE also could free up space for new investment by selling some of the existing LIHTC investments in their portfolios on the “secondary market.” Fannie Mae, for example, made at least two such sales in 2007, including a $676 million chunk to Citibank NA, announced in March, which accounted for less than 10% of its total LIHTC portfolio.
Even if they curtail new investment in housing credits in 2008, Fannie Mae and Freddie Mac can and have supported the LIHTC market in other ways. One is providing debt financing for LIHTC projects; Fannie Mae through its network of Delegated Underwriting and Servicing (DUS) program lenders, and Freddie Mac through its network of Program Plus lenders.
Fannie Mae spokesman Jon Searles told TCA his firm’s multifamily debt volume “really started picking up in the second quarter, and has been very robust through the third quarter.”
In addition to concerns about future LIHTC investment volume by Fannie Mae and Freddie Mac, several syndicators worried that some major banks and financial institutions may reduce their LIHTC investment in 2008, because of lower profitability caused directly or indirectly by the subprime loan crisis, current credit crunch, or changes in the economy.
Sources, though, felt the Community Reinvestment Act (CRA) will continue to prompt major banks to invest heavily in housing credits in 2008, particularly in large urban areas.
Syndicators and corporate investors interviewed by TCA all believed projected yields to investors will rise on new tax credit funds in 2008. They explained higher yields will be necessary to entice existing and new investors to commit sufficient amounts of tax credit equity, including to close the gap caused by curtailed investment by investors from prior levels.
Some syndicators felt typical after-tax yields to investors on new multi-investor funds in 2008 could hit or pass 6%. Said syndicator Steve Smith, of The Richman Group, “My guess would that yields are going to go up probably in the neighborhood of 6 [percent] for the funds for next year. But I don’t know if that’s the right number or not. It’ll depend a lot upon how all of this credit market meltdown plays out with the banks, how serious it is, and what impact it has ultimately.”
Typical fund yields bottomed out in the spring of 2006 in the low- to mid-4% range, and have risen steadily since. Boston syndicator Greg Judge, of MMA Financial LLC, said the typical projected yield on new funds now being marketed probably ranges from 5.35% to 5.50%. “That’s where the money’s being raised for the most part,” he said. “But it’s pretty thin.”
Chicago syndicator Joe Hagan, of National Equity Fund Inc., said the projected internal rate of return (IRR) is 5.40% on a new $175 million national multi-investor fund that NEF expected to close by year-end. This compared to an IRR of 5% on NEF’s first national fund in 2007, and 4.75% on a national fund that closed in December 2006.
Judge said typical credit pricing — excluding premium deals and hot markets — is probably now in the high 80s to low 90s. But he and others suggested credit prices will fall further. Hagan said, assuming an average price of 92 cents in 2007 as a starting point, pricing could by fall by 5 to 10 cents by year-end 2008.
Direct investor Cynthia Lacasse, president of John Hancock Realty Advisors, Inc., Boston, doesn’t expect a “blow-out” in credit prices in 2008, but rather said a small decline might boost yields sufficiently to spark greater LIHTC demand by investors. “We’re watching this market quite carefully, and anticipating that there might be opportunities next year that might cause us to increase our investment volume,” she noted.
Portland, OR-based syndicator Paul Cummings, of Enterprise Community Investment, Inc., described the current LIHTC equity market as “challenging.” Cummings said, “We’re not hearing [from our regular investors] about [their] appetite for equity amount going up” in 2008. “What we are hearing from investors”¦is that it’s going to be a tougher challenge to allocate resources to invest in tax credits” because of different considerations. “It’s a harder sell today,” he noted.
Elizabeth Stohr, of US Bancorp Community Development Corporation, St. Louis, a direct and fund investor in LIHTCs, predicted there will be a “flight to quality” by corporate investors in choosing LIHTC investments in 2008, with investors more conservative in their underwriting.
JP Morgan Capital Corporation’s Nash said, “As a buyer, I know there isn’t as much capital out there,” so he said he will be more selective in picking deals and look for the best price.
Stohr, 2008 president of the Affordable Housing Investors Council, said most other corporate investors she knows are budgeting to invest about the same or a little more in LIHTCs in 2008. She felt credit pricing in 2008 will fall the most for “B and C level” deals — projects that due to their quality or local real estate market are viewed as less attractive.
Advice, Adjustments
Syndicators and corporate investors offered some advice to LIHTC developers seeking equity in 2008.
Cummings urged developers to “identify your equity source early in the process.”
Judge advised developers to first approach the syndicators “you’re most loyal to, and you’ll get your best deal; there’s a lot of trust there, and they’re going to make sure to take care of you.” When equity capital is limited, he said syndicators typically will first fund the projects of their loyal repeat developers before those of newcomers.
Judge advised developers to stay attuned to current credit pricing and to try underwrite their deals so they are feasible at a lower price. If typical current pricing, for instance, is 91 cents, “try to make your deal work at 89,” he said.
Advised Horwitz: “Go with the syndicator that you know is going to be there at the closing, even though they may not necessarily have the highest price in the marketplace.”
Nash advised developers to assume a declining price the later in 2008 that they expect their deal to come to market for equity.
Stohr advised developers to “know your market and really test and re-test and stress the underwriting. Because that is what we’re going to be do.” Also, “make sure you have really done your homework when you project rents and expenses.”
Developers Bob Greer and Steve Lawson expect to business a little differently in putting together proposed new LIHTC projects in 2008.
Both indicated they expect to underwrite their new projects at lower credit prices, to intensify their efforts to try to control development costs, and to redouble their efforts to find soft debt for projects to close the gap from expected lower credit pricing and equity dollars. Greer, for example, expects his firm to begin making it a regular practice with its new projects to apply for subsidies from the Affordable Housing Program operated by the Federal Home Loan Banks — something his company in the past did “once in a while.”
Greer said his firm is also bringing its contractor in early during the design of a new project, so that the final design is most cost effective and is what the contractor thinks will “give us the best product for the best price.”
Lawson, who develops credit projects in Virginia and North Carolina, expects LIHTC developers to be squeezed on the debt side as well as the equity side in 2008, noting they are already from tighter underwriting by lenders and larger spreads above 10-year Treasuries that shrunk mortgage sizes.
“We’re really in a double jeopardy situation, where the underwriting is getting tougher on the mortgage, and there’s downward pressure on credit pricing,” he said. Lawson said some of his costs of development have come down, such as for lumber and labor, but steel and cement prices remain high.
