The Guru Is In

Which switches to flip?

By David A. Smith
September 28, 2017 5 min read

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So long have the Historic and Low Income Housing Tax Credits existed substantively unchanged that we take both for granted, not just in their existence but also in their particulars – procedural switches that were set one way for the Historic Credit, another for the LIHTC. Though you may never have thought about them, these switch settings have had enormous impact on the two value chains, business economics and structure and profitability of our roles today. With tax reform a common political vaporware phrase these days, now more than ever it behooves us to see clearly the comparative differences based on how the key program switches were originally set. I can think of eight of them:

1. As-of-right, not competitive. To secure LIHTC, a sponsor must win a competition against other sponsors; Historic Tax Credits are available as-of-right, provided the sponsor satisfies the state historic preservation officer (SHPO). While once we thought the SHPOs demanding and the HFAs reasonable, QAPs have grown in size and demands; costs of chasing allocations have ballooned and odds of winning shrunk; production costs have risen much faster than inflation; and HFAs have grown both administratively and financially.
2. Gatekeepers pro-transaction and not economically incentivized. Unlike state HFAs, which have an economic incentive in the entire capital stack and which believe themselves to be underwriters, SHPOs are motivated to find ways to see older properties historically renovated. In this pursuit, they’re largely unconcerned with economic feasibility; they care about antique windows, not financing windows. While that makes negotiating with a SHPO an exercise in patience, self-interest is never a hidden agenda.
3. Not capitated, so it expands as needed. While the LIHTC is fixed at a per-capita amount, Historic Credits expand as needed; add a property to the National Register of Historic Places and the supply of Historic Tax Credits automatically expands. Because historic designation creates net value, prospective developers with site control have common cause with SHPOs. This positive-sum game creates revitalization momentum. By contrast, every year the allocators who design a state’s QAP have another chance to squeeze the economics (and the developers) harder; the deal-making incentives are not aligned.
4. Earned at completion, not over time. Whereas it takes ten years to earn the LIHTC, and the earning must be continuous, the Historic Tax Credit is one-and-done. That makes it a much easier commodity to price and sell, and likewise simpler to structure into a partnership where the credit flows one way and the economics another.
5. One-and-done certification. Because property is immovable and unchanging, once the renovation is certified historic, it stays that way. LIHTC renters move; their household compositions change; their incomes fluctuate; so not only is affordability tested annually, it’s tested at every individual apartment. The annual administrative costs of maintaining and documenting compliance add up.
6. A significant boost but not a sine qua non. Historic’s 20 percent credit is certainly a nice boost, but by itself, it’s not enough to make an otherwise infeasible property fly. As a result, the property has to have value and NOI that will pass a quasi-normal commercial real estate underwriting – it has to be an economic proposition. In allocated LIHTC, the credit is always the make-or-break capital source, so everyone dances to the HFAs’ tune – and if there’s a DDA 30 percent basis boost, the LIHTC can be so large no other underwriting is worth a tinker’s dam.
7. Agnostic as to property use. Historic works with any type of real estate, whereas LIHTC must be pure and virtuous in spirit and keep itself aloof from other uses. Try adding commercial space, a charter school, health or wellness facilities and watch both the tax attorneys and the accountants furiously tie the pretzel knots necessary to satisfy the rules.
8. Naturally correlates with urban sustainability. By definition, historic buildings are in older neighborhoods, and by the organic growth of cities, older neighborhoods are still strategic and critical to the revitalization and sustainability of American cities. This makes historic redevelopers among the first movers of urban upgrading, and it makes cities more naturally sustainable than otherwise. As a byproduct of this correlation and the as-of-right entitlement, historic properties are spared the Affirmatively Further Fair Housing inquisition.

Taken as a whole, the Historic Tax Credit is simpler, easier, more reliable and more readily monetizable. It was designed to solve one and only one problem – the perceived non-recoverable cost premium of complying with historic preservation requirements. Those principles, Reaganesque as they are, have proved their merit over the decades. The Historic Tax Credit has steadily served this purpose, approving roughly 1,200 properties a year, 42,500 or more since program inception, and stimulating over $80 billion of rehabilitation investment – and along the way, it can share in the plaudits for rehabilitating over 250,000 apartments.

Both tax credits were presented as stimuli to jump-start desirable policies (urban revitalization and housing affordability, respectively). Both were created under a Republican president. Both have always had bipartisan support: indeed LIHTC, a life-preserver thrown to the affordable housing industry sunk when the tax-shelter flotilla was torpedoed, was a joint product of a Democratic House and a Republican Senate.

Herewith the lesson: no one can say when fundamental tax reform may happen, but if it does, we may not have much time to act. We’ll want to know how to pitch it in Washington, we’ll want to know which soundbites resonate with which political stripes, and most of all, if we have a moment to do so, we’ll want to know which switches we want to flip.