LIHTC Market Finishes Tough Year; Challenges Seen Continuing
By A. J. Johnson & Caitlin Jones
9 min read
Tax Credit Advisor January 2009: After a rough-and-tumble 2008, syndicators are anticipating a continuation of challenging conditions in the low-income housing tax credit (LIHTC) equity market in 2009, according to those interviewed by the Tax Credit Advisor around the beginning of December.
The year 2008 was arguably the toughest for the program since it began. With curtailed credit investment by major investors Fannie Mae and Freddie Mac, cutbacks or a pause by other financial institution investors, and multiple national crises, tax credit yields to investors rose significantly, sharply depressing credit pricing to developers. Many deals became infeasible, and developers competed for a much smaller pool of available equity. Active investors, especially direct investors, saw their star rise, wielding greater clout to be more selective in deal selection, reap higher yields, and impose stronger deal terms.
Chicago syndicator Joseph Hagan, President & CEO of National Equity Fund, Inc., predicted 2009 will be a year of “turmoil.” Said Hagan: “No one really knows what’s going to happen in 2009.”
Turmoil is virtually assured in 2009 as the LIHTC market continues to seek correction. That point, sources suggest, should occur when there is a substantial increase in the volume of tax credit equity raised. Syndicators hope this will largely be from an inflow from so-called “economic” investors that haven’t previously invested in housing credits – firms syndicators have been pitching year-long. These kinds of firms (e.g., manufacturers, utilities) were commonplace investors in the credit program’s first decade but are rare today. For many years now, the industry has raised equity primarily from Fannie Mae and Freddie Mac, and from “CRA” investors – banks and other financial institutions motivated largely by their ability to get credit for their LIHTC investments under the federal Community Reinvestment Act.
Syndicator Bob Moss, of Boston Capital, when interviewed on 12/1/08, estimated only about 30% of the total LIHTC equity needed in 2008 for all 9% and 4% tax credit projects would actually be raised by year-end, assuming an annual tax credit equity need of roughly $8 billion. Richard Floreani, of Ernst & Young, LLP, Boston, estimated a total raise for 2008 of $4-$5.5 billion, compared to 2007 volume of about $8.5 billion.
According to the latest edition of Corporate Tax Credit Fund Watch (see p. 15), prepared for TCA by Ernst & Young, LLP, eight syndicators responding to the survey in late November or early December had collectively raised nearly $2.2 billion in LIHTC equity in 2008 so far. But the respondents didn’t include several traditionally high-volume syndicators.
Differing Results
Paul Cummings, of Enterprise Community Investment, Inc., anticipated Enterprise would end up raising the same or more LIHTC equity in 2008 by year-end as in 2007, but didn’t disclose dollar amounts. Moss expected Boston Capital to raise around $500 million in 2008, “very close” to its 2007 volume. Stephen Daley, of The Richman Group, anticipated a drop to nearly $400 million in 2008 from about $1 billion in 2007, while Hagan expected NEF to do around $500 million in 2008 compared to $700 million in 2007. Hagan said he hasn’t set a volume target for 2009, explaining the market is too unpredictable.
Corporate investor Beth Stohr, of US Bancorp Community Development Corporation (CDC), said by email interview that her organization expected to invest $1 billion in 2008 by year-end in federal low-income housing, historic, new markets, and solar tax credits, and plans the same volume for 2009. In the LIHTC area alone, where US Bancorp invests both in funds and directly, she said her group had a 50% increase in 2008 in its direct LIHTC investment.
In 2008, for a number of syndicators, their national multi-investor funds have accounted for a smaller share of the total equity raised compared to past years, while a growing share has come from proprietary or single-investor funds they’ve set up and fill for individual corporate investors. Hagan, for instance, said NEF’s multi-investor funds have accounted for about 45% of the total LIHTC equity raised in 2008 compared to about 70% historically.
National Multi-Investor Funds
National multi-investor funds in 2008 were fewer in number and often took longer to complete, even though the funds often were smaller. Floreani said the six new multi-investor funds that Ernst & Young is currently reviewing for investors mostly range from $40 million to $60 million; the largest is $125 million.
Hagan said NEF is currently closing a national multi-investor fund of about $60 million, its first multi-investor fund since a $140 million national fund that closed in June. Enterprise, which last closed a couple multi-investor funds around the beginning of the second quarter of 2008, is in the process, Cummings said, of closing a new national multi-investor fund – likely a bit over $100 million – and a California multi-investor “green” fund (see article on p. 24). Moss said Boston Capital plans to roll out a new national multi-investor fund – size to be determined – in January; its last national fund closed in June. Daley said The Richman Group has a new national multi-investor fund on the street that he expected will close after year-end at $100 million or larger.
Yields, Credit Pricing
Daley said tax credit fund yields the last few months have continued to “creep up” – a view shared by others. Hagan expected the projected after-tax return on NEF’s current national fund to be close to 8%. Daley said Richman’s current national fund has a projected yield of 8%. Hagan said industry officials have been saying fund yields in 2009 will “start out around 9%, and will move up.” The latest Corporate Fund Watch survey results show current fund returns mostly clustered around 8%.
At a housing conference in Washington, DC on 11/13/08, Hagan and several other speakers suggested that tax credit yields will have to rise significantly higher to prompt significant numbers of new economic-minded corporate investors, and inactive prior investors, to begin or resume investing in housing credits, in significant volume. Conference speakers and syndicators interviewed by TCA said they’ve been meeting with prospective new economic investors for some time, but cautioned that it’s a long sales process and that it’s hard to get the focused attention of corporate executives given the other pressing issues they are dealing with in today’s difficult economic environment. As a result, dividends from these outreach and marketing efforts aren’t likely to begin until the second half of 2009 at the earliest.
Meanwhile, credit pricing to developers has continued to fall, although it isn’t clear exactly what the typical market price level for 9% deals is currently.
Floreani said deal prices on eight funds his firm is now reviewing range from around 80 cents [per credit dollar] to the very low 80s, but pointed out that many of these deals were negotiated and priced a couple months ago. Hagan felt typical credit pricing has dropped below 80 cents. Moss said typical pricing for transactions Boston Capital is currently doing is in the 70s. Daley said the average price for deals on his list of projects anticipated to be closed into Richman’s next fund(s) is in the mid- to upper-70s.
Syndicators generally anticipated credit pricing will continue to fall in 2009 in order to support higher yields to investors.
Hagan advised state housing credit agencies to “throw all the credits” they possibly can at deals receiving credit awards, in order to maximize their chances for feasibility and of attracting an equity investor. Additional credits might come in different ways from the recent Housing and Economic Recovery Act, which provided the states with additional per capita housing credits, established a minimum 9% credit rate, and allows state to boost the credit amount by 30% for designated projects.
Narrowed Geographic Markets
Sources said that investors still active today generally are interested primarily in 9% credit deals, less so in 4% bond deals.
Syndicators also noted the range of geographic areas in which they are investing in deals, and where they are considering new deals, has narrowed from a year ago, driven by the preferences and dictates of the remaining active, primarily CRA-motivated investors.
“There are vast regions of the country where there’s no equity capital available for any types of deals,” said Moss. He said some of these areas include the Plains States, the Upper Midwest, the Deep South, and the Mountain States. Areas where capital is available, Moss noted, include the five boroughs of New York City, Virginia, Maryland, North Carolina, Dallas-Fort Worth, the Phoenix area, and Southern California.
Projects in major metropolitan areas in favored states appear to enjoy the greatest odds of landing equity. Small deals and projects in rural areas or out-of-favor second- and third-tier markets, with some exceptions, are said to be having difficulty getting capital.
Syndicators indicated they’re giving preference in committing their limited amount of available equity to “repeat” customers – loyal, proven, strong developers they’ve worked with before.
“Because of the limited amount of equity, the only deals that are getting done are going to be the cream of the crop,” said Daley. “Best-positioned assets, strongest developers, and most favorable [to investors] deal terms.”
In many cases, deal terms are stiffer than a year ago, such as longer terms for guarantees, larger reserves, etc. Stohr said US Bancorp CDC’s underwriting “remains as it has [been] for the most part,” with minimum debt service coverage of 1.15 (9% deals) or 1.20 (4% deals), and reserves generally six months of operating expenses and debt service.
Outlook for 2009
The syndicators and Floreani were uncertain when the LIHTC market is likely to recover, or even whether it has hit bottom yet.
They cited various factors that will affect when the recover occurs. Among these are: how long it takes before prospective new and inactive prior investors begin or resume investing; whether Congress in early 2009 enacts legislation to make targeted additional changes to the LIHTC program intended to jumpstart investment; and whether there are significant secondary market sales by some corporate investors of their existing LIHTC investments, which could disrupt recovery. There is still some fear that Fannie Mae and/or Freddie Mac might try to sell some of their existing housing credit investments. A Freddie Mac official on 11/13/08 estimated that the two companies combined currently have about $10 billion to $12 billion in housing credit investments that they can’t use. The official, Kim Griffith, also said at the conference that Freddie Mac is exploring the possibility down the road of guaranteeing tax credit investments, as one possible way to support the LIHTC market short of resuming investment.
The driving factor affecting recovery, though, is apt to be when the U.S. economy rebounds. Said Hagan, “Until we get out of this recession, we’re not going to see a whole lot of capital that’ll come from banks to invest in tax credit deals. I’m not saying it’s going to be a long one, but I believe 2009 is going to be a pretty tough year.”
