Locating Equity Preoccupies the Housing Tax Credit Industry
By Caitlin Jones
10 min read
Tax Credit Advisor, September 2009:
“Show Me the Money.”
More than ever, developers of proposed low-income housing tax credit (LIHTC) projects are turning to this famous line from Jerry Maguire. And many of them aren’t getting a favorable response. The long dearth in tax credit equity supply continues.
How are developers dealing with this?
Some sponsors and syndicators are managing to find limited equity, including from non-traditional sources. And many beleaguered developers will soon receive critical subsidy dollars for their stalled LIHTC deals under the new federal Tax Credit Assistance Program (TCAP) and the credit exchange program.
Meanwhile, a large coalition has forged and endorsed a consensus package of proposed federal tax law changes designed to expand the investor base for LIHTCs and substantially boost equity volume. This comes as some worry that the current lack of equity for projects in certain areas threatens to undermine the longstanding support for the LIHTC in Congress.
The equity jam was on everyone’s mind in late July at the National Housing & Rehabilitation Association’s 2009 Summer Institute conference in Woodstock, Vt. (See p. 27 for related article on state agency activities.)
Equity Shortage
The main problem plaguing the LIHTC industry is the lack of enough equity from syndicators and corporate investors to support all of the proposed projects that already have or will be receiving awards of 9% and 4% housing credits.
This shortage, which began around year-end 2007, is due both to the sharp reduction in thenumber of corporate investors actively investing in housing credits (especially the withdrawal of major buyers Fannie Mae and Freddie Mac), and the cutback in new investment by some remaining active players, such as major banks. The reduced investor demand has caused a sharp decline in the price paid to developers for new housing credits – from a peak above $1 per dollar of tax credit, down to the 70s, 60s, or even lower – and a rise in after-tax yields to investors to 10% and greater.
“We don’t have enough equity,” said syndicator Ronne Thielen, of Centerline Capital Group. “There’s not a lot of business going on for syndicators at this point in time. There is direct [corporate] investment going on, but direct investment this year – we understand- is going to be lower than it was last year.”
“We’re going to end 2009 with a substantial amount of unsold LIHTC,” said Boston consultant David Smith, of CAS Financial Advisory Services. “A reasonable estimate is that we’ll sell between three and a half and four and a half billion dollars worth of new LIHTC in 2009.”
The total tax credit equity raised in 2009 by year-end promises to be less than the $5.5 billion raised in 2008, which was far below the annual peak of about $9 billion in previous years.
“There’s going to be a lot of housing that isn’t going to get done [in 2009], and good deals that aren’t going to get done,” said syndicator Mark McDaniel of Great Lakes Capital Fund, which operates multiple state equity funds.
With a huge number of proposed LIHTC projects with credits to choose from, and less competition, syndicators and corporate investors are cherry-picking the best deals. These are transactions that meet their investment parameters – yield, size, location, etc. In addition, they are deals helping bank investors to satisfy their obligation under the federal Community Reinvestment Act (CRA). These “CRA investors” still account for the bulk of LIHTC investors today.
“We’re all looking for the best quality sponsor… in the best markets, with the best structure for the deals,” said syndicator Bernie Husser, of Boston Financial Investment Management.
While syndicators have been talking for more than a year to new companies unfamiliar with housing credits to suggest they begin LIHTC investing, there reportedly have been few new entrants and little actual new investment, particularly by non-CRA economically motivated firms.
Syndicator Raoul Moore, of Enterprise Community Investment, Inc., suggested the primary deterrent to new investors isn’t yield level but rather their inability to accurately predict their profitability and tax shelter need over the next 10 years – the housing credit period.
“As a developer, it makes me very nervous that we’ve had 18 to 20 months of recognition of how vitally important it is to draw in new economic investors…but no tangible results,” said developer Tom Capp, of Oregon, Wisc.-based Gorman & Company, Inc.
Political Vulnerability
Active syndicators and corporate investors today are generally interested mainly in LIHTC projects in the coastal areas and strong major metro areas. Other regions, such as the Midwest and Upstate New York, along with rural areas and small projects, are in disfavor.
“We have markets where there is just no investor interest,” said Chicago attorney Ben Applegate, of Applegate & Thorne-Thomsen P.C., citing Peoria, Moline, and Decatur, Ill. as examples.
Smith said the geographically uneven availability of equity means the LIHTC is no longer a national program as it once was, when virtually any project getting a housing credit award could count on one or more equity offers from syndicators or direct investors.
Until this situation is remedied, the LIHTC program is politically vulnerable, warned Smith and Washington attorney Richard Goldstein of Nixon Peabody LLP. To ensure continued widespread support in Washington, projects in all states and virtually all markets need to be able to attract equity. Toward this end, a large number of industry groups and their allies have fashioned and are pushing a consensus legislative proposal aimed at increasing the number of LIHTC investors and the amount of equity raised, by providing incentives for existing and new investors, removing barriers to investment by small firms, and extending and expanding the credit exchange program. (See p. 3 for article on legislative proposals.)
Finding the Dollars
Strong developers with long and successful track records and big balance sheets can still raise equity for their projects, even in secondary CRA markets, said Moore. “It’s not easy. And it’s taking them a long time. But they are able to find equity for their deals,” he noted.
But the struggle for equity has encouraged creativity.
Some syndicators and developers are raising equity today from non-traditional sources, including non-national banks and affluent individuals.
Mark McDaniel reported success in getting some regional and small banks to invest in statewide equity or “community” funds that Great Lakes Capital has set up in Indiana, Michigan, Wisconsin, and Upstate New York. In each, the state banking trade association is a co-general partner in the upper-tier fund. Said McDaniel, “They’re bringing their member institutions to the table to talk about investing in housing credits.”
The model was first rolled out in Indiana, where the fund has $10-$12 million in equity commitments with pending discussions for another $8 million.
McDaniel indicated that a presentation to one small bank that might invest $250,000-$500,000 in a fund can blossom to 12 banks making similar investments. Moreover, he said this has led to other, larger state-chartered banks new to LIHTCs saying they’ll invest $3-$5 million.
McDaniel has also begun fielding calls from large, non-financial institutions that are interested in investing in a $100 million fund that has 15 projects meeting a
specific deal profile (preservation, large HOPE VI) if they can get a return of 10% to 15%. “It’s beyond the talk,” he noted. “Now they’re getting into the due diligence phase of the discussion.”
Rochester, N.Y. developer Nelson Leenhouts, of Home Leasing, LLC, recently completed a $1.44 million private placement raising equity from 20 individual investors, to help fund a 62-unit seniors LIHTC project near Rochester. Leenhouts and his brother went this route after being unable to find a syndicator by last December when their project was ready to close. The proposed offering was presented at a June 3 meeting to which Leenhouts invited “200 of my closest friends.” The brothers paid 72 cents per dollar for the project’s credits and sold them for 82 cents. Each investment unit is $72,000. Investors contributed $5,000 upfront; the balance is due at project full occupancy. The projected after-tax return to an investor without passive income is 14%.
Nick Ratti, of Reznick Group, said his firm recommends partnership units in the $50,000 range to client LIHTC developers considering their own private placement. This size works well with projects generating about $150,000 per year in housing credits. At credit pricing of 70 cents, a $50,000 unit generates about $7,000 in annual tax credits that can be fully utilized by an investor in the 28% federal tax bracket, said Ratti, who’s seeing after-tax internal rates of return on private placements of 8% to 10%.
Susan Jennings, of Rochester-based Conifer Realty, LLC, said her firm has expanded its search for tax credit equity beyond the traditional syndicators it has relied on in the past. Conifer, with more than 10,000 units in five states (N.Y., N.J., Pa., Md., Ohio), develops, owns, manages, and builds LIHTC projects.
“We’re keeping all of our options open,” she noted. “We’re doing some deals with syndicators, some direct placement. We’re also participating in the Upstate New York Equity Fund. We’re doing a variety of things to get investors in our deals.”
Conifer currently has seven projects with new awards of 2009 and 2010 credits; six have investor commitments. “Our priority now is to get those done,” Jennings stated.
In addition to syndicators, Conifer is approaching small and larger local and regional banks that it’s done business with to ask them to invest in its projects. “We’ve been pretty successful with that,” she said. Conifer – through various departments – provides asset management, compliance, and other services for novice small bank investors. Conifer is also encouraging novice smaller banks to partner with a larger bank experienced in LIHTCs to invest together in a single project, to get their feet wet.
To entice banks to invest in its projects, Conifer holds out the possibility of additional business for the institution, such as new deposits – project replacement and operating reserves, tenant security deposits, etc. “We have 170 projects, so on any given day we have $40 million in cash accounts in banks,” Jennings said.
Small banks are also given the opportunity to provide construction financing and letters of credit – the latter typically required by municipalities before installing infrastructure.
TCAP, Credit Exchange
The near-term viability of the LIHTC industry will hinge heavily on the speedy release by states of the massive new federal dollars from the TCAP and credit exchange programs to stalled deals, and the prompt completion of these assisted projects.
State housing credit agencies (HCAs) collectively have $2.25 billion in TCAP funds to distribute, and the U.S. Treasury Department has estimated eventual federal outlays of $3 billion under the credit exchange program. Treasury has approved more than $1.3 billion in exchange funds to states so far.
On July 28, the U.S. Department of Housing and Urban Development (HUD) announced approval of the final round of plans submitted by 26 state HCAs to participate in the TCAP program.
States and developers face tight federal deadlines.
State agencies must make awards of housing credits (9%, 4%) by 9/30/09 to projects for such projects to qualify for TCAP assistance. State HCAs must commit 75% of their TCAP funds by 2/16/10, and developers with TCAP awards must spend 75% of their TCAP funds by 2/16/11 and 100% by 2/16/12.
Projects receiving exchange fund assistance effectively must be completed by 12/31/10.
