Protect the Private-Public Partnership
By Caitlin Jones
6 min read
By Will Cooper, Jr., President and CEO, WNC & Associates, Inc.
Tax Credit Advisor, August 2009: On June 23, 1986, Senator George J. Mitchell addressed his colleagues from the floor of the U.S. Senate. Much was at stake that day. Congress was in the midst of debating the Tax Reform Act of 1986, which would become the most sweeping reform of the Internal Revenue Code in a generation. Senator Mitchell spoke eloquently about a new program – the low-income housing tax credit – intended to use federal tax credits to attract private capital to invest in much needed affordable rental housing. Senators from both sides of the aisle rose in support of this new program. That year, the low-income housing tax credit (LIHTC) program was signed into law under a Republican President, Republican Senate, and Democratic House of Representatives.
What these government leaders knew, and what we as an industry should not forget, is that the LIHTC program is, at its core, a private-public partnership. It is a partnership that brings two distinct and essential perspectives together to achieve the common goals of building and maintaining quality affordable housing. The private sector, which brings a unique ability to assess and manage risk while overseeing asset performance, is combined with the public sector’s focus on the social purpose of the program.
Troubled Equity Market
After 20 successful years of uninterrupted growth, the LIHTC industry is under pressure. Triggered by the mortgage meltdown of 2008 and the demise of Fannie Mae and Freddie Mac, the two largest LIHTC investors for much of this decade, LIHTC pricing has tumbled. The resulting equity shortage has left many developers with large funding gaps and, in some cases, projects that simply can’t be sold or completed.
Most industry participants seem to agree that, at least in the short term, prospects for a quick recovery of the LIHTC equity market remain dim absent additional temporary assistance from Congress. But what kind of assistance can be provided that supports – yet doesn’t compete with – the private-public partnership?
We have seen Congress pass the tax credit exchange program and the Tax Credit Assistance Program (TCAP) earlier this year. Like much of the first stimulus package, it is taking a long time to fully implement these programs. The effectiveness of each program and the impact of each on the LIHTC program is yet to be determined.
TCAP was designed and appears to be working to support the private-public partnership upon which the LIHTC program was founded. TCAP funds are intended for projects that have received an award of LIHTCs under Section 42(h) of the Internal Revenue Code. On May 4, 2009, HUD published a notice setting forth requirements for, and eligible uses of, TCAP funds. The notice makes clear projects must actually have LIHTCs in order to be eligible. Therefore, projects that exchange 100% of their LIHTCs under the exchange program (discussed below) would not be eligible.
Tax Credit Exchange
The exchange program, on the other hand, appears to be working in competition with the private-public partnership. Under this program, individual states (not projects) can exchange up to 100% of their unused 2008 and 40% of their 2009 LIHTC ceiling for cash grants from the federal government. A participating state receives 85 cents on the dollar through the exchange. In turn, the amount of any cash grant made to a project is determined by the state allocating agency. The amount is not dependent on the amount of LIHTCs allocated to or given up by the project.
Since states can exchange 100% of their unused 2008 authority for 85 cents, and the current market price for LIHTCs is now less than 80 cents, there appears to be little incentive for states or developers to look for private investors to buy their LIHTCs. Consequently, many state agencies – using direct federal funding – are not only bypassing private investors but are effectively competing with them under the exchange program.
If the developments of the last several months are any indication, the impact the exchange program will have on the LIHTC equity market will not be positive. Developers are submitting projects to exchange 100% of their LIHTCs even after investors have signed letters of intent and spent considerable time, money and other resources to perform due diligence. This is further damaging a less than robust LIHTC equity market at a time when industry participants – developers, state agencies and syndicators – should be working to attract new investors.
The exchange program should not be used by the states to compete with private investors. Doing so is counter to the spirit of the LIHTC program and jeopardizes the private-public partnership upon which the program was founded. By establishing the LIHTC program, Congress chose to have the private sector, not the federal government, invest directly in housing. Attracting new investors to bring more equity into the market should be the focus of the industry. States need to find ways to leverage exchange funds with private equity to accomplish this. The first and most important step necessary is to let the market set the price for tax credits and use the exchange money to fill the gap on projects that obtain equity commitments. Because exchange funds come from the U.S. Treasury to state agencies, not to individual projects, it’s up to the states to decide how and to whom such grants are made. Directing exchange funds to projects that are able to obtain equity commitments will not only accelerate a return of investor capital into the state, it will help the states fund more properties.
States should also look for creative ways to incentivize developers to find equity for their projects. Allowing higher cash development fees and cash flow for projects that obtain equity commitments is a way to do this. Projects that are unable to secure any private equity, however, could be required to pay a smaller development fee, defer a larger amount of their fee and/or receive less cash flow. The idea is to create a system of incentives – and disincentives – that are in alignment with, not against, the private-public partnership.
Developers and investors also need to be given sufficient time to negotiate, underwrite and close transactions. Even when the equity market was robust, it was not uncommon for a project to take from six months to a year after receiving a LIHTC allocation to identify an investor, negotiate terms, complete investor underwriting and close. Under the current exchange program, many states have set very aggressive deadlines for developers to commit to using the exchange funds, leaving little time for investor participation.
When Congress returns from its summer recess, the debate for a second stimulus is expected to reach a crescendo. Lobbyists from many and disparate industries will be descending on Washington, D.C., all seeking a piece of the action. Further assistance for the LIHTC industry is warranted, as long as it doesn’t jeopardize the private-public partnership.
