The Guru Is In
Ten Times More Valuable
By David A. Smith
4 min read
In today’s market, a dollar of tax-exempt volume cap that funds affordable housing is more than ten times more valuable than if it funds any other property type. Even if rates rise and taxable/tax-exempt spreads widen, as both surely will, there’s no scenario where any other use comes close to being as valuable.
Since you probably don’t believe me as you read this, before proceeding to the conundrum this poses for affordable housing advocacy and action, allow me to show the arithmetic.
Compared with taxable debt markets, volume cap bonds are a niche product, and as such, they generally have slightly higher effective issuance costs. They are pursued, therefore, in the common-sense belief that the exemption from income tax on the interest outweighs the lower yields achieved in the market. Although true in general, the interest rate spread between tax-exempt widens and narrows in response to complex market forces, and as of now, it’s 3.69 percent taxable, 3.35 percent tax-exempt, only 34 basis points, making the tax-exempt debt 9.2 percent cheaper. Then too, both loans pay principal, and assuming level-payment constant debt service, the difference in monthly payments is narrower, 5.52 percent taxable versus 5.29 percent tax-exempt, a 23-basis-point spread that is only 4.1 percent cheaper in actual monthly payments, equivalent to Uncle Sam rebating you a ‘debt value’ (D) of 4.1 percent of your cost.
When affordable housing is involved, of course, the bond issuance automatically generates a side benefit—a rebate, if you will—in the form of four percent credits. Sell these in today’s market and they’ll raise equity totaling 47.9 percent in installments. If discounted to present value, that zero-capital-cost rebate (R) is worth about 42.2 percent of the bonds’ face amount today. Add that 42.2 percent of Rebate equity to the 4.1 percent of Debt value generated by the debt service savings, and Uncle Sam has rebated 46.3 percent of your cost, 11.2 times as much.
The calculations can be made more sophisticated, and the multiplier narrows as interest rates and spreads rise – but it never disappears. For instance, taxable rates of six percent, tax-exempt of five percent, credit prices of $0.80, and a consequently higher discount rate of 7.5 percent, and the ratio is 44.3 percent to 10.5 percent, making affordable housing ‘only’ 4.2 times better. Even using the early-1980s’ financial nightmares (14 percent taxable, ten percent tax-exempt and a credit price of $0.65, he recalled with a shudder), the volume cap used for affordable housing is still 1.8x more valuable (47.5 percent to 25.9 percent).
No matter how much the debt benefit rises in value, and no matter how much the equity rebate declines in value, D + R > D: Debt value plus Rebate equity always beats Debt value by itself.
Most states have long since figured this out. The share of volume cap bonds used for multifamily housing has broadly risen in the last 15 years, and I’ve been surprised that few states had chewed up their volume cap carryforwards. Now many have, and in those states, volume cap allocation becomes a zero-sum political game where, unusually for us, instead of advocating to increase something, we need to defend against cutting our share. What do we say?
- Affordable housing is human infrastructure. It’s where jobs go to sleep at night, and volume cap properties are workforce housing. Housing is our most valuable infrastructure because it’s where tomorrow’s leaders grow up.
- Transit has a huge new funding source of its own and needs housing alongside it. The 2021 Infrastructure and Jobs Act added $15 billion in annual bond funding for transit, and without new housing in close proximity, new or improved transit tends to increase economic inequality.
- Remember the eleventh commandment: thou shalt not attack homeownership. Yes, the Low Income Housing Tax Credit multiplier effect applies only to multifamily, not single-family, but nobody got elected by challenging tax incentives for homeowners. Don’t turn silent supporters into vocal opponents.
- When all else fails, show the arithmetic. When used for housing, volume cap bonds are somewhere between 80 percent more valuable and ten times more valuable than if used for anything else.
