The Investment Landscape

Investors See Shifts and Opportunities

Dramatic changes in the investing landscape over the past year have pushed affordable housing investors to reevaluate funding strategies and keep a close eye on numerous upcoming changes. Yet even with the changes and uncertainty, many investors say they remain optimistic about the future of affordable housing investing.

“Syndicators have done an outstanding job the last two generations in addressing adversity,” says Dana Boole, president & CEO of CAHEC.

“Portfolio performance, the demand for safe and affordable housing and rising taxable income are all drivers of current and increased investor interest. That said, we are not expecting a slowdown anytime soon,” Boole adds.

The issues they are watching closely include income averaging, increases in Fannie Mae and Freddie Mac investments in Low Income Housing Tax Credits (LIHTC), possible dramatic increases in the amount of LIHTC available, changing tax rates and uncertainty around new Community Reinvestment Act (CRA) rules. Tax Credit Advisor spoke with leaders in the affordable housing space about how these changes or proposed changes could impact investing overall. Here’s what they said.

Increases in LIHTCs and Changing Tax Rates
The budget reconciliation bill currently under consideration in Congress proposes dramatic increases in the number of LIHTCs that are available to investors. This proposed increase has raised some concern over whether there will be enough investor demand for those credits, while there are those who also see it as a positive with more choices and increasing yields.

Investors say a glut of credits could be avoided, however. Earlier this year, the new director of the Federal Housing and Finance Agency raised Fannie Mae and Freddie Mac’s LIHTC investing cap, increasing it from $500 million a year to $850 million. Increased investment from government sponsored enterprises (GSEs) could gobble up some of these new credits.

Scott Hoekman, president of Enterprise Housing Credit Investments, believes the impacts from the increased LIHTCs would be “huge.”

“It would require folks like my company, syndicators, to help identify a lot more capital to invest in many more developments that would now have credits attached to them…that would require bringing in new investors and bringing current investors at higher levels,” explains Hoekman.

“I think it can be done, but it would be a pretty big expansion,” Hoekman adds, noting this is a potential big opportunity for investors.

Linda Hill, senior vice president for tax credit equity at Merchants Capital, says her company is definitely monitoring this element of the infrastructure bill closely. The firm is also monitoring proposed changes to the corporate tax rate. An increase in that rate from 21 to 26.5 percent would help meet the higher supply of credits because the increase in the tax rate makes tax credits more appealing since investment yields would increase.

“We are optimistic, but cautious, when it comes to the increase in the annual tax credit volume,” says Hill. “We are optimistic that there will be investors to step up to take on that additional supply. But we are also cautious about pricing transactions since we don’t know what the investor base will look like and at what yields will attract new investors.”

Julie Sharp, senior vice president for tax credit equity at Merchants Capital, echoes Hill’s caution.“We are proceeding with extreme caution when we are pricing deals that will close in 2022 because we expect there could be a shift if the infrastructure bill passes with additional housing credit provisions,” says Sharp.

Boole says higher tax rates may already be a catalyst for increased investor activity.

“We’ve seen an uptick in interest from seasoned and prospective investors,” says Boole. “Part of that may be a result of where investors believe corporate tax rates may settle, which would have a positive impact on yields.”

Income Averaging
A law passed in 2018 allows developers to average the income levels of residents to meet federal guidelines. The change was intended to allow higher-income units to cross subsidize lower-income units. The change also allows middle-income and workforce housing to participate in the program. Many states ran the program in good faith using their interpretation of the law as they awaited further guidance from the Treasury and specifically, the IRS. In 2020, the Treasury/IRS released its guidance, which differed significantly from the interpretation many states had been using.

Members of the affordable housing industry have asked the Treasury/IRS to issue new guidance, but the industry is still awaiting response. The uncertainty around the guidance is causing disruption.

“Income averaging has been a really hot topic driving investor decisions right now,” says Sharp, of Merchants. “We’ve seen a lot of investors step back from these deals or price them at a yield that compensates them for additional risk. These deals are ultimately generating less proceeds.”

“We are currently taking a harder look at any deal with income averaging and oftentimes are requiring additional compliance monitoring,” Sharp adds.

Hill, of Merchants, says, that “Until the IRS comes out with some clarification, those deals tend to be harder to get done than standard non-income averaging.”

Changes in Community Reinvestment Act Rule
In late 2020, then head of the Office of the Comptroller of the Currency (OCC) Joseph Otting issued a controversial new implementation rule for the Community Reinvestment Act (CRA). The rule was confusing and could create market disruption in the program. Otting stepped down from the post immediately after releasing the proposed rule. Michael Hsu, acting OCC under President Biden, rescinded the new rule and is currently working with the Federal Deposit Insurance Corporation (FDIC) and Federal Reserve to develop a new one.

While changes to the CRA could ripple throughout the investor community, Hsu’s recission of the previous rule has been met with relief. Investors contacted for this story say they are confident the new rule—out now for public comment—will bring clarity.

Boole, of CAHEC, says that when Otting released the new rule in 2020 “many investors held a tepid view on whether the new rule would hold and be adopted by the remaining agencies.”

“Many CRA-based investors held true to their long-standing investment test strategy…they were steady as you go,” says Boole.

Hoekman adds that he believes investors would like to see updates to the CRA implementation, but they need them to be done consistently across the Federal Reserve, OCC, Federal Election Commission (FEC) and with industry input. The previous rule was developed without that input.

“I think everyone can agree that the way CRA is implemented needs updating…it’s been decades. Banking has changed a lot,” Hoekman adds.

Qualified Contracts
A major concern among affordable housing advocates is that a large number of developers may return projects to market rate after 15 years in the program based on the valuation formula under qualified contracts. The current version of the infrastructure bill attempts to repeal the qualified contract option, which could eliminate some of the uncertainty regarding these projects.

“I am encouraged Congress seems willing to clarify Year 15 provisions,” says Sharp, of Merchants. “That will help us navigate that process better.”

Hill adds that regardless of the clarification, “most of the developers that we do business with don’t think it’s in their interest to convert their affordable housing to market rate.”

“These are developers that have a large pipeline of new affordable housing projects and a long history of maintaining the affordability of the units,” Hill adds. “Their intent is to try and hold and keep them affordable. I can’t think of one deal in my 25 years in affordable housing where a developer took a tax credit deal and converted it to market rate.”

Boole agrees.

“The spirit of the program since inception was preservation of affordable housing beyond the 15-year compliance period. Authors of the legislation did not contemplate early exits. Their vision was long-term housing solutions for underserved communities,” Boole says, adding that “at this juncture, the marketplace is simply seeking legislative clarity.”

ESG Investing
With all of the changes underway in affordable housing investing, the shift toward environmental, social and governance (ESG) investing is a positive development that could bring more investors into the space. Increasingly, investors are looking to invest their dollars in projects that are sustainable and have a positive impact on society. Affordable housing ticks those boxes.

“We are very encouraged by investors expressing interest in affordable housing to satisfy their investment goals and social responsibility initiatives,” says Sharp. “We think (social responsibility) is going to be a new investor path.”

The ESG goals also are leading to an increased focus on resident services, too.

“There seems to be an additional push to not only provide safe, adequate and affordable housing, but to also think about health and wellness and adding social services to help the tenant base,” explains Sharp.

“We want to be market leaders on this front,” Sharp adds. “Our multi-investor fund is structured with more than half a million dollars that will be deployed at the tenant level.”

Hoekman says the affordable housing industry in general is amazingly resilient and will adjust to whatever changes come. It has held its own and thrived through economic downturns, the pandemic and other adversities. It will continue to do so despite any pending changes in tax rates, CRA, LIHTC and other issues it confronts, he says.

“Our industry, as a whole, can handle change really well…even if it is difficult and challenging,” says Hoekman.