The Return of Good News: Equity, Debt Outlook for Tax Credit Deals Appears Brighter
By Caitlin Jones
14 min read
Might 2010 be “Dow 12,000″ for the tax credit market, a year in which every (good) tax credit project is able to land the equity and the debt needed to move forward?
Signs are promising, especially in the federal low-income housing tax credit (LIHTC) world. With the economy on the mend, major banks (the predominant LIHTC investors) and other U.S. companies are profitable again with more need for tax credits. Meanwhile, higher yields on new LIHTC investments (commonly above 10% after-tax) are attracting “economic” investors, particularly insurance companies. Unlike banks, which are heavily influenced by the Community Reinvestment Act (CRA) in where they make LIHTC investments, economic investors aren’t subject to CRA and can therefore be more open to investing in projects outside of high-demand CRA markets (e.g., New York City, major coastal cities) if this will generate the higher yields they seek.
After a grueling stretch, in which many LIHTC deals stalled as the supply of equity plummeted, resurging LIHTC investment has put a glint in the eyes of many in the industry.
“We’re pretty optimistic that it’s going to be a much better year,” says Raoul Moore, who heads the LIHTC syndication business at Enterprise Community Investment, Inc. “We’re hoping that with these new investors”¦we’ll be better able to serve the entire country in terms of people who need affordable housing.”
Enterprise, which raised about $357 million in LIHTC equity in 2009, is aiming at about $585 million in 2010, through proprietary (i.e. single-investor) funds and two new multi-investor funds. The latter are its third Green Western Fund, of about $60 million and expected yield between 10.25 and 10.5 percent that will roll out in May, and a subsequent $160 million national fund. The Western Fund will invest in properties in California, the Pacific Northwest, and Southwest.
Optimism About 2010
In interviews, syndicators, investors, and others were optimistic about a greater equity supply and ability to close deals this year.
“It appears, from all forecasts, that the market is back,” says Bob Moss of syndicator Boston Capital. Boston Capital is seeing growing investor demand, evidenced by a newly closed $224 million national multi-investor fund — with a yield around 10.5% — that had both repeat CRA investors and economic investors. The company, which raised about $325 million in LIHTC equity in 2009 and is targeting $600-$700 million in 2010, is already rolling out a new, $250 million national multi-investor fund.
A larger number of syndicators, both big and small, will be raising equity this year. For instance, recapitalized previous major players Boston Financial Investment Management (formerly MMA Financial) and Centerline Capital Group, after curtailed activity last year, are actively raising equity again. “We’re back in the business,” says Centerline executive Andrew Weil. “Now that our corporate issues are behind us, it’s time to ramp up the volume again.” Centerline once raised about $1 billion a year, but is targeting $200-$300 million by the end of 2010. “But over time we think we can get back to higher levels,” Weil said.
In addition to the major syndicators, there are numerous smaller and boutique-type syndicators, including some new ones, that are raising equity.
Bank of America Merrill Lynch expects to continue to be one of the top major LIHTC investors in 2010, as it was in 2009, says executive Sindy Spivak. The bank invests in housing credits about 70-75 percent through direct investment, and 20-25 percent through funds (mostly proprietary).
Spivak, the current president of the Affordable Housing Investors Council, said corporate LIHTC investment activity in the first quarter of 2010 was heavy, perhaps a record. Unlike a year ago, when many investors were unclear about the timing of closing of investments in 2009, this time things are different. “Going into 2010,” says Spivak, “most investors had a sense of what their investment goals were going to be, and were out of the gate earlier in terms of information and investment goals.”
Boston consultant David Smith, CEO of Recap Real Estate Advisors, said it appears that total LIHTC investment demand in 2010 will match the aggregate supply of available housing credits. “That’s a big deal,” he says. “The re-emergence of insurance companies and regular old Fortune 500s, and the education of a new generation of CFOs, means that the aggregate demand is back with the aggregate supply.”
The other good news, he noted, is that pretty much all of the stalled LIHTC deals that were in the pipeline have died or moved forward. This means there shouldn’t be any more lingering deals competing with new projects for extra resources.
Participants expect equity providers to continue to favor strong projects by well-capitalized and experienced developers in solid real estate markets.
Developers are more buoyant as well.
“We’re definitely thinking 2010 is looking up, and things are leveling out,” says Susan Jennings, of Conifer Realty, LLC, a Rochester, N.Y. LIHTC developer/owner/manager with more than 11,000 units in five states (N.Y., N.J., Pa., Md., Ohio). “We’re optimistic that we will get our deals closed, and be able to achieve a lot with the tax credit market.”
Conifer, which develops both 9% and 4% projects, has 10 LIHTC applications pending and seeks equity from a variety of sources. “We’re doing some direct investment with banks that we have relationships with,” says Jennings. “We’re also working with some syndicators that we have relationships with”¦And we’re looking for new syndicators and new investors to work with.”
Annapolis, Md.-based nonprofit developer Homes for America, Inc. has been getting LIHTC equity from both “old relationships” and “new relationships,” says President Nancy Rase. “The level of interest and the amount of equity seems to be a little more plentiful than it was in ’09,” she notes. But, she added, “I don’t think I’ve seen any significant improvement in the pricing.”
Like many other developers across the country, Conifer, Homes for America, and Rochester, N.Y.-based LIHTC developer Home Leasing, LLC have approached banks directly for equity. Home Leasing executive Nelson Leenhouts, for instance, is on the verge of a local bank taking out his equity position in two 88-unit LIHTC projects for which he and his brother provided the equity initially. Leenhouts, who raised equity last year for a different project from private individuals, is also thinking about structuring deals with equity from both a local bank and wealthy private individuals. “One bank I talked to would be delighted to be in a partnership with high net worth individuals,” he says
Geographic Ability
With more equity and dollars from non-CRA investors, participants expect equity to be available for more good deals like those that might have been passed over in 2009, and for syndicators to look beyond just CRA markets and invest in more projects in non-CRA markets, like much of the Midwest.
“With these new investors coming in, we’re able to look at deals in what we used to call the flyover states,” says Enterprise’s Raoul Moore. “We’re looking at, we’re doing deals, in Iowa and Missouri. We looked at some deals in Nebraska. Anywhere where there are markets that are strong enough to justify the real estate fundamentals.”
Also expected are more 4% tax-exempt bond-financed projects.
One trigger is the federal New Issue Bond Program (NIBP), established in 2009, under which some state and local housing finance agencies this year will be providing tax-exempt bond proceeds at very favorable fixed borrowing rates for development of low-income rental housing projects. The bonds will typically be credit-enhanced by Fannie Mae, Freddie Mac, or the Federal Housing Administration (FHA) of the U.S. Department of Housing and Urban Development.
Merchant Capital LLC, a Montgomery, Ala.-based investment bank, recently closed a New Issue Bond Program offering for a new construction project in Atlanta that generated an all-in borrowing rate of around 5%, said executive John Rucker III. The company’s California office has “quite a backlog” of pending NIBP bond issues in that state.
Rucker cited a recent “uptick” in multifamily tax-exempt bond issues generally. In addition to the Atlanta transaction, Merchant Capital recently closed two standard tax-exempt multifamily bond issues for acquisition/rehab projects in Austin and Louisville. “We’re getting a lot of new phone calls,” he says.
The LIHTC market could be significantly altered depending on the outcome of pending legislative proposals in Congress. These include proposals to extend the 9% Section 1602 LIHTC exchange program for one year; to extend the exchange program to 4% credits; to extend the carryback period for LIHTC investments to five years; and to encourage credit investment by certain individuals such as shareholders in S corporations.
Debt Financing
Developers should be able to continue to secure construction and permanent financing for new LIHTC projects in 2010. However, conservative lending underwriting terms and credit quality standards, making credit selectively available, will continue. As usual, banks will be the typical source of construction loans for 9% deals. For permanent financing, the prevalent sources are likely to be debt through programs of Freddie Mac, Fannie Mae, and FHA. Conventional bank permanent loans may or may not be hard to find.
There are some exceptions, though. For instance, Bank of America Merrill Lynch, which offers Fannie Mae, Freddie Mac, and FHA financing, also has a proprietary conventional/perm loan product for 9% tax credit projects that is popular, said bank executive Elizabeth Van Benschoten. She said the bank also makes direct purchases of tax-exempt multifamily bonds for 4% LIHTC projects.
Freddie Mac is doing brisk business in its multifamily debt financing programs, reported company executive Kim Griffith. Sarah Garland of Fannie Mae voiced similar comments. Both firms offer credit enhancement of tax-exempt bonds for 4% deals, as well as forward commitments for permanent financing for new construction or substantial rehabilitation 9% credit projects. The pair indicated, though, that current pricing is particularly favorable for immediately delivery cash mortgages to refinance or acquire existing properties, including with a modest level of rehab with tenants in place.
Both companies are doing many multifamily refi loans.
Debt providers will also be able to spur production through federal program such as the New Issue Bond Program. Bank of America and Freddie Mac, for instance, recently closed on one of the first NIBP multifamily transactions.
Another option for developers is FHA-insured financing, particularly the popular Section 221(d)(4) product for new construction/substantial rehab projects. Appealing features of FHA multifamily loans include that they are non-recourse, an attractive fixed interest rate, both construction and permanent funding, and a long loan term and amortization period. The downside is the lengthy processing time, which makes it difficult for time-constrained LIHTC developers.
The coming months will see changes at Freddie Mac, Fannie Mae, and FHA.
According to Griffith, Freddie Mac is going to begin purchasing, pooling, and securitizing cash multifamily mortgages under its Capital Markets Execution program, which will reduce the rate offered to borrowers. In addition, the company will be converting lenders in its targeted affordable business — which now has delegated underwriting — to a prior approval system.
Arguably the biggest changes will be at FHA, where the volume of multifamily loan applications has increased fourfold from a year ago with no increase in processing staff.
HUD official Christopher Tawa described a series of actions by the Department to reduce the risk level of FHA multifamily loans, cut processing times, and make FHA loans a viable option in many high-cost urban markets.
HUD just issued a final rule to raise the minimum net worth requirement for FHA-approved multifamily lenders. In addition, HUD will publish a proposed rule to overhaul its lender approval system. Under this, only lenders with proven expertise and experience will be able to make FHA multifamily loans for complex transactions (e.g., tax credit projects). HUD will also be issuing a standard underwriter’s narrative guide.
In addition, HUD will be revising certain underwriting standards for its FHA multifamily loan programs, including Section 221(d)(4), Sections 223(a)(7) and 223(f) (refinancing), and Section 220 (urban renewal). The changes will be made through mortgagee letters issued in the future, possibly in June. The implementation date for the changes will be sooner for the refinancing programs than for the new construction/sub rehab programs. In addition, applications already in process and new applications submitted during a specified window period will be grandfathered under the old standards. (For details on proposed changes, see Tax Credit Advisor, March 2010, p. 26.)
HUD also plans to reduce the number of processing stages for FHA multifamily applications for affordable projects.
One barrier to use of FHA multifamily financing in many high-cost urban markets has been the program’s statutory loan limits. Multifamily projects often can’t utilize FHA loans in many major metro areas because these per-unit mortgage caps are too low.
To try to make FHA loans a viable option in many of these markets, HUD recently issued a directive that now excludes land cost from the calculation of the multifamily mortgage limit for a project, thereby effectively raising the loan caps.
The Obama Administration is also pressing Congress to enact legislation to boost the FHA multifamily statutory loan limits. A bill has passed the House of Representatives and is pending in the Senate.
New Markets, Historic Projects
The future prospects for historic rehabilitation and new markets tax credit projects are a little murkier. These projects are more reliant than LIHTC deals upon a rebound in the economy and local real estate markets because they often are income-oriented developments such as hotels, offices, and retail.
Key for the NMTC is extending the program, which lapsed on December 31, 2009. The House and Senate have passed separate bills that would continue the program through 2010, provide $5 billion for a new funding round, and allow the new markets credit to offset alternative minimum tax (AMT) liability. But it’s unclear when a final bill will clear Congress and get signed. Nevertheless, the Community Development Financial Institutions Fund has opened a 2010 funding round.
Another challenge is a much smaller pool of active equity investors for NMTCs than for housing credits. These include US Bank, JP Morgan Chase, Bank of America, Wells Fargo, National Cooperative Bank, KeyBank, and a few others. Some, though, believe that enactment of the AMT change could draw new investors.
Marc Hirshman, of US Bancorp Community Development Corporation, said that US Bank has invested about $1.5 billion annually in recent years in NMTC qualified equity investments (QEIs). “We’d like to hit two billion in QEIs in 2010,” he notes.
Another ongoing challenge is the dearth of conventional funding sources for leveraged loans — the lifeblood of NMTC transactions. Hirshman said US Bank provides leveraged loans but only for deals where the bank also provides the equity.
Sources said developers and project sponsors increasingly are tapping non-traditional sources of funds to capitalize leveraged loans — grants, charitable contributions, dollars from various governmental and public programs, even monies from their own pocket.
Washington, D.C. attorney Andrew Potts, of Nixon Peabody LLP, says pricing for new markets credits has continued to fall, generally below 70 cents.
The historic tax credit world faces challenges, too.
For pure historic credit projects, the pool of active major equity investors is even smaller than for new markets credits, including Chevron, Sherwin Williams, US Bank, Bank of America, and PNC Financial.
Potts said that the historic projects getting done are those that don’t need conventional debt. As for profile, he is seeing projects of all sizes and for different uses. He suggested that the climate is favorable for projects combining both federal historic and housing tax credits.
Historic credit advocates are pressing Congress to pass one or more legislative improvements to the program crafted by the Historic Tax Credit Coalition. The one proposal that appears to have the brightest prospects would provide extra tax benefits for energy- and utility cost-saving improvements in historic buildings.
