Times Are a Changing for the Historic Credit Industry; Debt Is Much Harder to Find
By Caitlin Jones
8 min read
Tax Credit Advisor, October 2009: It’s a time of change for the historic rehabilitation tax credit sector.
The economic downturn is responsible for many of the changes rippling through the industry. Major banks, the predominant investors in historic credits and a key source of conventional debt financing, have in many instances seen their profits and tax shelter needs fall. Meanwhile, curtailed consumer and business spending, plus layoffs, have hurt retailers and depressed office and hotel demand.
“There’s been a reduction in [historic credit project] activity,” says Washington, D.C. attorney Jerry Reed, a partner in the law firm of Bryan Cave LLP. “That’s consistent with what’s going on generally in the real estate markets. It’s more difficult to get debt for the projects. Some of the investors in the historic credit space have been less active than in the past. So there’s not as much [investor] demand for historic credits as there has been.”
Administered by the National Park Service (NPS), the federal historic tax credit is claimed for 20% of the cost of renovating a qualified historic building. Projects must be on the National Register of Historic Places or in an historic district, renovated according to federal rehabilitation standards, and approved by state and NPS reviewers. The tax credit is claimed entirely in the first year, and available for the rehabilitation of historic buildings for any end use other than owner-occupied residential.
“Finding debt financing has become increasingly more difficult,” says Marc Hirshman, of US Bancorp Community Development Corporation, a major investor in federal historic, low-income housing, and new markets tax credits. “It’s harder to find deals that have a complete financing stack in place, and are just missing the tax credit equity,” echoes Claudia Robinson, of Bank of America, which also invests in all three credits.
The pool of active major corporate investors in historic credits is much smaller than that for the federal low-income housing tax credit (LIHTC). It includes oil company Chevron, Bank of America, US Bank, paint company Sherwin-Williams, PNC, and KeyBank. Other players have included Wells Fargo (which acquired Wachovia) and JPMorgan.
Companies primarily invest in historic credit deals directly or through proprietary funds, rather than through multi-investor funds.
Participants said active historic credit investors have pared back their new investment, because of less need for credits and/or greater difficulty in finding deals that meet their parameters, including stiffer underwriting standards. This pullback, and less competition for deals, has prompted credit pricing to drop and projected after-tax yields to investors to rise. Equity pay-ins are more backloaded and longer, up to five years. Bottom line: There’s less equity available and it’s costlier.
“Certainly our appetite has dropped,” says Robinson. She indicated that historic investors are “more nervous” because of the greater difficulty securing conventional debt – construction and permanent – for new projects. The debt is typically the largest piece of the financing package for an historic credit deal. Reticence by lenders is largely due to greater perceived risk from softer real estate markets.
The more conservative policies of lenders have spawned similar actions by equity providers.
“We’re being more selective in our underwriting criteria,” says Robinson. She notes that historic investors “are going to look for as many safeguards as they can get” in deals, including some they didn’t usually request in the past when there was greater investor competition. For instance, some investors are asking lenders for “non-disturbance” agreements, to protect themselves if the lender begins foreclosure proceedings, by preserving the lease in the deal structure.
Pricing, Yields
Pricing to developers for historic credits has dropped in the past 12 to 18 months.
Washington, D.C. attorney Andrew Potts, a partner in the law firm of Nixon Peabody LLP, called the price drop “modest,” a few pennies per credit dollar. Eric Darling, of Boston-based Carlisle Tax Credit Advisors, which advises corporate investors and acquires historic credit product for them, said that if the average price for a deal 18 months ago was $1.10 to $1.15, today it’s probably $1.00 to $1.05. Breed is seeing credit pricing just above $1.00, down from a peak of $1.20 to $1.25. Syndicator John Leith-Tetrault, of the National Trust Community Investment Corporation, had the starkest assessment. “Pricing has fallen back into the 90s. It’s very rare to see something over a dollar. If it is, it’s in the range of $1.00 to $1.05.” A year ago, a very large, highly sought after project might fetch $1.10, $1.15, he said.
Projects using a credit pass-through (master tenant) lease syndication structure typically command a higher price, and provide a more favorable benefit to investors.
Leith-Tetrault indicated that typical current projected after-tax yields to historic credit investors probably range from 10% to 15%.
With conventional debt harder to find and on stringent terms, participants are more frequently seeing regional and local banks supply the debt for historic deals. They’re also seeing more developers pursue mortgages insured by the U.S. Department of Housing and Urban Development (HUD), generally for apartment or mixed-use projects.
Developers must also pursue other dollars to bridge their tax credit equity, which is smaller in amount and coming in later. But even bridge funds are harder to find. Sources said they’re seeing more use of public and governmental funds for this purpose.
Some developers are even carrying the project themselves.
Potts is seeing a “fair number” of cases where developers with strong balance sheets are funding their projects with equity and no debt, temporarily filling the gap with dollars from their own pocket until “debt terms become more favorable.” He’s closed a couple of office and retail projects like this.
For some deals on the drawing boards, though, the headwinds are just too much.
Says Robinson, “I think deals are getting shelved and mothballed until the financing environment improves.”
Changing Project Profile
The kind of historic projects getting done has changed as well.
Due to the economic downturn and debt situation, there are fewer new historic credit retail, hotel, and office projects than in the past. More common are: apartment deals, especially those pairing the federal historic and housing tax credits; “community-type” projects (e.g., museums, theaters, YMCA); projects with significant public support; and projects by nonprofits and institutions. Nonprofits and institutions, for instance, can use contributed funds for projects.
Potts also said deal activity involving projects that “twin” the historic and new markets tax credits “is still very strong.” Robinson is seeing an increase in deals using both federal and state historic credits.
Other new developments are occurring. Potts, for instance, said some of the first affordable rental housing deals awarded new federal Section 1602 (low-income housing credit exchange) funds also have historic credits. The federal Tax Credit Assistance Program is another possible subsidy source for deals with historic credits and housing credits.
Participants also said there’s an increasing emphasis on energy efficiency and green building features in historic credit projects. More and more historic buildings, for instance, are pursuing LEED certification.
Pending issues in the historic credit field include:
- Continued challenges to obtaining swift HUD approval of a credit pass-through lease syndication structure in historic credit HUD-related projects. The approval process is time-consuming and case-by-case, operating under interim HUD guidelines issued last year.
- A lack of active federal direction. The Obama Administration’s nominee to head the National Park Service hasn’t been confirmed.
- Possible legislative improvements. An industry coalition has crafted and enlisted broad support for a package of proposed federal tax law changes designed to make the historic credit program more attractive, effective, and user-friendly. Legislation incorporating the provisions is expected to be introduced shortly. (For details on proposals, see Tax Credit Advisor, July 2009, p. 23.)
- More changes to state historic tax credit programs. New York just enacted several enhancements to its credit including a much higher per-project credit cap. Several states, though, have cut back their credit programs due to tighter budgets. Meanwhile, US Bank’s Hirshman says, “We’re looking to increase our investing in state historic tax credits, this year and next.”
To have the best chance of getting a new historic deal funded, Leith-Tetrault recommends that developers focus on primary markets, do moderate- rather than large-sized transactions, and pay greater attention to pre-leasing and tenant quality if doing a commercial project.
