With Interest Rates Rising, Syndicators Stop Lowering Fund Yields, But When Will Equity Prices Stabilize?
By A. J. Johnson & Caitlin Jones
7 min read
Tax Credit Advisor May, 2006: With long-term interest rates on the rise, the tax-credit fund marketplace has reached a clear turning point – syndicators have stopped reducing fund yields. But when tax credit equity prices will also come to rest is still an open question, syndicators say.
“A definite bottom point has been reached on yields,” said Stephen Smith of the Richman Group of Companies. “The issue now is the disconnect between yields and prices,” he said.
In response to investor resistance to falling yield levels, the Richman Group is no longer lowering the yields of its tax credit funds, Smith said. Speaking at the end of April, Smith said that he has not yet seen an end to the increase in tax credit equity prices.
Jeff Goldstein of Boston Capital Partners Inc. agreed that fund yields are no longer falling, even as a peak in tax credit prices has yet to occur. “Yields have stabilized in this climate, even if prices [of tax credit equity] haven’t,” he said.
Investors in tax credit equity funds receive a specified yield. As tax credit equity prices rise, funds contain less tax credits per dollar purchased, and yields decline.
Since the beginning of 2005, prices paid for tax credits have risen by about 10 cents per $1.00 of credit, with average prices now in the mid-$.90s per dollar of credit. In a number of markets, including California and New York, pricing now averages over $1.00 per $1 of credit.
As tax credit prices have soared during this period, yields on multi-investor non-guaranteed funds have dropped by about 100 basis points, and now average between 4.25 percent and 4.5 percent
A Change in Investment Climate
Both syndicators and investors said that the recent increase in 10-year Treasury bond rates to a level above 5 percent has fundamentally changed the climate of the tax-credit marketplace. As of the last week of April, those rates stood at 5.1 percent, up 40 basis points since the end of March, and 60 basis points from the beginning of the year. They are also at the highest level since May of 2002.
With benchmark bond rates this high, tax credit equity fund rates of 4 percent make little sense to investors in search of a competitive return, said David Kunhardt of AEGON USA Realty Advisors, a unit of the insurer AEGON N.V. Kunhardt pointed out that a tax credit fund with a 4 percent yield offers an after-tax yield of just 6 percent, less than one percentage point over the 10-year U.S. Treasury rate, an investment with no credit risk.
“The fact of the matter is that with interest rates where they are now, a 4 percent yield [on a tax credit equity] fund is not sustainable,” he said.
Complex Demand Factors
As syndicators survey the pricing of tax credits, they say that the picture is complicated by the fact that the funds still remain attractive to some buyers despite the rising yields of alternative investments. This allows developers to hold out for higher prices as syndicators compete for a limited number of credits to satisfy investor demand.
“I’m not saying that rates moving higher is not a detriment [to demand for tax credit funds], but the biggest factor is still that institutions have a huge amount of surplus capital, and they don’t have enough places to put it,” said Kevin Costello of Boston Capital. “Also housing tax credits are still a very valuable tool for tax planning,” he added.
A good example of this, he said, is the recent return to the housing tax-credit marketplace of a number of investors that had stepped to the sidelines in 2005. These investors, which include General Electric and United Parcel Service, have begun selectively buying corporate tax credit fund shares again because of a need to shelter corporate profits during a time of economic growth.
Costello also noted that there are still many fund buyers who are not primarily motivated by a search for the best investment return, including banks with Community Reinvestment Act requirements.
In addition, because it can take sponsors up to six months to assemble a tax credit fund, the impact of rising equity prices on yields is delayed, postponing a time of reckoning, said Sy Garber of WNC & Associates Inc.
The Response to Rising Prices
Both fund sponsors and investors have begun to develop strategies to combat the trend towards higher pricing of tax credits.
Smith said that one way that the Richman Group is dealing with this issue is by being “much more candid” with developers about tax credit pricing. “Previously, when we signed a letter of intent [agreeing on a price for tax credits] with developers, they have often increased prices before the close – now that game is over,” he said.
He noted that with yields stabilizing, syndicators can not continue to pay developers higher prices for tax credits unless the fees charged to offer funds are reduced. “With syndicators caught in the middle, it becomes a question of how much margins can be cut,” he said.
He said he expects a clear-cut peak in tax credit prices to be reached by the end of 2006, as syndicators push back on pricing. The addition of Gulf Opportunity Zone credits in the states devastated by Hurricane Katrina could also help by adding to the supply of available credits.
Kunhardt said that AEGON is dealing with “unrealistic” tax-credit equity prices by being extremely selective in making investments. He said he is currently adding LIHTCs that finance mixed-income projects to his portfolio, and state and federal historic credits combined in the same project. The insurer has also been an active investor in New Markets Tax Credits.
“We are buying in very specialized areas,” Kunhardt said. “What we’re not doing is getting in a position where we are one of 16 companies bidding on the same deal.”
With continuing investor demand in the housing tax credit marketplace, Kunhardt said that AEGON has begun to examine tax-credit investments outside of the housing sector. One alternative, he said, is federal tax credits awarded to qualified solar water heating and photovoltaic systems.
E&Y: Some Syndicators Report Rising Prices
Many of the syndicators participating in the Ernst & Young Corporate Tax Credit Fund Watch carried in Tax Credit Advisor this month reported continuing increases in the average tax-credit equity prices. Data for the most recent Fund Watch were collected in early April.
One notable exception was the Richman Group of Companies, which reported a decline in average pricing to $.97 per dollar of credit from $.98.
Prices reported by syndicators ranged from a low of $.93 per dollar of tax credit to $.98, compared with $.90 to $.98 reported in the previous Fund Watch, which was compiled in late January, and reported in the February edition of Tax Credit Advisor. Of the seven syndicators providing tax credit equity prices, five reported price increases.
The steepest average price increase was reported by PNC MultiFamily Capital, which said average prices paid for 26 properties specified in its PNC MultiFamily Capital Institutional Fund XXXI, which is expected to be $150 million in size, averaged $.98 per dollar of credit. In the February Corporate Fund Watch, it reported that average tax credit prices on 33 specified properties in PNC Multifamily Capital Institutional Fund XXX were $.95 per dollar of credit.
Two other syndicators, Boston Capital Partners and Charter Mac Capital reported average tax credit equity price increases of $.02 per dollar of credit, both from $.94 to $.96. Another two syndicators reported average price increases of $.01 per dollar of credit: Apollo Housing Capital, from $.92 to $.93; and Raymond James Financial, from $.95 to $.96. The price reported by one syndicator, Red Capital Markets, was unchanged from February at $.93 per dollar of credit.
