Resources: Novo’s Tax Credit Tuesday

For anyone working with tax credits, the Novogradac podcast “Tax Credit Tuesday” are a useful way to learn about Federal and state initiatives in the tax credit sphere. I’ve always subscribed via iTunes, so I had no idea there was a PDF transcript available.

In this week’s podcast, Novo reports on Rep. Frank’s “TARP for Main Street” proposal, which would direct $1B of dividends from banks that received TARP funding to the Affordable Housing Trust Fund, established last year in the Housing and Economic Recovery Act.

Also covered is a letter from the Affordable Housing Tax Credit Coalition expressing concern about the potential sale of tax credits held by Fannie and Freddie. The AHTCC, providing Congress with a short lesson in supply and demand, is concerned that the sale of tax credits on the secondary market will further depress prices that currently languish between $0.68-0.78 per $1 of tax credit. Instead of selling the credits, AHTCC advocates for the Treasury to accept GSE-held LIHTC as part of the dividend payments owed. Alternatively, AHTCC suggests that credits be sold to LIHTC investors who have been inactive for 10+ years and that the GSEs should immediately reinvest those proceeds back into LIHTC.

Atlanta Housing completing demolition and redevelopment

Last week the NYT noted that the Atlanta Housing Authority was nearly done demolishing its 32 largest communities totaling nearly 15,000 units.

The article presents a quick summary of pro and con positions and mentions a series of articles from Creative Loafing Atlanta, an alternative weekly that has provided more detail on Atlanta’s particular efforts.

Writes the Times:

The elimination of housing projects does not mean the abandonment of public housing. The Atlanta Housing Authority pays for more residents’ housing these days than it did in the 1990s. But they are scattered throughout the city in mixed-income communities and private housing financed with vouchers through the government’s Section 8 program.

Still, critics of the demolitions worry about the toll on residents, who must qualify for vouchers, struggle to find affordable housing and often move to only slightly less impoverished neighborhoods. Especially in a troubled economy, civil rights groups say, uprooting can lead to homelessness if more low-income housing is not made available. Lawsuits have been filed in many other cities, generally without success, that claim that similar relocations violate residents’ civil rights and resegregate the poor.

As always, David Smith, in “End of an Error, Pt. 1″ has both the background on Atlanta and places the demolition in context. In his introductory entry (David’s thoughts ran to 3 parts) he divides housing assistance between place-based (build it and they’ll come) and people-based (pay them and they’ll go).

Atlanta has clearly made the choice to reduce the concentration of poverty by largely eliminating the ownership of housing by the AHA and providing residents with vouchers to assist them in acquiring the housing on their own.

Mentioned in the article is research conducted by Thomas Boston, professor of economics at Georgia Tech. Boston is the author of a case study of mixed-income revitalization in Atlanta. The study (link above to the working paper), was peer reviewed for the Journal of the American Planning Association and studied 2,700 families (1,200 that relocated and 1,400 that did not) from Atlanta public housing communities during a 7 year period and found:

Families who moved from public housing projects to vouchers were 1.5 times more likely to be employed in the long term than were those who remained in projects. Families who moved to mixed-income communities were about 2.1 times more likely to be employed in the long-run than those who remained in projects.

Creative Loafing collected a few of the articles written about the AHA and troubles with the Atlanta affordable housing market. I submitted a few comments in the collector piece, to the extent that well run PHAs were essential to working well with private sector owners. The benefit to an owner of taking voucher holders is that a substantial portion of the rent can be relied upon each month, that lease violations (behavior problems, non-applicant residents, housekeeping standards, etc.) can be enforced by both property management and the voucher-issuing entity. Cooperation, however, requires a PHA that is responsive to residents and owners, provides clear guidelines for enforcement and inspections, and delivers the types of follow-up assistance and counseling needed to bring greater financial stability to voucher holders.

I’ve got some additional thoughts on funding sources in a future post.

Why do we need to broaden affordable housing funding sources?

Because you get things like this 44-unit 1992 LIHTC property that loses $25,000 per year with no hard debt.

Housingpolicy.org, an initiative of the Center for Housing Policy is doing yeoman’s work in spurring ongoing conversations amongst professionals in affordable house. At their nascent forums, Ed Kaminski shares his frustration with the deal above, and its inability to make financial sense.

[Pennsylvania's] low rent levels do speed up the intersection of operating expense with operating income. We even avoid hard debt on tax credit deals whenever possible because at some point, costs will exceed income. This is certainly true in hindsite with taxes, utilities, insurance and maintenance all rising at a greater rent than rents.

We are being offered – free of charge – a 17 year old 44 unit tax credit property that losses $25,000 per year. It has no hard debt payments, but soft debt exceeds the appraised value. [We] have come to the conclusion that the only way to preserve this is to find a source that will subsidize operations. We are willing to enter into a 15 year restrictive use agreement in exchange for a 15 year commitment of $25,000 per year.

That is $568 per unit per year ($8520 per unit for 15 years) and a total of $375,000 of subsidy for 15 years. Producing 44 new units will cost $6-8,000,000 or more.

The ability of a State Housing Agency to exchange tax credits for cash does nothing if the money goes simply to the construction of affordable housing and not to its operations. Financial stability, much less sustainability, will not occur until states and more importantly, counties, become more serious about providing and supporting affordable housing.

LIHTC cannot solve this problem.

Direct HUD subsidies, HOPE VI, vouchers, all are powerless to solve the long term danger to affordable housing: incomes (and thereby rents) do not rise in concert with expenses.

Sustainability: Green Communities at the NBM

In February, Dana Bourland, Director of Enterprise’s Green Communities program spoke at the National Building Museum as part of the multi-year Smart Growth program. If you are in the DC area, the series is well worth attending.

The audio of Ms. Bourland’s presentation is now available, as is a PDF of the presentation. The technical details of the program were touched upon in the audio, but the PDF provides additional details on utility allowances (pp. 29-32) and costs for meeting Green Communities benchmarks (pp. 40-42).

The presentation reviews progress made through Green Communities, including the launch of their $40m green equity fund to build 500 homes in California. After focusing on grants and capacity building initially, the program is now providing performance details and equity funding for green affordable housing.

Summaries of funded projects.

Finance and Investment: Can’t Someone Else Do It?

And we’re back.

As a longtime “Simpsons” watcher, I can find something from their 20+ years to apply in nearly every situation. In Trash of the Titans, Homer runs for Sanitation Commissioner by promising personalized trash handling, including in-house ‘cram downs’ by sanitation personnel. As you would expect, the whole enterprise ends in disaster with the town moving several miles away by the end of the episode.

But the lament that started Homer’s quest, “Can’t Someone Else Do It?” naturally contains a bit of truth.

[Note: Let's not pretend this is an original thought. Both "The Tao of Pooh" and "The Gospel According to Peanuts" applied children's characters or cartoons to weighty philosophical matters.]

Since the layoff I’ve been working on several ventures, consulting on others, and generally trying to promote sustainability in affordable housing. Many of these ideas include making use of stimulus funds for weatherization, community-based ESCOs, or enforcement of green building laws.

These conversations with people in DC and around the country have shown me that much of the work is repetitive. Everyone is so eager to solve foreclosures, propose stimulus funding, require sustainable building codes, that the work is inherently duplicative. As an antidote, I’ve pushed the belief that someone else can do this. Someone else can (or has) created a weatherization program, a foreclosure response protocol, or a useful residential green building code.

Thinking indirectly, there are already ways to verify or enforce programs. for weatherization, affordable housing, and green building by working with state and local housing agencies, utility companies, and tax assessors. Want to make sure that weatherization or modernization funds were spent correctly? Make it part of the annual filing to the state housing agency. Concerned about the energy efficiency of a new building (regardless of LEED status)? Use remote meter reading or create a review template as part of the annual assessment process.

Can’t someone else do it? Yes they can.

Whither LIHTC: H. R. 598 and LIHTC

Mary Levine at Parmenter asks about H.R. 598, “American Recovery and Reinvestment Tax Act of 2009″. I won’t pretend to have any well reasoned commentary, but I can suggest following the legislation at Novo.

Last week I ate lunch with a long time veteran of the industry with 20 years experience as an originator. My companion postulated that after a very successful run, it may be time to change the LIHTC program and recognize that LIHTC is not the sole vehicle for affordable housing. There is no demand for tax credits and on current performance it is likely to be 2011-12 before it picks up again if the GSE situation can be sorted out. Count on David Smith to keep you updated.

Over lunch what we hashed out is that nothing in the stimulus promotes the investment in affordable housing by outside firms nor does it enable the property to actually operate and generate a profit. Push all the money into the states that you want, if developers can’t get loans and properties can’t break even, none of this matters. The originator had strong words for the state agencies that historically held the upper hand. With credits going unused, they will now be required to think in new and challenging ways. LURAs may need to be renegotiated, QAPs may need to be rethought, and operating loans (or grants) will need to be offered.

Coming solely from the for-profit side of LIHTC, I see properties squeezed in a thousand ways. Underwriting standards over the past 5 years left something to be desired as DSCR fell from 1.25 to 1.15 to 1.1 and 1.05. There’s no cushion left for the lender or the owner in a time when delinquency is up, occupancy is stagnant or falling, and expenses continue to rise. If expenses cannot be cut, then income must be increased. Commercial income restrictions already hamper the profitable operation of properties in urbanized areas and the FCC removed the cable fees that previously provided some predictable non-residential income.

So what’s my half-baked plan for restarting LIHTC? Certainly half-baked, but I’m focused not just on reinvigorating investor interest but continuing operations. We have a tremendous need for affordable housing and need to be much more aggressive about its promotion.
1. CRA requirements must be raised and enforced to motivate financial investors. TARP money should be tied to CRA compliance and institutions should be strongly encouraged to meet CRA via LIHTC. Restrictions on commercial income should be reexamined.

2. Urban or transit friendly development is a favored QAP requirement. Unfortunately, because LIHTC developers compete with other developers who can realize greater revenues for this land, are frequently priced out of the market. If they can include a few retail bays, signage, or other methods of raising commercial income, they can compete.

3. Localities must provide some property tax relief. If you receive CDBG funds, you need to show that affordable housing is promoted and protected. Fixed costs in insurance, personnel, utilities, and property tax comprise an overwhelming amount of total expenses for properties. Maybe I’m just infuriated by Indiana’s abject incompetence in this area, but affordable housing provides an ongoing benefit to cities and states. They’re contribution should be recognized via property tax abatements.

4. The QAP needs some additional work. Acknowledging that sufficient demand should exist for some of the requirements, states may need to reexamine their urban/rural mix, very low income requirements, and show a willingness to make adjustments were necessary. We’re trying to protect affordable housing in toto and driving owners out of the program entirely does not serve this purpose.

5. Recognize that private developers are in business to make a profit. This doesn’t need to be obscene, but to expect developers to continue funding deficits caused by poor regulatory structure, QAP requirements, or aggressive taxation policies does not serve the industry well.

As I said, it’s half baked but represents this for-profit asset manager’s thoughts on what is needed for the long term health of affordable housing (separately from LIHTC).

Whither LIHTC, Part 5 (Short hits edition)

The ‘Whither LIHTC’ has turned into a much bigger discussion than I initially anticipated as more and more participants take the full measure of the macro impacts on LIHTC. I’d like to thank Mary Levine of Parmenter Group for adding to the discussion and for providing a copy of their LIHTC stimulus proposal. Parmenter’s idea to return tax credits held by the GSEs to the states as an ‘additional incentive’ to future purchases is not one I’ve seen before. Because so many of the GSE credits are of recent vintage, this would give investors some additional credit capacity at a low price. Mary kindly responded to some questions in comments.

I’m also wading through Recap Advisors new report (number 72 on the right) delivered to Mass Housing. The report collates their various thoughts and recommendations for making it through the affordable housing crunch. David Smith, founder of for-profit Recap Advisors and non-profit Affordable Housing Institute, writes about LIHTC issues at his blog. He has unpacked the RA report and shares some hard-won insights in a three part series. Part 1 (Investment in Knowledge), Part 2 (Go try to borrow), and Part 3 (Drive thy business)

Some of the complexity issues identified by David in “Go try to borrow” are complemented in this piece for Novogradac by Boston Capital’s Bob Moss.

In the initial “Whither LIHTC”, we made mention of an Affordable Housing Finance roundtable entitled “Where does the LIHTC industry go?”. Several follow up articles and reports have since been issued such as this summary + YouTube interview, full summary, and 59-page (!) transcript. I just found the transcript today, so I haven’t looked at it yet.

I’m still developing my own solutions, and in the midst of a job hunt, may not get these fully fleshed. Nevertheless, I think we need to increase CRA lending requirements to encourage more debt issuance and equity investment by financial institutions, work with qualified, liquid investors with a useful track record, and adjust IRS rules to increase the amount of commercial income that can be generated. This last idea would be particularly beneficial to projects in urban or TOD areas.

Whither LIHTC, Part 4b

Wherein we finish a surface discussion of the AHTCC’s recent white paper on saving the current LIHTC industry.

In the previous post, we reviewed the first 2 of 5 recommendations made by the Affordable Housing Tax Credit Coalition:

1. Provide a special allocation of additional direct subsidy to be used exclusively by Housing Credit agencies to provide gap financing necessary for financial feasibility for properties which have received Housing Credit reservations or allocations (including bond financed properties).
2. Permit taxpayers to carryback the Housing Credit for up to five years and these Housing Credits should be used to offset Alternative Minimum Tax (AMT) liability during that period.
3. Allow accelerated Housing Credits to be claimed in the first year of the Housing Credit period.
4. Fix the 30% present value Housing Credit at 4%.
5. Make the Housing Credit a refundable credit.

Allow Accelerated Housing Credits to be claimed in the first year
The existing rules for first year tax credits allow investors to take credits based on the average first year occupancy of a project. To borrow AHTCC’s example, if a 120 unit project is placed in service (ie. opens for occupancy) in January and is fully occupied by December at a rate of 10 units per month, the investor can claim 50% of the annual tax credits in the first year, with the remainder claimed in year 11. Through a DCF model, this reduces the value of the deferred credits nearly to $0. The Coalition proposes that where buildings achieve their minimum set aside requirements (see also glossaries from CHFA and NHHFA), that all allowable credits for the first year be claimed, with a reconciliation to take place in the second year. This would have the effect of boosting credits claimed in the first year, with a healthy increase in the value of the credits to the investor.

Comment: The method of claiming first year credits based on an average of the first year occupancy always made a certain simple sense to me. Nevertheless, deferring credits to the end of the credit period certainly reduces the value of those credits in a measurable way. Allowing investors to claim the full value of the credits in the first year and then reconcile anticipated with actual results in subsequent years seems to be a good solution to this challenge and should be implemented in code. In the current environment, however, we are still left with the challenge of who can use these credits in the near term, so I do not believe the immediate effect will be significant.

Fix the 30% present value Housing Credit at 4%
[Note: This is inside baseball for non-LIHTC readers. Tax credits (ie. equity) in affordable housing can be 9% or 4% depending on whether the deal is financed with 70% equity (ie. 70% of the qualified basis) or 30% equity (ie. 30% of the qualified basis) , respectively. New construction or rehabilitation can qualify for 9% credits, while existing properties (very little rehab) or new construction projects with additional federal subsidies receive 4% credits. After HERA, tax-exempt bonds are the only recognized form of federal subsidies, so most projects qualify for 9% credits. For a long time, most state agencies stretched their dollars farther by only approving 4% deals. The accountants at Novogradac are generally considered to be the experts in tax planning for LIHTC.]

AHTCC points out that by fixing the 9% credit to 9% instead of allowing it to float (where it generally floated at 8% in prior years), Congress enabled states to generate substantially more tax credit equity investment, which they calculate at potentially 12.5%. By fixing the 4% credit at 4% instead of its 12/08 rate of 3.36%, tax credit equity in 4% deals could increase 19%.

There is little justification for having the rate on bond financed transactions and existing buildings float while non-bond financed and newly constructed projects enjoy a fixed rate. Not only does the floating rate cause substantial uncertainty, it is also contributes to the financial infeasibility of many projects.

Comment: I’ve never fully understood the reason that the 9% or 4% credit floats, so purely from a desire to reduce brain damage, this seems like a reasonable adjustment.

The Housing Credit should be made a refundable credit
The tax credit program’s length, 10 years of credits plus an additional 5 years of continued compliance allow companies to manage tax expense over a long period of time. That long period of time, however, presumes that tax credits can be applied to predictable income. Suggests AHTCC:

Obviously, if a company does not have sufficient tax liability to utilize all its Housing Credits, the value of the investment is reduced and the risk of such an occurrence is a major deterrent in the investment decision. Permitting the Housing Credit to be refundable, i.e., Treasury would provide a cash refund to the extent that a taxpayer is unable to use its Housing Credits, would address this situation and help stimulate investment.

AHTCC would require such credit refunds only go to publicly traded or regulated C-corps that participate passively in these investments. Such regulated entities, AHTCC believes, ensure that all LIHTC projects are soundly underwritten, structured, and monitored for compliance.

Comment: Cough. Ahem. I’m not sure that this is the best time to be emphasizing how well investors required agencies and syndicators to ensure proper structure and underwriting given the challenges many investors had in underwriting deals for their own portfolio. Regardless, what troubles me about this proposal is the ‘heads I win, tales you lose’ aspect of the credit refundability. By my reading of the proposal, investors get the benefit of the tax credit in every year in which they can claim a credit against income. Where their own taxable income is too low, they get a check. While it is wonderful to be in such a position as an investor, I am troubled by the policy implications.

When you invest, you place money at risk, for which you receive a rate of interest that theoretically provides compensation for this risk. When the risk is that you either take credits or receive a check, I’m not clear on why you’re receiving much of a return since so little is being risked. I would be interested to see what AHTCC thinks this will do to fund yields for LIHTC funds, and whether this would enlarge the universe of tax credit investors. At this time, I don’t see the policy benefit.

“Whither LIHTC” is a continuing series on the difficulties of investing and financing affordable housing. More articles can be found via the LIHTC tag.’

Whither LIHTC, Part 4a

Wherein we discuss the AHTCC’s lengthy proposal to create immediate and ongoing incentives to support affordable housing. A play in two parts:

With the particulars of the stimulus bill awaiting imminent release, everyone is putting forward their recommendations. Shortly before the holidays, the Affordable Housing Tax Credit Coalition weighed in with theirs. The white paper has five points:
1. Provide a special allocation of additional direct subsidy to be used exclusively by Housing Credit agencies to provide gap financing necessary for financial feasibility for properties which have received Housing Credit reservations or allocations (including bond financed properties).
2. Permit taxpayers to carryback the Housing Credit for up to five years and these Housing Credits should be used to offset Alternative Minimum Tax (AMT) liability during that period.
3. Allow accelerated Housing Credits to be claimed in the first year of the Housing Credit period.
4. Fix the 30% present value Housing Credit at 4%.
5. Make the Housing Credit a refundable credit.

AHTCC’s white paper provides an extended discussion of these ideas and starts with a strong lede:

[In 2007] approximately $9 Billion of equity was raised in the Housing Credit industry. For 2008, that amount is likely to be somewhere in the range of $4 to $5 Billion, a reduction in one year of 44% to 55%! Even worse, at this time, there is hardly any investor demand, which means that 2009 could be even bleaker than this year.

The result of this lack of equity capital is that thousands of critically needed affordable rental units will not be built or preserved and lower income families and seniors throughout the country will find it more difficult or impossible to find the decent, safe and sanitary housing produced by the Housing Credit program. Many projects which have been awarded Housing Credits will not be built due to lack of equity capital. Although it is impossible to know this number with certainty, our estimate is that hundreds of projects may not be able to move forward.

Special Allocation to state housing credit authorities
This special allocation, to be provided directly by the government using the same dispersal method as standard tax credits, would be used as a ’soft second’ mortgage to fill the gap between equity and senior debt. The soft second could take various forms, either with variable payment terms “so that rents would not need to be raised to pay for the debt service associated with the loan and so that the loan would be treated as bona fide indebtedness for federal income tax purposes. ” Or, these funds could be treated as part of eligible basis per Section 42 but not treated as generating income, or only in eligible basis but not depreciable basis.

Comment: I appreciate that AHTCC modified the total housing credits to reflect both the increase to 9% via HERA and the decrease to $0.70/$1 credit reflecting no interest in the 2007 tax credit yields of $0.90/$1 credit. However I’m not sure $0.70 is low enough to attract buyers in this market. Except to meet CRA needs, in January 2009 it is very difficult to attract buyers at any price. We have a credit and financial slump on top of a cyclical downturn. This affects not just traditional buyers of tax credits such as banks and other financial institutions but also the larger corporations that might have a need to offset income if they weren’t facing a drop off in their main business lines and therefore little income to offset. For those companies making sufficient money to need tax credits, I think the education required to explain the investment type to them would take too long to get their money into the market in a reasonable period of time.

I also know that you can’t get loans in 2009 at 2007 prices. Pricing is higher, underwriters are much more skeptical of “and then a miracle happens” scenarios, and I don’t see them passing the more rigorous stress testing as easily as before. Furthermore, I’m not convinced that the “Local Subordinate Loan” that helped restructure the debt on deals in the past is still around. Cities and counties cutting spending to avoid raising property taxes too much are unlikely to provide any additional financing, much less a soft second. I’m willing to be wrong about this, however.

The bigger surprise is that AHTCC recommends an allocation of $5b in 2009, $4b in 2010, and $3b in 2011. This is a massive amount of spending, representing 50% of all tax credit investment in the first year, which would likely squeeze out traditional lenders or reduce the tax credits to purchased by private investors to negligible. If lenders are not lending (by choice or by inability to compete) then they are not generating profits that require offsetting.

Loss carryback up to 5 years and AMT offsets
The paper identifies two problems with current tax treatment: 1. tax credits cannot currently offset profits for the entire financial boom since 2004; 2. companies subject to the AMT (hint: their names start with ‘F’ and end with ‘e’) cannot use these to offset any profits subject to AMT.

Comment: AHTCC claims that the problem with the short carryback period (currently 2 years) is that companies with too many tax credits will simply sell their ‘overage’ at a greatly reduced price, lowering demand for new tax credits. While this change might reduce the risk that institutions dump their existing tax credits, it does nothing to generate additional investment. HERA already allows investors to use tax credits for buildings placed in service after 2007 against AMT, and this provision would not change that.

I’ll have Part 4b posted shortly.

“Whither LIHTC” is a continuing series on the difficulties of investing and financing affordable housing. More articles can be found via the LIHTC tag.

Whither LIHTC, Part 3

Lots of activity during the holiday break, but we’ll start with House Financial Service Committee Chairman Barney Frank

According to a well-written article in the Boston Globe, Congressman Barney Frank wants to include $10 billion for affordable housing in the stimulus bill to be announced later this month.

The $10 billion would take the form of $5b in Treasury purchases of tax credits and $5b in assistance to states for funding existing projects currently stalled by market conditions. “Frank said the Treasury could buy the credits and hold them until the market improves and then resell them to recoup its money. He said the government also could send money to states to help developers with funds they need to get projects moving.”

The Globe article does not discuss the length of time Treasury would hold the tax credits, whether the credit period would begin once the credits are sold to a third party, or whether the compliance period would be extended. If Treasury holds the credits, then deals will probably get done, but if the credit period begins at point of purchase, the credits will decline in value (because they burn off at +/- 10% per year) and Treasury will never realize any gain from the sale. If the credit period begins at point of sale to the eventual investors (TBD) then the investors will pick up a project either at completion (if conditions are good) or well into its first couple of years of service (if conditions aren’t). This means that equity investments will be due immediately rather than spaced over construction, replacement reserve costs will be higher, and that the property will be much more likely to require a major capital upgrade during the compliance period.

The direct assistance to states is much harder to evaluate, but there are many, many projects that cannot be built because neither equity nor debt is available for funding. In the spirit of “shovel ready” that predominates discussion of the stimulus bill, the National Housing Partnership Network claims “There are 230 projects ’shovel ready,’ with a combined 2,100 units that could go into construction if the federal government provides additional help.” Of course, 10 units/project seems a little low, so I’ll assume that the Globe missed a decimal place.

One of the things to remember is that even if a project can be built, that does not mean that construction expenses will not exceed budgets, that the project will deliver on time, or that operations will not require additional funding. This is particularly important because many developers are over extended or feeling pressure on existing deals and cannot be counted on to provide additional operating loans. I deal with developers across the country on a daily basis and I can’t find one that doesn’t feel heat.

Overall the article provides a good summary of complex issues and presents the policy challenges faced by the industry.

“Whither LIHTC”, a multi-part, semi-informed discussion of the current challenges to the Low Income Housing Tax Credit program is discussed in Part 1 and Part 2.

(Via Open House.)

NAHMA LIHTC White Paper

I discussed the National Affordable Housing Management Association’s 2 page position paper on LIHTC stabilization yesterday. In general, I felt it accurately described the challenges (tax credits have no value, knowledge base and infrastructure at risk) but that it did not necessarily prescribe what is required for a full cure. Due to the collapse of demand, the only way to stimulate additional demand is to increase CRA requirements and perhaps accept credits as some type of collateral for TARP. Like shredding old bills, removing these credits from active trading might help reflate the market.

Fears of a growing LIHTC meltdown were echoed in an internal company call recently, in which it was disclosed LIHTC originations for 2009 are expected to be <15% of 2006. This is a pretty gutting forecast and I think it is fair to ask how LIHTC businesses and investments should be valued through 2012.

Regardless, please read NAHMA’s thoughts on stabilizing LIHTC and comment below.

Whither LIHTC Part 2

The National Affordable Housing Management Association (NAHMA) issued a 2-page ‘white paper’ this week, “Stabilizing and Restarting the Residential Tax Credit Marketplace”, which was sent to various Congressional chairmen and ranking members.

I can’t find the document on their website, which seems an odd restriction for building legislative report.

The report identifies several challenges to the Low Income Housing Tax Credit program (LIHTC) that are familiar to regular readers. These dangers include:

1. Inability to close deals in the pipeline.

2. The reduction in credit value (from mid-80 cents per dollar to low 70 cents per dollar) requires increased equity contribution from the developer.

3. A small market made 40% smaller by the absence of Fannie and Freddie.

4. Banks and other tax credit holding institutions have no offsetting gains and experience a 10% reduction in value [Note: the tax credit period runs 10 years per project] each year the credits go unused.

5. No investors want or need tax credits, harming rural areas in particular.

6. State agencies rely on new projects and fees to fund operations and in some cases, provide general funding opportunities.

7. A sustained drought [Note: unspecified but MFG thinks 2+ years] will lead to a loss of expertise, investor interest, and professional infrastructure.

Most importantly, there is a risk that very little affordable housing will be built before 2012. If you assume that the financial institutions that drove the tax credit market for 10+ years will not show income before 2010, their current losses should carry forward well into the first part of the next decade. When combined with the long lead time to design and apply for tax credits, the lack of new product will be acute.

Unfortunately, most of the solutions proposed by NAHMA address supply rather than demand. The abject lack of demand is the crux of the problem and why lenders, syndicators, and developers are being crushed.

1. Provide either government guarantees or backstopping to unfreeze the current market in Tax Credits. As noted above, tax credits’ values depreciate over time. With the current lack of earnings in most sectors of the economy, those credits that are trading are priced at deep discounts. With the imbalance in supply and demand, there needs to be some modification to the use of credits that will preserve an orderly market.

[Note: There seem to be 2 goals here. One is a Federal backstop that would undermine existing guaranteed funds that are enhanced in some way. Secondly, NAHMA does not offer a solution to the 'imbalance'.]

2. Use existing enacted Federal Housing Administration lending programs to provide low interest “bridge” financing to permit new development to continue in markets with significant needs for more workforce and rural housing. FHA insured financing can be used where the loans are structured to permit new and rehabilitated developments and provide an option to use Tax Credits to take out the loan within one or two five-year terms. Initial loans could be structured as five-year financing with one renewal and no lock-ins that would permit earlier conversion if market conditions permit. These loans should be underwritten and administered through the State Tax Credit Agencies. The bridge financing would be designed to allow the properties to move to full Tax Credit status easily. This could occur either during the loan period or at the end of the loan period. The implementation of these bridge loans and subsequent Tax Credit compliance should begin either at the point of conversion from the bridge loan or year six, whichever occurs first, with a ten-year compliance period. Regulatory and compliance policies and procedures should be revised to allow investors assurance on tax credit compliance as the bridge loan converts.

[Note: Many deals have blown up because either the syndicator could not take or lay off the credits or, in some cases, the bank has refused to close. The problem is that most of the deals are underwritten aggressively so that there's not much room for FHA to make a credit-worthy decision. Now if we considered the FHA to be more of a 'soft second' lender, that would not be a problem.]

3. Address current tax and Securities and Exchange Commission regulatory policy to stabilize the book values, pricing and price volatility of Tax Credits. With the bulk of purchasers facing uncertainty in how purchases of new Tax Credits would be valued, the market is illiquid, and purchasers are risk averse. Greater certainty in subsequent valuation is needed.

[Note: I don't understand this proposal at all. Tax credits only have value to an investor to the extent they offset gains elsewhere. They have a defined benefit period and cannot be carried forward. Under Mark to Market principles, unused credits (for current or future years) should be valued at their current market price. The problem is there's no demand for the tax credits, not that there is uncertainty about valuation.]

4. Review current tax and regulatory policy with an eye to improve yield on Tax Credits. Policies should be developed that will allow the Federal Housing Finance Administration to place all “written down” and “written off” credits held by the GSE’s and other institutions in conservatorship with the Treasury, and allow the Treasury to hold the credits to maturity. This will prevent a “fire sale” in credits from undercutting the market. Methods to allow viable but unprofitable banks to place credits with the Treasury should be explored.

[Note: This is a good suggestion and should be enacted in concert with an increase in CRA requirements; eliminating the tax credits held by Fannie and Freddie and other institutions that accepted TARP funding would dramatically increase demand for tax credits to meet CRA regulations. If there is no demand for a product at any price, you must create demand by allowing it to fulfill other purposes. The traditional driver was CRA, but with so many CRA-subject companies combining or disappearing, that demand has slackened. Increasing CRA requirements for the survivors or eliminating old tax credits, would be one way to stimulate demand for fresh credits. Of course, what is not clear is what to do about the investments made in earlier tax credit rounds and whether that money is gone or must be returned by the developer or syndicator.]

5. A primary goal is to create new markets for Low Income Housing Tax Credits supporting affordable workforce housing, which continues to be in short supply in all major markets. Expanding the market in Tax Credits will permit expanded production both in the new construction and rehabilitation markets. Modifying current regulations to permit expansion in the market for Tax Credits is absolutely essential. 

[Note: Providing new and renovated affordable housing is the most important policy goal. It is not clear that the tax credit program can meet the demands for this product in the next 18-60 months. Ultimately what advocates of affordable housing want is more and better housing regardless of the funding source.]

Whither LIHTC

Although the articles don’t leap out at you, Affordable Housing Finance is providing some nice summaries of this week’s action at AHF Live in Chicago.

One industry roundtable, Where Does the LIHTC Industry Go? identified some significant challenges to the LIHTC program and the business models of affordable developers, syndicators, and financiers. The hard truth was highlighted by Kansas City’s Lee Harris of Cohen-Esry, “We’ve got equity for many developments that is simply not available. Where equity is available, pricing is down 20 cents or more.”

So how did we get here? The shortest answer is that for the past several years, the early LIHTC (Low Income Housing Tax Credit) non-financial investors disappeared and the GSEs and financial firms came to dominate the $10b market. In addition to the monetary benefits of the tax credits, the commercial banks could meet CRA (Community Reinvestment Act) needs and ‘green’ their portfolios by throwing a few ducats at Enterprise’s Green Community Programs (a laudable goal) and at those developers who anticipated the direction of the larger market. So long as the Fed enforced CRA and profits required tax credits, the industry hummed.

Some of you may have read recently that’s no longer the case.

Losses on other operations will be carried forward to offset profits (if any) over the next two years. With the early Fall panic in the banking industry, the Fed basically waived CRA requirements for urgent acquisitions. That may be temporary, but the carry-forward losses for 2007-09 will keep the commercial banks out of the market until 2010-11 at the earliest.

My firm essentially stepped away from the syndication business back in 1Q 2008. We had been one of the largest syndicators and debt originators of affordable housing in the country, but between stress placed on warehouse lines (where we stuck projects before selling them to the fund investors), wildly changing construction costs, and the inability to finance marginal deals with tighter credit standards, we are done for a while. I think we’ll limp through 2009 doing agency debt deals, but the equity side is not very busy right now. I don’t think they’ll ramp up again until 2010-11 at the earliest.

So the lack of demand for our product (tax credits) means that there is no supply for developers. Builder magazine highlighted the pain in the SFH market, but I promise it extends to multi-family developers as well. Unfortunately, since LIHTC funds an outsize portion of the affordable housing in the US, this means that there will be very, very few deals completed over the next several years. The shadow market of failed condo projects, REO homes, and aging market rate properties may take up some of the slack, but we are facing several years when no new affordable product is created or rehabilitated.

Which gets us back to the initial question: Whither LIHTC?

I don’t know yet. We are facing several bad years and the collapse of stalwart investors means that the entire program may need to be rethought. I’ll leave that for another post.

For those interested in the history of LIHTC or the Green Community Program, Enterprise provides an excellent summary. The NYT also has a nice summary of the challenges faced by Jonathan Rose even in the oddball NYC market.