Energy efficiency and green building play a crucial role in housing affordability. Some are concerned that green building adds to the cost of housing. I do not subscribe to that view. I believe that we can’t afford not to build green. Research increasingly shows that all types of affordable housing can be built or rehabilitated to rigorous green standards at a minor additional cost, and often without the need for capital investment. As we dispel the notion that green building will mean higher costs for low income families we must recognize while everyone is hurt by high energy costs, no one is more vulnerable to rising energy prices than low- and moderate-income families. Higher energy costs often result in cutting back on other critical needs, such as medicine and food.

HUD, Money & Green Housing 2010 – via Greenlandlady.com

PACE bonds are issued by local governments, with proceeds used to improve the energy profile of buildings. The most politically popular use of these bonds is to retrofit homes and add renewable energy capacity. The building owner repays the funds through an additional assessment on the property tax.

Because property taxes are superior in lien position to the mortgage, the GSEs are anxious that there is now another lender that will be repaid before them in the event of foreclosure.

PACE advocates describe PACE bonds as a simple extension of a state or municipality’s existing right to issue bonds. Typical descriptive language usually reads like this:

Land secured financing districts – which are creatures of state law and are variously referred to as assessment districts, public improvement districts and community facilities districts, among other terms – are a building block of municipal finance and have been utilized for more than a century. They are used to finance projects which serve a public purpose, including street paving, parks, open space, water and sewer systems and street lighting, among others.
All land secured financing districts operate by placing a senior tax/assessment lien on properties which will receive a benefit from the financed improvement. The lien secures a tax/assessment payment that is levied on properties through the property tax bill. Tens of thousands of these districts already exist in this country and are a standard part of the property appraisal, underwriting and disclosure processes.

PACE bonds are usually statutorily approved under the auspices of existing bond creation legislation. They have the following commonalities with a water treatment bond:
1. Issued by an entity with tax levying authority.

2. Repayment sources are individual properties within the affected district.

Here are some differences:
1. Tax levying authority does not design or complete the work directly.

1a. Contractors who actually design and complete the work may or may not be sufficiently licensed or inspected.

2. The improvements are speculative and the anticipated savings may or may not coincide with the period of repayment.

3. A property’s “share” of a water treatment plant is not due upon sale or foreclosure. In a PACE-related foreclosure, that cost can be accelerated and be payable upon foreclosure.

4. If a water treatment plant does not generate sufficient funds to repay the bond directly from user fees, the municipality is typically responsible for the shortfall. PACE bonds have no such mechanism.

Some quick math may illuminate the GSEs unease with the program:
$20,000 in efficiency improvements

6% rate of interest (the municipality may pay 5% to bondholders and keep 1% for overhead costs)

20 year term of repayment (supposed to be less than the lifespan of the improvements)

If you’re using Excel, it should look like this:

=PMT(6%, 20, 20000)

and the answer is = $1,744 (the amount paid for this improvement per year)

or $1,744/12 = $145 (the monthly amount your energy costs must fall to break even on your improvements).
From a lender’s perspective (because the improvements need to be either cost neutral or cost positive to the homeowner), that $145 in savings better be there each and every month or the borrower is not meeting the same income to debt ratio at the origination of the GSE-backed loan. From a lender’s perspective, there are a couple of ways to save money on utilities that don’t involve placing a $20,000 lien on the property. These include:
1. Reducing your energy use.

2. Reducing your energy use.

3. Reducing your energy use.

I’m not anti-PACE and I strongly believe that there is a method to integrate a program like this within a GSE framework. I don’t believe in headline hysteria like this, or this, or this, or this. When you write these types of articles and allow inflammatory link-bait headlines to summarize them, you come across as ill-informed, ill-tempered, and ill-suited to write something that actually advances the conversation toward the desired solution.

Wednesdays with Will Clark: Carbon, Corporate Insight and Uncommon Sense – Green Landlady.

The current plan would demolish about 10,000 houses and empty buildings in three years and pump new investment into stronger neighborhoods. In the neighborhoods that would be cleared, the city would offer to relocate residents or buy them out. The city could use tax foreclosure to claim abandoned property and invoke eminent domain for those who refuse to leave, much as cities now do for freeway projects.

via Detroit wants to save itself by shrinking – Yahoo! News.

I’m working REO for a special servicer and have a substantial portfolio of multifamily and mobile home properties, which is about all I can say.

You can catch up on some of the things in between the webhost expiration and the resuscitated MFG at Tumblr.

The Washington Business Journal provides a quick summary of changes in the new LEED 3.0 standard.

The standard implements and expands upon a few items I’ve written about before, specifically “sustainable sites” as part of a post, “Where does your life take place?” and “Needs more data”.

From an operational perspective energy tracking and reporting requirement (LEED requires reporting to the USGBC for 3-5 years) is the most important improvement from prior versions. Tracking and analyzing energy usage, comparing to baseline, and looking for additional efficiencies should be the most lasting legacy of this LEED version. While the reporting requirements have invited animated discussions, using energy analysis to improve LEED and all building science provides the path toward cost savings and greater loan proceeds (two items close to any developer’s heart).

I’ll have a short post on additional operational implications shortly.

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.

NAA Educational Conference (Twitter hashtag #naaeduconf)

Solutions for Working Families (hashtag #swf2009)

Association of College and University Housing Officers (hashtag #acuhoi).

If the Tweet streams provoke additional questions, a couple of folks have collected their thoughts (or Tweets) and posted them:

NAA Educational Conference

NAA-produced summaries, the ‘best of #NAAEduConf Tweets collected by Ellipse, a summation from Lisa Benson’s panel, Heather Blume’s Notes from NAA, a couple of dailies from The Apartment Finder Blog, and the poorly-lit but always informative Mark Juleen (video link).

Solutions for Working Families
The NHC’s Open House Blog provided most of the daily color, as well as a copy of Sec. Donovan’s remarks, plus a podcast from Nic Retsinas of Harvard’s Joint Housing Center.

ACUHOI

Adventures in Higher Ed summarizes three days of ACUHOI

The Wall Street Journal reports that the EPA is upgrading the residential Energy Star ratings, which currently require a home to achieve 15% greater efficiencies than model building-efficiency guidelines.

Perhaps embarrassed by the thought that homes 57% larger than the national average still receive Energy Star designations, the EPA’s actual motivation seems to be driven in part by technology and in part by a desire to reduce the number of Energy Star rated homes built.

Residential energy efficiency is rapidly evolving in the U.S. 10-20% of states have adopted or are studying the adoption of energy codes more stringent than the 2006 IECC, and many significant new requirements were adopted in the 2009 IECC. Furthermore, the current over-supply of housing stock in the marketplace reinforces the need for ENERGY STAR qualified homes to stand out from the competition. EPA is developing new guidelines to help ensure that ENERGY STAR continues to deliver homes that are high-quality and meaningfully more efficient than standard new construction. More rigorous guidelines will strengthen the integrity and value of the ENERGY STAR label, thereby increasing the success of raters’ and builders’ partnerships with ENERGY STAR.
(Source: Energy Star 2011 FAQ)

In the Fact Sheet, issued May 4, 2009, EPA went with the simpler to explain bullet points:

EPA believes that the next generation is an opportunity to:
• Add requirements that ensure a comprehensive approach to building science
• Ensure high‐efficiency equipment and products in qualified homes
• Add new, high‐value on‐site inspections to ensure that ENERGY STAR qualified homes perform to expected
levels
• Limit the carbon footprint of large homes earning the ENERGY STAR

(Source: Energy Star Qualified Homes 2011 Fact Sheet)

The short version of the upgrades are that new requirements focused on both whole building design and minimally intrusive efficiency selections will be incorporated into the guidelines. These include guidance on thermal, air, and moisture flow; an integrated HVAC system; efficient appliances; more efficient water distribution (low flow aerators); and higher efficiency hurdles for larger homes.

EPA estimates that the proposed changes will add about $4300 to the cost of a home, or $23/month in additional mortgage burdens. It estimates monthly energy savings of approximately $37/month. The financial estimates are well summarized in this 20-page PDF.

You can view all of the changes at the EPA’s Energy Star Qualified Homes website. The public comment period ends July 10, 2009.

Eligibility for the NSP program is limited to CDBG recipients and 1st round funding must be disbursed within 18 months of April 2009. It’s not clear when 2nd round money must be disbursed by recipients. Given the very tight cycle of rule writing, allocation, and disbursement, this lengthy research document is both well done and a welcome discussion piece.

[Note: HUD has lots of resources including a 1.5hr kickoff video.]

Enterprise’s report reviews the proposed uses of 87 of the 306 NSP funding recipients (58% of total 1st round funding) and identified 7 “promising approaches”:

1. Acquisition and discount strategies
2. Disposition strategies
3. Geographic targeting
4. Green building and rehabilitation strategies
5. Income targeting and long-term affordability
6. Leveraging NSP funds
7. Partnerships and management

Cherry picked areas of interest:

Acquisition strategies reflect the diversity of local experiences and the dispersed nature of the foreclosed properties, and include both individual property purchases and bulk asset purchases. The likelihood of one strategy or another depends not only on the pattern of foreclosure but also on the preference of the funding recipient to focus on specific neighborhoods or to make select investments in relatively stable neighborhoods to prevent further deterioration. Funds from NSP can be used for acquisition and rehab, but not for operating expenses or maintenance. This limitation highlights the need to either dispose of these assets upon rehab completion or to use secondary financing (or rental proceeds) to meet ongoing financial obligations.

Disposition seems to reflect a traditional bias in favor of ownership, and provide for homeownership counseling and DPA. I’ll note my objection to DPA, but the full case is amply made at Calculated Risk. In short, DPA increases costs to borrowers (someone has to recover the DPA), and psychologically reduces the ‘at risk’ component of home equity. What looks more promising is a loan guarantee or reserve use, such as that pursued by Chicago and Atlanta. This allows NSP recipients to maximize the utility of their funding because they can provide a guarantee of a portion of the purchase price rather than devote the full amount to the purchase. There are some lease-purchase and rental programs that do acknowledge the likelihood of depressed pricing or inability of some people to afford the obligations of ownership.

Top 100 Foreclosure Markets by MSA, 2008

Geographic targeting is a mixed bag. Enterprise notes that the funds must be disbursed within 18 months, which is far faster than the HUD’s HOZ program, which has shown the importance of extended funding horizons. Furthermore, geographic targeting could be politically difficult if results are not quickly seen or if funding is concentrated in a limited number of areas. Nevertheless, a variety of data sources, including HUD census tract data, postal service vacant address records, and locally generated data have helped reduce the amount of study required for geographic targeting.

A variety of sustainable building strategies are identified. Reducing ongoing costs are essential for stabilizing these properties in the short and long term. Any efforts to meet third party criteria are welcomed.

I think the income targeting components are the most questionable and will be the hardest to implement. I would recommend additional (or substitute) qualifications that aid qualified government workers (teachers, emergency workers, e.g.), supportive housing/co-housing (which can call upon additional public and private funding), or use of an existing mechanism to identify potential renters or owners. The 18 month deadline just makes it too tight to invent a new process.

Leverage of NSP funds should produce the greatest amount of benefit and allow lenders to recoup some of their tarnished reputations. Again, the short time period in which to identify spending or property purchases will limit the spread of this technique, I believe that multiplying NSP funds through leverage is the best way to provide the greatest good. Through the use of credit enhancements, revolving loans, loss reserves, or additional HOME or CDBG funding, leverage will allow NSP recipients to achieve more for their efforts.

I’ll have to better understand the legislation and the guidance, but proper use of leverage could also support the creation of ongoing community oriented enterprises such as non-profit ESCOs or state-backed enterprises.

Crafted and implemented within a short period, the NSP represents a substantial source of funding and innovation for communities with foreclosure risks. The Enterprise report provides an excellent summation of the legislation and a welcome starting point for implementation.

[Update: Here’s HUD’s FAQ on expenditure timelines:
TIMELINESS OF USE & EXPENDITURE OF NSP FUNDS

How long do States and local communities have to spend this money?

Grantees have 18 months to obligate these funds, and four years to expend funds. Congress was very clear that this money be put to work quickly. In some areas, this level of federal funding will be unprecedented. Thus, HUD expects that grantees will have contracts signed or, at minimum, made written offers for properties within 18 months. Options or other non-binding instruments are not acceptable.

Congress was very clear that there is an urgency to deal with a national housing crisis.

How does HUD determine when NSP funds have been obligated?

As stated in the NSP Federal Register Notice page 58332, “Funds are obligated for an activity when orders are placed, contracts are awarded, services are received, and similar transactions have occurred that require payment by the state, unit of general local government, or subrecipient during the same or a future period.”

What will happen if grantees don’t obligate their funding within 18 months?

HUD will recapture the funds.

[Source: Millicent Bystander, flickr.com]

What’s particularly interesting about the connection requirements is that it should increase the accessibility of retail centers to surrounding neighborhoods by multiple means of transit (primarily auto and pedestrian). It will be interesting to see if some of the land use changes highlighted by Galley Eco come to pass more quickly in Virginia.

As a resident of an urbanized area of Northern Virginia, this is welcome news. I also suspect that when combined with a greater focus on reducing car use, Walkscore (see comments for how the NYT fumbled its citations), new funding priorities for HUD and DOT, and most importantly, new lending practices, we will start to see a long-term shift in development patterns over the next 5-20 years.

This is a fascinating real estate topic, so expect more posts.

[Note: For more info on street grid designs, see New Urban News.]
Update: VDOT began public hearings on the connectivity standards in early 2009. Charlottesville Tomorrow recorded this hearing in April.

The HOZ program required coordination across governments and agencies and an extended commitment to funding large-scale neighborhood redevelopment schemes. The program involved 11 neighborhoods across the US and directed $50 million (which led to $273 million in total funds expended) toward the rehabilitation of these neighborhoods. The neighborhoods selected were dominated by low-income households, a low percentage of homeownership, high crime rates, and large tracts of vacant or abandoned properties. Cities with a strong administrative framework were the most successful.

Winning projects broadly included the following:
1. Visible improvement—provide for a significant number of new homeownership opportunities that will make a visible improvement in a concentrated area and stimulate additional investment in the area.
2. New Urbanism—incorporate the basic principles of New Urbanist design.
3. Additional investment—use the HOZ grants to leverage other support for the project.
4. Partnerships and initiatives—establish extensive partnerships with the private and nonprofit sectors.
5. Comprehensive neighborhood revitalization—demonstrate how the HOZ will contribute to the overall improvement of the entire area.
6. Rapid turnaround—demonstrate the ability to begin significant construction projects promptly upon final HUD approval of the HOZ proposal.
7. Affirmatively further fair housing—address how the applicant will affirmatively further fair housing

(Source: An Interim Evaluation of HUD’s Homeownership Zone Initiative

Although the interim report was completed while many HOZ projects were still underway, the entire report is informative.

With an well studied and reasonably successful program in existence, HUD and DOT cooperation should highlight many of the HOZ successes when establishing funding guidelines for the Sustainable Communities Initiative.

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).

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.

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.’

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.

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.)

In so many ways 2008 was a terrible year. No secret there. While the stimulus package and a renewed commitment to affordable housing through government gives one hope, credit is hard to come by, skips are increasing, rents are dropping, and at best we can hope for a bottoming 2009.

In the face of daunting conditions, MFG soldiers on and promises to have a couple more installments of “Whither LIHTC” this week and a lengthy discussion of sustainability at HUD soon thereafter.

In the first, Green Building Law Blog summarizes the substantial changes and reinvigorated focus on carbon footprint in LEED 2009 at: LEED 2009–A Tweak or An Overhaul? : Green Building Law Blog. One excerpt caught my eye:

The reference standard allowed up to 2.2 gpm for these faucets so a change to 0.5 gpm was significant. Trouble is the International Plumbing Code mandates 0.5 gpm for lavatory faucets in public rest rooms anyway so these savings were illusionary for many LEED buildings. With the new rating system, this [water efficiency] loop hole is closed – the International Plumbing Code is now a reference standard. In addition, there is now a 20% water reduction prerequisite. The strategies we have been using to get 3 points will now just barely allow us to meet the prerequisite.

In the second, Jeff Echols tweeted about changes to EPA Regulations on lead paint. The immediate change is a new, more comprehensive brochure entitled “Renovate Right: Important Lead Hazard Information for Families, Child Care Providers, and Schools“. By 2010, additional training and certification will be required for all lead abatement projects, and several techniques will no longer be permitted. Curtailing the aerosolization of lead particles by requiring HEPA filters with sanders is one of the techniques affected. Additional information from Remodeling Magazine or from law firm Holland and Knight.

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.

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.]

Without providing a timeframe, GEC says simply ‘soon’. Given the hellacious market conditions, most GPs or LPs are probably just trying to keep above water (or no more than 3″ below the surface). Certainly I’ve become much more skeptical of GP claims about pending payments and improved performance. Until we finish triaging portfolios, I’m not sure we will see an increase in portfolio reporting requirements. Once that process is complete, probably by 2Q 2009, we’ll need to start working on financial stabilization or exit strategies for properties. At that point, I think there is a tremendous role for sustainable analysis to play.

In that vein, here are a couple of articles inspired by recent postings at Globest.com. Globe Street is terrible about their paywall, so I’ll link directly to the source material where possible. CalPERs announced on November 30th that its real estate partners reduced energy consumption in 2007 by 13%, partway toward their goal of a 20% reduction in energy use by 2009. The primary vehicle is the Hines Green Development fund, which currently has $725mm for promotion of sustainable real estate holdings. The methods identified by CalPERs are standard steps any responsible owner should be taking such as low-flow and sensor-operated fixtures, recycling programs, and preemptive, onsite water treatment.

The more important (and actually reported) article discusses a new CA law mandating utilities to maintain an Energy Star Portfolio Management Database for all non-residential properties in CA. Contained in Assembly Bill 1103:
1) Requires electric utilities, beginning January 1, 2009 and upon the written request of the owner or operator of a nonresidential building, to provide the owner or operator monthly energy consumption data for the building in a format that is compatible for uploading to the US Environmental Protection Agency’s (EPA) Energy Star Portfolio Manager.
2) Requires electric utilities, beginning January 1, 2009 and upon the written authorization of a nonresidential building owner or operator, to upload monthly energy consumption data for the building to ESPM.
3) Requires an owner or operator of a nonresidential building, on and after January 1, 2010, to disclose to a prospective buyer, lessee, or lender the ESPM benchmarking data and scores for the building.

Writes Globest’s Brian K. Miller:

One year from January, anyone looking to buy, finance or lease an entire building will be entitled to obtain the building’s Energy Star Portfolio Manager benchmarking data and ratings. The Energy Star program rates buildings on a scale from 1 to 100 against other buildings within its class. Buildings within the top quartile will be eligible to be recognized as an EPA Energy Star Building and can use the “Energy Star Label” to communicate its energy efficiency to tenants, lenders, and other stakeholders.

Obviously buyers and owners do this kind of comparison already, but with the addition of the Energy Star scoring, all parties will be in a position to both analyze and act upon energy efficiency opportunities rather than passively accept the consumption rates.

My East Coast bias won’t allow me to say that most initiatives begin in California, but by sheer market size, these requirements or requests for information are likely to start moving east in the next 18-36 months.

The DC-based Equal Rights Center, which focuses on Fair Housing and ADA compliance, sued Trammell Crow Residential in June 2008. In a September 2008 article in MFE, prior recipients of ERC actions were criticized for quickly settling. “From an industry perspective, the Archstone folks didn’t raise any of the legal or factual issues or put up a fight. They entered into a settlement that many of the companies in the industry said they would never do.”

Trammell Crow Residential agreed to fund a 10-year, $1.5mm program with ERC to aid multifamily developers with compliance issues. Additionally, Trammell will rehab 4,500 units by improving accessibility.

(Via Multifamily Executive.)

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.

Equity and debt availability (or its perception thereof) was at the lowest confidence in over 10 years. Unable to read this in table form, I threw together this quick graph for further analysis. Looking at the history of the survey (50 is neutral) sentiment for debt and market tightness moved inversely until October 2006 when everything fell of a cliff.

The survey measures investor sentiment so it imperfectly reflects debt and equity availability. The Q2 MBA survey of commercial and multifamily originations has more quantifiable data. In that survey, commercial and multifamily originations were down 63% over Q2 2007 and fell to their lowest level since Q1 2004.

Quarterly reports from Q3 2004 onward.

Echoing this falloff was an item I saw in MBA Newslink on October 30th providing this summary of an RBC report:

“Fannie Mae and Freddie Mac continue to finance 80 percent to 90 percent of multifamily transactions across different regions of the country, supplemented mostly by local and regional banks, RBC reported.”

I’ll guess that any non-conforming deals simply cannot be done at any reasonable LTV these days. I’m still looking or the RBC report but please send it along if you have a link.

HT: Multifamily Executive