October 2007 VOL. 2

Affordable Housing:

Tax credit pricing drops as tax-exempt bond rates increase

Nearly 95 million Americans struggle with housing affordability, according to the National Low Income Housing Coalition, yet financing affordable housing projects grows more difficult and complex on a daily basis.

Over the past 12 months, pricing for low-income housing tax credits (LIHTCs) has decreased by as much as 20 percent, making it harder for developers to get affordable housing projects to pencil out. The pricing change also is creating some angst for LIHTC sponsors and syndicators. Even worse, the turmoil in the bond markets has caused rate increases on tax-exempt bonds (TEBs), also impacting developers' ability to finance projects.

"Affordable housing is definitely not for the faint of heart right now," says Kipling Sheppard, president of Wasatch Advantage Group, a Mission Viejo, Calif.-based affordable housing developer and owner. "We've been impacted by the fluctuations with tax credit pricing and bond rates. But the good news is that we've also seen construction costs and land prices stabilize because there's not as much demand from single-family home builders and condo developers."

After the market correction

Last fall, LIHTCs were priced from the high 90 cent range to $1.07 per credit; today, credits are priced anywhere from the high 80 cent range to high 90 cent range.

"I've been in this business for 15 years, and this is the biggest swing I've ever seen," says Carl Wise, senior vice president of Alliant Capital, a Los Angeles-based firm that has provided $2.9 billion in equity through its affordable housing funds. "Some affordable housing projects that worked six months ago donÍt work now."

Experts say the decreased tax credit pricing is, quite simply, a function of supply and demand. Previously, demand from LIHTC investors was much stronger and such strong demand caused the market to become overheated. "Yields on tax credit investments had become so low and the pricing had become so high, we were due for a market correction," says James Mendelson, managing director of GE Real Estate.

By historical standards, pricing for LIHTC is still pretty high. In fact, earlier this decade, LIHTC were in the low 80 cent per credit range, below where pricing is today. But, in the last six to 12 months, yields available to investors have increased from roughly 4.75 percent to somewhere between 5 percent and 5.25 percent. (The increase in yield translates into a lower price per credit paid to the developers and sponsors.)

"The yields that were being obtained just weren't that attractive to investors," says John Faust, president at Horizon Development Group, a Madison, Wis.-based company that focuses on affordable housing for seniors. The company has developed 1,300 affordable housing units for a total value of $83 million.

The yield derived from investing in affordable housing is a function of the tax losses and the tax credits available to the owner. "The real motivation is the dollar-for-dollar tax deduction you get when you invest in tax credits," Wise explains, adding that many of the Fortune 500 invest in Alliant's affordable housing funds. Verizon Wireless, for example, is one of the firm's biggest investors.

Like Verizon and many corporations, GE Real Estate has ramped up its investments in affordable housing over the past three years. This year, the company will invest a record $500 million in affordable housing by investing with sponsors in funds and by purchasing LIHTC directly from developers.

Now that tax credit pricing has softened, Mendelson predicts that GE Real Estate's affordable housing investment volume will increase by 20 to 30 percent next year. "These are profitable investments for GE," he says. "Despite the fact that these are equity investments, they provide an annuity like income stream? as long as certain threshold dates and other criteria are met you get the credits you signed up to buy."

Filling the funding gap

While the lower prices might encourage more LIHTC investment, they're causing some bumpy times for developers. "Developers need a level of certainty to do affordable housing, and if tax credit pricing is bouncing around, that can create a funding gap they might not have expected," explains Jeff Goldstein, executive vice president and COO of Boston Capital Corp, which is involved in both market rate and affordable housing. This year the company expects to raise and invest $600 million in equity in LIHTC.

The impact of decreased pricing isn't just limited to developers. The sponsors and syndicators that aggregate tax credits are also vulnerable to the pricing fluctuations. "The sponsors may have commitments to buy credits from a developer at a certain amount, but they may not be able to sell those credits at the price they expected," Mendelson explains.

Wise acknowledges that decreased pricing means thinner margins for his firm and other syndicators. To offset the thinner margins, Alliant has focused on improving efficiencies internally.

Developers have responded to the pricing change differently ? by seeking new sources of funds or by decreasing project costs. For example, it's common for developers to seek financial assistance from local municipalities, to renegotiate land prices and to hammer out better deals with sub contractors to make a deal work today.

Ultimately, most affordable housing projects today are financed by a combination of LIHTCs, tax-exempt bonds, grants and local government loans, Sheppard says. Wasatch Advantage Group, for example, used $8.3 million in tax credits, as well as $11.9 million in permanent debt and $3.2 million from San Diego County to acquire and transform a 136-unit market rate complex into affordable housing. Currently, the company has about 1,100 units under development or renovation that are being financed by $45 million in LIHTC and about $73 million in tax-exempt bonds.

"There are several layers of financing in these deals," Sheppard says, "and counties and cities have to fill in the gaps that are created by the market fluctuations." He points out that many municipalities have become very aggressive in pursing affordable housing and have made it a goal to become better educated on different financing structures so they can help developers.

"This is a big change that has happened over the past two years," Sheppard says. "Their participation can make the difference between a deal working and not working."

Wasatch Advantage Group hopes to tackle more acquisition and rehab projects in 2008, especially in urban cores where land is expensive and hard to come by. But, the current conditions are making it hard to create pro formas. "One day, we're underwriting to one tax credit price and bond rate, and the next day we're underwriting with completely different numbers," Sheppard says. "Developers are taking on the brunt of the risk right now."

But, experts are predicting a plateau in the market, at least when it comes to LIHTC prices. "It seems like the market is stabilizing so I don't foresee any major swings for 2008," Wise says.