October  2009 VOL. 2

Affordable Housing:
Agonies, Stimulus helps, but can't fix scarcity of investors

Although affordable housing developers are making good use of the funds offered through the American Recovery and Reinvestment Act, the stimulus money for the low-income housing tax credit (LIHTC) program will likely run out in early 2010, and experts say new legislation is needed to spur investor interest in LIHTC and to prevent affordable housing projects from stalling across the nation.

In fact, a new study from global consulting firm Ernst & Young suggests that there are likely to be 90,000 construction jobs lost and 60,000 fewer affordable rental homes produced nationwide without additional investment in LIHTC. The study was commissioned by Enterprise Community Partners Inc. and Local Initiatives Support Corporation in order to better understand the LIHTC investment market and to analyze investor responses to certain legislative proposals.

“I don’t want to be a total pessimist, but if you take a sober look at the market today, it’s very difficult and things need to change or we’re going to be in a lot worse shape a year from now than we are now,” says Bruce Gunter, CEO of Progressive Redevelopment Inc., a Decatur, Ga.- based affordable housing developer.

Gunter’s firm expects to receive about $1 million in federal stimulus funds to move forward on a 90-unit affordable housing project in northwest Atlanta. He plans to break ground this month on the project, which will house low-income seniors.

“Without the stimulus money, my deal would have been busted,” Gunter says. “It’s a lifesaver.”

Few equity investors

Since the inception of the LIHTC program in 1986, more than 1.7 million affordable apartment units have been developed. The program allows developers to replace a portion of their development costs with third-party investor equity. Private sector investors are compelled to invest through the receipt of the tax credits which, coupled with depreciation deductions, provide them with an acceptable economic return on their investment.

For the first few years of the LIHTC program, the vast majority of the equity capital came from individual investors, whose investments were pooled in funds raised and managed by syndicators, which made investments in affordable apartment communities. However, institutional investors began to dominate the market in 1994, accounting for the majority of investment capital.

For example, Fannie Mae, Freddie Mac and the 25 largest commercial banks in the United States provided as much as 85 percent of all the housing tax-credit-equity capital raised over the past several years. However, the recession has exacerbated the already dwindling investor base in the tax-credit-equity market.

Several active investors have been forced to leave the market permanently, and others have been sidelined due to liquidity constraints, or because they no longer seek tax shelter due to lack of profitability.

The E&Y study found that total equity volume this year will reach only $4.5 billion if no additional housing credit stimulus legislation is passed. This number represents a 34.5 percent decrease from 2008 levels, which itself represents a 14.8 percent decrease from 2007.

The scarcity of tax credit equity has caused a decline in the price per $1 of tax credits, reaching an average net price per credit of $0.74 in 2009, according to E&Y. “Nowadays, if you can get 60 cents on the dollar, people think you are doing well,” says Kevin Kelley, president of Leon Weiner & Associates, a Wilmington, Del.-based developer that specializes in affordable housing. “There are too many credits chasing too little equity.”

And, although tax credit pricing has clearly declined on a national basis, the drop has been geographically disproportionate due to stronger investor demand in some markets, and a lack thereof in others, the study says.

Gunter’s project, for example, received $8 million worth of LIHTC to help build a $12 million project. However, investor interest in the credits dropped sharply from the time the credits were allocated (late 2008) and when they were sold (mid-2009). He received only 70.5 cents for every $1 credit, and Gunter was forced to apply for stimulus funds.

“That’s a deal killer,” Gunter says. “You can’t expect $7 million of equity and end up with only $5 million. You just can’t cut costs enough to make up for that.”

Investor demand also varies depending on the type and size of affordable projects. For example, Baltimore, Md.-based Montgomery Housing Partnership is currently working on a small redevelopment project and had a “terrible time” finding investors for its tax credits, according to the organization’s president Rob Goldman.

“Investors are picking the projects they want to do, and our small project is just not worth their time,” Goldman says. “We had to go to the state and ask for funds from the Treasury’s Exchange Program.”

Funding the shortfall

The American Recovery and Reinvestment Act includes two provisions that assist the LIHTC program: $2.25 billion for the Tax Credit Assistance Program (TCAP), and the ability of housing agencies to exchange certain tax credit allocations for cash from the Treasury (Section 1602 Exchange).

Both provisions accomplish the same thing—they make up for the shortfall created by the decreased equity value of the tax credits, according to Dennis Shockley, executive director of the Oklahoma Housing Finance Agency (OHFA), the only LIHTC allocator in the state.

TCAP is administered by the Department of Housing and Urban Development and each state has received a specific amount of funds. Oklahoma, for example, received $26 million in TCAP funds, and the OHFA allocated the full amount in late September.

Meanwhile, the 1602 Exchange program is handled by the U.S. Treasury Department, and developers can “cash in” their credits for 85 cents per $1 credit.
 
“We are in a situation where more than half of the affordable housing projects are unable to find credit buyers,” says Gary Downs, a partner with Pillsbury Winthrop Shaw Pittman LLP and co-leader of the firm’s affordable housing and community development team. “The two stimulus provisions are allowing a lot of those projects to move forward.”

However, experts estimate that 5 to 10 percent of developers who have been allocated LIHTC are not receiving any stimulus funds even though they’ve been unable to find equity investors. Some of them haven’t even bothered to request assistance. For example, of the 19 Oklahoma-based developers who received LIHTC allocations in late 2008, 15 of them are requesting additional funds through TCAP or the 1602 Exchange program, Shockley notes.

But, the stimulus funds present their own challenges, says Judy Calogero, CEO of the New York Housing Conference and former housing commissioner for New York. “Yes, it’s great to have these programs, but using these funds make the deals much more complicated,” she contends, pointing out that using TCAP funds could increase development costs as much as 30 percent, create more tax issues for investors, and throw off more losses from depreciation.

Moreover, the stimulus funds have forced state housing agencies to take on new responsibilities —they are now administering federal funds instead of just tax credits. “We’ve had to complete new underwriting with no additional administration fees from Congress, and we’ve had to step up and take on the role of syndicators and asset managers,” Shockley says.
 

Legislative help

Congress has not turned a blind eye to the struggles facing the affordable housing industry. In fact, there are currently four legislative proposals under discussion:

1. Five-year carry-back: would allow investors with existing investments in housing credits earned between 2009 and 2011 (from pre-2009 investments) to carry those credits back for up to five years in exchange for a binding commitment to reinvest the funds in new housing credit investments made during the same period. Additionally, the statute would provide that credits earned from new project investments in which credits are first claimed after 2008 could be carried back for up to five years at any time during the 10-year tax credit period for such investments without a requirement that any refund from such carry-backs be reinvested in the program;
2. Accelerated credit: a proposal that would allow for an accelerated credit delivery period;
3. Passive loss relief: a proposal that would liberalize the passive loss rules to permit individual investors to join corporate investors in the market;
4. Exchange extension: a proposal that would extend the current credit exchange program, which allows states to convert credit allocations to grant dollars.

The main objective of the first three proposals would be to increase investor demand for credits. The fourth proposal would continue to absorb “excess” supply of housing credit projects, thereby closing the financing gap for many stalled housing credit developments and accelerating the re-stabilization of the market.

As part of the E&Y study, the firm surveyed tax credit investors, and they indicated that having the ability to carry back their housing credits for up to five years would be their preferred alternative. In fact, the company predicts investment would increase significantly in the near term if Congress were to enact this legislation—a $5 billion increase nationally through 2011 (14 percent more this year, 49 percent more next year and 47 percent more in 2011).

Under current law, a taxpayer can carry unused housing credits back for one year and forward for up to 20 years. In light of the economic downturn, this one-year limitation on credit carry-back appears to be less attractive to many investors, particularly for those that have recently experienced net operating losses, according to the study.

“I believe in the resiliency and creativity of the syndicators, and it’s in their best interest to try to make some changes so the tax credits will become attractive again to corporate investors and even to individual investors,” Kelley says. “But things are going to remain very challenging, if not painful, for the next 1-1/2 to two years, and maybe even longer.”