Despite Congressional assault, fundamentals remain strong for affordable housing. But many worry that when the LIHTC sunsets in 1997, affordable housing may face a rocky future.
Except for a vote in the House Ways and Means Committee to support Chairman Bill Archer's (R-Texas) $28.8 billion omnibus tax bill, it was a sizzling year for Low Income House Tax Credits (LIHTC), the federal program responsible for the creation of approximately 100,000 units of multifamily housing each year in the United States.
The rising interest rates, which took their toll on the tax credits market last year, stabilized in 1995, and the real estate industry generally reported a moderate comeback nationwide. In short, the real estate fundamentals for affordable housing remained strong, industry analysts say.
"The market is very competitive as it stands right now," says Wendell Johns, vice president for housing investment at Washington, D.C.-based Fannie Mae, which was expected to invest some $100 million in affordable housing in 1995. "The proposed sunsetting of the LIHTC in 1997 is making this market even more intense."
Even Rep. Archer's proposal, which would change LIHTC from a permanent program to a program that would require Congressional approval annually after the sunsetting of the LIHTC on Dec. 31, 1997, failed to deter industry players from plowing ahead with their investment, lending and development plans in the area of affordable housing. Those in the industry say the LIHTC program is not going to disappear and is here to stay in one form or other.
"It's the only program in America that is helping to create affordable housing, and it's one of the best examples of public/private partnerships," says J. Michael Fried, president and CEO of Related Capital Co., a New York-based real estate financial services firm that has financed more than 37,000 affordable housing units in 350 projects since 1987.
Thomas J. Kemper, vice president and managing director of Pacific Harbor Capital Inc., Portland, Ore., agrees that the LIHTC is a valuable program.
"Pacific Harbor Capital (PHC) invests exclusively in projects funded with low income housing tax credits as provided under Section 42 of the Internal Revenue Code," Kemper says. "PHC vigorously opposes the sunset of the credit. We believe it is a very successful program which promotes public/private partnerships."
Kemper says the administration of the program now has been delegated primarily to the states.
"We have a concern because there is no other program available to provide assistance for moderate-income people," says Robert Gould, vice president and chief underwriter for Reilly Mortgage Group, McLean, Va. "There is nothing out there to replace it."
Gould points out that affordable housing is not just for low-income people or people without jobs. "These are school teachers, policemen, secretaries and truck drivers." The LIHTC allows those people to pay a lower percentage of their income for housing, giving them more money for their families.
"It's just giving them a little help, and they need it," Gould says.
Other financing programs
Two weeks after the vote in the House Ways and Means Committee, Related Capital, which has $6 billion of assets under management, and Boston-based Bank of Boston Corp. jointly launched an innovative fixed-rate financing package for developers to cover construction, bridge loans and permanent and equity financing for projects benefiting from the LIHTC program.
Fried says the joint-financing program reflects maturity and efficiency of the affordable housing market.
It will serve as a "one-stop shop" for construction, bridge loan, permanent financing and equity financing, Fried says, adding that developers had to deal with various entities to secure a loan in the past.
"Now, it can be done with a single source. It's very important to eliminate duplication efforts," Fried says. "The entire loan process from the time of contact to the finish can now be completed within 60 to 90 days as compared with 90 and 120 days in the past. If we cannot do that, we should not be in the business."
The Patrician Cos., Bethesda, Md., offers financing under a variety of programs for affordable housing. Besides LIHTC projects, "we are also actively involved with Fannie Mae in providing credit enhancement for tax-exempt bonds, including refunding of pre-1986 and post-1986 bond issues and enhancing new tax-exempt bond issues," says Cathy Pharis, vice president at The Patrician Cos. "Patrician also continues to provide loans under the FHA mortgage insurance programs."
Another new financing program which has recently appeared on the scene is called Secure (Single-Source Commercial Underwriting of Real Estate). Developed by KeyCorp, a Cleveland-based commercial real estate lender, the Secure program allows developers to qualify for four different types of financing (construction, gap, equity and permanent financing) with a single application. Therefore, more high quality housing is available in lower-income neighborhoods.
Changes in the industry
Fried, of Related Capital, observes two major changes in the industry: first, there has been an increase in awareness of tax credits on the part of large multi-national companies; and second, there has been a significant shift from equity to debt business, or to combine both debt and equity.
Fried's Related Capital, which ranks as the nation's leading syndicator of low-income housing tax credits, provides loans for 75 units or more, and the average loan sizes exceed $2 million.
Under the tax credits, investors put money into taxable limited partnerships that must invest in properties that qualify as affordable housing units and must remain affordable for 15 years.
In return, individual and corporate investors receive a direct dollar-for-dollar reduction of federal tax liability from all sources of their income. Some restrictions apply."It's a program that a lot of companies should took at to reduce tax liability and do something good socially at the same time," says Jeffrey Perrone, a tax partner at the Boston office of Deloitte & Touche LLP.
Although yields have gone down from the high teens to the low teens in recent years, the market has become more efficient since the LIHTC was made permanent in 1993, Perrone says.
He also says annual returns on investments in affordable housing currently range between 12% and 13% on the upper end and 8% and 8.5% on the lower end.
Shekar Narasimhan, president and CEO of Washington Mortgage Financial Group Ltd., a Vienna, Va.-based commercial real estate lending firm, says he has been seeing three swift changes in the industry: competition for credit, a shift from mixed-income to low-income and a growing demand for rehab and renovation rather than just brand new construction.
"In earlier days, there was not much competition for credit. Now there is an overabundance of people who want to do it," Narasimhan says. Therefore, he continues, there is a shortage of credit, and the requirements for credit have gone up.
Unlike the 1991-94 period that saw mostly new construction, the 1995-96 era is seeing rehab and infill locations tied to tax-exempt bonds, Narasimhan says.
"Rehab projects have different kinds of risk characteristics because they have to be done on existing housing," Narasimhan says. "They're done in phases and have down periods. Rehab also takes a very special kind of expertise. It's also changing where affordable housing is happening now."
Most of the rehab work is taking place in inner cities rather than suburbs where new construction still dominates the market, Narasimhan says.
One new renovation project getting started in Atlanta is Progressive Redevelopment Inc.'s (PRI) renovation of the downtown Imperial Hotel. PRI has closed the construction financing for the project; it plans to redevelop the hotel as 120 units of affordable housing for individuals earning less than $20,460.
"Quality affordable housing in the heart of downtown is our goal," says Bruce Gunter, president of PRI. "This is a great victory for all who care about affordable housing, historic preservation and downtown."
Bill Szymczak, who is executive vice president of San Francisco-based TRI Financial Corp., says he is more worried by the threat of ending other financing programs besides the LIHTC which would hurt existing affordable housing.
"With affordable housing nationwide, the greater threat by far is not new construction, but terminating other programs that reduce existing housing," Szymczak says. He adds that as many of the programs for existing housing are threatened, many more projects would be lost as low income housing.
Tax credits still drive industry
Tax credits, however, still drive the new construction sector.
"It's a very active market. It has grown dramatically," Narasimhan says. "One-third of all new housing starts are driven by tax credits."
Of all the 250,000 multifamily housing starts in 1994 nationwide, 100,000 units were created under LIHTC programs. The remainder were earmarked either for sale or for conventional rentals. Since its enactment in 1986, LIHTC has financed more than 700,000 units of affordable housing, according to the Affordable Housing Tax Credit Coalition, Washington, D.C.
In addition, the demand for affordable housing seems to be stronger than at any other time in recent history.
Narasimhan said his firm is expected to lend approximately $700 million for multifamily housing in 1995, and some part of that will go toward financing affordable housing.
"We set 10% of total lending toward affordable housing," he says. "We hope to have $50 million to $60 million in affordable housing this year."
Hattie Dorsey, president and CEO of Atlanta Neighborhood Development Partnership Inc., an Atlanta-based non-profit housing and economic development agency, says that obtaining financing is becoming harder and harder, especially by not-for-profit organizations.
Financing low-income projects
"Financing for multifamily, affordable housing is difficult unless it's organized by a private sector developer who understands how to make affordable housing work," Dorsey says. "Sometimes the cost of financing will kill the deal too. By the time everyone gets his fees, it's no longer affordable."
The problem becomes more severe in lining up financing for affordable housing projects in center or inner cities, Dorsey says.
"There is unwillingness in the business community to take a risk in financing multifamily even though we have demonstrated that these units are more likely to lease up than units outside center city," says Dorsey. "There is always a feeling that it will work more readily in the suburbs than the inner city. We need the financing community to finance housing in the inner city and center cities and not to see it as an adverse risk."
Some industry studies predict a phenomenal growth in demand for afford, able housing on the lower-income end and in inner cities.
According to a 1995 report on the state of the country's housing from Harvard University's joint Center for Housing Studies, the number of renter households with incomes of $10,000 or less has increased to 10.1 million from 7 million during the last two decades. During the same period, the number of homeowners with incomes above $50,000 has expanded to 17.9 million from 9.2 million.
"These trends have lowered to 40% of the homeownership rate for households with incomes of $10,000 or less," the re port says.
Based on current trends and data, industry analysts say there is a demand for between 1 million and 2 million units of affordable housing in the country.
"The greater demand for affordable housing is in the middle range of incomes between $10,000 and $25,000 per house-hold, says William B. Kaplan, chairman of Senior Lifestyle Management Corp., a Chicago-based developer, owner and operator of senior housing communities and affordable housing.
"As soon as you break ground, there is a long waiting list," Kaplan adds. "There is a tremendous need for affordable housing."
For example, he says, a waiting list of affordable housing seekers at one of his Chicago projects has grown to 500 for a 96-unit complex, which is not scheduled to open until summer 1996. Another 86 unit complex, which opened in May, is 100% occupied, he adds.
Corporations jump into the game
But as demand for affordable housing has been growing, so has the growth in interests of developers and investors.
"As a result, there is a lot of competition for these dollars among developers. I don't know if there are any shortcomings in this program other than there is not enough money," Kaplan says.
He says the investment market has dramatically shifted from retail investors to corporations in the last two years.
"You're getting Corporate America involved. It's an immensely corporation-involved business now," Kaplan says, adding that corporations benefit the most from tax credits.
Donald Shek, a principal at Foss & Co., a San Francisco-based investment planning firm that specializes in tax-advantaged investments, cautions that while the program may sound attractive to corporations, it's not suitable for all companies.
"There is a very limited market out there for corporations who can invest in this type of program. It's an appropriate investment to corporations that are currently profitable and continually pay taxes," Shek says. "This is not good for start, up companies that don't have taxable income."
Only those corporations that can create a tax-planning strategy and use this program as a management tool should invest under this program.
"If they cannot predict taxable income, they should not use the tax credit," Shek says. "It's a long-term commitment for corporations."
Shek says financial institutions, banks and insurance companies have been very active in this area and have been benefiting greatly.
"For insurance companies, it's an alternative investment. Most insurance companies are better able to project their earnings for an extended period of time," Shek adds.
Some of the banks that have been active in this area include Columbus, Ohio-based Banc One Corp., Citicorp of New York and San Francisco-based Bank of America.
Richard J. DeAgazio, executive vice president at Boston Capital, which has raised more than $1 billion in equity from about 50,000 investors since it was founded in 1974, says between 70% and 80% of the total investments in the affordable housing industry have been purchased by corporations.
Corporations have invested about $8 billion in affordable housing nationwide since 1987, according to DeAgazio. The total affordable housing industry is about 10 billion to $12 billion.
"I would agree that more corporations are getting involved in affordable housing," says The Patrician Cos.' Pharis. "I believe a large part of the increase on the lending side of the equation stems in part from the outlet that is now available through both Fannie Mae and Freddie Mac to trade these loans in the secondary market. Also, the marketplace simply adjusted to the fact that LIHTC development represents a significant lending opportunity and created programs to fulfill the need to finance these properties."
"The investor market is very good. Corporations are aggressively investing," DeAgazio says. "They feel they are doing something very socially responsible, and they're making money while doing good."
Boston Capital is expected to raise about $93 million from private investors and approximately $122 million from corporate investors this year. In 1994, Boston Capital raised about $100 million from individual investors and $125 million from corporate investors, DeAgazio says.
In September, Boston Capital launched a $35 million offering of Boston Capital Tax Credit Fund IV, Series 25 to invest in a nationally diversified portfolio of 17 affordable housing properties in 15 states. For the Series 25, each beneficial assignee certificate, or BAC, is $10 with a minimum investment required of 500 BACs ($5,000). Additional purchases are 100 BACs of $1,000. The fund is suitable for individuals and corporations that meet certain financial criteria. DeAgazio says returns at Boston Capital are between 130% and 150% over a 10- to 12-year period.
"There are a ton of corporations coming on board," says Georgia Murray, senior vice president of The Boston Financial Group, Boston. "The biggest challenge is finding quality property." But, Murray predicts that if the government does not come back with a new program after the sunsetting of the LIHTC, about half of the corporations won't still be involved in affordable housing.
While many syndicators have either withdrawn completely or have curtailed raising investments from individual retail markets, Boston Capital has continued its focus on individual investors as well.
"The individual market is very good. It's the only finance strategy to save federal income tax. It's the last tax shelter," DeAgazio says.
"Every tax credit that is allocated is used. If a state does not use it, it goes to a national pool to be redistributed", he adds. "But it's rare that a state does not use its tax credits."
Life without the LIHTC
Although most industry players generally agree that the LIHTC is here to stay in one way or other, they insist that elimination of some direct federal subsidies and a return to annual renewal of the LIHTC could discourage some 1,000-plus developers of affordable housing and hundreds of Fortune 500 and individual investors.
When the House Ways and Means Committee voted to support the sunset of the LIHTC in September, it sent shock waves through the affordable housing market. Industry watchers say a return to yearly renewal could severely scale back corporate tax incentives and turn away developers who need long-term planning and strategy.
Alan Hirmes, president of the Affordable Housing Tax Credit Coalition, described the proposal as "shocking." Others were outraged and dumbfounded.
"This Congress is trying to undo what the last Congress did," says Dorsey of the Atlanta Neighborhood Development Partnership. "We need to keep this program permanent."
"I think that it is unfortunate that the only remaining incentive to provide equity for affordable housing is now under attack in Congress, and I would expect to see rehabilitation of substandard housing and construction of new rental housing severely curtailed if Congress moves forward with the sunsetting of the LIHTC program," says Pharis of The Patrician Cos.
National Realty Committee, a Washington, D.C. based organization involved in real estate public policy issues, says it is working to ensure that the LIHTC remains part of the 1993 tax code that made the program permanent.
"I would want to predict that LIHTC will not be sunsetted," says James Arbury, vice president at National Multi Housing Council, a Washington, D.C.-based industry organization. "It works extremely well, and it's the only program available to help build low-income housing."
Joseph Dlutowski, vice president at Palm Beach, Fla.-based Ocwen Financial Corp., says now it's much easier to find loans and raise investment capital for affordable housing projects.
That could change though if Congress makes the tax credit program annual.
"If it's made annual, it will only have a negative impact," warns Perrone of Deloitte & Touche. "The program will not necessarily go away, but a lot of companies will be looking at it. It clearly will have impact on some if they change it, but there is no reason to worry about the credit you have already bought."As for the future of affordable housing, Pacific Harbor's Kemper says it's unclear. "Lenders are increasingly offering competitive permanent loan products for low income housing tax credit projects," he says.
"On the equity side, the potential sunset of the credit creates some instability in the credit industry which simultaneously may drive some investors away given the short-term nature of the credit in the event of sunset and create a heightened bidding environment among known credit purchasers to capture the last deals before sunset. Hence," Kemper concludes. "Predicting the future in the light of the sunset is difficult."