It's been called the perfect public/private partnership - one that has made great strides in fulfilling this country's tremendous demand for affordable housing. Yet, at a time when deficit reduction is the name of the game in Washington, even the low-income housing tax credit (LIHTC) has become a target of the Congressional budget-cutting ax.

So despite the the strong bi-partisan support the tax credit enjoys in both houses of Congress as well as from the president, its termination was included in the Omnibus Balanced Budget Bill of 1996. That bill, which provoked the well-known standoff between the president and Congress and resulted in a government shutdown, not once but twice, had not yet been signed at the time of this writing.

At press time, the government was operating under a continuing resolution scheduled to expire on March 15, 1996, and the future of the low-income housing tax credit remained in doubt. Experts in the real estate industry expressed guarded optimism, however, that the tax credit provision would either remain intact or revert to a pre-1993 environment, in which Congress would need to reauthorize it every 12 to 18 months. The worst case scenario would be that the LIHTC program would be targeted for sunset, probably in December 1997.

"Our expectation is that there will not be a comprehensive budget and tax bill enacted this year," says Patrick Dober, a vice president of the National Multi Housing Council, an industry advocacy group that tracks legislation related to the multifamily industry. "As a result, the outlook for the tax credit is better than it was." Dober adds that "the good news is that this situation is a result of high level political gridlock, and not the result of debate over the tax credit itself - the tax credit is just getting swept in and out with the tide; currently the tide is out."

Ironically, it was only three years ago that Congress passed the Revenue Reconciliation Act of 1993, which made the tax credit program permanent after years of short-term extensions. The provision's permanency was credited with infusing the affordable housing arena with a virtual tidalwave of fresh capital from a host of new corporate investors. In fact, 1993 saw the biggest year ever for the industry up until that time, with $1.5 billion invested by major corporations.

Although the influx of new investors - as well as developers vying for the tax credits - has spurred competition and driven yields down somewhat, interest in tax credits has not waned among new players and repeat investors. "The rate of return is somewhere between 11 percent and 13 percent - typically companies are selling funds in the 11-1/2 to 12 percent range," notes Marc Schnitzer, executive vice president of Related Capital Company, a real estate financial services company that has raised more than $1.1 billion for affordable housing investment since the inception of the LIHTC program in 1987.

Schnitzer says that even though these yields are lower than a few years ago - when they hovered closer to 15 percent - they're still attractive, a fact evidenced by the success of Related's most recent public funds. "Last year we had a record year in terms of dollars raised for equity investment - $340 million." He adds that the type of investor attracted to low-income tax credits has been undergoing a transformation during the last year or two.

"When this first started, yields were higher, and manufacturing companies, utilities and non-financial services companies were willing to invest $10 million to $15 million dollars; they'd get a 15 percent yield and there wasn't a huge risk involved for them," explains Schnitzer. "As the yields have come down, people who are not involved in real estate finance have stepped back a little, and now the typical investors are financial services companies - either banks or mortgage lenders or insurance companies - entities that have made real estate loans in the past and understand the business of real estate finance," he says. "These companies are in a better position to assess the risk on larger average investments; typically an investor now is making a $20 million to $25 million investment, whereas two or three years ago, a $15 million investment was more typical."

Mark Hasencamp, senior vice president of SunAmerica Affordable Housing Partners, Inc., also notes this trend.

"SunAmerica is a direct investor in low income tax credit properties, but we also resell part of our interest to other corporations, so I'm familiar with the other investors out there," says Hasencamp. "The change in the type of investor has been dramatic - even just a couple of years ago, the dominant institutional investor was typically a company that was looking to reduce some of its taxes on a one-shot basis," he says. "Now you have large corporations that have investment subidiaries staffed with professionals who do nothing but make tax-advantaged investments for their companies, and they are very interested in the low-income housing tax credits."

According to Hasencamp, most of these companies would never be involved in this business if they thought of it as real estate. "That's the interesting part of this," he says. "The real estate departments of corporations are coming to this very late in the day; with few exceptions, this business has been driven by professional tax-oriented investors." Hasencamp notes this is because the tax credit is the primary benefit of the program."Investors are not looking at these properties to generate traditional real estate benefits in the same way as conventional multifamily investments - it's not the cash flow they're looking at - but the ability to reduce their federal tax liability," he says.

It's exactly the structure of the program - which is administered under IRS Section 42 - that has been lauded by private industry. Unlike many federal housing programs, the LIHTC is not a direct subsidy. Instead, the tax credit encourages the creation of low-income rental apartments by offering investors a credit against their income taxes for part of the cost of developing such housing. Investors receive an income tax credit each year for 10 years equal to approximately 4 percent of total eligible project costs for acquisition-rehabilitation projects and 9 percent for substantial rehabilitation and new construction.

The tax credits are allocated directly by the states, all of which receive tax credits annually in the amount of $1.25 times the state's population. To qualify for the credits, projects must include a set-aside of at least 20 percent of the units for households earning no more than 50 percent of the area's median income, or at least 40 percent of the units for persons earning no more than 60 percent of the area's median income. Projects often have 100 percent of the units set aside, however, because the credit is taken only on those units designated for low income use.Industry experts estimate that about 70,000 to 100,000 apartment units are created annually under the LIHTC program. Although there are some smaller subsidy programs such as the HOME program that assist:in the creation of affordable housing, they are not, says NMHC's Patrick Dober, sufficient to produce affordable housing in any volume. Dober also notes that there have been no proposals made to replace the LIHTC with another program.

"I think Congress would be challenged to find another program that meets the same needs," says Rory A. Brown, a managing director with Ocwen Financial Corporation, a financial services company that has invested more than $150 million in tax credits to support affordable hosusing properties. "We see [the LIHTC] as being one of the best programs around to facilitate affordable housing throughout the country."

According to Brown, the program got a significant boost when it was made permanent a few years back, because it gave potential investors more surety that the program would be ongoing.

"There are a lot of large, well-respected institutions that have invested in the low income housing tax credit," notes Brown. "Tax credit are an excellent investment for corporations, and that's why the market has gotten so much attention - with the tax credit you typically get a dollar-for-dollar reduction in federal taxes, it flows through to the bottom line immediately."

Although the uncertainty of the program's future has caused a ripple in the investment arena, Brown is confident in the value of current tax credit investments. "The important thing to recognize from an investment perspective is that even if the program is sunset, all current tax credits are vested and will become even more valuable. We feel it still makes sense to invest in the program."

Michael P. Alexander, vice president of NHP Inc., the largest owner/manager of affordable housing properties in the country, agrees that the market experienced a chill when talk of the program's elimination surfaced. "Corporate interest remains strong, but some companies have been inhibited by talk of a sunset," he says.

Dan Reynolds, senior vice president of The Midland Companies, a debt and equity provider for the affordable housing industry, notes that while some corporations may be hestitant to move forward with their investments, others have reacted by investing now, "while the getting is good." He says, for example, that The Midland Companies closed a $40 million fund in 1995, which sold out in about six months. In addition, Midland already has forward commitments for a fund that isn't due on the streets until April.

"We have corporations coming to us all the time, trying to invest in our funds, and there is not a [congressional] proposal at this time that would change the effective utilization of the tax credits that these corporations would buy, "says Reynolds. "If they buy them now, the tax credits will be in place - there's no threat that would take them away."

Reynolds also stresses the bottom line: The tax credits provide an attractive internal rate of return one that alternative investment vehicles are hard-pressed to beat. Most of the funds that we've issued have been at 11 percent or more," Reynolds says, adding "muncipal bonds are paying 5 percent, if that, so it's 5 percent versus 11 percent tax-free." An added advantage is that the return is stable for 10 years. "A corporation would have to earn about 20 percent on its money before taxes to equate to the same return it gets after tax with the credit," he says.

Boston Financial has had similiar success with its affordable housing funds, raising approximately $260 million from corporations in 1996. According to senior vice president Georgia Murray, Boston Financial will issue a new fund in April 1996, its 12th fund in six years. Most of the funds are in the $60 million to $80 million range and offer a portfolio of properties that are geographically and economically diverse. In 1995, Boston Financial raised between $280 to $300 million for affordable housing investment.

According to Murray, investors - as well as developers - have expressed concern over the possible sunsetting of the program, but most think it is likely that the program will survive the chopping block. "The talk of sunset has made investors look at companies like ours to make sure that we have the wherewithal and the ability to survive the sunset," says Murray. She says the fact that Boston Financial is so strong as well as diversified worked to the company's advantage In addition to being a tax credit sponsor, Boston Financial also does multifamily property management as well as asset management.

"Corporations don't invest tens of millions of dollars in a program just because it's the hottest thing out there," she says. "These corporations are very strategic and very careful about what they're doing with their investment dollars, so I don't think we've seen any mad rush for the `last train leaving the station.'" Murray also notes Boston Financial has about a 60 percent rate of repeat investors.

Although the ambivalence surrounding the program has affected the investor side of the market a little, says Murray, it's really the developers who have been impacted most.

Strong Competition for Credits

Many developers also have been affected by the rush of newcomers to break into this market segment. Most states now have two-to-four times the number of applications than tax credits available. Once the domain of very specialized "niche" developers, tax credits now attract many developers of conventional multifamily properties.

Some investors, however, prefer to work with developers who have experience in this niche market.

"We like to work with developers who've done tax credit properties before - that's the easiest way to do business" notes Tom Kemper, vice president and managing director of Pacific Harbor Capital, which is a direct investor in affordable housing projects. However, because Pacific Harbor Capital has strong in-house asset management capabilities as well as extensive tax credit compliance experience, it will work with developers who have experience doing traditional market-rate multifamily properties. "If we're in a position to control the Section 42 aspects of the project - because we've got that experience ourselves - it makes a good marriage," he says. He notes that his company is uniquely involved in reviewing the management functions of each property, to ensure that the tenants of their properties are in compliance with the strict income criteria mandated by Section 42.

Pacific Harbor got into the LIHTC business as a passive investor in 1988, and since then has become a direct investor. It currently has about 4,200 units in 15 states, having invested about $25 million in equity. Pacific also helps finance debt, and is in the process of developing a "package loan" product that would provide both debt and mortgage financing for LIHTC properties.

"I think one of the biggest concerns for developers right now is getting debt and permanent financing at reasonable rates," says Kemper.

In October, Related Capital Company announced that it had formed an alliance with the Bank of Boston to offer a streamlined integrated financing package for LIHTC projects. The fixed-rate financing program provides construction, bridge, permanent and equity financing.

"We had found that fixed-rate financing was the one difficult piece of putting together these projects," says Denise Kiley, an executive vice president of Related Capital. "This program will allow developers to lock in fixed-rate financing upfront - they won't have to wait until the property is leased up."

Strategic alliances such as these fill a significant need within the affordable housing arena, and are becoming more commonplace. Multi Family Capital Markets, which specializes in permanent financing for properties that have low-income housing tax credits associated with them, has arranged a partnership with SunAmerica Housing Partners, for example, to provide permanent debt financing. According to senior vice president Mike Sugrue, Multi Family Capital Markets has typically provided approximately $120 million annually in permanent financing and will have considerably more than that on the books in the future. It has already agreed to provide SunAmerica with approximately $400 million in permanent debt over the next two years.

Programs such as these indicate that the outlook for debt financing is now quite good, even though it lagged behind the equity side in the early years of tax credit deals. Industry professionals note that lenders see these projects as a way to comply with community lending requirements under the CRA, and also that the risks are minimized due to the amount of equity brought to the table up front.

NHP's Mike Alexander notes that the real difficulty comes not in securing financing, but in locating suitable projects right now. "Capital is readily available for feasible projects," he says, "the challenge is finding quality tax credit product.

"We have an experienced quality development team, and we know that it's a balancing act," says Alexander. "So we look for a balance sheet that is conservative and reasonable and for long-term fixed rate financing so that there's not a lot of leverage to burden the deal on the debt side," he says. "We also look for an affordable development where there is a reasonable income and expense forecast - it's our knowledge base that crushes a lot of deals because we won't buy deals that have unrealistic income or expense forecasts."

Developers with strong experience doing tax credit deals know that local market knowledge is a critical element to the mix, because of the unique tenant criteria mandated by the tax credit component. The fact that residents of LIHTC properties must be able to afford the rents, while not exceeding established income limitations, narrows the potential renter pool, so developers must be sure that the local market can support these projects.

"We only want to work with developers who have a good track record for building these products, and who know how to run them," says Jim AcAuliffe, president of John Hancock Realty Advisors Inc., a subsidiary created by John Hancock Mutual Insurance Co., to participate in the affordable housing tax credit market. John Hancock Realty Advisors issued its first fund in June 1995, which was fully invested by its parent company. Its second fund will be issued by the end of March 1996, and will have at least $200 minion of equity and $150 million of debt to place. He also says that the key to Hancock's fund is that it will be offering both debt and equity to the developers.

"When a developer calls us up, there will be an acquisitions officer who will do both the equity and debt structuring," notes McAuliffe, who says that the ability to offer both equity and debt "under one roof" is the most efficient and developer-friendly way of doing deals. McAuliffe also stresses the need to consider the underlying asset in all tax credit transactions.

"We look at every single deal as a pure real estate deal," he says. "We can underwrite the tax credit side in very little time, but we really spend a great deal of time underwriting the real estate deal, because if it's a good real estate deal, the tax credits are just a bonus," he says. "Just because a developer has been allocated the tax credits doesn't make the project a fundamentally sound investment."

"The tax credit provides access to financing, but you may not be in the right market," agrees SunAmerica's Hasencamp. "In a traditional multifamily development, if your costs increase, you try to get more rent," he says. "But in a tax credit situation, you may be already at the maximum rent that you can charge, so you can't increase your revenue to match the increasing costs. Therefore, the equilibrium between revenue and costs is even more critical in an affordable housing property."

Mike Alexander says that this is one reason NHP Inc. often tries to obtain additional subsidies for LIHTC projects. "We prefer to do deals that have state or federal favorable financing components," he says, either in the form of grants or real estate tax abatements, or some other for of "soft" finance. "It's our experience that these products have a better track record than just conventionally financed apartment developments," he says.

Even with the strict criteria for renters and the inherent difficulties of developing projects with the right renter pool in the right market, almost all housing industry professionals agree that the tax-credit program has been tremendously beneficial to this country, producing affordable housing apartment units in unprecedented numbers. And with investor interest remaining strong and the need for affordable housing continuing to be great, the future of the program looks promising - if Congress decides to keep the LIHTC intact.