The weather is grim. The retreat of several leading low-income housing tax credit investors brought with it a heavy fog, leaving a shroud of uncertainty over the usually sunny world of tax credits.
So what kind of season is in store? An unsettled one, if early 2008 is any indication. The price per dollar of tax credit for developers fell, while yields to investors rose over the last several months. The hope is that higher returns will combat the sagging demand of investors and push new ones to buy tax credits, but the lower pricing hurts developers who need every penny to make their deals work. That ultimately may mean fewer affordable housing developments are built.
It is anticipated that Fannie Mae and Freddie Mac will either sit out or reduce their LIHTC investing this year, and banks are facing losses because of the turmoil in the mortgage market, which could reduce their need for tax credits.
“It's all about equity in 2008 … will there be enough … will the market diversify … how will risk-based pricing impact different kinds of deals in different kinds of markets?” says Joe Hagan, president and CEO of the National Equity Fund. “There is an awful lot of uncertainty within financial and housing markets generally. We will most certainly feel that in the LIHTC [market] as well.”
Indeed, the price per dollar of credit averaged about 93 cents in the fourth quarter of 2007, according to a survey of LIHTC syndicators conducted by AFFORDABLE HOUSING FINANCE. That's a notable fall from the nearly 97 cents average reported a year earlier, and prices were expected to drop further. Yields were in the 5.3 percent range in the fourth quarter and climbing.
Syndicators, too, formed their own Greek chorus, sounding a warning of what may lie ahead and offering similar advice for LIHTC developers in early 2008: “Developers should expect a lower price per credit and more stringent deal terms, particularly around guarantees and reserves,” says Michael Riechman, director of investor relations at Apollo Equity Partners, a division within RBC Capital Markets. At Enterprise Community Investment, the advice is to be conservative on pricing expectations. “Be prepared to improve the underwriting presentation of the deal as this will be necessary to ultimately place the deal in a scarce equity market,” says Paul Cummings, senior vice president of tax credit syndication at Enterprise Community Investment. In deals with challenging underwriting issues, LIHTC prices could drop as much as 10 cents or more from where they were a year ago, Enterprise officials said.
“Developers need to be realistic both in their project planning and in managing key relationships related to their deals. There are just fewer dollars to go around, and most syndicators and investors will be focusing on their key customers and critical markets over the next 12 months,” NEF's Hagan explains.
And it's not just pricing. Syndicators expect 2008 to be unlike all prior years in other ways. “There is a ‘flight-to-quality' element of the current market, which means investors are looking for the highest of quality, from the qualifications of the development team to the strength of the rental market and the structure of the deals,” Riechman says.
Several state agencies have initiated discussions with LIHTC syndicators about allocations in the current market, resulting in some good ideas, Riechman adds. For example, some states are considering changing their application processes to accept soft commitment letters for tax credit equity. Other ideas that may be explored include raising the cap on the amount of credits that a project can receive and removing or adjusting deep targeting requirements.
Still, despite the gloomy forecast, syndicators see some potential bright spots on the horizon. “With internal rates of return rising, we may see non-bank investors return to take a look at LIHTCs in a way that they haven't for many years,” Hagan says. Some syndicators estimate that yields would need to approach 7 percent to entice new corporate investors.
While some investors are expected to pull back from the market, others may increase their volumes, says Carl Wise, senior vice president at Alliant Capital, who adds that the volume of secondary-market activity will likely decrease. Until then, the forecast remains cloudy.
Donna Kimura is deputy editor of AFFORDABLE HOSING FINANCE, MULTIFAMILY EXECUTIVE's sister publication.