The low-income housing tax credit market (LIHTC) holds a distinct place in the multifamily world.

While the industry is rooted in government support, it’s also a vastly successful illustration of robust public/private partnership. And in stark contrast to market-rate deals—where debt comprises most of the capital stack—LIHTC developments are funded mostly with equity.

Yet the debt financing needs of LIHTC owners and developers are also distinct, and can’t really be found in the private sector.

Long-term fixed-rate debt is absolutely critical to an industry that must contain costs during a 15-year compliance period. Yet the private sector struggles to offer what Fannie Mae, Freddie Mac, and the Federal Housing Administration routinely deliver—mostly because the private sector doesn’t issue debt wrapped in a government-guarantee.

Most banks, or any private sector balance-sheet lender, often won’t go beyond five- or seven-year loans—they have no appetite for loans of 10-years or longer. And the private securitized debt world beyond the agencies offers little help, since most investors on the secondary market balk at buying 15-year paper.

“If you took away all government guarantees for apartment finance, you would find the debt market for tax-credit deals shrinking rapidly,” says David Abromowitz, a Boston-based senior fellow at Washington, D.C.-based think tank Center for American Progress (CAP), and a partner at the law firm Goulston & Storrs. “History shows that private capital will not buy 15-year or longer apartment loans in any volume. But you really wouldn’t have a healthy tax-credit market on the 9 percent side without long-term financing.”

Some people argue that market-rate developers don’t really need the GSEs, that the private sector can serve their needs. But few would argue that the LIHTC world could thrive without a government guarantee. When it comes to GSE reform, the LIHTC industry may be the exception to the rule.

The market for tax-credit equity, as well as construction debt, is also directly affected by the availability of low-cost permanent debt. Most banks are active LIHTC construction lenders, driven by the Community Reinvestment Act. Yet the availability of a permanent loan takeout on the back-end of a construction loan affects a project’s front-end financing as well.

“The question is, are you comfortable beginning your construction not knowing what your permanent debt situation is?” Abromowitz asks. “The tax-credit investor can’t take the risk that at mini-perm maturity, there won’t be a long-term takeout.”

And the tax-exempt bond (TEB) world—the 4 percent LIHTC market—also has a gaping need for the GSEs. Both Fannie Mae and Freddie Mac have played key roles in the TEB credit enhancement market, and continue to do so, as the New Issue Bond Program shows. That credit enhancement helps to attract bond buyers, giving a peace of mind in taking long-term risk.

“If you lose the bond programs and the credit enhancements, then you’re talking about having to rely upon S&P and Moody’s,” says Phil Melton, managing director of affordable housing debt at New York-based Centerline Capital Group. “So you’re looking at A, maybe AA. It’s not the same as having Fannie, Freddie, or the FHA AAA credit enhancing these bonds.”

Setting Goals
CAP has proposed a system that provides a government guarantee to the next generation of entities, which it calls “mortgage credit guarantors.” Unlike today’s system, that guarantee would be explicit, and paid for by the entities. In return for the guarantee, at least half of all units financed would have to be affordable to people earning less than 80 percent of the area median income.

Yet, the very idea of affordable housing goals sends shivers down a lot of spines. Many conservative members of Congress believe that affordability goals were the reason for the financial collapse—that Fannie and Freddie took on increasingly risky behaviors to satisfy those goals.

The Mortgage Bankers Association (MBA) has proposed a housing finance reform scheme similar to CAP’s, featuring an always-on government guarantee, mirrored in the Obama administration’s Option 3. Yet, the trade group balks at mandating affordable housing goals.

“We do think these new entities should participate in the affordable housing world, but we don’t want to distort their participation by mandating goals,” says Michael Berman, chairman of the Washington, D.C.-based MBA. “We do think that some of the affordable housing goals in the past have ended up distorting some of the behavior and markets.”

For instance, there was a time when Fannie and Freddie received credit in their affordable housing goals for buying a lot of AAA-rated CMBS multifamily-directed traunches. And that dynamic distorted the CMBS market, since many CMBS lenders stretched their underwriting, competing too aggressively for multifamily assets, to take advantage of Fannie's and Freddie’s appetite.

Risky Business?
Still, given the fact that equity drives the LIHTC world—the debt-to-equity ratios in the 9 percent LIHTC world are extremely low—loans for LIHTC developments exhibit an extremely low default rate, far below conventional market-rate deals.

The bigger issue is that the private sector has limited appetite for long-term permanent debt and tax-exempt bond credit enhancements for LIHTC deals. In many ways, underwriting LIHTC deals is a highly specialized skill, a totally different animal to conventional apartment loans.

“Everybody’s saying you can’t link their activities with affordability goals anymore, that that was the killer,” says Doug Bibby, president of the Washington, D.C.-based National Multi Housing Council. “But with affordable housing, you must take more risk—you’ve got to layer financing and layer subsidies. There are some real questions about how a fully privatized market would handle those.”