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Home > News > ... Capital Issue Winter 2008 > Affordable Housing

Affordable Housing

Behind the Jargon: What's Going On with LIHTC
By Ginger McGuire

The recent turmoil in the capital markets has trickled into the complex world of tax credits. Affordable housing borrowers who anticipated a tax credit equity infusion this year may have to seek additional ingredients to round out their financing stew, or face the possibility that a project may become more expensive or even fall through. Understanding the situation and monitoring the players in a tax credit agreement can help developers prevent further losses and anticipate potential setbacks.

Tax Credits in a Nutshell
Low-income housing tax credits (LIHTCs) provide equity to affordable housing projects. They are often a major controlling component in what is typically a conglomeration of funding resources. Because projects that receive LIHTC equity need to borrow less money to pay for new construction or renovation, they require less operating income to service their debt, and can offer lower rents. LIHTCs help finance 140,000 new affordable apartment units each year and account for 90 percent of the country’s new affordable rental housing, according to the National Council of State Housing Finance Agencies.

The federal government issues a limited amount of tax credits to state allocating agencies (typically a housing finance agency) each year, which in turn award them to eligible affordable housing projects. The project developers then work through a LIHTC syndicator to match up the project with a buyer who invests in the tax credits by purchasing them. The syndicator also administers the exchange. The price for the tax credits is determined by investors’ demand for yield on their investment.

For every tax credit a buyer pays for, the buyer receives a $1 tax reduction. For every tax credit that developers sell, the developers receive equity to fund their projects. The amount the project receives depends on the going price of LIHTCs. As of February 2008, that price is dropping from an all-time high to lower prices similar to those five and six years ago. 
LIHTC flowchart
What’s Changed in the Market?
As investors demand higher yields on their investments, borrowers receive less equity for tax credits that are being purchased. In the current market, fewer investors are buying tax credits because of the uncertainty surrounding the markets in general and housing in particular.

Government-chartered organizations Fannie Mae and Freddie Mac together purchase 30 to 40 percent of available tax credits, by some estimates. The rest are generally sold to banks. But Fannie’s and Freddie’s appetites for 2008 LIHTC investment are questionable at this time. And banks are earning less money because of the liquidity crunch in the capital markets. With less taxable income – some banks have actually lost money – they have less reason to purchase LIHTCs to offset their tax obligations.

With fewer entities interested in buying tax credits, and investors seeking higher yields from all investments, LIHTC prices have come down. One dollar of tax credit benefit now costs a bank only 80 to 85 cents, compared to 92 to 95 cents just a few months ago. A property that was awarded $1 million in tax credits would formerly have received $920,000 to $950,000 in equity; the same award now provides only $800,000 to $850,000 in equity – if the tax credits can be sold at all. Even borrowers who had worked with their syndicators to set a price are finding that some syndicators are either repricing the tax credits lower, pulling out of agreements to match up borrowers and investors, or waiting on the sidelines to see what happens in the market and not offering quotes for the 2008 tax credit cycle.

Which leaves borrowers holding unsold tax credits with no promise they’ll be able to access the equity they were counting on, some borrowers who have managed to sell their tax credits with less equity than they anticipated, and borrowers who have not yet been awarded tax credits wondering if the process will pay out. Finding additional gap financing to fill in the equity loss is a competitive and challenging exercise; walking from the project is often not an option because developers have already invested in upfront pre-development costs.

Stop-losses and Funding Gap Plugs
Borrowers can receive LIHTCs up to the amount required to make the project financially feasible and affordable. If the value of the tax credits is reduced during the process, the borrower does not have the option to make up the difference with additional LIHTCs. The borrower expecting $1 million in equity who is now receiving $800,000 will likely need to make up the difference. The options for each borrower depend on what stage they are at in the tax credit and borrowing processes.
Developers who have received awards and are working with syndicators, or who are submitting applications for an award, should be conservative and cautious when underwriting to a LIHTC price – they should check, and re-check, to make sure the syndicator is honoring the price quoted. While there is generally no legal recourse if the syndicator reprices, the borrower will know earlier if there will be a need to fill a funding gap.

Developers who are earlier on in the process have additional options. This is where knowing the lender and having a lender with the flexibility to explore multiple options comes in.

Seek additional funding sources
LIHTCs are only one element in the stew that is affordable housing finance. Funding gaps can be filled, but developers, syndicators and lenders will have to work together to find additional resources. Options include federal HOME funds, trust funds, the Federal Home Loan Bank Affordable Housing Program and other soft sources of funding. State or local housing departments and finance authorities may be a resource.

Modify the loan
Interest rates dropped sharply early this year after rising slowly for several years, which may make it possible for borrowers to afford to borrow more. These lower interest rates are particularly useful for rural properties that may not have considered using the U.S. Department of Agriculture Section 538 loan guarantee program. The program offers an attractive product for rural communities, and an interest rate buy-down to the applicable federal rate. Further, it provides amortizations of up to 40 years, as do Federal Housing Administration (FHA) new construction programs. Increasing a loan’s term may allow the developer to borrow more as their equity drops, while keeping annual debt service affordable.

Watch and wait or work on something else
Developers who have the option to wait on projects may want to sit this tax credit season out and pursue other projects that do not need tax credits. Rehabilitations of USDA Sec. 515 properties can be completed without tax credits with the Sec. 538 program, and Sec. 202 affordable senior housing properties can be refinanced through HUD in several ways. A straight FHA Sec. 221(d)(4) loan can be used as financing without tax credits, as can an FHA Sec. 223(a)(7). If the scope of a rehabilitation project is not too extensive, it could be a good candidate for a USDA Sec. 538 or FHA Sec. 223(f) guaranteed loan.

Tax credit projects still are being completed, but the uncertainty of the markets may give pause to some borrowers. The low interest rate environment, however, leaves multiple options for affordable housing developers, provided they are working with a lender that can access multiple funding sources, assist in monitoring each player’s responsibilities, and follow through in difficult markets.

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