How Would Tax Reform Affect LIHTC Pricing and Yields?

Published by Michael Novogradac on Monday, April 1, 2013 - 12:00am

The prospect of tax reform raises a myriad of questions. Even if the low-income housing tax credit (LIHTC) itself emerges from tax reform unchanged, other changes to the tax code would affect the LIHTC market. As such, it’s worth considering the possible ripple effects of various tax reform outcomes on LIHTC equity pricing, investor yields and the amount of equity raised.

To gauge the effect of tax reform outcomes on LIHTC pricing and yields, Novogradac & Company ran a series of calculations using an investor internal rate of return (IRR) model, for a range of equity prices for 9% investments and 4% tax-exempt bond investments. We examined these models in four tax rates scenarios ranging from the current corporate rate of 35 percent to 25 percent at the low end. We also ran calculations to estimate the effect of extending the depreciation period for residential rental property from 27.5 years to 40 years.

Novogradac & Company is finalizing this analysis and our findings will be released in early April. In the meantime, I can report that our evaluation confirmed my previous hypothesis that lower top corporate tax rates would result in lower LIHTC yields and create downward pressure on LIHTC pricing.

For example, our analysis shows that for a 9% volume cap new construction investment, assuming investors need to achieve the same yields after tax reform as they did before, a drop in the top tax rate from 35 percent to 25 percent would reduce the price per dollar of LIHTC between 5 and 8 cents, or more. For the equity market as a whole, this could mean a loss of $500 million to $1 billion dollars, or more, in equity used to finance affordable rental housing.

On the other hand, if investors were willing to pay the same price for tax credits, we found that a drop in the top tax rate from 35 percent to 25 percent could reduce yields for a 9% volume cap new construction investment by 105 to 130 basis points, or more.

Layering in the effect of extending depreciation periods would further exacerbate the lower pricing, reduction in equity raised and/or lower investor yields.

Stay tuned for the release of the complete analysis this month, which will feature our findings in more detail. Our analysis also looks at the impact on credit pricing, equity raised, and investor yields at less dramatic reductions in corporate tax rates. It also addresses the impact tax reform might have on equity raised in 4% tax-exempt bond transactions.