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What Does Equity Market Uncertainty Mean for Recent, Upcoming LIHTC Awards?
As has been widely reported, the prospects for significant tax reform in 2017 increased dramatically as a result of the election. If substantial tax reform is enacted, it will undoubtedly result in lower corporate rates, which in turn reduces the value of some tax benefits. Because of this distinct possibility, some low-income housing tax credit (LIHTC) investors have paused activity, and others are making decisions based on less equity per dollar of credit (sometimes referred to as the “price”).
Holding off on closings, or doing so at lower prices, creates concerns in two distinct areas: 2016 awards for which financing has not yet closed and the 2017 application cycle. Answers are not currently known for either area, but it’s worth noting the issues and relevant questions.
Context of Recent History
It’s tempting to think the unique nature of current events makes the market situation unprecedented, but in fact a variation of it has happened before. From mid-2007 to early 2008, before the Great Recession hit in force, equity prices dropped substantially and a few investors pulled out. Although the causes are very different (political shift versus overall economy), the market is similarly disrupted.
Another difference is what the solution may be. Back then, developers, syndicators, and allocating agencies responded primarily by using resources created by the American Recovery and Reinvestment Act. At this time there is essentially no chance of similar legislation. For now, the affordable rental housing community will have to figure out what to do on its own.
Deal and Program Concerns
Investors’ pause creates the risk of LIHTC deals failing to meet regulatory and financial progress deadlines. Closing with less equity also is problematic. Consider a hypothetical 80-unit new construction development with $10 million in total sources awarded LIHTCs in 2016. If the price drops from $1.00 to $0.85, there will be a funding gap of $950,000 or more. Novogradac & Company is currently analyzing what effect on pricing LIHTC investors might expect.
Looking ahead to the 2017 cycle, allocating agencies will need an equity factor for application underwriting purposes. The best number to use was always an estimate, but recently the range of reasonable possibilities was fairly narrow. At the moment it’s anyone’s guess.
Not-Closed 2016 Awards
To start moving towards closing an on-the-sidelines investor would need to gain confidence in an assessment of what will happen with corporate tax rates. In the meantime deals will have to stand by, even in the face of missed deadlines.
By contrast, as a general matter there are several ways to respond to lower pricing:
- less paid developer fee,
- “value engineering,”
- increased debt, and/or
- being awarded more LIHTCs.
Each of these approaches has limits, if an option at all, as described below.
1. Developers need fees to run their business and cover the initial costs of future applications (e.g., buying land options). Also, both equity and debt providers want a certain amount showing as paid to provide a cushion for other contingencies (e.g., unexpected site work). Plus some deals already have a low number before deferring more.
2.”Value engineering” means finding ways to reduce building costs without reducing sources. Doing so may be possible, but should involve advance approval from the allocating agency. Trade-offs may include higher maintenance expenses and utility allowances.
3. Another new reality in the market is interest rates going up, which actually means borrowing even less than had been planned. Subsidized loans may be an option, but they are oversubscribed and a few sources can be difficult to use at later stages of development (such as the HOME program).
4. The applicable qualified allocation plan or other state policy may restrict the ability to award LIHTCs to developments from past cycles. Also, many allocations already were for the maximum amount allowed.
It’s important to note that any resource used for these investments would unavailable for future production. For example, an allocator could “fix” the shortfall with an additional $100,000 in annual LIHTCs. However, doing so would result in 10 to 15 fewer low-income households having an affordable apartment in a property awarded in 2017.
2017 Application Cycle
LIHTC equity price is a crucial component of underwriting for feasibility and providing the appropriate level of subsidy. Most states require applications to include letters from syndicators stating the amount. Therefore, deadlines in the next couple of months present a challenge and it’s unlikely conditions will become clearer during the first half of 2017.
Even so, agencies cannot hold off on starting their processes indefinitely. Developers have a pipeline ready to submit on established timetables. The necessary real estate (land and buildings) will not wait for long periods.
As mentioned at the outset, this discussion is not intended to provide complete answers. The solutions will be developed over time and vary by state, even by deal. The only uniform key is frequent, open communication between all interested parties, with a clear understanding of each other’s goals and limitations. The good news is everyone wants to see past awards succeed and the next application cycle go forward.
Relevant Qualified Allocation Plan Provisions and State Agency Guidance
QAP: “[A]ll applicants receiving any readiness points... must provide an executed Letter of Intent (LOI) from the project’s equity partner within 90 days of the Credit Reservation. Failure to meet the 90 day due date... shall result in rescission of the Tax Credit Reservation or negative points.”
Treasurer email Dec. 6, 2016: “In the event that the Committee on December 14 approves the proposed regulation change giving me some flexibility on how to respond to 2016 competitive tax credit reservation awardees who miss their readiness deadlines, I intend to extend the 90-day letter of intent deadline for 2016 second round awardees by 90 days in light of the current turmoil in the tax credit market.”
2016 application: “ $0.95 is the preliminary rate to be used. If your syndicator, however, verifies that the project will have a higher equity factor, then use the syndicator's verified preliminary rate.
At the time of the carryover allocation, there is a requirement that the project has an executed partnership entity document that clearly states the equity factor. That equity factor is to be used in the gap calculation for the carryover allocation.”
QAP: “DSHA requires that a minimum of $.95 cents on the dollar of net equity be raised.... However, DSHA reserves the right to amend this amount due to changing market conditions.”
QAP: “Applicants receiving Housing Credit allocations from the current funding round have until Friday, January 13, 2017 to close with their equity investor.”
QAP: “Because the market for LIHTC equity is variable, DHCD intends to provide notice ahead of each funding round about its current assumptions for equity pricing and reserves the right to establish both minimum and maximum pricing.”
QAP: “The amount of equity raised per tax credit dollar is determined by market forces and, therefore, is subject to change. For 2016 underwriting purposes, DHCD will assume that each project sponsor will obtain $.95 per tax credit dollar available for development costs. In determining the financial feasibility of the proposal, if a developer is assuming an equity raise higher than $.95, DHCD will consider the adequacy of the developer’s fee and overhead to cover any gap that would result if an equity raise of only $.95 per tax credit dollar is achieved.”
QAP: “Pricing above $0.99 will require a commitment letter from a syndicator or investor …”
QAP: “The Agency reserves the right... to provide an allocation of Year 2016 Tax Credits to a development, without requiring re-ranking under the Year 2016 Allocation Plan. The development must be currently holding a valid allocation of Tax Credits and, due to circumstances beyond its control, be unable to meet Tax Credit program placed in service deadlines. Such circumstances may include delays caused by local government's opposition to affordable housing; delays due to the failure of the federal government to release funding program guidelines or regulations in a timely manner or due to temporary freezes in federal government budget authority for program activity; or similar extraordinary and compelling basis (and but for such circumstance, Agency program deadlines and requirements would have been met).
Further, the Agency will generally not consider any other Applications for Tax Credits for a new development submitted by the same applicant (or related entity or material participant) during the same or subsequent funding round …”
WHEDA email Dec. 8, 2016: “We have been contacted by a number of developers and consultants during the past 7-10 days regarding the turmoil in the LIHTC equity market – we are aware that changes in LIHTC pricing have created funding gaps and delayed closings for properties with LIHTC allocations. In addition, the change in pricing is causing challenges for those assembling applications for the 2017 LIHTC round. In response to the equity market uncertainty, WHEDA will be extending the application deadline for the 2017 LIHTC round from February 3rd to March 3rd.”