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Competing Interests, Falling Yields Create Conflict

Published by Jennifer Dockery on Wednesday, August 1, 2012

Journal cover August 2012   Download PDF

In today’s low-income housing tax credit (LIHTC) market, competition is getting fierce. Community Reinvestment Act-motivated investors are vying against economic investors for a finite number of credits and syndicators are again seeing credit prices rise above the dollar mark. Uncertain tax policy and expiring provisions are also contributing to a challenging environment. According to syndicators, the LIHTC equity market has become red hot as yields fall and stakeholders search for some kind of equilibrium, which may be impossible to find until after the November elections.

It’s Getting Hot in Here
The LIHTC market has recovered from its low point a few years ago. Economically motivated investors from outside the financial industry entered the market several years ago as yields rose and credit prices dropped. Now, the market has absorbed surplus tax credits, said Michael Gaber, WNC’s chief operating officer (COO). This left the market a little sluggish until states awarded allocation to new properties, said Jeffrey Goldstein, Boston Capital’s COO.

“The market appears to have absorbed much of the pent-up demand which drove yields down to a level that seems to have bottomed out after a roller coaster couple of years. We expect investor demand to remain strong for the remainder of 2012, due largely to low interest rates and a lack of fixed-income alternatives with a low risk profile and reasonable returns,” said Gaber.

Robust CRA markets, such as New York, Chicago, Los Angeles, San Francisco, Miami and Philadelphia, have remained strong with prices rising above the dollar mark. Jeffrey Whiting, CEO of City Real Estate Advisors Inc. (CREA), attributes that strength to a selective loosening of terms, such as fewer personal guarantees and lower operating reserve requirements, for experienced developers. Christoph Gabler, AEGON USA Realty Advisors LLC’s senior vice president of community investments, said that AEGON is seeing CRA-motivated buyers paying $1.05 in California and $1.08 in New York markets. Gabler and Goldstein have also seen pricing exceed a dollar in other CRA-desirable locations.

“Pricing has become very competitive in the last six months. One oddity is competing deals are bid up by five or six cents sometimes. No slight increments [are] made to win a deal,” Gabler said.

In the rest of the country, pricing has been in the 80s to 90s. Goldstein has seen low- to mid-80s per credit while Whiting has seen prices around 90 cents. WNC’s Gaber has seen prices at 80 cents and AEGON’s Gabler reported prices ranging from 86 to 95 cents. Gabler has also watched prices rise as developers seek increasingly aggressive terms.

Because banks and other CRA-motivated investors are willing to pay higher prices for the credits, developers who accepted 83 to 85 cents per credit last year won’t even consider that price today, Whiting said. He expects pricing to return to 2011 levels, and Gabler said that pricing was likely to drop in the next few months.

“I’m not optimistic that the market is going to sustain itself at these prices. It’s all going to be based on the earnings of the financial sector. That’s what’s going to drive the pricing,” Whiting said.

Falling Yields, Fewer Investors
Whiting, Goldstein and Gabler all cited a conflict between CRA-motivated investors and economic investors. CRA-motivated investors are paying upwards of one dollar for credits in popular markets, driving down yields. Economic investors, on the other hand, are looking for higher yields and a lower price per credit. The conflicting interests are creating two competing markets, Whiting and Goldstein said.

Direct buyers with CRA requirements are investing in properties with yields of less than 6 percent, said Goldstein. Multi-investor funds, which consist primarily of economic investors, want yields of at least 6.5 percent. He added that it is becoming more difficult to put together funds that provide a higher yield and that some economic investors are leaving the marketplace.

“You have a lot of equity that’s interested in those credits and that’s what is driving yields down,” Goldstein said.

According to Whiting, credit pricing needs to come down because economic investors, who comprise about half the market, won’t invest in properties that don’t meet their minimum yield requirements. As yields fell below 7 percent, for example, Whiting saw a number of insurance companies leave the market. Gabler has also seen insurance companies exit the market because of falling yields. He said that some economic investors will invest in a few transactions that are above their yield floors and then back off as yields drop too low.

“Deals in key CRA markets will continue to drive up pricing as banks compete to deploy funds in their assessment areas. CRA needs to be changed but until it is, we will see bank competition result in such uneven pricing to the detriment of economic investors,” Gabler said.

Election Year Challenges
The industry faces several challenges in the coming months, including economic uncertainty, the November elections and a potential reduction in the corporate tax rate.

Whiting said that economic uncertainty could drive away economic investors and Gabler expressed concern that national, state and local debt issues would draw attention away from the program. Gabler and Gaber both saw the expiring 9 percent credit floor as a challenge for the program. Other factors, such as changes to the tax code and even the European financial crisis, could make alternate investment opportunities seem more stable to economic investors than LIHTCs. “It doesn’t matter where the yield is [if] they can go find investments that are more attractive to them,” Whiting said.

A lower corporate tax rate could also affect the LIHTC market. Congressional Democrats and Republicans as well as the president have proposed reductions in the corporate tax rate. Gabler said that some companies have already started modeling the probable outcomes and investment yields from lower tax rates. The November elections could play a significant role in determining a new tax rate.

“The biggest thing on the horizon is the election and how the government views and acts upon taxes going forward,” Goldstein said.

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