Debt Availability, Other Factors Affect Historic Tax Credit Market

Published by Jennifer Dockery on Thursday, July 1, 2010
Journal thumb July 2010

Volatile. Challenged. Fair. Those are a few of the words experts have used to describe the current historic tax credit (HTC) equity market. Like the low-income housing tax credit (LIHTC) and new markets tax credit (NMTC), the HTC market has fallen victim to the recession and diminished tax credit appetites of many major corporations. Investors have left the market, credit prices have fallen and projects have stalled. Yet, things are looking up. Most tax credits still fetch more than a dollar in equity and the industry has recently regained some of the strength it lost in the past two years. When polled in June, optimistic industry experts predicted that the market would improve when the commercial real estate market recovered and banks began providing more access to conventional debt financing.

“[The recession] hasn’t affected the market for the credits themselves. Our investors want them just as much today as they did three years ago,” said John S. Bowman Jr., president of Tax Credit Capital LLC (TCC), an HTC syndicator.

Pricing Projects
For HTC syndicators and investors, credit price reflects numerous benefits and considerations including the time value of money, priority returns from cash flow and exit benefits that an investor receives as a partner in the project, in addition to the return generated by the discounted pricing of the credit itself.  

The equity investor receives 100 percent of the tax credits upon certificate of occupancy, regardless of when he invests his money. This could result in the investor receiving the tax credits several months to a year before making the final equity pay-in. Investors typically receive an annual priority return of 2 to 3 percent of the equity invested. If the investor exercises a voluntary put option, the owner purchases the investor’s interests at the end of the five-year compliance period for 5 to 15 percent of the original investment. These added incentives often push the equity investment above $1 per credit.

“We look at each deal as a case-by-case opportunity and that will drive pricing,” said Zachary M. Boyers, chairman and chief executive officer of U.S. Bancorp Community Development Corporation (USBCDC).

In providing average credit prices, syndicators and investors stressed that HTC prices and yields depend heavily on pay-in schedules, project size, investor interest and recapture risk. Syndicators and investors said that they had seen a 10 to 15 percent reduction in credit pricing for 2009 and 2010 transactions when compared to pre-2008 deals.  USBCDC has been seeing prices in the $1.10 range and Brian Tracey, tax credit investment executive with Bank of America Corporation (BAC), said that the majority of deals he’s seen have ranged from the high 90-cent area to around $1.10.

Less encouraging, National Trust Community Investment Corporation’s (NTCIC’s) John Leith-Tetrault said that credits have priced around $1, down from $1.10 to $1.15 in 2007. Sharing that viewpoint, Kasper Mortgage Capital LLC’s president Thomas Kasper said that before 2008 he had seen deals at $1.05 and higher, but that in today’s market, a more realistic amount would be 10 to 15 percent lower.

Paul Hoffman, managing director at CityScape Capital Group, an HTC syndicator, said projects with at least $1 million in HTCs attract between 85 cents and $1 per credit. TCC’s Bowman has seen $3 million to $4 million deals attract around $1 per credit, down from about $1.20 in 2007. He added that smaller $1 million to $3 million projects are attracting equity in the low 90s. “There’s product out there but you have to be more careful in the stones you turn over,” Hoffman said.

Attracting Capital
“Overall, [the industry] is healthier now than it had been for the last six to 12 months,” said CityScape’s Hoffman. “One of the key factors is the debt markets are just starting to thaw.”

Historic rehab projects usually rely on conventional debt for capital because eligible historic rehabilitation expenditures only earn a 20 percent credit. Acquisition and site costs and the expense of new additions do not qualify. Tighter credit markets make it more difficult for developers to secure capital for historic rehabilitation projects and the economic downturn has resulted in fewer companies expanding or relocating. Softness in the commercial real estate sector has also left many developers struggling to fill their buildings, resulting in banks using discounted lease rates to determine how much they will lend.

“The greatest challenge is accessing capital to get deals done … There are fewer regular investors and there is a shortage of good quality deals,” USBCDC’s Boyers said.

The reduced number of active investors has not affected the HTC market as adversely as it has the LIHTC market. In 2009, the National Park Service issued fewer than $1 billion in HTCs. With less debt financing available, developers complete fewer projects, resulting in fewer credits. NTCIC’s Leith-Tetrault said that the HTC’s smaller market size, when compared to the LIHTC and NMTC markets, means that two or three larger, active HTC investors have been able to keep pricing relatively stable.

Developers are increasingly seeking federal NMTCs and state HTCs to fill funding gaps. NMTC allocatees, such as NTCIC and USBCDC, are using NMTCs to attract investors for both credit types. USBCDC’s Boyers said that in the last two years, a significant percentage of USBCDC’s HTC projects have included NMTCs. CityScape’s Hoffman said that his company syndicated more than $50 million in HTC/NMTC combination deals last year. State HTCs can often provide additional equity for projects.

“The good news is, in a very, very tough financing environment with a state and federal credit, you can get 40 to 50 percent of your total project financing from credit equity,” Kasper said. He said that the state tax credits can also increase the attractiveness of the federal credit and allows his firm to price more aggressively when it secures state and federal credits in a single deal.

Cautiously Optimistic
Industry experts believe that the HTC market will improve when the rest of the economy improves. “The traditional avenues of credit have to reopen for the market to come active like it was, [but] it’s better than it was a year ago,” TCC’s Bowman said.

BAC’s Tracey said that he has seen increased interest in tax credits from insurance companies, utility companies and others. Syndicators have also been actively pursuing new investors.

Congressional support could also bolster the program. “If applied to the right kind of projects, the HTC has very strong economic multiplier effects,” Leith-Tetrault said. “We need to show [the HTC] has an important role to play as much a part of a broader federal stimulus strategy that includes NMTCs and LIHTCs.”

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