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Specter of Tax Reform Turned 4 Percent LIHTC, Bond Market from ‘Robust’ to ‘Chaotic’ in 2017

Published by Teresa Garcia on Wednesday, January 3, 2018

Journal cover January 2018   Download PDF

Call it déjà vu. The years 2016 and 2017 ended in chaos for the affordable housing community, with tax reform the culprit in each case. 
One difference is that as 2016 drew to a close, low-income housing tax credit (LIHTC) transactions came to a screeching halt; whereas, 2017 concluded with an industrywide push for deals to close before year-end.

“It’s got the whole industry in an uproar … Last year around this time, we were scrambling to deal with the fallout of the results of the election and the impact that had on credit prices,” said Art Bowen, managing director of rental housing for the Virginia Housing Development Authority (VHDA). “We jumped through a bunch of hoops to work that out, and now we’re scrambling again.”

LIHTC Roller Coaster

LIHTC activity in the past 18 months was a roller coaster with soaring highs, unexpected lows, hairpin turns and sudden stops. The first half of 2016 saw a hot LIHTC market with credit pricing starting in the low-to-mid-90-cent range up to a dollar or more for stronger deals in larger markets. The Novogradac Journal of Tax Credits at the time reported syndicators seeing $1.20 or more per credit for transactions in hot Community Reinvestment Act markets.

In the immediate aftermath of the 2016 election, LIHTC pricing plummeted at the expectation that a Republican-controlled Congress and a Republican president would enact lower corporate tax rates through tax reform, which would reduce the value of the LIHTC. Postelection anticipation of tax reform caused a 10 percent to 20 percent drop in LIHTC pricing and transactions across the country were put on hold.

After Republicans failed to enact tax reform in the first quarter of 2017, liquidity returned to the market and pricing recovered. “The market had been stable and dependable, and pricing was very good and competitive,” said Mark Sween, vice president and project partner of Dominium, one of the nation’s largest affordable housing development and management companies. Sween said there were Dominium deals where the pricing actually came out better than anticipated. 

“After late first quarter [2017] was where it started to normalize and we saw an increase in 4 percent transactions steadily increase up until the House bill came out,” said Chris Barnes, vice president and senior project partner of Dominium. “We were not back to the pre-election highs by any stretch, but we went from worrying about not getting any bids to getting two to three bids again.”

Beth Stohr, director of LIHTC investments at U.S. Bancorp Community Development Corporation (USBCDC), said credit pricing in the second half of 2017 increased by about 5 cents over the end of 2016 and that pricing hovered in the mid to low $0.90s on 9 percent LIHTC deals and low $0.90s to slightly over $1 on bond deals. 

Reaction to Tax Reform Bills

That changed this past November when House Republicans released and passed the Tax Cuts and Jobs Act, with Senate Republicans following suit with their own version of tax legislation. Both tax bills initially proposed a 20 percent top corporate tax rate and retaining the volume cap allocated LIHTCs, including the 9 percent and 4 percent credit for acquisition. The key difference was the House bill also proposed repealing private activity bonds, which generate 4 percent LIHTCs and finance more than half of affordable rental housing each year.

The mere potential of tax reform had a dramatic effect on the LIHTC and bond markets, even before a final tax bill was signed. “It went from robust to chaotic,” said Sween. “It’s an unbelievable nightmare.”

As tax reform negotiations continued into the first half of December and a new top corporate tax rate had yet to settle at the final rate of 21 percent, some investors and syndicators began underwriting transactions to between 20 and 25 percent, occasionally with upward adjustment factors. 

Affordable housing providers scrambled to close as many existing tax-exempt bond deals as possible before the end of the year. “We’re triaging on different fronts,” said Barnes, who said in November that he spent about 80 percent of his time helping prepare existing deals for the potential of tax reform. “To the extent that projects haven’t drawn down their bonds, we’re doing everything we can to draw those bonds down and meet the 50 percent test. We want to preserve as much as we can of our existing pipeline. We’re working with our debt and equity partners to do whatever we can to expedite the closing process.”

USBCDC similarly prepared for the end of 2017 by evaluating each transaction on a case-to-case basis and collaborating with project partners to keep them feasible. “We are evaluating each investment individually to gauge the impact of fully funding bonds prior to year end and working with the developers to solve the gaps,” said Stohr.

State Action

State allocating agencies drafted strategic plans to get as many bond deals across the finish line as they could before the tax-exemption for multifamily housing bonds potentially expired. The California Debt Limit Allocation Committee prepared a dual-track strategy to accept streamlined applications and issue as much remaining bond cap allocation as possible through the end of December. 

Virginia, which has seen an upswing in the use of 4 percent LIHTCs in recent years, was similarly proactive. “In Virginia, for the last two years or so, the usage [of 4 percent LIHTCs] has been pretty strong,” said Bowen, who noted that VHDA offers extra points on its competitive 9 percent LIHTC application for transactions that can use 4 percent and 9 percent LIHTCs on the same site. 

“What we’re going to do is issue short-term bonds and set certain dates for the next 12 to 18 months, every three to four months, where bonds will be remarketed. At that point, they’ll be on a fixed long-term rate,” said Bowen. “That’s our contingency plan.”

2018 Outlook

Questions about how a final tax bill would look were finally answered when the tax overhaul legislation was enacted in December. The landmark bill will have significant consequences for the affordable housing industry. Even though the LIHTC and the tax exemption for private activity bonds were retained, the amount of equity used to finance affordable rental housing will likely see a dramatic drop as the tax bill lowers the top corporate tax rate from 35 percent to 21 percent, slightly higher than the 20 percent rate proposed in each chamber’s separate legislation. Furthermore, the 21 percent rate became effective in 2018, rather than the Senate proposal to delay until 2019.

Industry participants say strong partnerships and collaboration will be crucial in navigating 2018 and ensuring that affordable housing continues to get built and preserved. On that front, a post-tax-reform landscape brings the affordable housing community one advantage that was lacking in previous years: a clearer idea of the challenges that lie ahead.

Bowen said, “This entire episode with potentially losing [private activity bonds] should be a wake-up call for the entire industry that we all need to be constantly making the case for affordable housing to elected officials at all levels.” 

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