The LIHTC crisis and states: Part 2, go try to borrow some
[Continued from yesterday's Part 1.]
“If you know how to spend less than you get, you have the philosopher’s stone.”
– Benjamin
Yesterday’s post introduced a white paper (available in .pdf here as Recap Update 72), published by my for-profit Recap Advisors at the request of the Massachusetts Housing Partnership (MHP, www.mhp.net), that focused on the crisis in US affordable housing rental production, and offered recommendations to policy makers (particularly states) to revive LIHTC syndication volume. After dealing with two admonitions one might even consider philosophical – participate with stakeholders in a collective response, and avoid incentives that align against equity markets – we got more focused on practicalities:
3. Allow strong, equity-backed applicants to apply and win. Viability is key, as is reliable execution. As we explained:
Evidence is proliferating that, as one would expect, the backup in pricing and the logjam in pipeline properties is placing great stress on sponsors, who have built their business plans and organizational budgets on the historically plausible premise that they can win 1-2 LIHTC allocations annually and then rapidly close their LIHTC equity syndications. If they cannot, such entities can find themselves out of cash, leading to a deteriorating spiral where staff cutbacks lead to capacity atrophy which in turn leads to portfolio weakness. (Section 3H)
Liquidity at the bottom?
Smaller sponsors, particularly non-profits, are especially vulnerable.
I heard through the grapevine that this statement caused some kerfuffle. It goes against t he grain of many Qualified Allocation Plans (QAPs), and for that matter much of the conventional wisdom around who constitutes the ‘best’ sponsor. Is it the financially strong but morally questionable for-profit developer, or the true-blue but makeshift-capitalization non-profit? The truth is that either or both can be a Mission Entrepreneurial Entity (MEE). What you favor depends in part on whether you think MEEs are plentiful and robust, or vulnerable and declining?
That depends on context. I’ve been through several sponsor-generation shakeouts, starting with the non-profit-to-limited-dividend conversions of the late 1970’s, triggered by the massive recession of 1974-76. The shakeout hitting us now is as bad as then, possibly worse, and in such times, the primary goal is survival of the fittest:
The same consolidation that is happening elsewhere in the LIHTC value chain—in investor financial institutions, in intermediary syndicators—will soon hit sponsors. When a sponsor exits the business, however, its portfolio lives on, and the operating and managerial responsibility must be transferred to a survivor entity.
When a sponsor goes down, its properties need financial lifeboats
A sick sponsor doesn’t just affect its pipeline but also all its progeny.
Resource allocators need to develop a strategy to address sponsor shakeout and consolidation, and to have flexible, fact-acting resources to facilitate property and portfolio control and ownership transfer so as not to lose the valuable inventory already developed.
Just as flowers have a stake in the health of honey bees, allocators have a stake in the health of the sponsor population.
This will mean streamlining the LIHTC allocation and award process and setting realistic, clear expectations. Many of the LIHTC allocation processes—some of them of many years’ standing—represent hurdles that sponsor and equity investors would surmount when demand exceeded supply, but which they now will not.
That’s not the goal
4. Make non-critical transaction features optional, for points. Thresholds can be counterproductive when demand is less than supply.
Threshold requirements that add cost may prevent pipeline properties from closing. Optional-for-points features that add cost may be sacrificed for cost savings when pipeline properties run into trouble, so keep points for such features low to avoid painful rescoring later
One might think it obvious that most things should be point-based, but the entire industry trend over the last decade has been to establish administrative minima. There’s a reason for this – if certain things are readily available, achievable, and affordable, why not make all of them mandatory? That makes sense with statutory requirements such as handicapped accessibility, but less sense for new features, however laudable, like green features.
It’s not just accessible, it’s the law
Or deep income targeting:
Deep income targeting is a useful illustration but no means the only example. LIHTC is a capital subsidy designed for properties serving residents at 40-60% of area median income (AMI). Rents affordable to that 40-60% AMI income tier can just barely sustain operations given the low debt service that follows the heavy capital subsidy.
Attempting to target residents at lower income levels, particularly 30% of AMI and below, means that rents will not be sufficient to cover operating costs, even with no debt service at all. That means a sinking fund up front or ongoing income subsidy to tenants. That has always been difficult to do, but some pipeline properties have been done, much to the credit of those worked to structure and fund them.
Put differently, LIHTC can stretch, but is being asked to stretch beyond its limits. (Section 4E)
Underwriting 2008 LIHTC is giving me a headache
5. Break the equity bottleneck using QAP criteria. Give substantial extra points for reliable and ready equity. As we observed regarding the Massachusetts QAP:
The single biggest factor impeding the effective deployment of
In proposing extra points for financial readiness, we are not naive enough to think that this condition will be easy to verify or frequent:
Credibility could be established by transparency past the syndicator to the investor level and a cash deposit by the investor.
Nevertheless, since this is the proof we want, establishing it as a goal worth a truckload of points will motivate parties to pursue it:
Few properties could provide that, but those that did would certainly close.
Will Federal relief arrive in time?
We’re from the government and we’re here to help you
No, and not for lack of trying:
In the midst of this flux, the federal government is acting, but with the usual blunt, time-delayed instruments available:
· The Housing and Economic Recovery Act of 2008 (HERA) adopted many long-awaited improvements to LIHTC such as removal of the
· Federal block grant funds are flowing to communities to combat foreclosure and its effects, but focused mostly on single-family housing.
· Treasury’s Troubled Asset Relief Program (TARP) has pivoted from buying so-called toxic assets to acquisition of equity in banks, with more twists likely to come as markets react, but with an overall focus on maintaining confidence by flooding financial markets with liquidity.
· Federal regulators are encouraging consolidation in the banking sector, effectively subsidizing acquisitions of weaker financial institutions by stronger ones.
None of these actions, however helpful in the macroeconomic context, will do much to counteract the effects on affordable housing. Section 2B.
However helpful these will be in the macroeconomic context – and as I’ve previously blogged, I think they’re enormous and wise steps – they’ll have little impact on affordable rental housing, which is a very small fraction (about 1½%) of the overall inventory. We’re going to have to solve this problem on our own.
Got to dig out of this ourselves
[Continued tomorrow in Part 3.]
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