Affordable Housing Institute : US

[Continued from yesterday's Part 2 and the previous Part 1.]

 

“He that is of the opinion money will do everything may well be suspected of doing everything for money.”

– Benjamin Franklin, who was born and raised in Massachusetts

 

Drive thy business or it will drive thee

 

So far our review of the 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), has hammered home the necessity for clearing LIHTC equity markets by lowering the prices to the point where new buyers come in. 

 

If we don’t sell it, we lose it

 

This will take a while:

 

In a market where CRA equity investment had a measurable monetary value, all non-CRA-motivated buyers—such as profitable Fortune 500 industrials, insurance companies, utilities, and so on—were largely priced out, a concentration by investor type that only now is revealed to have been dangerous for the industry as a whole.

 

New buyers likely to emerge in 2009 will be precisely those Fortune 500 entities with reliable earnings, of which, recession notwithstanding, there are plenty.  However, the emergence of such buyers will provide little short-term relief, because of:

 

·         Time delay.  It takes a fair interval of time to educate a corporation to LIHTC and to move that education through to an actual equity investment check.  If past experience (the early 1990’s) is any guide, 6-9 months is a typical decision interval.  Given the recent correction and overall reevaluation of financial risk, the interval may be longer this time.

 

New market entrants take many months to develop

 

·         Pricing at lower levels.  Entities that are not financial institutions will place no premium on CRA consideration, so they will enter the space only at prices competitive with other CFO earnings management tools, such as other tax credits.

 

In this, unfortunately, the LIHTC will suffer in competition with other tax credits.  When LIHTC was enacted in 1986, it was virtually the only such tax credit.  In the 22+ years since then, other tax credits have emerged as investment vehicles: historic, New Markets, energy, and so on. Compared to these new credits, LIHTC has a long delivery period (10 years), a longer risk period (recapture, 15 years), and greater relative complexity (it is the longest section of the Internal Revenue Code).

 

The market clearing price for new LIHTC, therefore, must be at levels well below the 2007 equilibrium, and probably below the 2008 asks of $0.85 or so.  (Section 3A)

 

In the paper, I was cautious; in reality, I think this market clears at $0.65.  Which leads to our next important point:

 

6.  Provide an underwriting cushion to handle equity price drops.  The industry faces two problems:

 

No dead deals, please

a.  LIHTC equity prices are much lower than they were before.

 

Prices that in some desirable coastal markets were above $1 per dollar of LIHTC (observed by Recap to be “hyperactivity” back in 2006) are now below $0.80 in some cases.  Observable prices now are legacy deals—properties in the pipeline from before the disruption.  Much lower price are not registering yet because fewer pipeline properties are feasible at those prices and markets have yet to accept the few that will.  Section 2E.

 

There went my feasibility

 

b.  Pipeline properties that relied on old prices will need to be re-underwritten. 

 

The first problem is solved by getting to a new price quickly, so that markets can clear. 

 

Based on pricing adjustment alone, Massachusetts’ allotment of credits will go only 77% as far as it did last year.  Fewer pipeline properties will get done in the new reality. 

 

Once you know that prices don’t work, the next step is apparent:

 

Stress-test applications at lower-than-average equity prices, at least until the market settles at an equilibrium price.  That will avoid having pipeline properties come back for additional credits because markets have moved during the allocation process

 

7.  Have resources available to assist pipeline properties to close.  They represent a sunk cost (by somebody) and an affordability opportunity. 

 

Part of that flexibility can come from recognition that simpler financing will help pipeline properties get done.  Currently, political incentives are such that funding providers are encouraged to provide a little help to many pipeline properties—that shows they are supposedly leveraging contributions from others and allows claims to large numbers of units funded.  The result, however, is complex, multi-source financing subject to many different timetables, and leading to rickety, vulnerable deal structures.  Section 4D

 

You think your bridge financing structure is sound?

 

New resources are essential because the development pipeline is long, and complex:

 

In an LIHTC underwriting of allocated credits, the LIHTC equity is normally the largest chunk of the capital stack, typically 45-60% of total sources.  However, it becomes a firm commitment last in the development sequence, specifically:

 

Make sure you do them in the right order!

 

1. Sponsor secures site control.  This requires expenditure of funds.

2. Sponsor sizes debt and/or secures permanent debt commitment.

3. Sponsor secures preliminary commitment for soft gap-filling funding.

4. Sponsor applies for LIHTC, stating an expected LIHTC equity price.

5. Sponsor wins LIHTC competition.

6. Sponsor places LIHTC at an actual LIHTC equity price.

7. If the actual equity price is ‘too far’ below projections, then sponsor returns to Step 2 and iterates until success.

8. Sponsor closes the property transaction.

 

The development sequence is also financially bass-ackwards:

 

 

The significance here is that Steps 1 through 4 involve expenditure of non-recoverable costs, and that the transaction does not work—in the sense of sources matching uses—until Step 6. 

 

LIHTC development is thus a poker game where you make escalating bets and increasing risk, and now the game’s rules have been entirely changed.

 

If the actual equity price is below the level needed to align sources and uses and the transaction lacks the necessary cash cushions, then the sponsor returns to an earlier stage and repeats the entire process, with no guarantee that prices will not further erode in the next cycle.  Section 3D

 

8.  Maximize flexibility with gap-filler resources.  Allocators should increase and concentrate any other LIHTC-compatible resources available to them.

 

We can divide LIHTC properties into three cohorts, each of which will need additional resources:

 

·       Past – Properties with pre-2007 allocations should all be closed (though there are always exceptions), but they will be under stress as resident incomes fall.  Properties expecting to refinance to address capital needs or with maturing debt to repay may turn to public sources if private capital markets remain frozen.

·       Present – Properties with 2007-2008 allocations but no equity investor may need intervention with additional credits or gap fillers to stay alive.  Some will fail to attract investment and will turn back their allocation.

 

You may need a little present assistance

 

·       Future – Properties with 2009 allocations will need more credits, given the slump in pricing.  They will also likely require more gap-fillers in the form of soft loans or grants.

 

All of this implies a greater concentration of affordability resources per unit of housing.  In other words, triage.  Section 4A

 

Some of you aren’t coming out

 

9.  Collect and disseminate reliable data on LIHTC markets: allocations, awards, pricing.

 

For an eight-billion-a-year industry, every step of which is in the public domain, we have surprisingly little good information.  We put some into the report, using the specific to imply the general:

 

For example, of 39 Massachusetts pipeline properties allocated in 2007 and 2008, only 8—barely over 20%—have closed with firm equity.  That means roughly 80% of pipeline properties are still lacking in solid equity, with a whole new round of allocations coming up in 2009.  For the first time in the LIHTC’s history, not only will there be a substantial pool of unused credits to be redistributed nationally, but there will be $2-4 billion of 2008 LIHTC without an equity investor, even as another $8 billion or so of new LIHTC will be allocated to states.  Section 1B

 

Can’t play the game if you can’t see the cards

 

10.  Keep the competitive process.  It harnesses market forces, even in weaker markets.  As the report put it:

 

We have heard calls for handing out credits on a first-come, first-served basis on the theory that competition among developers is a thing of the past.  Such calls miss the central role competition has in the success of the LIHTC program.  Competitive allocation harnesses market forces to the efficient allocation of scarce resources.  What Massachusetts must do, however, is focus the competition on the aspects critical to the success of pipeline properties—provision of equity.

 

Competition for resources – by developers to a state, and by states with each other – has been among the principal reasons why housing tax credits work. 

 

Who wants tax credits?

 

As I wrote two years ago:

 

There are investment tax credits and investment tax credits, and yet in political and programmatic terms, the LIHTC stands head and shoulders above the others.

 

“One of these things is not like the others, one of these things is just not the same.”

 

What makes the LIHTC so nifty?  A remarkable, one might almost say prescient, confabulation of features, some of which are intrinsic to fiscal tax expenditures rather than appropriated programs.

 

[Snip]

 

4.             Capped and competed.  The amount of credit is fixed, so sponsors have to compete with one another.  This leads to a virtuous-circle feedback cycle as each year’s competition is a bit fiercer than the preceding one’s.

 

Each time I cycle, I get better.

 

5.             Allocated on a use-it-or-steal-it basis.  Each state has a specified amount to spend, with uncommitted amounts returned to a national pool where other states can claim it.  As a result, each state is highly motivated to spend all of its credits.

 

Wanna try to steal those tax credits?

 

Competition is also healthy among states, because some will heed the warnings (like ours) and react faster and better. 

 

When there are more properties chasing less capital, the easiest to close have an advantage.  Allocating agencies should see themselves as a critical link in an aggregate value chain that works only if the awards are funded and closed.  The private sector—syndicators, developers, investors—in Massachusetts will certainly invest their efforts in crafting a revised operating protocol if they have reason to believe the public sector will approach in the same spirit.

 

Such leadership by Massachusetts government officials will not only help the state’s stock and stakeholders, it can help lead LIHTC allocators in other states to rethink their own procedures and policies.  There is no time to lose, else national players will perform their own unsympathetic triage and cross off their lists states whose agencies are hidebound by a delivery paradigm that is two years out of date.

 

Those that demonstrate syndication-friendliness will be the winners:

 

Whether they realize it or not, states are now competing with each other on their ‘equity syndication friendliness.’  

 

I’m competing to be friendly

 

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