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Scrambling for tax credit investors

<i>As banks pull out, low-income housing developers left in lurch</i>

One source of their funds has been the resale of tax credits, including many that they sold to big financial institutions. But now that the financial institutions are dealing with their own dire problems, the demand for those credits is shrinking.

Last year, for instance, Freddie Mac, which was just bailed out by the federal government, purchased $450 million of low-income housing tax credits nationwide. The company’s highly publicized losses this year, however, have driven it to a wait-and-see attitude toward buying more credits, spokesperson Eileen Fitzpatrick said.

“It doesn’t look like we’re going to need very many this year, if any,” Fitzpatrick said.

Financial institutions “have a ton of losses that they’re already writing off, so they don’t need the tax credit,” added Dan Moritz, a principal at the Arker Companies, a developer of low-income housing that uses the credits. “So that’s eliminated a huge source of the buyers of tax credits.”

As supply of the credits increases and demand falls, prices of the credits continue to sink. As recently as three years ago, the tax credits were getting snatched up for as much as $1.07 on the dollar. Nowadays, some credits are pricing in the mid-80 cent range.

Even before the government bailout of Fannie Mae and Freddie Mac, the mortgage giants — and other financial institutions — had pulled back from buying the credits in the face of lower tax liabilities caused by lower profits. Developers, in turn, have been scrambling to find ways to plug financing gaps in projects that would have worked a year ago.

“Fannie and Freddie were a pretty large segment of the market. That’s a huge chunk of capital to replace,” said William Traylor, president of Richman Housing Resources, a syndicator of the credits.

Freddie’s withdrawal alone represented a significant chunk.

“In some ways, it’s a correction,” said Tony Lyons, vice president and regional director for the northeast for National Equity Fund, a syndicator.

“A year ago, there was a high demand for these credits because a lot of investors were very profitable, and they needed to offset their taxes — this was a pretty sought-after investment,” he noted.  “[Then] the returns got pretty low, and they were probably not sustainable at that level.”

Since the federal low-income housing tax credit program began in 1987, it has helped finance new construction or rehabilitation of 2 million rental units nationwide, according to a report released this year by the U.S. Treasury.

But as the market for the credits slows, housing developers who depend on the credits are realizing that projects that would have worked financially a year ago may now need extra money, especially in the face of rising construction costs.

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“We’ve been looking for other ways to fill the gap, such as building more green buildings and going to [the New York State Energy Research and Development Authority] to get financing from them,” Moritz of Arker Companies said. “This causes us to have to become a bit more creative.”

The federal tax credits come in two flavors based on the tax savings that they generate. Those savings are calculated as a percentage of certain eligible costs and determined by a formula.

Developers in New York can apply to the state Division of Housing and Community Renewal or to the New York City Department of Housing Preservation and Development for so-called “9 percent” tax credits. These credits are allocated to each state on a per capita basis, and are meant to serve the low-income residents in locations that have high poverty rates.

The other option is for so-called “4 percent” tax credits, which are given to eligible projects on an “as of right” basis whenever tax-exempt bond financing is used. That applies to cases such as 80/20 deals financed by the New York State Housing Finance Agency or affordable housing using one of the New York City Housing Development Corporation’s programs — provided the bonds finance more than 50 percent of the cost of the low income housing.

Regardless of the type of credit, typically a developer will sell them to a syndicator, who will re-sell them to investors (developers do also have the option of using the credits themselves). The investors end up with an ownership interest in the development, which allows them to claim passive losses like depreciation and interest expenses.

The syndicators — firms like Richman or National Equity Fund — aggregate capital and serve as intermediaries between developers and investors. But they also go a step further than brokers because they manage the investments and make sure that the projects are in compliance. That service is essential, because if a project is out of compliance during the time that the investor holds the tax credits, the IRS can recapture some tax benefits.

The equity that the investors contribute allows the developer to need less debt financing, which in turn lowers debt service to a level that lower rent rolls can support.

The investors must commit for 15 years, but the tax benefits can be accelerated so that the investor can get them over 10 years. After the 15-year period has ended, the investors generally exit the transaction.

Currently, with the prices of tax credits falling, yields are rising. “The investors that are left are getting a much better return,” National Equity Fund’s Lyons said. “It’s almost to the point where some of the non-financial institutions are going to start to be attracted back into the market.”

Another plus for buyers is that under the Housing and Economic Recovery Act of 2008, the tax credits now affect alternative minimum tax liabilities in addition to ordinary tax liabilities. This means that corporations subject to AMT can reduce their tax liabilities by buying these credits.

And, the new law helped developers in another way by making more tax credits available so that projects could generate greater equity by selling more credits, even at a lower price.

“That’s a very helpful provision, making a credit more useful to a broader range of investors potentially,” said Traylor of Richman Housing Resources. “We will see new investors coming into the market —  as yields go up, we are seeing interest from other sectors … It’s just hard to tell how much it will be, how much new capital will be coming in and whether it will be anywhere near what would replace those investors who had left the market.”

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