A new permanent minimum 4% low-income housing tax credit (LIHTC) rate is one of the big changes for the affordable housing industry this year.
Included in a fiscal 2021 spending and COVID-19 relief bill passed by Congress and signed by President Donald Trump at the end of December, the change was a longtime priority for industry leaders.
Now that a 4% minimum rate is a reality, what does it mean?
Assuming the same level of bond issuance this year, the Novogradac firm estimates that the 4% floor will mean about $3.3 billion more in available tax credits this year. In addition, the recent legislation provided about another $1.2 billion in disaster LIHTCs to states hit by recent disasters, says Michael Novogradac, managing partner of the accounting and consulting firm.
The floor rate would help finance about an additional 130,000 affordable units over 10 years, according to the company.
The long-term prospects from the 4% rate are great, but industry leaders will be closely watching to see how the LIHTC market reacts to the additional credits, including whether it can absorb the new supply, and what moves may be made by state credit and bond agencies.
“We’ll see an increase in competition for private-activity bonds (PABs),” says Novogradac. “More projects will become financially feasible so we’ll be seeing more applications. As a consequence, you will see more states managing their pipeline of applications for PABs. I’m hopeful that more states will allocate more of their overall PABs to rental housing, and within the rental housing category they will have to deal with an influx of applications for bond volume authority, and they will have to decide how to determine who the winner and losers are.”
Roughly a third of the states have more demand for tax-exempt bonds for rental housing than supply, and that number will rise even more with the 4% floor—a change from a rate that recently hovered around 3.07%.
“With the expected rise in demand for the 4% credits and bonds, states will have to look at how they want use their resources—such as new construction or acquisition and rehab, 100% affordable or mixed-income developments,” Novogradac says. “In addition, there may be more public housing authorities using PABs for their Rental Assistance Demonstration transactions. How much bond volume authority do states want to set aside for housing authorities?”
The 4% floor applies to buildings financed by bonds issued after Dec. 31, 2020, and the buildings have to be placed in service after Dec. 31, 2020.
Deals that are applying for bond allocations for the first time in 2021 will be using the 4% floor.
There is an exception for some in-place acquisition-rehab developments applying for bonds this year where the buildings were purchased last year. They can receive 4% on the renovations but not 4% on the acquisition, explains Novogradac.
Looking ahead, there are still several questions that need answers.
In the near term, guidance is needed from the Internal Revenue Service (IRS) as to the effective date of the 4% floor for bond-financed projects. There are many properties currently under development that are being financed with tax-exempt bonds for which eligibility for the 4% floor is not sufficiently clear, says Novogradac.
Beth Mullen, partner and affordable housing industry group leader at CohnReznick, also notes the importance of resolving the issues that have emerged.
“The applicability of the fixed 4% rate for buildings that started construction prior to 2021 and will be placed in service after 2020 depends on the situation,” she recently explained on the CohnReznick website. “If tax-exempt bonds used for the construction or rehabilitation are ‘issued’ after 2020, there is a case to use the fixed 4% rate. Some deals have additional bonds being issued to help them meet the 50% test. Others are financed with tax-exempt bonds that are drawn as needed or as permanent financing only. The IRS will have to clarify what ‘issued’ means in these situations. State tax credit agencies and equity investors are likely to wait for IRS guidance before proceeding with using the 4% rate for the deals in the gray areas.”
LIHTC Prices Dip
Despite the early questions, industry leaders are enthusiastic about the rate change.
Transactions that used to have about 25% equity may now have about 35% equity from the 4% credit, says Brian Coffee, senior director and head of the affordable housing business at Synovus and president of the Affordable Housing Investors Council.
“I think the deals are getting a little stronger,” he says. “We’re also looking at stronger underwriting. There are a lot of states with subsidies. There are other states that don’t provide any subsidy, and, in those states, we may have some bond deals that never could get done before that are now viable. I think that’s the more exciting and harder part to judge.”
The Millennia Cos., one of the nation’s largest owners and operators of affordable housing, averages about five 4% LIHTC transactions a year.
In general, deals that normally would not be viable as a 4% bond transaction are now viable, agrees Frank T. Sinito, founder and CEO of Millennia. “That’s not across the board, but it’s going to help many,” he says.
Like others, Coffee says it will be important to see if the market can absorb the additional 4% credits. Overall, with more supply in the market, it could push yields up a bit and push prices down a bit, he says.
So far, the market has seen a 2 to 5 cent drop in prices in early 2021, according to several LIHTC leaders.
That’s meant the gain realized by a minimum 4% rate is offset a little by the dip in prices, but deals are still realizing a larger LIHTC investment than before the rate change. It’s also hoped that the higher yields will attract more economic investors into the market.
“Four percent bond deals have always been a large part of our business for both investing and lending, and that will continue to be the case,” says Rob Likes, national manager of KeyBank’s Community Development Lending and Investment group.
Projects are seeing increased construction costs, and the additional proceeds from the 4% floor will help with those costs, he says.
The minimum rate also means larger investments are being made into deals. While it’s still early, Likes says he’s seeing some investors partnering on individual transactions and some syndicators are splitting the deals among multiple funds.
“We’re happy with the fix,” he says. “It will provide more equity for affordable housing units.”
Millennia’s Sinito also has a big-picture take on the new change.
“The one thing that we all know is there was yesterday, there is today, and there will be tomorrow a shortage of affordable housing, especially with the catastrophic effects of COVID,” he says. “We need more housing. We’re pleased we have widespread support from both parties.”