How to price a LIHTC deal
By David A. Smith
5 min read
“I am not omniscient, but I know a lot.”
– Mephistopheles, in Goethe’s Faust (1808)
Do you want to be an affordable housing investment banker, a titan of structured finance making a market in low-income housing tax credits? You are ready to spend hours upon end laboriously gathering minute financial information on a proposed property; analyzing its risks in painstaking detail; performing two-dimensional scenario sensitivity analysis; and then surfacing and innovatively managing transaction, operational, and counterparty risks.
That’s work, you say? You’d rather just fake it?
My friend, you are in luck, for I shall show you how to price a LIHTC property despite doing no work at all.
Just sign right here – in blood, please.
Don’t read the agreement; it’s all boilerplate, legal jargon.
Instead, call the developer; tell him you have a crack team ready to work on the number and give him the best actually achievable price for his tax credits. Make him send over a full case file. Don’t look at any of the materials that arrive. Rather, give them to the most junior person on your staff. Ask him or her to request obscure additional documents from the developer. Wait two days, then underwrite as follows:
Step 1: Interest-rate equivalency. Start with 90 cents. For a generic property in today’s market, this price delivers a market-competitive risk-adjusted after-tax yield to the investor.
Step 2: Real estate risk. If the property is located in a questionable neighborhood, a secondary or tertiary city, or a weak-growth state, subtract 5 cents from the price. If the property has two or three of these listed weaknesses, subtract 10 cents.
Step 3: CRA sizzle. Add 5 cents for each major bank with a significant footprint in the property area, up to a maximum 25 cents.
The result will be a tax credit price between 80 cents and $1.15.
You say it can’t be that easy? That I’ve omitted elements proclaimed as essential by equity providers? Items such as evaluation of the general partner (capacity, experience, net worth, liquidity, integrity); property design and operating expenses; the viability of social services; market surveys; site visits; and environmental Phase I reports? And while we’re at it, tax opinions, accountants’ letters, and sponsors’ reviews?
My friend, what truly matters are the factors that affect price. When was the last time any of the preceding elements changed the price by even half a cent?
Armed with your number, call the developer and quote your price. He or she will remonstrate, telling you he or she has three other quotes, all better, and is going directly to the banks. After a 45-minute call (do it on a speakerphone and stretch it out), tell the developer in your most serious voice that you’ll go back and sharpen your pencil (use the phrase word for word; its very anachronism gives it gravitas) because:
- “I deeply value the existing relationship I have with you,” or,
- (B) “I believe in building long-term relationships with people of integrity.”
One of those two phrases should work for every situation.
Meanwhile, make sure that your junior analyst devotes long, cubicle-trapped days inputting each data point into your company’s proprietary financial model, and produces a detailed financial projection (in 6-point font) the size of a hymnal. The first two times your analyst returns with the projection, take up your thick red marker and arbitrarily circle one number on each of three different pages, add large question marks, and return it without explanation. Then wait two days for the revised projection. Circle three more numbers, return without explanation, and repeat.
Call the developer and tell him you’re sweating the chief underwriter.
When the bleary-eyed analyst returns to your office once again, have only the latest revised projection on your otherwise immaculate desk. Steeple your fingers, gaze sternly, and let the silence build. Tap the papers almost inaudibly. Finally break the silence and ask, in your most manly ominous voice, “Is this the best you can do?” After the analyst gulps “yes,” look out the window for 30 seconds. Without making eye contact, and in a voice as if talking with distant angels, instruct the analyst to raise the price two cents, allocated equally over the last two installments.
Then call your developer and tell him that you achieved this final price after a four-hour investment committee meeting.
Here endeth the lesson.
“And remember, everything I’ve just told you is a lie. Including this statement.”
– George Spiggott, a/k/a Lucifer, in Bedazzled (1968)
David A. Smith, who ordinarily writes this column, is Chairman of Recap Real Estate Advisors, a Boston-based real estate services firm that optimizes the value of clients’ financial assets in multifamily residential properties, particularly affordable housing. He also writes Recap’s free monthly essay State of the Market, available by emailing dsmith@recapadvisors.com.
