A Set of Modest Proposals
By David A. Smith
5 min read
Congressman Steve Pearce (R-NM-2): Mr. Russ, can you tell me what rates of return [LIHTC] investors are looking at in this market? A lot of money sits idle, desperately looking for return. – House Subcommittee on Housing and Insurance hearing,“The Future of Housing in America: A Comparison of the United Kingdom and United States Models for Affordable Housing”
Dear Congressman Pearce:
At your recent hearing you asked a trenchant question, and I am writing to give you a more thorough answer than was possible during your brief Q&A time, and to offer some modest proposals for your consideration.
Both debt and equity yields are incredibly low, yielding extremely efficient capital raises, but that is only part of the story.
- Equity rates-of-return are so low the government reaps a premium. Even though the LIHTC is delivered over ten years, for most properties today prices are above $1.00 of net cash equity per dollar of LIHTC, sometimes as high as $1.18.
If this seems impossible, it isn’t. It’s due to two factors: the advantage to CFOs of converting $1 of balance sheet cash into $1 of additional after-tax earnings, and the capture of CRA ‘investment test’ credit. LIHTC monetizes the Community Reinvestment Act equity investment obligation: the result is prices for credits that are 20-25% higher (my personal estimate) than they would be without the CRA motivation.
An idea for your consideration: Expand CRA to include non-bank financial institutions. Today, we have banks with no branches (Ally), totally mobile money, a bank in a grocery store (Walmart), and consumer operations (Amazon, Facebook) that have all the functions of a bank without the name or the regulatory overlay. Why are they, along with insurance companies and brokerage houses, exempt from the Community Reinvestment Act?
- Debt yields are analogous to high-grade corporate paper. The senior debt on any LIHTC property is financed with classical debt service coverage (DSC) and loan-to-value (LTV) ratios, and is in fact priced as a high-grade loan. But rates are not the whole story of pricing, because costs of issuance differ between taxable and tax-exempt. Even so, tax-exempt debt is often used because the 4% credits’ value (25-30% of total development cost) outweighs the interest/issuance cost differential.
An idea for your consideration: Allow Community Development Financial Institutions, or similar private non-profit entities, to issue tax-exempt bonds. Allowing CDFIs to issue tax-exempt debt and to revolve the debt periodically as it is repaid would open up potential for larger-scale ‘shelf’ tax-exempt offerings that likely would bring down issuance costs.
- If both debt and equity are so hotly competed, what then is the resource challenge?
Although you did not directly ask this, it’s reasonable to infer from your questions: why then is financing these transactions so hard? LIHTC properties now fill what they were never meant to fill: the workforce housing affordability gap and the place-based services gap.
The urban workforce housing affordability gap. When LIHTC was enacted in 1986, as-of-right zoning prevailed in most of urban America, and as a result people who earned more than 60% of Area Median Income (AMI) could generally find conventional market-rate rental housing that they could afford, so 60% AMI became the LIHTC statutory income ceiling. Over the ensuing three decades, development barriers have choked off new housing supply in many markets, especially urban markets experiencing job growth. This translates into higher land prices, higher soft costs to surmount the NIMBY barricades, and higher development costs that price out affordable production.
The result is an ‘urban workforce housing gap’ – little or no quality conventional rental housing affordable to households who earn just above the LIHTC income ceiling. The urban workforce gap varies by city; it widens dramatically in cities with a combination of job growth and supply constriction. Urban workforce housing is essential urban infrastructure; it’s where critical local service jobs go to sleep at night. Because the people who make the town work should be able to live in the town they serve and protect, many communities throughout America, including Albuquerque, face a challenge of workforce housing that LIHTC by statute cannot meet.
An idea for your consideration: Use Federal pre-emption to allow zoning override for qualifying workforce housing properties. When national programs can be stymied for years by local barriers, then national policy is subverted inequitably and job-creating communities suffer.
The place-based services gap. At the other end of LIHTC’s income range are people for whom housing is the symptom of a much deeper problem in two parts: minimal income, and a personal challenge. Some people need support in building their lives to independence, and that starts with a safe place to live while that independence-building is going on. Beyond these LIHTC QAP mandates for supportive housing, usually unfunded, the rents people who have minimal incomes pay are so low they support only a tiny first mortgage, leaving a huge gap to be filled with soft financing. To corral the needed subsidies or soft capital at the same time and with non-contradictory regulatory requirements is akin to development finance whack-a-mole.
An idea for your consideration: Divert social-service budgets ‘upstream’ so they can be place-based and underwritten into supportive housing. If providers of supportive housing were able to capture even a fraction of the per-customer funding streams now spent on impacted populations (for instance, §1115 Medicaid waivers for elderly health-related services), via a multi-year contract that they could then finance, they could and would build housing typologies and modes that would not only change lives, but also change our whole perception of how to help people help themselves onto their feet.
David A. Smith
Chairman, Recap Real Estate Advisors
Founder and CEO, Affordable Housing Institute
Excerpted from a much longer letter; full text available by emailing dsmith@recapadvisors.com.
