A Closer Look at Tax Credit Investments

By Alexandra Pacurar

Laura Bailey, Capital One

Changes in tax legislation, proposed budget cuts to the U.S. Department of Housing and Urban Development (HUD) and rising interest rates are just some of the factors that could have a negative impact on tax credit ventures, particularly in the multifamily industry. While banks remain the most common lender in the affordable housing space, due partly to the prospects of stable returns, they are increasingly  partnering with other lenders such as tax credit syndicators to overcome the challenges that make this investment niche tricky.   

One such partnership that has flourished over the years has been between Capital One’s Community Finance team, which is celebrating its 10th anniversary, and Low-Income Housing Tax Credit syndicator Hudson Housing Capital. Laura Bailey, senior vice president of Capital One Community Finance, and Joseph Macari, founding & managing member of Hudson Housing Capital, discussed the evolution of the bank-tax syndicator partnership and the current environment for this investment vehicle.

What are the current challenges disrupting the business flow between banks and tax credit syndicators?

Laura Bailey: Tax credit investing sounds complicated—and it is. Yet, the end goal is to provide capital that enables a community-centered development to move forward, something vital in importance in cities across our country and, in a sense, beautiful in its simplicity. The technical features matter and now more than ever, following changes in tax law is crucial.

Also, an inability to work in partnership can absolutely disrupt the business flow between banks and tax credit syndicators. You need to work together to tackle the many intricacies that make tax credit investing complicated and that can come to bear in different ways on a transaction.  

How can banks and tax credit syndicators work together more effectively?

Joseph Macari: In order to find the most appropriate LIHTC investment opportunities for a bank, the syndicator needs to understand the bank’s needs in terms of location, sponsor type, risk tolerance and economics. Furthermore, regular and open communication during initial evaluation, as well as during underwriting and closing, is crucial. When unforeseen problems or risks are identified, they should be openly discussed so that solutions can be reached on a collaborative basis.

The syndicator needs to be a strong and effective advocate for the bank throughout the process. Having worked with Capital One Bank for nearly a decade, Hudson understands the bank’s needs and due diligence process intimately, and we believe that this is the key to our working together so effectively.

Joseph Macari, Hudson Housing Capital

Some investors may be hesitant to pursue affordable housing projects because of minimized returns. What would you say to these investors, considering the high demand for low-income housing?

Bailey: The best feature of providing high-quality affordable housing is the one that might most interest investors. And that is the fact that you rarely have a problem finding residents. We have invested in properties where there are hundreds of applicants for each available unit. But, returns in this field are limited in order to ensure that the government subsidy stretches to help as many people as it can.

So, the investors most commonly seen in affordable housing are banks motivated by making high-quality investments that fulfill their responsibilities under the Community Reinvestment Act and attracted by the prospect of stable returns over a 10- to 12-year period.  

What can you tell us about the impact of current political and economic factors on tax credit investments?

Macari: The primary political issue affecting affordable housing in 2017 was tax reform. Due to uncertainty regarding the final legislation, many investors curtailed their appetite for LIHTC investments last year. With the passage of the tax reform in December and the preservation of the LIHTC program, there is now more certainty in the market and investors are returning. But the reduction in the corporate tax rate from 35 to 21 percent means that there is less after-tax benefit from tax credit investments and tax credit pricing has fallen as a result.

The president’s fiscal year 2019 budget request released on Feb. 12 calls for significant cuts to the HUD budget, including programs that fund development and operation of affordable housing, such as Section 8 rental assistance and Community Development Block Grants. Of course, the president’s budget request is just a starting point and Congress will have its own say, but the request will likely carry weight as it frames the upcoming debate.

What about rising interest rates?

Macari: Given the robust economy, real estate fundamentals remain strong. With upward pressure on home prices and apartment rents in most markets around the country, the need for affordable housing is greater than ever. With rising interest rates and lower tax credit prices, there is increased pressure on the financial feasibility of affordable housing projects. Higher interest rates will also likely lead to higher yield targets for investors, which could further reduce the prices they pay for tax credits. Unfortunately, these factors, along with increasing construction costs, are going to take a toll on affordable housing production nationwide.

Which type of tax credit investments are considered to be most appealing for investors at the moment? Affordable housing, rehabilitation of historic buildings or energy efficient (re)developments?

Bailey: From our point of view, each has its merits. And when you think about it, a balanced community needs each of these in order to fulfill its promise as a truly great place to live.

Images courtesy of Capital One and Hudson Housing Capital