Significantly Affect LIHTC Equity Market

 
Published by Dirk Wallace, Michael Novogradac  December 29, 2016

 

As noted previously in this space, the election has increased the likelihood of substantial tax reform being enacted in the coming years. This has renewed concerns about the potential effects—intended and unintended—of that reform on the low-income housing tax credit (LIHTC).

Simply put, if current efforts to enact corporate tax reform are successful, the resulting changes to the tax code will affect the amount of LIHTC equity that can be raised and in turn the number of affordable rental apartments that can be built or preserved. It’s important to note that the overall effects of tax reform could be net positive or net negative, depending on the totality of the impact of the various changes.  

One of the basic tenets of tax reform is to broaden the base and lower the marginal tax rate. In their tax reform “blueprint,” House Republicans have targeted a lower top corporate tax rate of 20 percent. President-elect Donald Trump campaigned on a top tax rate of 15 percent for corporations. Additionally, accelerating depreciation periods is one of many measures reported to be under consideration.

As investors and others in the affordable housing community consider what tax reform could mean for the future of the LIHTC, Novogradac is analyzing the possible ripple effects of these two tax reform outcomes on LIHTC investor yields, investor equity pricing and the amount of equity raised. This analysis is a partial update to the report Novogradac & Company published in 2013 on how tax reform could affect affordable rental housing.

To gauge the effect of lower corporate tax rates and accelerated depreciation periods on LIHTC yields and possible investor equity pricing, Novogradac & Company ran a series of calculations using an internal rate of return (IRR) model, at a range of investor equity prices from $0.95 to $1.10, for 9 percent investments and 4 percent tax-exempt bond investments, both with and without basis boosts (allowing the project to increase its eligible basis by 30 percent).  

The calculations estimated the IRR effect of the corporate tax rate dropping from the current level of 35 percent to 28 percent, 25 percent, 20 percent and 15 percent. We also ran calculations to consider the effect of tangible and intangible assets being expensed when the asset is placed in service and interest on the debt only being deducted to the extent there is interest income for tax purposes. (Under the House tax reform blueprint, land would not be deductible.) The investor equity price per credit at each tax rate represents the investor equity price per credit required to achieve an assumed investor level yield of 4.5 percent to 5 percent.

These calculations didn’t vary for factors that commonly affect investor demand and investor equity pricing, such as property type, transaction terms or Community Reinvestment Act considerations. These calculations do not assume any transition rules, where changed tax rates and/or changed policies on depreciation or interest deductibility are phased in over time.  Also, the investor equity pricing estimates, as explained above, are based on an IRR model and, as such, do not incorporate adjustments that might be needed if corporate investment models based on earnings per share, return on equity and other assessments were included. Novogradac plans to update this report as such additional assessments are made and are publicly available.

9 Percent Property Not Receiving a Basis Boost at Various Top Tax Rates
To begin, Novogradac & Company considered implications for LIHTC properties not receiving a basis boost. This calculation shows estimated credit pricing at 35 percent tax rate down to a 15 percent tax rate, but with all other aspects of current tax law in force. The base scenario of the analysis assumes the current 35 percent tax rate. As tax rates decrease, the tax credit investor equity price is adjusted to achieve the same yield as the base scenario of 4.5 percent to 5 percent. All other assumptions in the analysis remained constant. For 9 percent properties not receiving a basis boost, there is a higher debt to equity ratio when compared to a 9 percent property receiving a basis boost because the property isn’t receiving the additional equity generated from the 30 percent basis bonus. As a result, any fluctuations in tax rates for this type of property generally impact the yield and investor equity price per credit to a greater degree when compared to the same property receiving a basis boost. Assuming the property received equity contributions equal to $1.00 per tax credit, the results show that if the top corporate rate is lowered to 25 percent, the investor equity price per credit necessary to achieve the same yield as current tax law drops from $1.00 to $0.89. If the top corporate rate is lowered to 15 percent, the investor equity price per credit necessary to achieve the same yield as current tax law drops from $1.00 to $0.83.

Blog Chart 9 Percent Property without Boost: Current Tax Law

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9 Percent Property Not receiving a Basis Boost at Various Top Tax Rates with Expensing Depreciable Assets and Limited Interest Deductibility
Next, Novogradac considered the effect of two of the tax reform proposals in the Tax Reform Task Force Blueprint on that same LIHTC property with a 9 percent tax credit allocation not receiving a basis boost. In this analysis, tangible and intangible assets, except for land, are expensed when the asset is placed in service and interest on the debt is only deducted to the extent there is interest income for tax purposes. Again, the investor equity price per credit at each tax rate represents the investor equity price per credit required to achieve the investor level yield of 4.5 percent to 5.0 percent. Because of the substantial benefit created by the immediate expensing of tangible and intangible assets, except for land, the investor equity price per credit is higher in this scenario than in the base scenario that reflects current tax law. And as tax rates decrease, the benefit from expensing the fixed assets has less of an impact on the yield and investor equity price per credit decreases.

Blog Chart 9 Percent Property without Boost: Tax Reform - Depreciation Expensing and Interest Expense Limited

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4 Percent Tax-Exempt Bond Property Not Receiving a Basis Boost at Various Top Tax Rates
These figures assume a property is financed with tax-exempt bonds, is not receiving a basis boost, and tax law is unchanged with the exception of the top corporate tax rate. As illustrated, if the top corporate rate is lowered to 25 percent, the investor equity price per credit necessary to achieve the same yield as current tax law drops from $1.00 to $0.88. If the top corporate rate is lowered to 15 percent, the investor equity price per credit necessary to achieve the same yield as current tax law drops from $1.00 to $0.81.

Blog Chart 4 Percent Tax-Exempt Bond Property without Boost: Current Tax Law

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4 Percent Tax-Exempt Bond Property Not receiving a Basis Boost at Various Top Tax Rates with Expensing Depreciable Assets and Limited Interest Deductibility
Next, Novogradac estimated investor equity price ranges for a property financed with tax-exempt bonds, not receiving a basis boost for which the tangible and intangible assets, except for land, are expensed when the asset is placed in service and interest on the debt is only being deducted to the extent there is interest income for tax purposes. Again the investor equity price per credit is higher because of the expensing change. The debt to equity ratio is also higher for a non-boost property and the inability to deduct the additional interest has a greater negative affect on equity investment credit pricing when compared to a property with a basis boost. 

Blog Chart 4 Percent Tax-Exempt Bond Property without Boost: Tax Reform - Depreciation Expensing and Interest Expense Limited

Click to Enlarge

 

9 Percent Property Receiving a Basis Boost at Various Top Tax Rates
Of course, it’s essential to also consider implications for LIHTC properties that receive a basis boost (allowing the project to increase its eligible basis by 30 percent). In this scenario, Novogradac calculated investor equity price per credit for a LIHTC property that received a 9 percent tax credit allocation and receiving a basis boost at different top tax rates, but current tax law otherwise in effect. Assuming the property received $1.00 per tax credit, the results show that if the top corporate rate is lowered to 25 percent, the investor equity price per credit necessary to achieve the same yield as current tax law drops from $1.00 to $0.90. If the top corporate rate is lowered to 15 percent, the investor equity price per credit necessary to achieve the same yield as current tax law drops from $1.00 to $0.83. 

Blog Chart 9 Percent Property with Boost: Current Tax Law

Click to Enlarge

 

9 Percent Property Receiving a Basis Boost at Various Top Tax Rates with Expensing Depreciable Assets and Limited Interest Deductibility
Next, Novogradac layered into the previous calculation the estimated effect of tangible and intangible assets, except for land, being expensed when the asset is placed in service and interest on the debt being deducted to the extent there is interest income for tax purposes. Again, the investor equity price per credit at each tax rate represents the investor equity price per credit required to achieve the investor level yield of 4.5 percent to 5.0 percent. And again, because of the substantial benefit created by the immediate expensing of tangible and intangible assets, except for land, the investor equity price per credit is higher in this scenario than in the base scenario that reflects current tax law. As tax rates decrease, the benefit from expensing the fixed assets has less of an impact on the yield and investor equity price per credit decreases.

Blog Chart 9 Percent Property with Boost: Tax Reform - Depreciation Expensing and Interest Expense Limited

Click to Enlarge

4 Percent Tax Exempt Bond Property Receiving a Basis Boost at Various Top Tax Rates
The breakdown below assumes a property is financed with tax-exempt bonds and receiving a basis boost at different top tax rates, but current tax law otherwise in effect. As tax rates decrease from the base scenario, the tax credit investor equity price is adjusted in order to achieve the investor level yield of 4.5 percent to 5.0 percent. All other assumptions remained constant. In this scenario, if the top corporate rate is lowered to 25 percent, the investor equity price per credit necessary to achieve the same yield as current tax law drops from $1.00 to $0.90. If the top corporate rate is lowered to 15 percent, the investor equity price per credit necessary to achieve the same yield as current tax law drops from $1.00 to $0.82.

Blog Chart 4 Percent Tax-Exempt Bond Property with Boost: Current Tax Law

Click to Enlarge

 

4 Percent Tax Exempt Bond Property Receiving a Basis Boost at Various Top Tax Rates with Expensing Depreciable Assets and Limited Interest Deductibility
Finally, Novogradac considered the estimated effect of tangible and intangible assets, except for land, being expensed when the asset is placed in service and interest on the debt being deducted to the extent there is interest income for tax purposes, on a property that is financed with tax-exempt bonds and receiving a basis boost. This analysis again found that the investor equity price per credit is higher than in the base scenario under current tax law because of the substantial benefit from the immediate expensing of tangible and intangible assets, except for land. Properties financed with tax-exempt bonds typically have a greater proportion of tax benefits from depreciation compared to 9 percent properties and thus, tax law changes that accelerate cost recovery of assets have a more positive IRR effect on these properties than 9 percent properties. And as with the 9 percent property calculation, as tax rates decrease, the benefit from expensing fixed assets has less of an impact on yield and investor equity price per credit decreases.

Blog Chart 4 Percent Tax-Exempt Bond Property with Boost: Tax Reform - Depreciation Expensing and Interest Expense Limited

Click to Enlarge

 

Conclusion
As shown in these calculations, lowering the top corporate tax rate from 35 percent could lower the investor equity price per credit by as much as $0.17, depending on how low lawmakers are able to drop the top tax rate. This would substantially reduce the amount of equity available to build and preserve affordable rental housing. In 2015, the annual LIHTC equity raised was about $13 billion, of which approximately $3 billion was in the 4 percent market. Based on that total, Novogradac estimates that a reduction of as much as $2.2 billion, or more, in annual LIHTC equity would be available under various tax reform proposals. Using historical unit production data from the National Council of State Housing Agencies, this reduction in equity could translate into as many as 16,000, or more, fewer affordable rental homes created or preserved each year.

However, it’s important to also note that in addition to lower rates, proposals to allow immediate expensing of tangible and intangible assets could have some offsetting positive effects as well.

Want More?
Clearly there are a number of additional considerations than those discussed here that will affect the LIHTC equity market. Contact a Novogradac professional to evaluate how those considerations could affect your current and proposed investments.

Additionally, Novogradac & Company has formed a Tax Reform Working Group. Please contact Dirk Wallace, CPA, to learn more. 


Low-income housing faces headwinds

Trump’s policies may curb pursuit of tax credits that aid developers’ Low-income housing faces headwinds

By Rebecca Elliott

President-elect Donald Trump has pledged to rebuild the nation’s “inner cities,” but his proposed tax policy could stifle a key revitalization tool: low-income housing tax credits. Pointing to a state funding system still seen as favoring housing subsidies in suburban areas over urban and wariness about the fallout of Trump’s plan to slash the corporate tax rate, housing policy experts are bracing for what they worry could be a difficult year for Texas cities seeking to expand their affordable housing stock.

“There’s a lot of nervousness in the industry right now,” said Scott Marks, an Austin-based lawyer with The Coats Rose law firm who specializes in affordable housing. “In the cities like Houston, it means it’s going to be a lot harder for afford-able housing to be built, at least in the near future.” 

Houston is home to some 78,000 subsidized housing units, provided by the Houston Housing Authority, private developers and nonprofit organizations.

That leaves roughly 100,000 city households—or more than a quarter-million people—in need of affordable housing, according to housing authority President Tory Gunsolley, as demolition and new construction in historically working- class areas continue to displace residents.

Limited projects

Low-income housing tax credits, which companies purchase to lower their tax liability, are one of the primary funding sources for new subsidized housing.

In 2015, Texas awarded tax credits to 94 developments, 11 of them in Houston.

Some in the industry say the state application process has made it difficult in recent years for developers to receive tax credits for projects in densely populated areas.

After the Texas Department of Housing and Community Affairs was ordered by a court in 2012 to remedy its longtime pattern in the Dallas metropolitan area of concentrating low-income housing in high-poverty minority neighborhoods, the agency rewrote its rules to favor developments in so-called “high-opportunity” areas. Such neighborhoods are home to better schools, lower crime rates and residents with higher incomes.

That made it more challenging for developers to receive tax credits for projects in areas attempting to revitalize. Meanwhile, development costs and local lawmakers’ ability to essentially veto projects also stymied affordable developments in affluent urban areas, housing experts said. As a result, new tax credit developments— particularly those with higher subsidies—were pushed to the suburbs.

In Houston, for example, just two of 11developments approved in the last three years for the larger subsidy—a 9 percent tax credit—are located within Loop 610, which surrounds the traditional inner city. Two are between Loop 610 and Beltway 8, and seven are located along the beltway or beyond.

Several other projects in the region were approved outside city limits.

“There’s just not a whole lot of areas within the city limits that qualified under those scoring criteria,” said Zach Cavender, director of the Mark-Dana Corp., a private developer that specializes in affordable housing. ”That’s why you’ve seen a lot of the development in the past few years pushed into the suburbs.”

The state’s tax credit allocation process for next year attempts to correct for that imbalance in cities with a population of more than 500,000 by guaranteeing tax credits for at least one project in an area primed for revitalization. Developers in those cities also receive additional points if their project site is within four miles of City Hall.

“The department has sought a more balanced approach, creating a set of incentives and threshold requirements that balance revitalization efforts with ‘high opportunity’ areas, and promote greater dispersion of properties in communities, including (this year) dispersion into urban core areas that may be heavily impacted by escalating rents as gentrification occurs in our larger cities,” Texas Department of Housing and Community Affairs spokeswoman Kristina Tirloni said in an email.

Uncertainty reigns

Tom McCasland, director of Houston’s Housing and Community Development Department, said the city has yet to designate its revitalization area but intends to do so in the coming weeks.

“This might actually get some deals closer in to the urban core, where property areas typically are going to be higher and it’s harder to develop,” said Matt Hull, executive director of the Texas Association of Community Development Corporations.

Marks, the affordable housing lawyer, agreed that the state’s changes may help level the playing field for urban areas but said suburban neighborhoods remain at an advantage.

Another concern, he said, is that Trump’s plan to slash the corporate tax rate to 15 percent from 35 percent would reduce the incentive for companies to invest in tax credits because they would have smaller tax liabilities.

That uncertainty already has frozen the tax credit market, as investors struggle to calculate the return on purchasing tax credits, Marks said.

“Some have said that if the corporate tax rate drops from 35 percent to 15 percent that could actually crowd out the entire low-income housing tax credit program” Marks said. “I think that’s a bit too pessimistic.”

At a minimum, he expects closings scheduled for the beginning of the year to be delayed. Gunsolley shares Marks’ concerns.

“We are looking at a massive re-evaluation of the tax credit market and what the value of a tax credit is,” Gunsolley said. “That’s going to make deals harder to get done, and we’ll probably see deals not happen that would have happened in better times.”

The state housing agency is monitoring the situation, Tirloni said, and is “working to refine its tools to accommodate and address changes in the market to assure that disruption to the development of affordable housing can be managed and minimized.”

‘Get more creative’

If tax credits become less valuable, developers would need to lean more heavily on outside entities, such as city housing departments, to close their funding gaps.

“If we follow the same model we’ve been following of chasing tax credits and that being the majority of how we get units on the ground, we’re not going to keep up,” McCasland said. “Without abandoning the approach and trying to get tax credits, we are going to have to be more creative.”

With that in mind, McCasland plans to focus next year on alternative ways of assisting low income residents: financing home repairs, providing down payment assistance and piloting a program to build alternative housing for senior or disabled homeowners in life-threatening situations.

The housing department also is working to establish a community land trust, which would let the city preserve land for affordable housing while allowing residents to purchase a home and build equity.

“We’ve got a lot of work to do,” McCasland said.

rebecca.elliott@chron.com 


Founded in 1997, the Texas Affiliation of Affordable Housing Providers (TAAHP) is a non-profit trade association serving as the primary advocate and leading resource for the affordable housing industry in Texas. Our vision is to inspire and engage our members and stakeholders to end the affordable housing crisis in Texas.

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