Rising interest rates dinging commercial real estate and multifamily assets have plunged low-income housing tax credit (LIHTC) properties back into reality, especially those coming to the end of their 15-year compliance periods.
“There were some huge profits made in the affordable housing space over the last two or three years,” says Cliff McDaniel, a managing director with Lument, which is representing Harmony Housing in the $1.4 billion sale of its affordable housing portfolio to the Michaels Organization. “We sold a lot of properties for $60,000 a unit or even $120,000 a unit, and the debt was $40,000 a unit. But the mania over that type of profitability is over, and values are going back to where they were before.”
Up until about five years ago, the phrase “huge profits” and “affordable housing” would rarely if ever have occurred in the same sentence. Or even in the same story. Prior to that, affordable housing properties typically had very little value at the end of their initial 15-year compliance periods, and limited partners who provided equity to the project by buying tax credits routinely agreed to sell their interest to the general partner for a nominal fee. At that point, the general partner would either raise funds through another sale of tax credits to new limited partners to recapitalize and improve the property or sell its general partnership interest to a buyer who would do so.
But historically low interest rates combined with rising average median incomes — and hence, rising rental rates — began creating value in the projects at the end of the 15-year compliance period. The paradigm shift turned the structure of the 15-year capital event on its head, often pitting limited partners and general partners against each other in legal fights over who had the right to the unexpected profits.
Now that interest rates have climbed roughly 300 basis points over the last year, affordable housing values have reverted to the mean, says McDaniel, who is based in Houston and heads the firm’s affordable housing real estate investment sales team. Because cap rates have ticked up only 100 basis points by comparison, however, affordable housing property sellers can still achieve a nice profit — just not one that is rewarding enough to fight over anymore — amid a market that remains awash with liquidity.
“At the annual National Multifamily Housing Council conference in November, our team met with over 30 investment groups targeting affordable acquisitions,” he adds. “Every one of them reported that they had raised funds to pursue deals in 2023.”
Looking for an Exit
The atypical dynamic of the last few years also fueled an increase in affordable housing purchases by so-called yield buyers, and now higher interest rates are forcing them to rethink their game plans, McDaniel says. These investors were able to take advantage of the low interest rates and rising rents to the properties at year 15 and to keep them affordable without selling tax credits, he explains. But such buyers are having a tougher time making deals work financially today.
Plus, yield-driven investors who purchased affordable housing assets using short-term, adjustable-rate bridge debt are facing new challenges. The benchmark Secured Overnight Financing Rate (SOFR), for example, has soared to 4.80 percent over the last year from near zero, according to the Federal Reserve Bank of New York. Consequently, many yield buyers are upside down on their loans and want out of the deals, McDaniel notes.
“My sense is that we’ll be working with a lot of general partners (GPs) who are looking to monetize their GP interests,” he predicts. “In those situations, limited partners have the right to say ‘yes’ or ‘no’ to a GP selling its interest, and a lot of them will want something in return. They are more difficult to do, but more are coming.”
The good news for those general partners is that the pool of buyers for affordable housing properties remains deep. Economic slumps create more renter demand for affordable housing and drive occupancy. Similar to the conventional multifamily category, LIHTC assets performed well during the pandemic lockdowns. Both are appealing to investors.
On the other hand, just as they do with other property categories, many investors focus on the largest metros where the need for affordable housing is greatest. Conversely, smaller communities tend to lack pricing power.
Recently, McDaniel’s team represented the seller of the Park at Woodland Springs near Houston, which had purchased it from Trammel Crow some years ago. That asset, which fetched an attractive price, benefitted from a good location in a dense market and a California buyer’s desire to get a foothold in a market with high demand for affordable housing.
“In markets where LIHTC properties are seeing a $200-plus rent advantage to neighboring market rate properties, we are still seeing tremendous demand from institutional investors,” McDaniel says. “In their minds, that investment offers almost no downside risk and will have a significant value increase when the affordable housing program concludes.”
On the other end of the spectrum, the team represented a seller who had owned an affordable housing property with some maintenance and capital needs in the much smaller town of Pine Bluff, Arkansas. It eventually found a buyer in New York who already owned property in the market.
Back to Basics?
As a result of the economic changes taking place, the recapitalization of affordable housing assets using equity from the sale of tax credits could once again become the preferred way to resolve the 15-year capital event.
But the deals are suffering from a financing gap: Not only are high interest rates limiting the amount of debt proceeds borrowers can secure, a decline in tax credit prices over the past few years has also led to a reduction in equity being raised. As of September 2022, the three-month average price per tax credit was 90 cents, down from a high of 94 cents in early 2020, according to Novogradac, an accounting, valuation and consulting firm. In 2016, the three-month average was consistently over $1.
Additionally, with the 10-Year Treasury hovering around 4 percent — and shorter-term bond yields decidedly above 4 percent — corporate LIHTC investors like Berkshire Hathaway may demand even lower prices for tax credits to make them more appealing than a bond, McDaniel suggests. Unlike banks, which buy the vast majority of tax credits in order to satisfy their Community Reinvestment Act obligations, corporate LIHTC buyers typically seek a return on their investment.
“What kind of return does a buyer of credits require in this market?” he asks. “If it used to be four percent, they’re going to say, ‘I’m not doing that anymore. I can get that buying a bond.’ So I think the tax credit prices are going to change among return-driven buyers.”
— By Joe Gose. Lument is a content partner of REBusinessOnline. The views expressed herein are those of the author and do not necessarily reflect the views of Lument.
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