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Running Into A Wall

Shortage of tax-credit investors threatens low-income housing development.

Contractors in Sarasota, Fla., are tearing down the notorious Janie Poe housing project, where the sound of gunfire once was commonplace. On the site, Michaels Development Co., based in Marlton, N.J., is building phase one of the $150 million, 800-unit Newtown development of affordable and market-rate housing.

Michaels has signed the first nine tenants for the new, 86-unit Janie's Garden, where a four-bedroom, 1,472 sq. ft. unit, the Rose apartment, is advertised for rent at $695 per month. Potential residents are clamoring for the available 77 apartments.

“Our wait list is in the neighborhood of 500 applicants so far,” says Milton Pratt Jr., senior vice president of Michaels Development, which builds affordable housing across the country and will manage the Sarasota apartments.

One-third of the Newtown units, scheduled for completion in 2015, will be market rate, and one-third will be public housing to replace demolished apartments. The remaining third, for tenants earning no more than half the area median income, will be financed through the federal Low Income Housing Tax Credit (LIHTC) program.

The tax credit program contained in Section 42 of the Internal Revenue Service tax code has become the most powerful of the government's low-cost housing programs.

In fact, the LIHTC program accounts for $6 billion of the more than $12 billion the government will spend this year for affordable housing development, says Garth Rieman, advocacy director at the National Council of State Housing Agencies, a nonprofit that represents state interests in Washington, D.C.

“I think most people would agree that the Low Income Housing Tax Credit is the most significant affordable housing program and the largest program supporting the development of new affordable housing in the country today,” says Rieman. It allows participating developers and investors to reduce tax liability in return for producing rental housing for low and moderate-income families (see sidebar).

For years, big corporate investors, including mortgage securities giants Fannie Mae and Freddie Mac, invested billions in tax credits to offset profits and reduce their taxes. In fact, the government-sponsored enterprises served as pillars of the program, annually buying as much as 50% of the available credits and fueling construction and rehabilitation of affordable housing across the country.

But the program, created in 1986, faces a dire shortage of investors as corporate earnings have plunged to the point where companies no longer have vast profits to offset. Fannie and Freddie were placed in federal conservatorship in September, while former investors Chrysler and General Motors are embroiled in bankruptcy, and some investment banks failed amid the nation's credit and capital crisis.

“The market has collapsed,” says David Cardwell, vice president of capital markets at the National Multi Housing Council (NMHC) in Washington, D.C., which represents major apartment companies. “I think you're going to see a lot of stress in that [tax credit] market.”

Tax credit value plummets

Today, in addition to the problem of sliding profits, investors find the Section 42 program less inviting because the credits have dropped in value. A few years ago, says Cardwell, corporate profits were so high that some investors paid $1.30 per credit to offset their taxes. Now the value of a tax credit has dropped to about 70 cents or 75 cents.

The reversals have dealt a blow to the tax credit industry. “There's clearly a need for affordable housing — a critical need. Something has to be done to help the program and to get money back flowing in this sector,” says Tom Fischer, senior vice president of the national tax credit advisory group at CB Richard Ellis. “There was nobody there to buy the credits [in 2008], and the debt markets stopped as well. So a number of projects that were needed last year didn't come to fruition.”

Asked whether Fannie Mae would resume its investments, spokeswoman Amy Bonitatibus issued a statement saying, “Fannie Mae has been a provider of liquidity for the Low Income Housing Tax Credit market for nearly 20 years and looks forward to continued participation in this important affordable housing market in the future.” The statement did not indicate whether purchases would reach earlier levels.

“As with other investors in this market, we periodically adjust our levels of new investments and our levels of sales of LIHTC assets to correspond to our current corporate tax liability,” Fannie Mae said.

Filling a void for families

The demand for affordable housing has become acute. The unemployment rate reached 9.4% in May, a 25-year high. Since the start of the recession in December 2007, 6 million payroll jobs have been lost, according to the U.S. Bureau of Labor Statistics.

In April, home foreclosures climbed to 342,000 filings, 32% higher than a year earlier, reports Irvine, Calif.-based research firm RealtyTrac. “Every day we see families knocking on our door,” says Pratt of Michaels Development. Recently, at the Newtown site he spoke with a nurse and her husband, a truck driver, who brought their young daughter and filled out applications.

Construction spurred by tax credits now accounts for about one-fifth of all U.S multifamily starts, says Mark Obrinsky, chief economist of NMHC. In 2007, the most recent year for which tax credit data is available, 52,382 of the 277,000 multifamily starts, or 19%, were aided by the tax credit program.

“It's a higher percentage of new multifamily construction than it was a few years ago simply because the other part of the market has tanked,” explains Obrinsky.

Starts of all U.S. multifamily buildings with at least five units dropped to 266,000 in 2008, Obrinsky says, and he predicts they will plunge to 150,000 in 2009. Employment declines are the key reason for the drop.

David Cooper, a principal with the Woda Group, a developer based in Westerville, Ohio, sees firsthand the fallout from an inadequate supply of modestly priced housing. Woda builds about 15 affordable apartment projects a year across 10 states.

“If we don't have someone to buy those credits, then we cannot generate the funding necessary to build the development,” says Cooper. “We manage about 4,300 units and we've never had more demand for our units than we do right now.”

Deals are dying

“A lot of deals that were awarded tax credits and can't find an investor are dying. In many cases, developers are even returning the tax credits awarded to them to the state housing finance agency because they can't find an investor to make the deal work,” says Bob Greer, president of Michaels Development, which has built 40,000 affordable housing units over three decades and has about 4,000 under construction.

Since the recession began, many syndicators have vanished or had trouble securing investors, says Greer. Frustrated, he started a costly syndication department within Michaels, hiring tax specialists and approaching potential investors directly.

Greenbelt, Md.-based Bozzuto Group often partners with nonprofits to build housing, says CEO Tom Bozzuto. The developer is completing the $53 million Jericho Residences in Landover, Md. with Jericho Baptist Church to create 110 affordable and 160 market rate seniors units. “They just don't have the technical skills to put together a real estate project, any more than I would have the skills to run a church.”

Some observers see encouraging signs for affordable housing. “Some economic investors are coming back, because the yield on the tax credit has increased as the price has dropped. That is a new trend,” says Robert Sheppard, senior vice president of investments for real estate services firm Marcus & Millichap, based in Encino, Calif. Such signs are helpful to an industry that Sheppard says has withered from a robust $10 billion in 2007 to less than $4 billion annually.

Stimulus offers hope

In February, the American Recovery and Reinvestment Act of 2009 was signed into law, allocating $2.25 billion for the Tax Credit Assistance Program administered by the Department of Housing and Urban Development (HUD) for Section 42 properties. The act also allows states to exchange housing credits for cash, which could yield an additional $3 billion for housing credit property, says Rieman of the state housing agencies group.

The Obama Administration also is spending $330 million to spur affordable housing in the Midwest and Puerto Rico. In Canton, Ohio, a vacant three-story tenement will be torn down and replaced by 40 new apartments.

In Detroit, the aging Across the Park Apartments will get a $13 million facelift. And in Osawatomie, Kan. a seniors housing complex that lost its funding and was halted when three-fourths complete will get the needed funds to finish the job.

Although some analysts are skeptical about government efforts to prop up Section 42, Fischer of CBRE is cautiously hopeful that stimulus funds will increase affordable housing transactions. Milwaukee and Omaha developers have told him they can't even get quotes for deals, while a client in Great Falls, Mont. got three rejection letters, Fischer adds.

“If things happen the way it's been laid out, deals will get closed that otherwise would not have gotten done.”

Denise Kalette is senior associate editor.

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