Why the New Housing-Tax-Credit Fix Is Just a Drop in the Bucket

Few folks, especially anyone connected with affordable housing, want to look a gift horse in the mouth.

For that reason, bankers have lauded the enactment last month of a federal tax law that, they say, could pave the way for an increase in the construction of affordable rental housing. But relative to the post-crisis boom in demand for apartments and soaring rents, the increase will be minor unless more reforms are enacted, according to bankers and others in the business.

"It helps, but there's still so much more that needs to be done," said Annette Billingsley, a managing director and group head of community development finance at Union Bank in San Francisco.

The change, a tiny provision tucked into the $1.1 trillion spending legislation that President Obama signed Dec. 18, is expected to provide more stability to banks and developers that use low-income housing tax credits. That program is the main vehicle for increasing the supply of affordable, below-market-rate apartments.

The tax credits, which apply to new construction or renovation of low-income housing, are one of the primary ways for banks to earn Community Reinvestment Act credits. Banks are the primary investors in affordable rental housing typically by providing construction loans, permanent loans and equity investments on such projects. [See related story]

The new law made the annual rate used to calculate the low-income housing tax credit permanent at 9%, up from a previous floating rate of roughly 7.5%. In 2008, when the financial crisis hit, Congress set the temporary annual tax credit rate at 9% and extended it twice before the rate expired and floating rates went into effect, upsetting the apple cart for the industry.

Beth Stohr, the director of low-income housing tax credit investments at U.S. Bancorp, said the legislation could mean affordable -housing projects will get finished faster. States where land and construction costs are low such as Missouri and Ohio could get a bigger boost than California, she said.

"Anything to increase the stability of the [low-income housing tax credit] program is helpful in the long run," Stohr said. "There are certain markets where this is going to have a greater impact. For big states, the dial still moves, but not explosively."

Bankers concede that the permanent rate will not make a dent in the severe shortage of affordable rental units, which has reached crisis proportions in most cities. Stagnant incomes, higher rents and demand by low-income renters that far outstrips supply have made the depth of the crisis too big a problem for the tiny legislative change to make much of a difference.

In fact, the permanent change in the annual tax credit rate is so miniscule that it will only cost the government $19 million over 10 years.

The change will primarily aid developers who are awarded the tax credits, which are worth anywhere from 30% to 70% of a project's costs. Developers typically sell the credits to banks, which need them to comply with the reinvestment act, the 1976 law that requires banks to invest in low-to-moderate income areas where they take deposits.

Developers take the annual credits over 10 years and are required to keep rents affordable for people who make below 60% of an area's median income.

Union Bank's Billingsley said making the 9% rate permanent provides more certainty to developers, who can raise more capital from investors up front and thereby reduce a project's debt load.

But "they would have to double the tax-credit capacity … to really have a big impact, and that's unlikely to happen," she said.

The tax credit program has not had a substantial increase since it was created by the Tax Reform Act of 1986. Yet the program has been responsible for the construction and rehabilitation of more than 2.6 million affordable-housing units over 30 years. Nearly all new affordable apartment properties constructed since 2000 received some form of subsidy under the tax credit program, housing experts said.

Fred Copeman, a principal at the accounting firm CohnReznick, said floating rates made the underwriting of tax credits unnecessarily complicated. Because the tax credits moved in tandem with interest rates, developers often had funding gaps between their available financing and actual development costs. That meant fewer affordable-housing projects got built at a time when they were needed the most.

"This provides a level of certainty in the financing and structuring of these credits that we haven't had for years," Copeman said. "As interest rates got lower and lower, the credit percentage moved along with it, and kind of screwed up the financing and structure of these deals. Now we no longer have to worry about interest rates."

Affordable-housing advocates say the move to a permanent rate will have an impact only on the margins.

"Some deals that are not able to qualify for the amount of credit to make them financially feasible will be able to go forward with that extra amount [of tax credit]," said Garth Rieman, the director of housing advocacy and strategic initiatives at the National Council of State Housing Agencies. "For some of the harder-to-finance deals, this will be a limited but significant change to help those properties go forward."

The market for low-income housing tax credits is near its all-time high at $12.5 billion last year, up from $4.5 billion in 2008, and $9 billion in 2006, Copeman said. Commercial banks account for 85% of the market; Wells Fargo is the largest investor by volume at $2 billion.

Demand for the tax credits also has skyrocketed to 95 cents on the dollar last year, up from 72 cents on the dollar in 2010, Copeman said.

While overall rental vacancy rates typically hover at 7%, in recent years vacancy rates on affordable rentals have plummeted to below 1%, Copeman said.

Demand for affordable housing is so dire that last year a new building on Manhattan's Upper West Side attracted more than 88,000 applicants for just 55 units.

Low-income renters "are so desperate to hold on to decent quality housing that they will do anything to stay," said Benson "Buzz" Roberts, the president and chief executive at the National Association of Affordable Housing. "This is the best-performing asset class in real estate."

The tax credit program produces a maximum of roughly 90,000 units a year. But the Harvard Center for Joint Studies has estimated there is currently an 8 million-unit shortfall in affordable-housing units.

Lenders, developers and affordable housing advocates are expected to lobby lawmakers to increase the total supply of tax credits.

"More credits are needed — it is a crisis," said Stohr at U.S. Bancorp. "Right now if we had 50% more credits there would be demand for it."