An October 8 report prepared by Ernst & Young examines the funding issues currently impeding the Low Income Housing Tax Credit (LIHTC) program, as well as some proposed resolutions. The recent decline in the program’s investment levels has slowed or stalled affordable rental housing development projects nationwide. The study finds the proposed “five-year carry-back” to be the legislative option most preferred among investors and syndicators and the option that would likely have the largest impact on housing credit investment.
Since its inception, the LIHTC investor base has evolved from one based primarily on individual investors to one that by 2003 was dominated almost solely by large financial service conglomerates. This reliance on large investors left the program particularly vulnerable during the recession. Fannie Mae, Freddie Mac and the 25 largest commercial banks, all of which suffered extensive losses in the recession, provided an estimated 85% of all housing credit equity capital in 2006. Many housing credit investors have either left the market or sold or decreased their investments, particularly those financed by tax-exempt bonds. From 2007 to 2008, investment levels decreased 14.8%, from $6.9 billion to $5.9 billion. Tax-exempt bond financed investments saw a 44.4% decline over the same period. According to the report, this trend is expected to continue, with a predicted 22.4% decrease in tax credit investment from 2008 levels in 2009
Ernst & Young surveyed current, former, and potential investors as well as syndicators and brokers active in the housing credit industry and found that the main reasons investors are leaving the housing credit market have to do with investment characteristics rather than the investor’s financial condition. Eighty-three percent of former investors identified low earnings levels as the primary reason they left the market. With dissatisfaction with the program representing the main impetus for departure from the market, the study surveyed the projected impact on market investment that internal program modifications could generate. Legislative proposals meant both to attract new investors and absorb the excess supply of tax credits were examined.
The five-year carry-back proposal would allow current housing credit investors to “carry back” credits earned between 2009 to 2011 for up to five years in exchange for a commitment to reinvest the funds in new housing credit investments made during the same period. To “carry back” means investors can use current credits to reduce tax liability in earlier/prior years when they do not have sufficient income to use the credits in the current year.
This change would allow investors to immediately realize value by applying unused credits to offset previous years’ liability.
In the second part of the proposal, credits earned from new project investments first claimed after 2008 could be carried back up to five years at any time during the 10-year tax credit period, a reassurance to potential investors concerned about the predictability of their future tax profile. The Ernst & Young survey reports, among both investor and syndicator respondents, a preference for the five-year carryback proposal over alternative legislative options. If the proposal were enacted, investor respondents projected a 37% increase in total expected housing credit investment through 2011. This figure would represent an addition $5 billion investment in the program.
Respondents also voiced their preference for investments financed with allocated credits over those financed with tax exempt bonds. More than half, 55%, would prefer to invest exclusively in allocated credits, while the remaining 45% would prefer a 75%-25% split. They cited higher loss levels associated with tax-exempt bond financed investments as the reason for this preference.