Regardless of your political views, I think most political observers would admit to some degree of surprise at the results of the 2016 presidential election. Polling data and most (but not all) pundits were proven wrong by the election of President Trump. To some extent, the financial markets reflected this surprise. Dow futures plunged and interest rates rose overnight following the election results — only to rebound the following day. The market for low income housing tax credit (LIHTC) pricing was severely disrupted in the weeks following the 2016 presidential election. By December 2016, barely a month after the election, investors in LIHTC appeared to have reassessed the likelihood of comprehensive tax reform.
Investors in LIHTC receive a return on their investment from tax credits and passive losses, which can be used to defer tax liability. Everything else being equal, a reduction in marginal tax rates for investors will reduce the value of these tax benefits, resulting in a lower return (expressed as an IRR).
Statements from the newly elected administration suggested that tax reform would be a top priority, and public statements suggested that top corporate rates could be lowered to as little as 15%. Almost overnight, the market seemed to reassess the likelihood of tax reform. By March 2017, the market looked to be pricing in a reduction in the top corporate rate from 35% to 25%, resulting in a decline in the value of LIHTCs from 12% to 18%, depending on the capital structure.
Some investors determined that the uncertainty of tax reform presented an unacceptable risk and withdrew from the market altogether. Others either re-priced LIHTCs to a lower price or required protection from a lower rate through an “adjuster,” which would lower the price paid for tax credits in the event of a reduction in marginal tax rates.
For LIHTC transactions that were scheduled to close at year-end 2016 or early 2017, this was a very difficult time. Some transactions were delayed while they were restructured to work with lower equity pricing. Sadly, some transactions were not feasible at lower equity prices and did not move forward. Over time, industry participants adjusted to these reduced equity prices, and the market regained its footing in the spring and summer of 2017.
As year-end 2017 approached, it remained unclear whether tax reform would be passed. However, on December 22, President Trump signed the Tax Cuts and Jobs Act of 2017 which, among other things, provided for a top corporate rate of 21%. Since this rate was lower than the assumed rate of 25%, the result was another reduction in LIHTC pricing, albeit far more modest than that which occurred in early 2017. Today, many affordable housing developers still seem to struggle to identify incremental funding sources to fill the gaps in project budgets that result from lower equity pricing compounded by rising construction costs, land values and interest rates.
Thankfully, most stakeholders have proven resourceful and seem to find ways to create feasible projects despite what is currently a challenging environment for affordable rental housing development.
Help may be on the way in the form of a recently legislated increase in LIHTCs. The Affordable Housing Credit Improvement Act was passed in March 2018 as part of the omnibus spending bill. This bill calls for a 12.5% increase in 9% tax credits each year for four years, totaling a 50% increase phased in over the four-year period from 2018 to 2021.
With these additional resources, state allocators will be able to award credits to create and preserve more affordable rental housing as well as give states greater flexibility to more adequately fund certain projects.
At PNC, we manage a robust investment portfolio and one of the largest tax credit syndication platforms in the industry. We are proud of the role we play as an industry leader in the creation and preservation of affordable housing.
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