VI. How Does the Cost or Pricing Structure of LIHTCs Work?

LIHTC investors receive financial benefits on their investments through the credits they are able to take against their federal income tax liability, as well as the additional deductions from real estate losses. Bank investors may also receive favorable CRA consideration of LIHTC investments.

Understanding the returns of LIHTC transactions involves understanding transaction costs and the timing of costs and benefits.⁷⁶ For investors, the financial return on their investments is maximized when equity is invested at the time the properties are placed in service, and the tax credits can be claimed.⁷⁷ The tax benefits are realized over the next 10 to 15 years. Given the time value of money, the investor expects the financial return on an LIHTC investment over 10 years to exceed the price paid for the investment. Because the tax credit benefit is fixed, the investor invests an amount less than the expected benefit from the tax credits and real estate losses. The amount invested, relative to the amount of tax credits, is referred to as the “price” paid for the credit. Industry professionals note that other factors that may affect this price include the perceived risk associated with the investment, the competition among investors for individual projects, the ability to use the effective yield method to account for LIHTC investments, ⁷⁸ the amount of tax losses, and the CRA.⁷⁹

Historically, the price paid for LIHTCs has varied considerably. As shown in figure 3, yields on LIHTC investments exceed the after-tax, 10-year U.S. Treasury yields. The difference in yields varies largely due to variations in LIHTC demand. Transactions early in the program’s history reflect a great deal of uncertainty about the tax credit. Over time, as investors became more comfortable with LIHTCs, the industry became much more standardized and predictable. Prices became much more competitive and were relatively stable from 2000 through 2004.

In 2005, yields dropped as Fannie Mae and Freddie Mac substantively increased their investments. In 2008, yields rose (and the price paid for LIHTCs fell) significantly as Fannie Mae and Freddie Mac were placed into conservatorship and were no longer active in the market. In addition, the financial crisis affected bank profitability, which

also affected demand for LIHTCs. In 2008 and 2009, Congress authorized several efforts to help stabilize the market and keep existing projects moving forward.⁸⁰ By the end of 2010, the LIHTC market rebounded with a more diverse investor market.

Investors incur costs in underwriting their investments, whether the investments are made directly or through a multi-investor equity fund. After the affordable housing projects are financed, investors have management costs associated with monitoring the performance of the properties and addressing any problems that might arise.

Investors can obtain guarantees on investment yields through agreements with third-party guarantors. For a fee, these guarantors fund shortfalls in expected returns. In addition, investors can negotiate so-called tax credit adjusters with the general or managing partners of project partnerships, so investors can reduce their anticipated capital contributions in the event that the general partner fails to meet certain benchmarks that affect the amount or timing of the tax credits. ⁸¹ These tax credit adjusters help LIHTC investors achieve their projected yields.⁸²

⁷⁶ Appendix C offers an example pay-in schedule.

⁷⁷ In contrast, project sponsors/developers prefer to receive equity contributions earlier in transactions, to reduce borrowing costs.

⁷⁸ “Do Firms Incur Costs to Avoid Reducing Pre-Tax Earnings? Evidence from the Accounting for Low-Income Housing Tax Credits,” Robinson, Leslie A., Accounting Review, vol. 85, no. 2, pages 637–669.

⁷⁹ Understanding the relative impact of these factors on the price of housing credits has been a challenge for the industry. The Community Reinvestment Act’s Impact on Housing Tax Credit Pricing, CohnReznick, May 2013, found that “the largest single determinant of housing tax credit pricing is based on the CRA investment test value of a given property’s location.” The U.S. Government Accountability Office, in the Community Reinvestment Act: Challenges in Quantifying its effect on Low-Income Housing Tax Credit Investment , August 28, 2012, found that “quantifying the extent of any effect of CRA on LIHTC equity contributions is difficult given data and methodological challenges.”

⁸⁰ HERA contains numerous LIHTC program provisions, and the American Recovery and Reinvestment Act of 2009 authorized two temporary programs (the Tax Credit Assistance Program and the Tax Credit Exchange Program) to help keep the pipeline of projects moving despite the weakened demand among investors during this period.

⁸¹ Housing Tax Credit Investments, Adjusters, and Timing, Stonehouse, Jill, Affordable Housing Finance, October 2007, www.housingfinance.com/economic-development/housing-tax-credit-investments--adjusters--andtiming.aspx. Basis adjuster provisions adjust the overall amount of investor equity based on the amount of credits expected. Timing adjusters adjust investor equity for delays in benefit delivery that may result from construction or lease-up periods that exceed initial expectations.

⁸² Memorandum from Joseph Urban, Acting Director, Exempt Organizations Rulings and Agreements, Internal Revenue Service, on Low Income Housing Tax Credit Limited Partnerships, April 25, 2006, www.novoco.com/low_income_ housing/news/archives/resource_files/UrbanMemo42406.pdf.