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03/07/2018
2017 Housing Tax Credit Equity Market Lookback: How Did Uncertainty Over Tax Reform Affect Market Volume?
Given data from a survey of housing tax credit market participants, CohnReznick estimates the 2017 gross housing credit equity volume to approximate $15.1 billion. Last year’s volume reflects a $1.7 billion (10 percent) reduction from the 2016 level. The equity volume retraction is attributable to the prospective reduced corporate tax rate that the industry grappled with for most of last year.
From December 2016 to December 2017, housing tax credit net equity pricing dropped by $0.10 to a national median of $0.92, once tax losses were devalued at the 25 percent hypothetical tax rate. Fund offering cycles were disrupted in 2017 until adjuster provisions and tax rate assumptions normalized. Volume in the second half of 2017 was robust as the industry worked hard to share the risk of uncertainty and maintain production goals.
Of the $15.1 billion total equity closed in 2017, 73 percent ($11.0 billion) was syndicated and 27percent ($4.1 billion) was directly invested. While the surveyed direct investors collectively reported a much larger volume reduction from 2016, we note that the 2017 syndicated volume included carried over product from 2016 that did not close until early 2017; otherwise the 10 percent overall reduction would have been more pronounced.
Post-tax-reform: how are existing deals affected?
Impact of corporate tax rate change from the hypothetical 25 percent corporate tax rate used in 2017 to the current 21 percent corporate tax rate resulted in a negative impact to IRR ranging from 45 bps to 85 bps for national multi-investor funds. The industry is working collaboratively to share the risk and manage investment returns. We note that the impact on IRR was directly related to the level of hard debt leverage on the lower tier properties. The more loss-heavy a fund is, the more significant the loss devaluation would be.
| Corporate tax rate assumption | Minimum yield impact | Maximum yield impact |
|---|---|---|
| 25% | -45 bps | -85 bps |
While not intending to cover technical details contained in the Tax Cuts and Jobs Act (Act), we ran five recently closed transactions to illustrate the scale-of-impact from tax reform effected changes. Note that these are not necessarily “representative” deals and were selected solely for illustrative purposes. While deal size and characteristics vary, these are in general located in higher price markets. By combining 100% bonus depreciation, 30-year straight line real property deprecation, and a 21 percent corporate tax rate, each deal would suffer from a 50 to 111 bps drop in yield; or would have required a roughly 3-4-cent drop in pricing to make yield constant.
| Sample transaction | Yield impact - (100% vs. partial bonus depreciation on $4,500/unit personal property) | Yield impact - (30 vs. 27.5-year real property depreciation) | Yield impact - (21% vs. 25% corporate tax rate) | Net change | Change in pricing to maintain yield |
|---|---|---|---|---|---|
| 9% credit with hard debt | 8 bps | -13 bps | -81 bps | -87 bps | 4 cents |
| 9% credit without hard debt | 3 bps | -4 bps | -49 bps | -50 bps | 3 cents |
| 4% credit new construction | 11 bps | -22 bps | -80 bps | -74 bps | 3 cents |
| 4% credit acq/rehab | 18 bps | -14 bps | -78 bps | -77 bps | 3.5 cents |
| 4% credit + historic | 5 bps | -38 bps | -81 bps | -111 bps | 2 cents |
The provisions of the new tax law are complex. You should contact your tax advisor to determine how the Act impacts your deals.
2018 housing tax credit equity market look ahead: where will investor demand land?
While ultimately governed by the law of supply and demand, what drives pricing and return considerations, and how have these considerations been affected by the most sweeping tax reform since 1986?
The Base-Erosion and Anti-Abuse Tax (BEAT) could depress the value of housing tax credits by 20 percent through 2025 or 100 percent after 2025 for those foreign-owned investors or investors with significant overseas operations. Assessing impact to BEAT-affected multinational corporations is not straightforward. Beyond the complex formula itself, the exact impact would depend on individual companies’ business structure, as well as reflecting a balanced act of tax management strategy and Community Reinvestment Act (CRA) related considerations. There are several secondary trades contemplated for BEAT and other reasons. While there will be some impact felt by the market, the industry consensus is that this impact is not expected to be significant enough to cause any turmoil in the market. Further, anticipated economic growth and repatriation of profits could ultimately increase investors’ tax appetite.
Actions taken by the two Government-Sponsored Entities also suggest that their participation this year may fill in some holes left in the market and bring diversification to the investor market.
As of mid-Feb 2018, multi-investor funds that are poised to enter the market for second quarter closings were priced to offer a base/economic-tier internal rate of return (IRR) of up to 5.50 percent, with varying tiers for CRA-motivated investors that are expected to continue paying a higher price premium in exchange of products in their target CRA footprints. Everything else being held constant, pricing would have to further come down by roughly 4 cents to accomplish a level return under a lower tax rate scenario, which may be hard for the market to swallow for multiple reasons.
While IRR is the most frequently quoted return metric amongst housing tax credit industry professionals, most investors have other means of benchmarking housing tax credit investments internally. A 2017 survey run by the Affordable Housing Investors’ Council concluded that return on equity (ROE) was ranked as the most important methodology when it comes to evaluate and compare potential housing tax credit investments. More so than IRR, ROE will be affected by cost of fund increases in a rising interest environment.
It remains to be seen how investor demand will impact pricing/return targets and overall volume for 2018. Many investors, while having verbally expressed their commitment to the industry, are taking the first few months of the year to recalibrate their legacy portfolios and tax appetite going forward at the 21 percent corporate tax rate. As 2016 has proven, the industry appears to be resilient enough to handle this level of delay/adjustment.
Subject matter expertise
Cindy Fang
CPA, Partner, Tax Credit Investment Services Leader, Project Finance & Consulting
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Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute legal or professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice specific to, among other things, your individual facts, circumstances and jurisdiction. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its partners, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.