View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

Innovative Ideas for Revitalizing
the LIHTC Market

InnovatIve Ideas for revItalIzIng the lIhtC Market

The views expressed here are those of the authors and not necessarily those of the Board of Governors
of the Federal Reserve System or the Federal Reserve Bank of St. Louis.

InnovatIve Ideas for revItalIzIng the lIhtC Market

table of Contents

Foreword .................................................................................................................................................... 3
Background ............................................................................................................................................... 4
Articles
The St. Louis Equity Fund and LIHTCs: Past and Future ......................................... 9
Modifying CRA To Attract LIHTC Investments............................................................. 13
Federal Co-Investment in LIHTC Properties.................................................................. 19
Create a More Robust LIHTC Market by Attracting Individual Investors .......... 25
LIHTC: The Dilemma and A Secondary Market Solution......................................... 31
Enhancing LIHTC Investment in Preservation Projects............................................ 35

1

InnovatIve Ideas for revItalIzIng the lIhtC Market

foreword
Heidi Kaplan and Matt Lambert
Senior Community Affairs Analysts
Board of Governors of the Federal Reserve System

G

iven the adverse impact of the current economic conditions on homeownership, the development of rental
housing is becoming increasingly important, not only to provide homes for families, but also to help stabilize
neighborhoods.
The Federal Reserve System, because of its interest in maintaining economic stability, has long had an inter­
est in the Low Income Housing Tax Credit (LIHTC) program, a major source of capital for the development of
rental housing. The Fed’s Community Affairs function is particularly focused on stability and opportunity in
low-income communities. This includes sustaining the production of affordable rental units during the economic
downturn. To that end, the Board of Governors’ and the Federal Reserve Bank of St. Louis’ Community Affairs
functions have commissioned a series of short articles by practitioners and experts to highlight their ideas for bol­
stering the LIHTC program.
This publication presents six ideas to strengthen the LIHTC market. John Wuest reviews the St. Louis Equity
Fund’s strategies to continue developing LIHTC projects despite the market downturn. Buzz Roberts of the Local
Initiatives Support Corp. (LISC) suggests ways the Community Reinvestment Act could be altered to attract
increased investment in LIHTCs by financial institutions. Joseph Flatley of the Massachusetts Housing Invest­
ment Corp. proposes restoring the market for LIHTC projects through federal co-investment in the tax credit.
Ian Galloway of the Federal Reserve Bank of San Francisco builds a case for using innovative ways to expand the
LIHTC investor pool to individual investors. Shekar Narasimhan of Beekman Advisors offers a secondary market
solution to bring additional investors into the market. Finally, Debra Schwartz of the MacArthur Foundation
highlights a promising model for an “enhanced” structure for a LIHTC fund that would provide equity for highquality projects.
The development of this publication was helped considerably by Linda Fischer of the Federal Reserve Bank of
St. Louis and David Erickson of the Federal Reserve Bank of San Francisco whose knowledge and editing
contributions were invaluable.

3

InnovatIve Ideas for revItalIzIng the lIhtC Market

baCkground

T

he Low Income Housing Tax Credit (LIHTC) pro­
gram is the federal government’s primary tool for
financing the development of affordable rental housing
for low- and moderate-income households. Over the
past 20 years, these tax credits emerged as the leading
source of capital subsidy for the construction and reha­
bilitation of such housing. Using equity investments
from public–private partnerships, the LIHTC program
has created over 2 million housing units since its incep­
tion. Furthermore, until the recent economic down­
turn, the program peaked at financing and constructing
approximately 100,000 rental units per year.
The LIHTC program was established under the Tax
Reform Act of 1986 to encourage the investment of
private equity in the development of affordable rental
housing. The program uses an indirect subsidy to
promote private investment in the development of lowincome rental housing by providing a dollar-for-dollar
credit against tax liability. The subsidy makes it pos­
sible for both private and nonprofit developers to build
high-quality housing with affordable rents.
LIHTC allocations are administered at the state level,
with each state receiving a fixed number of credits
based primarily on its population. Each state desig­
nates an agency, typically the state housing finance
agency (HFA), to allocate the credits to applicants
based on its Qualified Allocation Plan. The state may
use the plan to support specific policy agendas, such as
promoting geographic targeting for rural or distressed
urban neighborhoods.
The LIHTC program provides two types of tax cred­
its. Most new construction and substantial rehabilita­
tion projects are eligible for the “ 9 percent” credit that
allows investors to claim credits for 9 percent of quali­
fied project construction costs annually over a 10-year
period. The “4 percent” credit is used for projects that
are financed in conjunction with tax-exempt bonds and
other gap subsidies. Typically, LIHTC projects receive
the vast majority of financing through the tax credits.
The tax credits are intended for permanent rental
housing projects that meet one of the following
occupant income-eligibility requirements. Under the
“20-50 Rule,” at least 20 percent of the units must be
occupied by households with incomes at or below 50
percent of the area median income (AMI). Likewise,
the” 40-60 Rule” provides for projects with at least 40
percent of the units rented to households with incomes
at or below 60 percent of the AMI. In most cases,
4

100 percent of units are affordable. All units receiving
LIHTCs have rent restrictions based on the number
of bedrooms, household size and household incomes.
Rent and income restrictions are applicable for a mini­
mum of 15 years.
A competitive market for the purchase of tax cred­
its arose primarily from the developers needing to sell
credits to raise equity capital for projects. In most sales,
syndicators are used to assemble a group of investors
for the developer and to certify or guarantee project
compliance for the investors. Individual investors are
restricted in their use of LIHTCs. As a result, most
credits are purchased by widely held C corporations,
which use the credits against any amount of tax liability.
Because LIHTC investments are considered qualified
investments under the Community Reinvestment Act
(CRA), a large portion of the investors are regulated
financial institutions. Traditionally, government spon­
sored enterprises (GSEs) have also been strong investors
in LIHTCs, which helps them meet affordable housing
requirements established by their regulator.
Challenges Facing the LIHTC Market
Since the recent economic downturn, the LIHTC
syndication market has experienced severe distress due
to a lack of investor interest in the credits. Tradition­
ally, the market for LIHTCs has been concentrated
among relatively few major investors. Therefore,
losing one or two investors in the market can have
a large impact on pricing and the ability for deals to
be sustainable. Many banks, the main investors in
LIHTCs, have drastically reduced their investment in
LIHTC projects as their need to offset taxable income
has declined. Likewise, a large drop-off in tax credit
purchases by the GSEs, which previously comprised
about 40 percent of the market, has also contributed
to the recent decline in LIHTC market volume. Many
experts now estimate that the size of the market for
LIHTCs in 2009 will be less than half the size it was
in 2007, dropping from around $9 billion to less than
$4.5 billion.
In the current economic environment, low investor
demand for tax credits has led to multiple challenges
for the affordable rental housing production market.
With a glut of tax credits available, the price paid to
developers of housing projects by investors recently
dropped from over 90 cents per credit to lower than 70
cents. The drop in price received by housing develop­
ers means that money must be made up elsewhere to
close project financing gaps. This is a difficult proposi­
tion given that the pool of equity investors and debt
sources continues to shrink. Many projects planned

InnovatIve Ideas for revItalIzIng the lIhtC Market

for higher tax credit income now must be slowed or
stopped as the math no longer “pencils out.” The
resulting decline in LIHTC production likely means
thousands fewer affordable apartment units built last
year and this year.
Efforts to Revitalize LIHTCs
A number of federal efforts are under way to stabilize
and revitalize the LIHTC program. For example, the
American Recovery and Reinvestment Act (ARRA) of
2009 included two provisions designed to improve the
functionality of LIHTCs for currently planned, but
stalled, developments. These provisions are intended to
fill the financial gap created by the reduction in value
of the tax credits.
First, the Tax Credit Exchange Program (TCEP),
administered by the U.S. Department of the Treasury,
provides grants to states in lieu of non-used credits at a
price of 85 cents per dollar over 10 years. Many ana­
lysts estimate that housing developments will receive
about $3 billion under the program in 2009. However,
there are some indications that a number of states are
not planning to use the TCEP due to the program’s
complex structure. The program is authorized for 2009
and may be extended for another year by Congress
because many organizations are organizing to support
this provision. Second, another temporary program,
the Tax Credit Assistance Program (TCAP) provides an
additional $2.25 billion in Home Investment Partner­
ship Program funds from HUD to fill in the growing
financing gaps in LIHTC transactions.
Additional ideas for stimulating the LIHTC mar­
ket include a proposal for the Treasury to extend the
LIHTC carryback period. Tax credits would hold their
value today regardless of whether the tax credit investor
is currently booking profits. This is relevant as many
equity investors in LIHTCs are forecasting sharply
lower income tax liabilities for 2009 and beyond. This
provision would require a legislative change to allow
current tax credits to be used against investor profit
made during any of the last five years. Current law
allows LIHTC benefits to be carried back one year and
carried forward 20 years. The industry is also propos­
ing that Congress extend the TCEP for another year
and include the “4 percent” tax credits. n

5

InnovatIve Ideas for revItalIzIng the lIhtC Market

the st. louIs equIty fund and lIhtCs:
Past and future

John J. Wuest
President and CEO
The St. Louis Equity Fund

N

ow, more than any time since the creation of
the Low Income Housing Tax Credit (LIHTC)
program, there is a need to build safe, decent, affordable
housing. With the country in the throes of an economic
downturn, there is a new group of individuals and fami­
lies who could well utilize the housing created by these
tax credits. The question is: Can the program survive?
When Congress passed legislation in 1986 estab­
lishing LIHTCs, the intent was to promote the con­
struction of affordable rental housing throughout the
country. The tax credits would accomplish this by par­
tially shifting the responsibility for building such hous­
ing to the private sector. Most agree that the program
has been very successful in accomplishing this goal.
However, during the current recession, a large dis­
ruption in the overall tax credit market has occurred,
resulting in a dramatic reduction in the price being
paid for each credit. Consequently, insufficient funds
are being generated by the sale of the credits to success­
fully complete projects. While it is true that the reduc­
tion in the price paid for the credit raises the yield to
the investor, from a practical standpoint, if the project
cannot be built, neither investor nor general partner
benefits in that there is no transaction.
It’s Not All Bad News
Despite the economy, the St. Louis Equity Fund
(SLEFI) has not experienced a significant disruption
in the flow of investment capital and plans to continue
providing affordable housing for communities.
The equity fund has strong support from local finan­
cial institutions and corporations. In 2008, SLEFI
raised approximately $24 million from 22 investors.
In addition, SLEFI formed the Kansas City Equity
Fund (KCEF) in 2007, which has raised an additional
$7 million from Kansas City based financial institu­
tions. SLEFI is currently working on a plan with the
Missouri Bankers Association to contact banks in outstate Missouri with the idea of forming a separate fund.
This fund would be available to invest in transactions
that receive LIHTC allocations in the more rural areas
of the state.

SLEFI was the idea of a group of St. Louis civic
leaders who thought it would be very positive for the
city if an entity could be formed to syndicate LIHTCs.
This entity would have the dual mission of protecting
the investment while providing affordable housing that
otherwise may not be produced. Desiring to move
forward, they petitioned a civic organization in St.
Louis for a $75,000 grant. The grant would serve as
the seed money for SLEFI’s first annual fund in 1988,
raising $3.25 million and facilitating the production of
105 affordable housing units.
Since that time, SLEFI has formed an annual fund
for all but one year. During its 20-year history, SLEFI
has raised more than $240 million for the production
of 3,442 housing units. These units have a total devel­
opment cost of $443 million, and it is estimated this
economic activity has created in excess of 5,000 jobs.
The reason the fund has not felt the full impact of the
slumping LIHTC market may be that it has a broad
base of smaller investors—22 in the 2008 fund—so
that losing one or two is not catastrophic. However,
there are two or three larger investors that would obvi­
ously have a larger effect if they dropped out.
Bolstering the LIHTC Market
In an effort to mitigate the adverse conditions in the
LIHTC market, the Administration included two pro­
visions in the American Recovery and Reinvestment
Act (ARRA) to ensure the continued production of
affordable housing. They are the Tax Credit Exchange
Program (TCEP) and a mechanism for gap financing
known as the Tax Credit Assistance Program (TCAP).
The exchange provision allows the state housing
credit allocating agency, in our case the Missouri
Housing Development Commission, to exchange
up to 40 percent of its 2009 volume cap credits and
100 percent of any unused 2008 credits for cash at the
rate of 85 cents on the dollar. According to the Con­
gressional Budget Office, this could generate as much
as $3 billion in additional funds for the construction
of new projects. The 85 cents compares to a market
price today in the range of 65 cents.
The second provision, TCAP, will make $2.25
billion of HUD Home Funds available to assist in
providing the additional gap funds to permit comple­
tion of projects. The funds will be distributed by and
administered through the traditional LIHTC distribu­
tion channels following all of the LIHTC protocols.
In allocating these funds, priority is to be given to
projects that will be finished within three years of the
date of passage of ARRA. The funds will be distrib­
uted to states with the same formula used for the
9

InnovatIve Ideas for revItalIzIng the lIhtC Market

distribution of the 2008 Fiscal Year Home Funds. The
state agencies will be required to commit a minimum
of 75 percent of the funds within a year of the enact­
ment date of ARRA, and 75 percent of the funds must
be spent within two years of this enactment date. Any
unused funds will be recaptured after three years.
While there are still many questions concerning the
implementation of these programs, the general consen­
sus seems to be that they both will be helpful in ensur­
ing the continued production of affordable housing.
SLEFI has several projects in its pipeline that will be
helped significantly by using these programs.
However, some concern still remains in the market­
place regarding the overall availability of investment
capital. The original draft of ARRA included two provi­
sions designed to facilitate the flow of capital. The first
would have allowed investors to carry back, for up to five
years, tax credits earned in 2008 and 2009. The second

10

was an acceleration of the recognition of the credits,
allowing the owner of the credits to claim 60 percent of
the project’s LIHTC credits in the first three years of the
investment and the remaining 40 percent over the next
seven years. Unfortunately, neither provision made it
into the final legislation, primarily because of the associ­
ated costs. The current wisdom is that Congress will
consider another housing bill in the coming months and
that there will be a concerted effort to include these pro­
visions in the new legislation, as previously mentioned.
However, it might not be acts of Congress alone
that revive the LIHTC market. The restoration of
confidence in the financial markets will go a long way
toward creating interest. In addition, when banks are
satisfied that they have identified most of their loan
problems and have provisioned for them properly, they
will be more aggressive in seeking opportunities to
shelter future income. n

InnovatIve Ideas for revItalIzIng the lIhtC Market

ModIfyIng Cra to attraCt lIhtC
InvestMents

Buzz Roberts
Senior Vice President for Policy
and Program Development
Local Initiatives Support Corp. (LISC)

M

ulti-regional banks, motivated by the Com­
munity Reinvestment Act (CRA), remain the
primary Low Income Housing Tax Credit (LIHTC)
investors today, although some banks have scaled back
investments because their financial condition limits
their ability to use tax credits and motivates them to
conserve capital. However, CRA has been less effective
in attracting regional and local banks as investors that
could restore balance to the LIHTC investment market.
Moreover, CRA is contributing to a geographic skewing
of investments—many markets are facing serious short­
ages of capital while a few places have plentiful capital.
Modest changes to CRA policy could provide a
significant stimulus to bank investment in LIHTCs,
especially from regional and large local banks. In
particular, policy changes should ensure that banks
receive full CRA recognition for investing in nation­
wide or regional funds with geographies well beyond
their immediate assessment areas. The changes would
benefit all communities, and especially rural and disas­
ter areas, small and mid-sized metropolitan areas, and
states served by few multi-regional banks.
Before the Economic Downturn
Prior to the recent economic downturn, about
40 percent of LIHTC investments came from banks
and about 40 percent came from Fannie Mae and
Freddie Mac (combined). Among banks, a limited
number of very large, multi-regional banks were the
primary investors. These institutions shared a familiar­
ity with rental housing finance; a relatively low cost of
funds; a willingness to make long-term investments
with uncertain liquidity; a desire for good public
relations; and, for banks, CRA recognition.
Corporations had been investing in multiple projects
through nationwide or regional funds (multi-investor
funds) for several years. These funds offered investors
risk diversification, centralized underwriting and asset
management. Corporations also gained confidence
from co-investing with other experienced, sophisti­
cated investors.

The system generally worked well. Investor demand
was high, driving down yields to investors and driving up
investment proceeds to project sponsors. Projects in all
parts of the country attracted investment on competitive
terms, even if they were located in inner cities or rural
areas. The properties performed better than other classes
of real estate, with the national annual LIHTC foreclo­
sure rate below 0.1 percent. If anything, the system may
have worked too well, as yields dipped unsustainably low
and large investors crowded out smaller ones.
CRA Policy and LIHTC Investments
In general, a bank receives CRA credit for LIHTC
and other community development investments that
“benefit its assessment area(s) or a broader statewide
or regional area that includes the bank’s assessment
area(s).” 1 A 1997 interpretive letter issued jointly by
the four federal banking agencies appeared to endorse
regions as broad as a quadrant of the country, such as
the Northeast, South, Midwest and West.2 These poli­
cies made it easier for banks to receive CRA recogni­
tion for LIHTC investments.
However, the more detailed Interagency Question
and Answer (Q&A) guidance subsequently sent
mixed signals.3
On one hand, the agencies tout the value of nation­
wide and regional community development funds. The
Q&A even assures banks that a fund’s activities need not
directly benefit a bank’s assessment area or the surround­
ing region—as long as the fund’s geography includes the
bank’s assessment area.
On the other hand, the agencies direct bank examin­
ers to discount CRA recognition for such investments
if the region is large, depending on the actual and
potential benefit to a bank’s assessment area. In addi­
tion, a bank receives credit for regional investments
only if it is adequately addressing its assessment areas’
needs, which a subsequent examination will deter­
mine. In other words, a bank would receive credit for
investments in large regional or nationwide funds, but
perhaps not much credit unless its assessment areas
directly benefit.4
This policy makes it difficult for a bank considering
an investment to predict how its regulator will treat it
in an examination a year or two later. However, the
syndicators that manage the multi-investor funds were
1
2
3

See, e.g., 12 CFR 288.23 (a).
Interpretive Letter 800.
Interagency Questions and Answers Regarding Community are released periodically
by the staffs of the Board of Governors of the Federal Reserve System, Federal
Deposit Insurance Corp., Office of the Comptroller of the Currency, and Office of
Thrift Supervision to provide guidance to financial institutions and the public.
See www.ffiec.gov/cra/qnadoc.htm
4 See Community Reinvestment Act; Interagency Questions and Answers Regarding
Community Reinvestment; §__.12(h)–6 and -7.

13

InnovatIve Ideas for revItalIzIng the lIhtC Market

able to make the policy work as long as they could also
attract investors not constrained by CRA policies, such
as Fannie Mae and Freddie Mac. By pooling invest­
ments, syndicators could ensure that banks received
CRA credit in their assessment areas and, in effect,
invest some Fannie and Freddie money where no bank
investor could get or needed CRA recognition. In
this way, rural areas, small and mid-sized metropolitan
areas, and states not served by the largest banks could
still attract investment on competitive terms.
Multi-regional banks with numerous assessment areas
could be reasonably confident that a nationwide or
regional investment fund would finance at least some
projects in some of the banks’ assessment areas, assur­
ing CRA recognition. However, the system did not
work as well for most regional and local banks because
they could not be sure the fund would invest in their
areas, and some were surprised when examiners denied
CRA recognition for fund investments, sometimes even
within the same metropolitan area. In any case, the
multi-regional banks—along with Fannie, Freddie and
some other nonbanks—provided enough capital to
make the system work until recently.
LIHTC Challenges in the Current Economy
When Fannie and Freddie encountered financial
problems and withdrew from the market starting in
late 2007, the direct impact was a 40 percent gap in
the market that needed to be filled. However, CRA
geographic targeting requirements hurt efforts to raise
new investments from regional and local banks in the
absence of nonbank co-investors.
Most syndicators have curtailed investment in places
outside the banks’ CRA priority areas. With few
nonbank investors, it has become difficult or impos­
sible to support housing in most rural areas and small
and mid-sized cities, since these areas tend to attract
little attention when the largest banks are examined.
Housing sponsors in some markets with strong bank
presence could not attract investment if the banks had
already done enough to meet CRA obligations. More­
over, housing in the Gulf Opportunity Zone and other
disaster areas, where Congress had allocated additional
LIHTC authority, could not attract much investment
because few major banks needed CRA credit there.
Special regulatory guidance allowing banks nationwide
to get CRA credit for investing in the Gulf Opportu­
nity Zone did not generate much response.
In addition, multi-regional banks are tending more
to invest directly or enlist syndicators to form pro­
prietary or “private label” funds and are less likely to
participate in multi-investor funds. This allows them
14

to maximize CRA recognition and cross-market loan
products to project sponsors. Some multi-regional
banks have also decreased their overall LIHTC invest­
ment activity because of reduced capacity to use tax
credits and a need to conserve capital.
As a result, regional and local banks that could enter
the market have few good vehicles for generating CRA
recognition. These banks want to see live projects in
their CRA assessment areas before committing to a
regional or nationwide fund. Yet, a bank unfamiliar
with LIHTCs usually requires six months to a year to
make a LIHTC investment decision after a CRA-rel­
evant project appears. Most sponsors and syndicators
cannot wait that long for a bank’s decision. Regional
and local banks also usually lack the capacity to invest
on their own and probably cannot commit enough
money for a syndicator to create a single-investor or
proprietary fund for them.
A CRA Solution
Regional and nationwide LIHTC funds could pro­
vide an improved vehicle to increase LIHTC invest­
ments, especially by regional and local banks, provided
these institutions could be guaranteed full CRA credit
for their investments. Technical changes to the Q&A
on geographic targeting of LIHTC investments could
motivate additional participation from financial institu­
tions in regional funds.
Policy changes to CRA could include the
following provisions:
1. CRA credit should be given for a LIHTC invest­
ment made through a fund serving a region that
includes any of the bank’s assessment areas. CRA
credit should be given unless the bank has received
a rating below satisfactory on its latest CRA exam.
In other words, if the bank has met its past CRA
obligations for its assessment areas, it should be
given full CRA credit for investments in regional
funds. This approach would offer predictability for
investors, but not allow them to ignore local needs.
2. CRA credit should not be discounted for invest­
ments benefiting a large regional area. As previ­
ously explained, the Q&A suggests that examiners
discount CRA credit for participating in a fund
that serves a large area because the benefit to a
bank’s assessment area may be diffused and, there­
fore, unresponsive to assessment area needs.5 This
uncertainty discourages bank investments through
such funds.
5

Interagency Q&A §__.12(h)-7.

InnovatIve Ideas for revItalIzIng the lIhtC Market

3. Banking regulating agencies should make it clear
that an eligible region may be as large as a quadrant
of the country.6 To maintain bank investments,
eligible regions must be large enough to accommo­
date multiple bank participants and diversify risks,
resulting in more efficient management. Defining
region as a quadrant would assuage these fears and
could increase investment. n

6

This definition would be consistent with Interagency Interpretive Letter 800.

15

InnovatIve Ideas for revItalIzIng the lIhtC Market

federal Co-InvestMent
In lIhtC ProPertIes

Joseph Flatley
President & CEO
Massachusetts Housing Investment Corp.

T

he Low Income Housing Tax Credit (LIHTC)
market has experienced a serious downturn in recent
months. Political actions are needed to stimulate the
market and respond to the demand for the develop­
ment and preservation of affordable rental housing. The
federal government has an opportunity to correct the
supply-and-demand disparity by co-investing in LIHTC
properties and restoring a market for viable projects.
Rationale
The LIHTC program is the major federal program
supporting the production and preservation of lowincome rental housing. Today, the LIHTC market is
experiencing a substantial lack of investor demand.
The current challenges facing the banking industry,
coupled with the conservatorship of Fannie Mae and
Freddie Mac, have created an enormous shortfall in
demand. It is estimated that more than 60 percent of
the investor demand available in previous years will not
be available in 2009, with a similar, though improving
slightly, outlook for 2010. As a result, many projects
that have received LIHTC allocations from states are
unable to secure sufficient investor commitments to
proceed.
Concern about the lagging LIHTC market has
generated actions and proposals to enhance and
expand investor interest in the program. For example,
Congress provided short-term relief through the Tax
Credit Exchange Program (TCEP), also known as Sec­
tion 1602, which provides equity for tax credits that
are unused in 2009. This program may need to be
extended into 2010 to provide equity for some planned
projects lacking investor financing. In another exam­
ple, LIHTC advocates have proposed allowing inves­
tors to carry back the tax credits for five years so that
the credits could be applied to past profits.
Although these strategies will increase investor
demand for credits, additional steps could accelerate
the process of stabilizing the market and revitalizing
stalled projects. Rather than supplanting private capi­
tal, federal actions should also promote private investor
discipline in the LIHTC program.

Co-investment Proposal
The U.S. Department of the Treasury should directly
co-invest with private investors in LIHTC funds or
projects. This strategy would support normal private
market investment, including pricing, underwriting
and risk management, while doubling the impact of
the initial investment. The co-investment proposal
includes the following features:
Timeframe – The Treasury would provide match­
ing investments for any LIHTC deals that closed
within a specified period of time. For example, the
timeframe could be set as either the earlier of an
established date (say, Dec. 31, 2010) or when the
credits reach a stabilized market price (say, 85 cents
per one dollar of tax credits).
Matching funds – The Treasury would provide
direct investments on a matching basis in any
“9 percent” or “4 percent” LIHTC project. In
other words, the Treasury would provide one
dollar of federal investment for every one dollar
of private investment.
Investment conduit – The Treasury contribu­
tion could be provided through multi-investor or
single-investor funds or in conjunction with direct
project investment. To expedite the process, the
Treasury could establish minimum investment
levels and offer to prequalify fund managers or co­
investors. The administrative process for making
these investments could be simplified by relying
on the terms and oversight of the private investors.
For example, there are a number of existing direct
investors and fund managers with proven track
records with LIHTC investments. Identifying and
“qualifying” these proven participants could bolster
confidence in this approach.
Terms and schedule – The Treasury co-investment
would have terms and pricing identical to the
matching private investment. The federal invest­
ment would be made on the private investment
pay-in schedule, available upon certification that
the private investment had been made in a quali­
fied LIHTC project. As a result, there would be
no need for federal officials to select, underwrite or
monitor projects.
Zero net cost for government – The Treasury and
the private investor would receive identical finan­
cial returns. The government would “receive” tax
19

InnovatIve Ideas for revItalIzIng the lIhtC Market

credits and losses that would otherwise reduce
federal tax revenue and would also receive cash
distributions. As a result, the Treasury would be a
true economic partner. However, the government
would be a business partner with no voting rights
or control over the project investment.
Co-investment funding – Funding for this
proposal could be provided through the Trea­
sury’s Troubled Asset Relief Program (TARP), the
American Recovery and Reinvestment Act (ARRA)
funds or other Treasury resources. The goal of the
co-investment proposal is to stimulate community
development and to provide affordable housing at
no net cost to the federal government.
Impact
The co-investment proposal would significantly
increase the flow of capital into LIHTC projects and,
therefore, increase the number of properties financed
with private dollars. The initiative would provide
equity for deals not currently funded through private
investors, while maintaining the investor discipline that
has been central to the LIHTC program’s success. The
proposal would also stabilize pricing by correcting the
current mismatch in supply-and-demand of LIHTCs.
Accordingly, the co-investment proposal would acceler­
ate the process of restoring investor confidence and a
predictable market.
The cost of the proposal to the federal government
would be negligible and would likely produce a net
savings for the Treasury. With the current price of the

20

tax credits at 62 cents to 72 cents (per tax credit dollar
over 10 years), or well below the present value of the
federal tax revenue, which would have been forgone if
the credits were claimed, the proposal would generate
a positive net return for the Treasury. In other words,
by virtue of the Treasury making these investments, the
anticipated IRS revenue losses from these tax credits
(currently accounted for in the federal budget) would be
eliminated. Therefore, a proposal creates a gain in fed­
eral tax revenue. For example, if the Treasury purchased
half of the tax credits in a project that had been awarded
$2 million in LIHTC credits over 10 years, the cost and
benefits to the Treasury would be as follows:
Investment by the Treasury
($1,000,000 in credits @ 70 cents)

$700,000

Tax credits not claimed
($100,000 per year for 10 years)
[present value at 5 percent]

$772,173

Net gain for the Treasury
(benefits exceed cost)

$72,173

Furthermore, there is enormous public gain from
maintaining the affordable rental housing production
system and its chief financing vehicle, the LIHTC
program. Under the proposal, the cost to the federal
government would be negligible. Equally important,
the program would be easy to administer as investment
decisions would rely on the proven discipline and due
diligence of private investors. n

InnovatIve Ideas for revItalIzIng the lIhtC Market

Create a More robust lIhtC
Market by attraCtIng
IndIvIdual Investors

Ian Galloway
Investment Associate
Federal Reserve Bank of San Francisco

T

he universe of Low Income Housing Tax Credit
(LIHTC) investors is limited to a small group of
large institutions. Since the tax credit was created in
1986, banks, corporations and government-sponsored
enterprises (GSEs) have purchased nearly all the credits
made available through the program. Unfortunately,
the concentration of investor demand in a small group
of institutions has introduced volatility to the LIHTC
market. Specifically, demand for these tax credits has
proven extremely cyclical. As financial institutions and
other large institutional LIHTC investors suffer losses
(as they have in the current recession), their appetite for
tax credits decreases rapidly. The result is a collapse in
the price of LIHTCs, which endangers the very feasi­
bility of tax-credit-financed affordable housing projects.
Affordable housing investment was not always domi­
nated by large corporate entities. In fact, individual
taxpayers played a prominent role in financing afford­
able housing development during the early 1980s.
That role changed with the passage of the Tax Reform
Act of 1986.
Prior to this legislation, individuals could deduct
construction period interest and taxes, accelerated
depreciation, and amortization of building costs.
Taken together, these tax benefits were significant
enough to attract many wealthy individuals to the mar­
ket. By 1986, however, Congress had become wary of
overly generous tax benefits, loopholes and deductions.
The result was the passage of new passive loss, passive
credit and at-risk rules. Among other changes, the new
rules established a financial disincentive for individual
taxpayers to claim credits in excess of their marginal tax
rate multiplied by $25,000. These rules have not been
updated since 1986 and continue to suppress individ­
ual demand for tax credit investments.1

1

Internal Revenue Code establishes a $25,000 limitation on passive loss deductions.
Individual taxpayers can claim LIHTCs up to their marginal income tax rate multiplied
by $25,000 without offsetting passive income. With a marginal tax rate of 35 percent,
for example, the maximum annual credit amount allowed would be $8,750 (based on
Section 469 of the Internal Revenue Code).

Benefits of Individual Investors
Bringing individual investors into the LIHTC
market would have several important benefits.
First, bringing individuals into the LIHTC investor
pool would stabilize pricing and create a more robust
market for the credits. Of course, individuals are
not immune from economic hardship. Nevertheless,
most people carry tax liability from year to year and,
presumably, would benefit from a program that
offsets this liability.
Second, individual investors would also help round
out the LIHTC market’s financing of smaller projects
and underserved geographies. Increasingly, large institu­
tional LIHTC investors have dealt directly with afford­
able housing project developers. To maximize efficiency,
investors have sought large projects with correspond­
ingly substantial tax credit allocations. As a result, “it
has been difficult to attract corporate investor interest to
small and rural deals, since corporate investors look for
larger deals with higher amounts of tax credits to offset
their federal tax liability,” according to the National
Association of Home Builders.2 Individual investors, by
contrast, have lower tax liability than corporations and
might be more attracted to smaller deals.
Finally, opening up the LIHTC market to the grow­
ing number of individuals seeking social impact invest­
ments would diversify the investor pool. According
to the Social Investment Forum, “socially responsible
investment (SRI) encompasses an estimated $2.71
trillion out of $25.1 trillion in the U.S. investment
marketplace.”3 This growing market indicates that
investors are increasingly looking for mission return in
addition to financial return. Financial products such as
socially responsible mutual funds, positive and nega­
tive stock screens, and deposit accounts in community
development credit unions are frequently used by
individual investors to satisfy both social and financial
preferences. Socially motivated individuals might also
invest in LIHTCs if given a cost-effective, efficient way
of doing so. This would benefit the market by further
diversifying the pool of LIHTC investors.
Barriers to Individual Participation
in the LIHTC Market
In addition to passive loss tax restrictions, individuals
have largely remained outside of the LIHTC market
because of four key challenges: high transaction costs,
program complexity, compliance risk and the illiquidity
of the investment.
2

National Association of Home Builders, “Low Income Housing Tax Credit: Stimulus
Proposals from the National Association of Home Builders,” April 8, 2009, available at
www.nahb.org/fileUpload_details.aspx?contentID=114251.
3 Statistic as of 2007. Social Investment Forum, “Socially Responsible Investing Facts,”
available at www.socialinvest.org/resources/sriguide/srifacts.cfm.

25

InnovatIve Ideas for revItalIzIng the lIhtC Market

High Transaction Costs
The limited tax benefits offered by LIHTC are often
insufficient to offset the cost of individual participa­
tion. Tax-credit-financed deals can be multimillion
dollar projects. New construction financed by LIHTCs
can require raising tax credit equity of 70 percent of
eligible construction costs. The cost of soliciting such
investment from small-dollar individual investors is
cost-prohibitive for most affordable housing developers
(and most syndicators, for that matter). Historically, it
has been more cost-effective to engage a select group of
large investors not restricted by passive loss rules that
can finance whole projects on their own.
Program Complexity
LIHTC deals are extremely complex. The technical
expertise required to complete a LIHTC project is a
dizzying array of real estate, legal, tax, development and
policy know-how. Most individual taxpayers lack even
a basic understanding of the LIHTC program—let
alone how to responsibly evaluate the investment risks.
Compliance Risk
LIHTC investors are subject to credit recapture and
penalties should a project fall out of compliance during
the first 15 years of its operation. Compliance is
a function of the rents charged to the development’s
low-income tenants. Should rents exceed specific
federal guidelines, the project is deemed out of compli­
ance, the credits are recaptured and a penalty is levied.
Individual investors have likely shied away from
tax credit deals because they lack the expertise to
quantify and price the risk posed by this central
program requirement.
Investment Illiquidity
The 15-year compliance period, coupled with restric­
tions placed on the reselling of credits, makes purchas­
ing LIHTCs a relatively illiquid investment. This tends
to favor investors with long investment time horizons.
Further, the tax benefits that flow from a LIHTC
investment only begin when the project is completed.
This can be up to three years after the credits are
originally allocated. To date, corporate entities with
long-term tax obligations have been most comfortable
with the illiquidity of the investment.
An Individual Investor Solution
First and foremost, the easiest way to attract indi­
viduals into the LIHTC market is to change the passive
loss restrictions that discourage individual investment.
Whether the passive loss limit is increased or the rule is
26

eliminated altogether, increasing the tax benefit would
make the credit more appealing to individuals. Even
with tax reform, however, the barriers outlined above
would still discourage many individuals from partici­
pating in the program.
While only a partial solution, the creation of a fully
transparent online platform to broker the sale of tax
credits to individual investors would address some of
these challenges, specifically high transaction costs
and program complexity. An online marketplace for
LIHTC investments would keep the cost of soliciting
capital low while simultaneously organizing and com­
municating important information to potential smalldollar investors. In fact, such technology already exists
in the form of so called “peer-to-peer” (P2P) lending.
P2P lending sites attempt to lower transaction costs by
cutting out the middleman in debt transactions—usu­
ally a bank or a credit card provider. While the longterm viability of their core business model is unknown,
P2P lenders such as Prosper, Kiva, LendingClub and
others have demonstrated that individuals can lend
responsibly in the consumer debt market. The same
technology could be adapted to match LIHTC inves­
tors with affordable housing projects.
Direct Investment Model
The simplest method for organizing a LIHTC
platform for individual investors is to directly connect
these investors with affordable housing developers that
have received tax credit allocations. Developers could
post project listings on the platform and the tax credits
they have available. As part of the listing, develop­
ers would also have the opportunity to promote the
project’s financial and social merits as well as set the
initial price for the credits. The investment period
could be designated by a preset date or simply end
when sufficient equity has been raised to proceed with
the development.
Tax Credit Syndicator Model
A second way to organize an online LIHTC plat­
form would be to use tax credit syndicators. The
platform could connect individuals to syndicators who
identify and invest in LIHTC projects on their behalf.
There are two reasons to favor this approach. First,
it addresses the complexity barrier noted above. Even
with detailed project listings, most individuals would
be ill-equipped to evaluate the range of risks that come
with an affordable housing investment. In contrast,
tax credit syndicators have a great deal of expertise and
in-house capacity to accurately assess these risks and
invest responsibly.

InnovatIve Ideas for revItalIzIng the lIhtC Market

Second, the syndicator model brings economies of
scale. It seems unlikely that an online LIHTC platform
would ever attract enough tax-credit-savvy individu­
als to fund more than a handful of deals. Instead, tax
credit syndicators could create limited liability invest­
ment funds that invest in a range of tax credit deals
on behalf of a combination of individuals, corpora­
tions, GSEs and other investors. Such a diversified,
“high touch” investment approach could finance more
LIHTC deals more quickly than would be possible if
developers had to rely on individuals to purchase their
tax credit allocations directly. In fact, a similar strategy
is used by the Calvert Foundation to raise financing
for its Calvert Note, a double-bottom-line securities
product. Calvert Notes are purchased by institutional
and individual investors alike through financial bro­
kers directly from Calvert and on the P2P lending site
MicroPlace. A similar multipronged approach could be
used to engage individuals in the LIHTC market.
The drawback to the syndicator model for individual
investors, versus the direct model, is cost. While the
syndicator model would likely make tax credit invest­
ments more manageable, syndicator fees would reduce
investor yield. Ultimately, the choice between the two
models for investors comes down to a tradeoff between
complexity and cost.

Conclusion
The recent collapse in the price of LIHTCs has
exposed the folly in the market’s over-dependency on
large corporate investors. Encouraging individual par­
ticipation in the LIHTC market would diversify and
expand the overall investor pool, smooth LIHTC price
cycles, bring untapped capital to the market, and help
finance small, often rural, affordable housing develop­
ments that today struggle to raise tax credit equity.
An online LIHTC platform, while potentially dif­
ficult to scale and develop, would lower transaction
and information costs and allow individual investors
to enter a market that, heretofore, has been nearly the
exclusive purview of institutional investors. Also, such
a marketplace could allow for dynamic, real-time price
setting. If sufficient scale could be achieved, a price
auction mechanism would be effective in either of
the models outlined above and, importantly, it would
create complete price transparency. Online platform
or not, however, the benefits are clear: It is time to get
individuals into the LIHTC market. n

27

InnovatIve Ideas for revItalIzIng the lIhtC Market

lIhtC: the dIleMMa and
a seCondary Market solutIon

Shekar Narasimhan
Managing Partner
Beekman Advisors Inc.

T

he Low Income Housing Tax Credit (LIHTC)
market is fundamentally challenged by the lack of a
viable secondary market. The substantial impact on avail­
able project equity resulting from a collapse in tax credit
demand underscores the need for a broader investor pool,
more standardization and credible intermediaries.
The creation of a robust secondary market would sub­
stantially increase the universe of LIHTC investors and,
thereby, increase the supply of new affordable hous­
ing. It would provide assurance to potential investors
that they would not get “stuck” with credits for their
lifetime, especially as their tax needs changed. Creation
of such a market would also ensure that the exchange of
tax credits remains efficient, with steady availability of
project equity through credible intermediaries.
Barriers to LIHTC Investments
Over the past 22 years, the LIHTC program has
grown into the dominant financing tool for the devel­
opment of affordable rental housing. However, the
downturn in investor demand threatens the viability of
the program. In recent years, the LIHTC program has
represented approximately $9 billion per year in annual
credits issued and the production of about 100,000
affordable rental units per year. During the current
credit crisis, LIHTC utilization rates have fallen signifi­
cantly. Some estimates show that less than 70 percent
of 2008 tax credits will be used, and the number may
fall to 50 percent in 2009.
Falling utilization rates are primarily due to the
current lack of investors and difficult pricing environ­
ment, not because of a lack need for decent affordable
housing or because of a lack of competition for tax
credit allocations.
Recently, the investor pool for LIHTCs has been
concentrated among a few large players, including the
government-sponsored enterprises (GSEs) and the larg­
est banks. This small investor pool has become even
more concentrated during the credit crisis, with many
of the players significantly reducing their investments.
Until recently, Fannie Mae and Freddie Mac were the
largest tax credit investors, making up 40 percent of

the market. These GSEs bought LIHTCs for profit
and mission, but are no longer buying new tax credits.
There is also a concern that limited capital available for
the multifamily sector will be further eroded if Fannie
Mae and Freddie Mac conduct “fire sales” of their tax
credit book to ease pressure on their balance sheets.
Banks, which are motivated to invest, in part, to
satisfy requirements of the Community Reinvestment
Act (CRA), have also reduced investment. Compound­
ing the recent reduction in investment is a decrease in
buying by other large companies (software, retailers,
energy, diversified financials). Because the need to off­
set profits is uncertain, they see no benefit to investing
in LIHTCs.
Other factors affecting investor interest in LIHTC
projects are the substantial risks of falling out of
compliance and default. While real estate investments
traditionally include risk of default, LIHTC invest­
ments also include compliance risk associated with a
requirement that projects offer affordable rents for 10
years. This requirement translates to a 15-year total
investment duration that is often at odds with the tax
obligations of investing corporations, which tend to
change annually. Such a lengthy time requirement has
traditionally been a key barrier to increasing the pool of
investors in LIHTCs.
The syndication model currently used for funding
LIHTC projects is broken—large, front-loaded fees can
no longer be supported and the annual asset manage­
ment fees are insufficient to meet the increase in work­
load caused by problem assets. Also, liquidity advances
to keep projects current or viable are taking their toll on
already-stressed companies in this sector. The noncon­
forming nature of many guaranteed and pooled fund
structures and the low annual compensation makes the
sale and transfer of these obligations a difficult, expen­
sive and sometimes impossible proposition.
The recent lack of investor demand has created
significant stress in the functioning of the market for
LIHTC projects. The price of tax credits has fallen sig­
nificantly, which has created large equity gaps in project
development budgets and few resources to fill them.
There are now wide variations from project to project
in the median sales price for tax credits. This unstable
market in LIHTCs has been further exacerbated by
wild fluctuations of yields and tighter debt underwrit­
ing standards. Fundamental issues for the LIHTC
program remain, even if the market “normalizes” again.
Therefore, the development of a strong secondary mar­
ket for LIHTCs, accompanied by an expansion of the
investor base, is essential to its continued viability.
31

InnovatIve Ideas for revItalIzIng the lIhtC Market

A Secondary Market Solution
Fundamentally, secondary markets mesh the investor’s
preference for liquidity (the ability to enter and leave
the market quickly) with the capital user’s preference to
have capital available for an extended period of time.
LIHTC securities represent a diverse bundle of project
investments that could be sold in a secondary market
where credits are traded between sellers and buyers. The
creation of a secondary market for LIHTC securities
would improve liquidity and allow investors the flexibil­
ity to tailor their tax appetite for credits while making
collected capital available for long periods of time.
Creation of a secondary market would accomplish
three important goals.
First, it would attract new investors who are less
knowledgeable about real estate projects. The addi­
tional benefits of standardization, credible interme­
diaries and more transparent pricing would attract
less-sophisticated investors and enable more rational
pricing even in times of credit contraction.
Second, it would draw investors who are interested in
shorter investment periods. Currently, many potential
investors are dissuaded from LIHTC investments due
to the lengthy timeframe of the investment. Creating a
secondary market would increase liquidity and the abil­
ity to significantly shorten required investment periods,
while still providing sufficient capital for completion of
housing projects.
Third, it would promote the funding of a more a diverse
portfolio of projects, including smaller developments and
those deemed more complex due to location or other
factors. The pooling of projects in securities would spread
risk across a broad group of investors, which would ulti­
mately lead to stabilization in the pricing of tax credits.
Stabilizing Pricing
A secondary market option would more accurately
price securities for risk than the current syndication
model. Furthermore, by creating uniform structures
and documents, a secondary market should reduce costs
and eliminate the need for multiple parties to do due
diligence on the same assets.
Under the current model, LIHTC syndicators collect
upfront fees for the sale of the credits and management
of the compliance requirements. The secondary market
model would relieve fee stress that exists in the current
syndication model. A risk-premium would be attached
for this asset class, and sufficient asset management fees
would then be included in the secondary market struc­
ture to provide incentives and align interests. As noted
earlier, the current syndication model does not accom­
plish this and will not likely do so in the near future.
32

Developing the Secondary Market for LIHTCs
Fulfilling the secondary market solution for stabiliz­
ing the LIHTC market would require credible enti­
ties, or counterparties, to enter the LIHTC space with
securitized products. The logical parties to fill this role
are the GSEs and a few other proven intermediaries,
including social investment funds (such as ProgramRelated Investment funds in foundations).1 The devel­
opment of a viable secondary market would require
both new investors and counterparties who have experi­
ence, financial depth and infrastructure to underwrite,
structure and asset manage. Furthermore, to be truly
successful, this product must become a serious line of
business for the intermediary. In other words, it must
be a short- and long-term financially attractive proposi­
tion based on underwriting and guarantee fees.
The new products would need to offer features that
broaden the LIHTC investor pool. For example,
LIHTC securities would have to be structured to
respond to the market demand for shorter-term invest­
ments that match investors’ tax-planning models. In
addition, the market would need to provide the putoption to guarantee the minimum return and/or the
potential for exit at a market-driven price. Therefore, a
product design that creates structures to tranche credits
by duration, such as five-year and 10-year tranches with
a put-option, could solve this problem.
The pool of investors interested in these new prod­
ucts could also be expanded by changes in the tax code.
For example, changes to passive loss rules that limit
investment by closely held C, sub-S and LLC corpora­
tions would allow greater involvement from commu­
nity banks and other potential investors.
Conclusion
The ultimate goal of creating a secondary market is
the development of private-sector mutual funds for
retail tax credit buyers. This market could be designed
similarly to the existing tax-exempt bond market and
the market for mutual funds and municipal and other
bonds. Mutual funds could be set up for tax credit
retail investors with the pass-through of the tax ben­
efits, liquidity and surety guarantees. This would fill a
hole in the social investment world for individuals who
want to participate in creating affordable rental hous­
ing, but who have only a small amount to invest. If it
worked for corporations for 20 years, it can be made to
work for individuals as well. n

1

For an example of a foundation offering a secondary market product, see Schwartz article.

InnovatIve Ideas for revItalIzIng the lIhtC Market

enhanCIng lIhtC InvestMent
In PreservatIon ProjeCts

Debra D. Schwartz
Director, Program-related Investments
John D. and Catherine T. MacArthur Foundation

T

he dramatic contraction of investor demand for the
Low Income Housing Tax Credit (LIHTC) that
began in early 2008 has stalled hundreds of worthy
projects that would help meet the nation’s growing
need for affordable rental housing. The impact of this
capital market contraction is being felt throughout
the country. However, as reported by not-for profit
developers, lenders and syndicators in Window of
Opportunity: Preserving Affordable Rental Housing, it has
become especially difficult to raise LIHTC investment
for projects that preserve affordable rental housing
supported by long-term federal subsidy.1
As part of the Window of Opportunity initiative, the
Foundation has been exploring innovative financing
mechanisms that might be used to address this prob­
lem. This article describes the problem’s underlying
causes and suggests a possible approach that combines a
limited third-party guarantee with a senior-subordinate
structure, providing additional credit enhancement and
accelerated financial return for senior investors. This
model could help stimulate LIHTC investment to the
benefit of low-income renters living in federally assisted
affordable housing.
Preservation of affordable rental housing enables new
and existing owners to recapitalize and renovate exist­
ing properties already occupied by low-income families
and senior citizens. Preservation projects often are
prompted by an expiring subsidy contract or affordabil­
ity restriction. In these cases, the preservation project
entails financing a transfer of the property to a new,
long-term owner (frequently a not-for-profit organiza­
tion) who agrees to keep it in good repair with afford­
able rents well into the future.
The LIHTC is an essential tool for owners seeking
to preserve and improve the nation’s aging stock of
affordable rental housing. According to the National
Housing Trust, preservation projects accounted for
52 percent, or 65,000, of the 125,000 units of rental
housing financed through the LIHTC program dur1

The MacArthur Foundation’s $150 million initiative, Window of Opportunity: Preserving
Affordable Rental Housing, directly supports the preservation of 300,000 units of
existing, affordable rental housing nationwide and fosters improvements in policy and
financing needed to preserve at least one million affordable rental homes over the
decade ahead. For more information, visit www.macfound.org/housing.

ing 2007. Over the past five years, LIHTC financ­
ing helped preserve and improve more than 280,000
affordable rental homes nationwide.
Three key factors make it especially difficult to
finance preservation projects in today’s LIHTC market.
First, many properties targeted for preservation by local
government or mission-driven nonprofit owners are
located in smaller towns or weaker real estate markets.
Meanwhile, the investors who have remained in the
LIHTC market favor new construction projects in a
few, robust metropolitan areas on the coasts because
they consider these to be less risky.
A second challenge is that preservation projects
have depended heavily on the “4 percent” form of the
LIHTC, which is available to developments financed
by tax-exempt, private-activity bonds. This form of the
LIHTC accounted for an estimated $2 billion of the
total equity provided to preservation projects in 2007,
according to the National Housing Trust. Although
data for 2008 and 2009 are not yet available, the
amount is believed to have fallen dramatically, espe­
cially because projects financed with “4 percent” credits
are ineligible for the two special funding measures
approved in early 2009 as part of the federal govern­
ment’s stimulus program.
Third, even before the current market contraction
began, investors had grown increasingly concerned that
the federal government might fail to renew or fully
appropriate funds needed to pay the subsidies prom­
ised in HUD’s project-based Section 8 contracts. As a
result, many LIHTC investors, including Fannie Mae
and Freddie Mac (before they entered into government
conservatorship in the fall of 2008 and withdrew from
the market), demanded that preservation projects estab­
lish large, additional cash reserves to hedge this per­
ceived Section 8 risk. Because the price that LIHTC
investors pay has fallen from a high of 95-97 cents per
dollar of future tax credits to only 65-70 cents today,
establishing an extra Section 8 reserve has become even
more difficult and makes it impossible to finance pres­
ervation projects that are otherwise perfectly sound.
To help preservation projects obtain cost-effective
financing in the face of these challenges, the Founda­
tion is exploring an “enhanced” structure for a LIHTC
fund that would provide equity for high-quality
projects sponsored by leading not-for-profit hous­
ing owners and supported through the Foundation’s
Window of Opportunity initiative. This would include
projects that use the “4 percent” form of the tax credit
and those located outside the country’s strongest real
estate markets.
The structure for this enhanced LIHTC fund would
35

InnovatIve Ideas for revItalIzIng the lIhtC Market

Annual Allocation of Tax Benefits
Ordinary vs. Enhanced Tax Credit Fund

Ordinary Fund

All investors

year

1

2

3

4

5

6

7

8

9

10

Enhanced Two-Tier Fund

Senior investor
Subordinate investor

year

1

2

3

4

5

6

7

8

9

10

Senior investors exit @ yr. 7
Plus: Guaranty
for

• Construction
• Section 8
• Recapture

Continues to yr. 15

combine a guaranty from the Foundation with a twotier, senior-subordinate capital structure that allows
a group of senior investors to shorten their invest­
ment horizon by two to three years.2 This structure is
designed to enable the senior investors (accounting for
up to 80 percent of the total fund capital) to exit the
fund once they reach an agreed-upon level of return.
The fund would be designed to generate this return
within a period of seven to eight years versus the 10
years that the LIHTC ordinarily requires.
The shortened investment period for senior investors
would be possible because the fund would include a
higher-risk, subordinated, limited partner class, pro­
viding roughly 20 percent of the fund’s total LIHTC
equity investment. The subordinate investor would
agree to receive only 1 percent of allocable investment
2

The Foundation’s guaranty would be provided through a form of grant-making known as
a “program-related investment,” usually a below-market loan or other investment made
primarily for charitable purposes. For more information, visit www.macfound.org and
www.primakers.net.

36

benefits until the senior investors have received sufficient credits and other tax benefits to obtain their
agreed-upon minimum return. Following the senior
investors’ exit, all benefits for the remaining investment
term (two to three years) would flow to the subordi­
nated investor.
At a time when existing LIHTC investors are increas­
ingly uncertain about their future taxable income
and, hence, their ability to utilize future tax credits, a
shortened investment horizon has significant appeal. It
also would enable the fund to obtain better pricing and
thereby deliver more upfront resources for the projects
it finances. Importantly, the fund would retain the
private sector discipline that has been a hallmark of the
LIHTC program’s success to date. The subordinate
investor would have a significant stake in the successful performance of the financed properties over the full
15-year compliance period. In addition, the subordi­
nate investor would provide a valuable layer of credit
enhancement for the senior investors, ideally making
investment easier for institutions new to the LIHTC
market. Finally, senior investors would be further pro­
tected against certain risks by the Foundation’s unse­
cured, general guaranty.
Unlike traditional guaranteed LIHTC funds, the Foun­
dation’s guaranty would not be used to ensure a targeted
investment yield. Rather, its purpose would be to miti­
gate specific risks that could cause projects to fall out of
compliance with the affordability and occupancy require­
ments of the LIHTC program and, therefore, not deliver
the expected tax benefits to the senior investors or trigger
a recapture of benefits that were provided previously.
The Foundation’s guaranty would be capped at a
specified percentage of the total fund amount (e.g.,
20 percent of the fund size). It could be drawn in the
event that sponsor guarantees and various propertylevel and fund-level reserves were insufficient to cover
the cost of (1) shortfalls related to upfront renovations
and project stabilization; (2) operating deficits due to
the nonrenewal of a federal Housing Assistance Pay­
ment contract under HUD’s Section 8 program or
the failure to appropriate and pay amounts due under
these contracts; and (3) recapture of previously pro­
vided federal tax benefits in the event that a LIHTC
property is not operated in compliance with all appli­
cable regulations during its initial 15-year period. The
construction and recapture guaranty provisions would
be available only to the senior investors. Both the
senior investors and the subordinated investor would
be covered by the Section 8 guaranty.
Based on preliminary discussions, the Foundation
believes that this structure offers a feasible way to raise

InnovatIve Ideas for revItalIzIng the lIhtC Market

LIHTC equity for a wide array of preservation projects
on cost-effective terms—despite today’s tight credit
environment and diminished appetite for real estate
investment of all kinds. Because the guaranty would be
limited and the subordinate investor would be posi­
tioned to receive a higher return in exchange for a longer
investment duration and higher level of risk, the model
also appears well-suited to rapid, large-scale replication.
Of particular importance, the Foundation’s Section 8
guaranty would enable the fund to finance properties
near the expiration of their subsidy contracts—and
therefore at greatest risk of loss from the affordable
rental stock. This guaranty should eliminate the need
for developers to set aside the large cash reserves that
most LIHTC investors now require. For a $50 mil­
lion sample portfolio of Section 8 preservation projects

examined by the Foundation, eliminating a special Sec­
tion 8 reserve gave a $13 million boost to the properties.
Assuming that the uncertainty and temporary underfunding problems that occurred with the Section 8
program in recent years are reversed, the Foundation
expects that market perceptions of Section 8 appro­
priation and contract renewal risk will lessen over
time. Meanwhile, others in the philanthropic, private
and public sectors could adopt this new approach,
providing the credit enhancement and subordinate
investment necessary for worthy projects to proceed.
Enabling a healthy volume of preservation projects to
build a reliable track record of timely contract renewals
and successful delivery of financial returns to LIHTC
investors is an essential next step in restoring vitality to
the overall LIHTC market. n

37