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The Disruption of
the Low-Income
Housing Tax
Credit Program:
Causes,
Consequences,
Responses, and
Proposed
Correctives
Joint Center for Housing Studies
of Harvard University
December 2009
The Disruption of the Low-Income Housing Tax Credit Program:
Causes, Consequences, Responses, and Proposed Correctives
Support for this paper was provided by the What Works Collaborative
December 2009
© 2009 President and Fellows of Harvard College.
All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission
provided that full credit, including © notice, is given to the source.
The opinions expressed in The Disruption of the Low-Income Housing Tax Credit Program: Causes, Consequences,
Responses, and Proposed Correctives do not necessarily represent the views of Harvard University, the Policy
Advisory Board of the Joint Center for Housing Studies, or the other sponsoring agencies. Any errors are those of the
Joint Center for Housing Studies.
WHAT WORKS COLLABORATIVE
Building Knowledge and Sharing Solutions for Housing and Urban Policy
The What Works Collaborative is a foundation-supported research partnership that conducts
timely research and analysis to help inform the implementation of a forward-looking housing and
urban policy agenda. The Collaborative consists of researchers from the Brookings Institution’s
Metropolitan Policy Program, Harvard University’s Joint Center for Housing Studies, New York
University’s Furman Center for Real Estate and Urban Policy, and the Urban Institute’s Center
for Metropolitan Housing and Communities, as well as other researchers and policy experts. The
Annie E. Casey Foundation, Ford Foundation, Kresge Foundation, John D. and Catherine T.
MacArthur Foundation, Rockefeller Foundation, and Surdna Foundation provide funding to
support the Collaborative.
ACKNOWLEDGEMENTS
The following is a partial list of those who helped this research effort by agreeing to be
interviewed, attending a focus group session, or reviewing an earlier draft of this report. The
Joint Center for Housing Studies is grateful to Sulin Carling for research assistance.
David M.Abromowitz
Goulston & Storrs/Center for American Progress
David Gasson
Housing Advisory Group
Amy Anthony
Preservation of Affordable Housing
Richard S. Goldstein
Nixon Peabody LLP
Richard D. Baron
McCormack Baron Salazar
Kimball Griffith
Freddie Mac
Sharon Dworkin Bell
National Association of Home Builders
Ethan Handelman
CAS Financial Advisory Services
Doug Bibby
National Multi Housing Council
Bart Harvey
Former Chairman Enterprise Community Partners
Michael Bodaken
National Housing Trust
Bill Kelly
Stewards of Affordable Housing for the Future
Raphael Bostic
U.S. Department of Housing and Urban Development
Peter Lawrence
Enterprise Community Partners
James M. Chandler
Virginia Housing Development Authority
Joseph A. Macari
Hudson Housing Capital
Lawrence H. Curtis
Winn Development
Michael May
Freddie Mac
Thomas Deyo
NeighborWorks America
Shekar Narasimhan
Beekman Advisors
Rachel Diller
Goldman, Sachs & Co.
Pat Nash
JP Morgan
Andy Ditton
Citigroup
Jenny Netzer
Tax Credit Asset Management
Frances Ferguson
NeighborWorks America
Erika Poethig
U.S. Department of Housing and Urban Development
Anthony Freedman
Holland & Knight LLP
Garth Rieman
National Council of State Housing Agencies
Carol Galante
U.S. Department of Housing and Urban Development
Buzz Roberts
Local Initiatives Support Corporation
Robert M. Rozen
Washington Council Ernst and Young
Lydia Tan
BRIDGE Housing Corporation
Jon Sheiner
Committee on Ways and Means
Cara Wallo
Virginia Housing Development Authority
Mark Shelburne
North Carolina Housing Finance Agency
Charles Wehrwein
Housing Partnership Exchange
Brian Shuman
Mercy Housing
Charles Werhane
Enterprise Community Investment, Inc.
David A. Smith
CAS Financial Advisory Services
EXECUTIVE SUMMARY
As a result of the credit market meltdown, the Low-Income Housing Tax Credit (LIHTC)
program, the nation’s primary mechanism for producing and preserving affordable rental
housing, was severely disrupted in 2008 and 2009. When the corporate investors on which the
program relied—primarily large, national banks and Fannie Mae and Freddie Mac—swung from
profitability to loss and could no longer use tax credits, demand for LIHTCs plummeted. As a
result, the price of LIHTCs fell, creating funding gaps in projects that had received tax credit
allocations in 2007 and 2008 but had not yet sold them. Thousands of projects and tens of
thousands of units that would have otherwise been bought or rehabilitated stalled. It is important
to recognize that the LIHTC crisis is due to a drop in investor demand in the wake of the worst
financial crisis since the Great Depression, not with the performance of the program to date in
delivering affordable housing at a very low loss rate.
In February 2009, the government created two programs as part of the American Recovery and
Reinvestment Act—the Tax Credit Assistance Program (TCAP) and the Tax Credit Exchange
Program (Exchange)— to address the absence of LIHTC private investment capital. TCAP was
intended to provide gap financing for projects, and Exchange was designed to offset the drop in
tax credit demand and pricing.
This paper examines the experience to date with these two stopgap measures. Its purpose is to
assess whether TCAP and Exchange are effective and sufficient or if additional actions may be
necessary to mitigate the vulnerabilities in the LIHTC program exposed by the recent financial
crisis. The main finding of the report is that more needs to be done and that longer term issues
surrounding investor demand must be addressed.
TCAP and Exchange were not intended to revive demand or improve the market price of tax
credits. Indeed, demand and pricing for the tax credits remained seriously depressed in many
markets in the fourth quarter of 2009. Bringing demand back will likely require: (1) a market
workaround (such as a viable secondary market) that could be challenging to develop and would
not be implemented quickly, (2) legislative solutions to one or both of two aspects of the tax
1
code (passive loss rules and the 10-year use and 15-year compliance period of the tax credit) that
inhibit demand and result in lower tax credit pricing, and/or (3) an expansion of the Community
Reinvestment Act (CRA) that provides regulatory as well as financial motivation for financial
institutions to invest in tax credits.
The following summary of findings is based on interviews with over two dozen industry experts,
a review of analysis conducted by others, and a focus session with leading stakeholders to
discuss the current situation and assess several proposals for reform.
Salient Features of the LIHTC Program and the Investor Base
Understanding the challenges the LIHTC program faces and the prospects for improvement rests
on grasping the following features of the program.

The LIHTC program depends on the sale of tax credits to private investors. The
LIHTC program is able to deliver apartments at rents affordable (at 30 percent of income) to
households with low incomes (at or below 60 percent of area median) by selling tax credits to
investors and using the net proceeds of the sale to reduce the debt the property must support.

The LIHTC program enjoys widespread support because it has been successful
across the country and minimizes taxpayer exposure to failure. Throughout the
program’s 23-year history, its default experience has been low by multifamily rental
standards and extremely low relative to previous subsidy programs. This history includes a
period of national rent deflation in the first part of the 1990s and rising rental vacancy rates
in the wake of the 2001 recession. When properties do fail, the program rules require
recapturing a fraction of the tax credits from private investors so taxpayers do not pay for
affordable housing services that are not delivered. Typically, the property is transferred to
new owners who restore it to financial viability and compliance. Taxpayer protections, low
default rates, and allocation of credits on a per capita basis to all states have led to
widespread support of the LIHTC program in Congress.
2

Private capital drives excellent program performance. Everyone we spoke with
suggested that a key reason for the LIHTC program’s success was that private investors had
significant capital at risk. “Having skin in the game” encourages investors to underwrite
carefully and step in to support properties in temporary trouble to avoid recapture events. As
discussed below, the investors which performed LIHTC underwriting this decade are
sophisticated multifamily real estate investors with the best access to market information and
the greatest ability to underwrite private capital investment.

Passive loss rules and the long investment horizon of the tax credit, as well as
its tie to the performance of residential real estate, narrows the investor base.
Although the LIHTC program initially relied on individual investors, passive loss limitations
quickly shifted the investor base to widely held corporations that are allowed to use the
credits and depreciation expenses generated by tax credit projects to offset their incomes. The
same passive loss rules that made individual investment unattractive also limited the
participation of sub-chapter S and closely held C corporations and other pass-through
entities. Tax credit prices were initially low enough and yields high enough to attract some
nonfinancial corporate investors without experience in real estate. The program, however, is
designed so that tax credits are taken in each of 10 years from when a property is placed in
service and compliance is maintained for 15 years from that date. Most corporate investors
are reluctant to make such a long-term investment because they cannot dependably forecast
their tax liability that far in advance. In addition, compliance requires that project sponsors
maintain tenant income limits, adhere to rent restrictions, and make debt payments. Over
time, therefore, large financial institutions with experience making long-term investments
have been willing to bid more for the credit than other investors.

Uneven regulation of financial institutions caused the LIHTC program to
migrate to investors willing to pay the most for the tax credit and accept a
below market return. Not only did the investor base migrate to financial institutions best
able to underwrite real estate investments and accustomed to longer-term investments, but
also to those willing to bid the most for the credits. The financial institutions willing to
accept low returns had more than just tax planning and financial reasons to invest.
3
Specifically, banks were motivated to buy LIHTCs in areas where they had branch operations
to boost their scores on Community Reinvestment Act (CRA) examinations. Large banks
tend to aim for higher CRA ratings and, therefore, had a special motivation to invest in tax
credits. Fannie Mae and Freddie Mac were also willing to accept lower yields to satisfy
mission regulators and because they are restricted to earnings from residential assets.

Tax credit pricing in the first half of the decade discounted recapture and tax
liability risks. By the mid-2000s, the height of the housing bubble, average prices for tax
credits implied yields in only the low to mid-single digits. At such low yields (comparable to
risk-free 10-year Treasuries), investors were clearly discounting both real estate risk and tax
liability risk (the risk of not owing enough taxes to use the tax credits as planned). Though tax
credits can be carried back for one year and forward for up to 20 years, pushing potential tax
benefits forward into the future makes them much less valuable in the present to investors,
especially when they also have net operating losses and foreign tax payments to carry forward.

The staging of capital in LIHTC projects left the nation’s affordable rental
production and preservation system vulnerable to a downward repricing of tax
credits. Developers (also called project sponsors) typically line up other forms of financing
before receiving—let alone pricing—tax credit allocations. This left the system vulnerable to
falling tax credit prices, causing financing gaps relative to pro forma expectations.

When demand from the existing investor base fell, areas without large banks
concerned with CRA compliance faced especially severe disruption. When Fannie
Mae and Freddie Mac could no longer use the tax credits and withdrew from the market,
large banks were the only significant source of tax credit investment left. These large banks
concentrated on a limited number of large metropolitan areas where they were competing for
CRA credit. Other places saw much lower, if any, bids for their tax credits. The departure of
Fannie Mae and Freddie Mac meant that as much as 40 percent of the investment in tax
credits according to some estimates evaporated nationally, and in small metropolitan and
rural areas investment fell by much more. The falloff in demand drove tax credit prices down
to the high 70 to low 80 cent range in the most competitive markets for tax credits and to
4
around the low 60 cent range or lower elsewhere. Average yields appear to have increased
from a low of about four percent to nearly 10 percent in 2009. In 2009, though, the range of
yields widened and the average price was biased upward by the fact that most tax credit
investment was by a limited number of banks operating in only a small number of mostly
large and coastal metropolitan areas. Outside these areas yields are well above average and
prices well below average.

Making changes to the LIHTC program takes time because the federal
government and more than 50 allocating and administering agencies must
interpret and implement rule changes. Another widely viewed strength of the LIHTC
program is that it is allocated and administered primarily through state housing finance
agencies and a few local housing finance agencies. This provides for local oversight and
keeps the program sensitive to local needs and politically popular. It also means that when
there are program changes, each allocating agency must develop a process for implementing
and remaining in compliance with the new rules. With the creation of two new programs in
February 2009, state housing finance agencies began planning their implementation while
simultaneously anticipating necessary program guidance from the Department of Housing
and Urban Development (HUD) and the U.S. Treasury. It would inevitably take at least
several months before the guidance was issued and the allocating agencies could respond to it
and reach a point where funds could be deployed.

Absent additional legislative action or the formation of a liquid secondary
market, neither tax credit demand nor tax credit pricing is likely to return to
mid-2000s levels any time soon. Fannie Mae and Freddie Mac have no reason to return
to the tax credit market because their losses are so great that they can already offset future
taxes for many years to come. The same holds true for the large banks that remain in the
market primarily to comply with CRA, and even this source of investment for new projects is
at risk. In fact, existing owners without current tax liability have a powerful incentive to sell
their tax credit investments to capture residual value. New investors must become
comfortable with the long investment horizons of tax credits and will demand either high
yields or some form of guaranteed return. Meanwhile, the current tax code discourages
5
individuals and closely held corporations from investing in LIHTCs because they cannot
offset active income with credits and depreciation from these properties. This means tax
credit prices, even if new investors can be found, will remain far below the levels reached
before the financial crisis.
Operation and Effectiveness of the TCAP and Exchange Programs
The express aim of both the Tax Credit Assistance Program and the Tax Credit Exchange
Program was to help ensure funding was available in sufficient volume to allow shovel-ready
projects in the pipeline with 2007 and 2008 allocations and projects with 2009 allocations to
proceed. While both stopgap measures were slow to start, investors and project sponsors
increasingly report using the two programs successfully. While it is too soon to tell how much of
the stranded pipeline will be cleared, funds are starting to flow. The following assessment
reflects industry experts’ perceptions of effectiveness to date.

Of the two programs, TCAP triggers greater additional compliance
requirements. Because TCAP funds are appropriated through the Department of Housing
and Urban Development, TCAP projects must comply with many additional federal rules
such as requirements for environmental review. LIHTC- and Exchange-funded projects do
not have these requirements because they are provisions of the federal tax code. These
additional requirements add to both delays and costs. There does not appear to be any way
around this problem because of the funding mechanism for TCAP.

Allocating agencies had to take on new responsibilities and risks while
ensuring compliance with new program rules. For properties funded by Exchange
without private capital, agencies have had to assume additional responsibilities for asset
management and for recapturing funds in the case of noncompliance. Moreover, TCAP
requires that agencies assume construction period risk and take responsibility for monitoring
compliance with federal assistance requirements.
6

Tighter credit terms add to project financing gaps. Financing gaps are being caused
not only by the drop in tax credit pricing but also by tightening credit terms. Changing debt
markets have compounded the financing problems for project sponsors. Lenders are
demanding more equity protection and tighter credit terms, including lower maximum loanto-value ratios and higher interest rates.

Exchange pricing may be inhibiting the return of tax credit demand in places
where market prices are significantly lower. In markets where tax credit bids are low,
the 85 cents offered by the Exchange program is a powerful incentive for allocating agencies
to swap larger shares of unused credits and fund projects with little or no limited partner
capital. It is possible, therefore, that Exchange pricing may be forcing some investors out of
the tax credit market rather than bringing them in at market prices.

Even so, Exchange funds are critical to plugging funding gaps in places with
low tax credit demand and may still prove insufficient to meet the need.
Demand for tax credits has reportedly fallen so sharply and debt financing become so costly
in many areas that the TCAP and Exchange programs may be insufficient to fund the
pending projects as well as new activity in 2009. The Exchange program was reportedly set
at 40 percent of the 2009 allocation to make up for the exit of Fannie Mae and Freddie Mac.
However, the 40 percent figure is applied pro-rata to all allocating agencies even though the
withdrawal of Fannie Mae and Freddie Mac meant the loss of far more than 40 percent in
areas without significant presence of CRA-oriented investors and far less in other areas.
Indeed, New York and a handful of other states have so far refused Exchange funding, and
instead have focused on using TCAP alone to plug gaps.

Some aided properties may have little or no private capital, raising questions
about asset management. Reports that projects are being funded with little or no limited
partner capital raise concerns that asset management may be weaker than when private
investors have significant capital at ri …
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