Although affordable housing is still associated with excessive government rules and regulations, the perceived risk could be offset by potential rewards. Moreover, the federal low-income housing tax credit program is so widely accepted on Capitol Hill that it is becoming the tool of choice to restart apartment construction along the hurricane wracked Gulf Coast.

Victoria Spielman, executive director of the Affordable Housing Tax Credit Coalition, says the federal low-income housing tax credit program has become the program of choice to rebuild housing devastated by Hurricanes Katrina and Rita, especially in light of potential increased allocations of credits for Texas, Louisiana, Mississippi, Alabama and Florida.

Under federal law, each state can authorize $1.95 per capita in low-income housing tax credits each year. Under pending legislation, that amount would double in hurricane-struck states for at least two years.

The federal government long ago reduced direct funding of low-income housing. But since 1986, the federal tax credit program has stimulated the construction of hundreds of thousands of new housing units. It has also handsomely rewarded private equity investors. Until recently, investors in low-income housing partnerships were scoring 20% annual yields.

Now demand from private equity investors for limited federal low-income housing tax credits has grown so strong that anticipated yields have dropped to single digits. What investors like about the tax credit program is that defaults on privately owned low-income housing project are virtually nil. "We found a foreclosure rate of 0.02% on multifamily buildings financed through the federal low-income tax credit program," says Richard Floreani, senior manager with Ernst & Young's Boston-based tax credit investment advisory services.

In his recently released third annual study of the real estate sector, Floreani notes that low-income housing tax credit investments provided average returns 2% greater than originally projected. He reviewed more than 13,503 low-income developments, representing a cumulative 1.02 million units that were funded by $4.37 billion in tax credit equity. Currently, about 80,000 apartment units a year are funded through the federal tax credit program.

In recent years, private investors nationwide have purchased nearly $600 million in federal income tax credits. That's roughly enough, when leveraged, to finance five to seven times that much in construction, industry experts say.

Along with virtually no risk of foreclosure, the median occupancy rate in the properties averaged 96%, the study reports. Low-income housing is easy to rent and rents are collectable, Floreani adds.

In any given year, however, some projects have too little income to cover their debt payments. Such statistics would normally raise red flags. But the report notes that the tax-credit properties are designed just to break even. There may be years when projects fall below the threshold of profitability, but they could subsequently cut costs or raise rents to move above the redline.

Under federal law, apartments constructed with the help of tax credits for investors have to remain certified low-income units for 15 years. One expectation was that the units would then revert to higher market rates. However, the study found that happened with only about 20% of the properties. The majority sought new federal tax credits and remained certified low-income housing--an indication of the attractiveness of the investment to investors.

Spielman says the future of the federal low-income housing tax credit program seems assured. In past votes, Congress assured the permanence of the program, she explains.

In addition, the capital market for federal low-income tax credits has matured. There are about 40 major syndicators nationwide that command the bulk of the business, Floreani adds. The Affordable Housing Investors Council, which represents developers, syndicators, lenders, nonprofit groups, public agencies and others concerned with the low-income housing tax credit program, estimates that its 60 members buy 80% of the annual allotment of federal tax credits.

Instant Insights /

Tax Credits Spurring Development

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