White House talk of a national tax-code rewrite has caused hand-wringing among some housing developers in Arkansas and across the nation.
The expectation of significant tax cuts has caused a sudden drop in the value of federal Low Income Housing Tax Credits -- the primary way developers finance housing projects that rent to tenants making 60 percent or less of an area's median income.
Created under President Ronald Reagan in 1986, the program distributes a finite number of tax credits to each state. In Arkansas, the credits are then awarded to developers on a competitive basis by the Arkansas Development and Finance Authority. The developers then sell those credits to banks and corporations in exchange for private investment; investors use the credits by writing them off against their taxable income.
In Arkansas, the credits typically cover 60 percent to 70 percent of a project's total development cost. Developments financed by the credits are required to rent to elderly or low-income tenants.
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Since the program's inception, it has enabled the construction or rehabilitation of nearly 30,000 housing units across the state and 2.4 million across the nation -- investments valued at more than $87 million in the state, and $9.5 billion nationwide, according to federal and state numbers.
Last year, Arkansas developers were valuing the credits between 92 cents and 98 cents on the dollar, meaning that banks and investors were paying that much for every dollar's worth of credit. But with President Donald Trump and the Republican-led Congress' promising to slash corporate tax rates -- from 35 percent to as low as 15 percent -- investors no longer see the tax credits as being worth what they were paying last year.
The Arkansas Development and Finance Authority recently received it's annual round of tax credit applications, in which the Arkansas market was valuing the credits between 85 cents and 88 cents on the dollar.
Real estate experts expect the revenue decline to negatively affect the number of low-income housing units constructed this year. There's no way to calculate how many fewer units the decrease might lead to, "but it's going to be a known decrease if other funding sources can't be found," said Ben Van Kleef, the Development and Finance Authority's vice president for housing.
The 30-year tax credit program has historically been stable and popular among investors and developers, who often walk an economic tight-rope when financing low-income housing projects.
Jim Petty, a longtime Van Buren-based real estate developer, has used the credits to construct numerous projects around the state. The housing availability in the state's more rural markets would be most affected by the predicted decline in the tax credits' value, he said.
"These [credits] are not just essential, they are the lifeblood of affordable housing of the less populous counties, cities, as well as the other rural areas of the state," Petty said. "It's one thing to develop blue collar housing in Fayetteville, Little Rock, or Fort Smith. But to provide affordable housing in the lesser populated areas, the economics just wouldn't make sense."
According to data from the federal housing department, the majority of tax credit investments in the state have gone into projects in smaller cities, from McGehee and Lake Village in the east, to Nashville and Ozark in the west.
Since 2014, Regions Bank has held $58 million worth of investments in 13 low-income housing projects in Arkansas. Many of the bank's current investments are in smaller rural areas such as Ashdown and Hoxie, a company spokesman said.
With the current 35 percent corporate tax rate, banks and investors eagerly bought into the program in order to reduce their tax liabilities.
"You've got a seasoned program out there. You've got corporate buy-in, you've got public good, everybody's happy. It's doing good things for the public. It has support from both sides of the political isle, and you have support from companies looking to offset their tax liability," said Darrick Metz, senior vice president of WNC & Associates, a national real estate investment company with more than $90 million of investments in 47 different projects in Arkansas.
Metz said Trump's talk of tax-cuts had the unintended effect of throwing a stable program into uncertainty soon after the November election. Without any concrete idea of what the corporate tax rate might be after a tax overhaul -- or even when such an overhaul might happen -- investors are hesitating to invest in credits that might be worth less in the near future.
Metz said this is the first time he has seen such instability in the tax credit program since the housing market crash in 2008-09. And although the present value of the credits is not the lowest the market has experienced in recent memory, he said, past deviations in value have been offset by different economic environments and interest rates.
In Mountain Home, developer Thomas Embach, owner of Leisure Homes Corp., has already been affected by the instability.
Embach was the first developer in the state to use the program after it's creation in the 1980s, and since then he's developed about 40 different housing projects across northern Arkansas and in towns just across the Missouri state line.
One of his projects, however, has been caught in the middle of this market flux.
Embach had plans for a $5.7 million renovation of a 40-unit housing complex in Fayetteville before the November election. With credit rates then in the range of 92 cents to 98 cents on the dollar, his project was squared away to break ground this year. The majority of his development costs were going to be covered by investor dollars via tax credits.
Now he's having a harder time finding an investor, and the lowered value of the credits opened a gap in the project's financing. To fill that gap, he said, he may have to take a $600,000 loan to fully finance the development costs.
"We never had this problem before, so we didn't really anticipate any of this," Embach said.
That equity gap may cause him to raise rents by $25 to $505 for a one bedroom unit.
"That's tight, I can tell you. It leaves very little cash flow in the deal and enough to pay reserve accounts and your operating bills," he said. "If the rents went up much higher, we don't feel like it would be feasible. ... We can't possibly have those low rents and borrow much money."
And the lower the credits' value sinks, the less feasible low-income housing projects become.
Embach emphasized that this change is happening at an especially inopportune time -- as low- to median-income housing stock shrinks and rents rise in areas undergoing rapid growth, such as northwest Arkansas. A market study Embach commissioned for his Fayetteville project found 1,500 potential renters for his 40-unit project -- "a huge demand there," he said.
"If credits dropped below [86 cents on the dollar] and we couldn't build it, well then the demand would still be there, but there would be no housing," he said.
"The bottom line is, this has been a great program, and it's a fair program," Embach said. "But affordable housing is getting tighter and tighter in terms of availability of good stuff -- something you'd want to live in or I'd want to live in."
A Section on 04/10/2017