EXTRA CREDIT FOR HOUSING DEALS: ADMINISTRATION PROPOSES INCREASE IN PROGRAM

When Congress closed the door on a key loss-related tax write-off more than a decade ago, sending thousands of shaky real estate deals into a tailspin, it also opened up a new market in tax credits on affordable housing projects.

Since 1986, real estate developers and syndicators have raised $33 billion, mainly from corporate and institutional investors, by pooling credits from various projects into a limited partnership and selling partnership units to investors. But more and more retail investors are getting in on the action.It’s not hard to see the appeal. Investors typically earn 100% to 120% of their principal back in the form of tax credits over 10 years. That translates into a tax-free internal rate of return of about 4% to 6% a year for most investors. The rate of return assumes the properties are worthless at the end of a 15-year holding period, which is typically not the case.

The Clinton administration is proposing to boost the program by increasing the credit by as much as 40% and indexing it for inflation in coming years.

Created as a result of the Tax Reform Act of 1986, the credits were intended to spur development of affordable housing by rewarding investors with tax advantages.

The credits, which are phased in over 10 to 15 years, reduce taxes dollar-for-dollar. For instance, a tax deduction of $1 is worth 31 cents for taxpayers in the 31% bracket, while a $1 credit is worth $1 regardless of bracket. The maximum investment for individuals is $90,000; corporations aren’t subject to the cap.

Ideally, partnership investors get back their original investment and earn a profit once the properties are sold, refinanced or resyndicated after the holding period. The credits are pre-funded by Uncle Sam, which provides investors with some assurance that they won’t be stripped of the benefits. By contrast, after 1986 investors were no longer allowed to write off passive losses on limited partnerships against all types of income.An estimated 90% of the credits are bought by corporations, la
rgely because syndicators have focused their efforts on big-ticket sales.Firms that hawked credits to retail investors in the early days – including Boston Financial Group, the Richmand Group in Greenwich, Conn., and the Related Cos. in New York – have since shifted their focus to institutions.

But one company, Boston Capital Services Inc., has dominated the retail market by selling through a network of 400 broker dealers, including Royal Alliance Associates, LPL Financial Services and SunAmerica Securities, with a total of 20,000 reps.

While some advisers are skeptical, others tout the credits as useful for clients ranging from retirees facing taxes on IRA distributions to those who have racked up huge stock-market gains. Congress has authorized credits of $3.3 billion yearly, enough to build or rehabilitate 100,000 low-income housing units nationwide. So far, the program has spurred the construction of 75,000 to 90,000 rental units a year.

“It’s a way of keeping the government directly out of the affordable housing industry and encouraging private investors to accomplish this goal and reap tax benefits as a reward,” says Marianne Shine. She is president of Shine Financial Inc. in Deerfield Beach, Fla., a planning firm with $3.5 million under supervision that has invested $400,000 for clients in affordable housing credits.

What’s more, proponents say, demand for affordable housing will grow if the economy slows.

Under the program, 20% of the units in a particular development must go to tenants who earn 50% or less than the median income in the area or 40% must go to tenants earning 60% or less of the local median income.

“In good times, we are the cheapest place to live and in bad times we are the cheapest place to live, and we have more people who qualify,” says Richard J. DeAgazio, president of Boston Capital. It has raised $1.5 billion for affordable housing projects since its founding in 1974.

$300 million last year

Last year, the privately held firm, which specializes in
developing garden apartments in rural and suburban areas, raised $300 million by selling credits in diverse pools of properties, up more than 500% from the $55 million it raised in 1987. About 60% of Boston Capital’s business comes from corporations, with the remainder coming from individuals through advisers.

The company is one of the largest owners of multifamily rental property in the country, with 1,900 properties, which it says are 98% occupied.

Boston Capital’s pools offer annual tax credits of about 12% on investments. In other words, a $10,000 investor gets $12,000 in tax credits over 10 years.

In addition to sharing in half the profits, Boston Capital collects a hefty 8.5% fee on the equity it raises. The firm declined to release its revenues.

President Clinton’s recent proposal to fatten housing tax credits was welcome news to industry veterans.

In 1995 Rep. Bill Archer (R-Texas), chairman of the powerful House Ways and Means committee, called for a review of the program after the Internal Revenue Service cited the possibility of as much as $600 million a year in improperly claimed credits.

Critics also point to some highly leveraged projects, built during the early years of the program, that underestimated operating costs and overestimated rental revenues.

early problems cited

But the industry weathered a 1997 review by the General Accounting Office, which merely called for more administrative oversight.

“There are some projects that have been troubled in various parts of the country,” says Mary Tingerthal, president of the Chicago-based National Equity Fund, which raises $400 million a year by selling tax credits to companies. The money is used to finance projects developed by non-profit community groups.

As a result of past troubles, the newer pools have large reserve funds and less leverage, she adds.

Still, some advisers say certain clients are better off investing for higher returns even if they have to pay taxes.

What’s more, not all can afford to tie up their
money for 10 to 15 years. Investors who want out are likely to have to sell at deep discounts in the limited secondary market.

“An investment in tax credits is not a liquid investment,” says Ms. Shine. “It should be money (clients) can afford to tie up.”