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Minimum Wage Debate Is Really About Affordable Housing

The arguments against minimum wage center on its impact on employment—a forced increase in wages will only result in further reduction of jobs—or the cost increases that will be passed through to the consumer.  The common argument, especially coming from fast food establishments, is that the consumer will ultimately pay the increased wages through the cost of the happy meal.  If the government forces an increase in the minimum wage, we all ultimately pay for it.

Many studies have been done on the impact minimum wage has on unemployment, but the impact on consumer prices are nearly impossible to quantify.  In the restaurant industry it could be argued that the costs of beef, eggs, milk, etc. have a much greater impact on profitability than labor.  Inflation statistics have shown that the former has increased at a much faster pace than the latter.  

Regardless of whether or not these arguments have merit, it misses the bigger picture of how we provide support for the working poor.  If we don’t increase pay through minimum wage mandates, we have to bridge the living standard gap through food stamps, SNAP, Earned Income Tax Credit, etc. So we’re already paying for these supportive programs through our taxes or indirectly through cost increases in our products.  In fact, it could be argued that these programs are subsidizing the labor costs for companies that rely on minimum wage employees.

The minimum wage debate tends to resurface when costs of living increase.  Housing remains the single highest component of living costs for the working poor.  Most are paying over 50% of their pay towards rent.  Unfortunately the press tends to focus on home prices, but rent in most cities has seen double digit increases.  Affordable housing has been replaced by luxury apartments and condos, putting further pressure on the working poor.  Housing subsidies have not increased to address this.  

If we looked for ways to improve our housing policy across the country, I believe we will better address the needs of the working poor than pushing for minimum wage mandates.  The Low Income Investment Fund (LIIF) has even introduced a method to calculate the social impact of affordable housing investments. Many of our housing programs can benefit from better public/private participation without government mandates.  Let’s address the root problem and not risk our employment recovery.

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Tax Considerations for Corporate Investors’ in Low Income Housing Tax Credits

Investing in Low Income Housing Tax Credits (LIHTC) is something entities recognized as C corporations under the US tax code investors should consider. These tax credits arrived in the tax code in the 1980’s as a means for the federal government to provide support and additional financing for low-income housing.  

The federal government allocates a certain amount of tax credits for low income housing to be built in each state.  State housing authorities allocate these tax credits to property developers, which in turn create qualifying low income housing units.  Typically, the property developer sells these tax credits to individual and / or corporate investors.  The funds raised from these investors help to finance construction of the project.  The project typically claims the tax credits over a ten year period.  

On an annual basis, investors in a LIHTC project will receive a federal form K-1 – “Partners Share of Income, Deductions, Credits, etc.” This form will provide the corporate investor with its share of the LIHTC’s available to it during the tax year. In addition to the LIHTC that is available to the investor, the project will also likely generate a tax loss.  Rental properties often generate tax losses due to depreciation, which is a non-cash expense.  The following outlines these two tax benefits:  

a.          Low Income Housing Tax Credit:  The IRS considers investments in low income housing partnerships to be a rental activity and subject to the passive loss rules.  However, widely held corporations are not subject to the passive loss rules.  As such, these types of corporations are ideally suited to invest in low income developments and it is estimated that up to 85% of all LIHTC investors are widely held C corporations.  The LIHTC will typically reduce the overall tax burden of the corporation over a ten year period.

Low income housing tax credits are nonrefundable to the corporate investor, but can be carried forward to future years.

b.         Low Income Housing tax losses: As noted above, the typical low income housing investment will also generate tax losses on an annual basis.  Again, these losses should be deductible for the corporate taxpayer.  Any unused losses would be eligible to carryforward to future tax returns.  

Tax Credits vs Tax Deductions: It is worth noting that the primary benefit of these investments is the tax credits that are generated.  Tax credits are much more valuable for taxpayers than tax deductions are.  Tax credits provide a dollar-for-dollar reduction in a taxpayers’ federal income tax, whereas a tax deduction only reduces the entities taxable income.  A tax credit of $100 will reduce ones’ tax liability by $100.  Conversely, a tax deduction will reduce ones’ taxable income by $100.  For a corporation in the 15% tax bracket, a $100 tax deduction will only net a tax savings of $15. (Consequently, in this situation the tax credit is more valuable by $85.)

Tax planning: LIHTC’s are designed to reduce the taxpayers federal tax liability generally over a period of ten years.  This is the primary investment return for investors in LIHTC projects.  Thus, the investor should be able to reasonably project their taxable income over the period which the credits will be earned.  If the investor does not anticipate having taxable income or a tax liability in the next ten years, investing in LIHTC’s will be of little use to that taxpayer.  Conversely, if the investor anticipates $500,000 of taxable income each year for the next ten years, an investment in LIHTC’s might be very beneficial to that investor.    

The preceding article was written by Jamie Downey of Downey & Company, LLP, a CPA and accounting firm located near Boston, Massachusetts, please contact Jamie Downey at jmdowney@downeycocpa.com or 800-849-6022.  

Disclaimer:

The information in this website is not offered as legal or tax advice. Examples of tax benefits are based on stated IRS Guidelines and on other assumptions which may not apply to your personal situation.  

We suggest that you seek the advice of your tax advisor, attorney, and or financial planner to determine if investing in Low Income Housing Tax Credits is a good choice for your personal circumstances.   

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Financial crisis of 2008 and the failure to address LIHTC investor base

In the early years of the LIHTC program, prior to 1992, a vast majority of the equity capital came from individual investors, whose investments were pooled in funds raised and managed by intermediaries (syndicators), which in turn made investments in affordable apartment communities. By 2003, institutional investors had come to be the source for virtually all of the equity capital required to finance housing tax credit developments. Data from a 2009 Ernst & Young study suggests that while investors came from a diversified base of industries in the early 1990’s, the core of corporate investment has increasingly been concentrated in the financial services sector.  

As the entire banking sector saw a massive decline in income, there was little tax liability, and therefore demand, for tax credits to offset.  As a result, the price paid for newly secured LIHTCs declined significantly and developers were left with less capital to develop projects.  The government introduced new temporary measures that placed a floor on LIHTC prices, and for a short period the development of affordable housing continued during the downturn.

Now that investors have returned to the market and prices for tax credits remain robust, Congress has not taken any action to remedy the risk of investor concentration in the LIHTC market.  There are proposals to change parts of the tax code, but like most proposals in Washington there has been little movement or push for change.

The Community Reinvestment Act and its influence on LIHTC demand

Bank investors have continued to focus their equity in areas for which they will receive positive consideration under the CRA Investment Test.  As a result, those areas with limited national bank presence are attracting significantly lower demand, resulting in a marked differential in tax credit pricing in these areas.  A recent study by Cohn Reznick suggests that price differences can be as much as 40% less.  The lower price per dollar of housing credits, especially those obtained for deals in “CRA-lite” markets, has resulted in financing gaps.  As these funding gaps prevent certain projects in these markets from coming to fruition, many projects are never submitted for credit application.  Affordable housing developers should address all markets where there is need, not where the banks most benefit.  

Conclusion

The technology exists today to aggregate multiple individual investors without burdensome administrative costs.  In addition, new laws including the 2012 JOBS Act and tax law changes favoring LIHTC investing have laid the groundwork for the re-introduction of individual investors to the LIHTC market.  Individuals who are seeking social minded investments will provide an important supplement to current investor base, and provide a committed presence to underserved communities, primarily those located outside of Community Reinvestment Act (CRA) markets.

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Shark Tank Takes On Real Estate Crowdfunding

A few weeks ago a lot of discussion circulated among those of us in the real estate crowdfunding community bemoaning the poor representation of our industry on a recent episode of Shark Tank.  A colleague from 1871 in Chicago took to their blog to dispute some of the criticisms leveled by the Sharks.  Rather than rehash those arguments, I will acknowledge that a few of their criticisms of real estate crowdfunding have some validity.  However, many of the Sharks arguments either don’t apply in the world of LIHTCs.  For example, Kevin O'Leary stated that an individual can always buy a REIT instead of direct real estate.  However it isn’t possible for an individual to buy into a LIHTC fund. 

LIHTC investors have always understood their passive role in the real estate partnership.  For that reason, partnership agreements have evolved in the 20+ years of the program to afford them certain protections.  Real estate crowdfunding is simply the digital age equivalent of what syndicators, particularly LIHTC syndicators, have been doing for years.

It Starts With Structure

Although technically equity, tax credit investments have more similarities to real estate debt in that 1) the investor is purchasing a fixed stream of benefits/payments, and 2) terms are structured for downside protection rather than upside benefits. This is key—although LIHTC investments can still provide strong returns, the investor should be concerned more with protecting their benefits rather than achieving higher returns.  Think of them as bonds rather than growth stocks.

There are many unique aspects of LIHTC transactions that provide investor protections that typically commercial real estate deals do not have.  Some of the more significant aspects of LIHTC investing include:

State Housing Authority as a Gatekeeper—Prior to the sale of the LIHTCs, a developer must receive an award from the State Housing Authority.  Many states have different application and screening processes, called Qualified Allocation Plan or QAPs.  The State Housing Authority’s priority is to ensure that approved projects meet the particular state’s affordable housing goals and objectives, but they also review the experience and feasibility of the proposed development.  Think of the credit awards as a first line of defense in the underwriting process.  Given the demand for LIHTCs in the developer community, only the most experienced sponsors typically get these awards.  

Timing of Equity Payments—Unlike market rate real estate developments, LIHTC projects receive equity payments in staged fundings as the developer achieves certain benchmarks in the process.  Since 90% of the risk lies in the construction and lease-up of a project, withholding equity is a key motivator to make sure the developer follows through on the business plan.

Tax Credit Adjusters—Tax credit adjusters allow the investor to reduce their capital contributions if they do not receive the anticipated tax credits.  This could occur if the developer failed to rent the units quickly enough—this is typically called the timing adjuster.  This provision is a powerful tool that incentivizes the developer to meet the compliance standards in a timely manner.

Guarantees—Similar to construction loans, developers are typically on the hook for completion guarantees.  But unlike market rate equity investments, developers are typically required to provide operating deficit and reserve guarantees.  One key issue the real estate crowdfunding industry has yet to address is how it will handle capital calls in their partnership agreements.  In LIHTC partnerships, capital calls are available but not typically necessary so long as the developer is well capitalized.

Finally, the default rates of LIHTC transactions are less than 1%, lower than all other commercial property types. This is attributed to the high demand for affordable housing units and the overlapping underwriting done by the State Housing Authorities, banks and equity investors.  Robert Herjavec is right (but not for the reasons he thinks), this is not an investment for Grandma.  Grandma needs another 10 years of income tax liabilities to fully benefit. Otherwise, it is among the most predictable investments out there.

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LIHTC Return Comparisons

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How Crowdfunding Can Return Individual Investors To The LIHTC Market

The Wall Street Journal reported last November that dozens of real-estate crowdfunding sites have popped up in the past year after the passage of the 2012 Jumpstart Our Business Startups (JOBS) Act, including FundRise and Realty Mogul. Already, these companies have raised more than $135 million in debt and equity for real-estate deals, according to The Journal's calculations. While that is tiny compared with the more than $700 billion market value of publicly traded real-estate investment trusts, it is the fastest-growing category in the crowdfunding arena, according to Crowdnetic, a firm that tracks crowdfunding data.  Real estate crowdfunding provides individual investors access to investments that were once the exclusive option to high net worth individuals and institutions. 

Affordable housing investment, on the other hand, was not always dominated by large institutions. In fact, individual taxpayers played a prominent role in financing affordable housing development during the early 1980s. That role changed with the passage of the Tax Reform Act of 1986, which created new passive loss, passive credit and at-risk rules.

Despite these limitations, individuals can still benefit from tax credits albeit in smaller amounts. The Omnibus Budget Reconciliation Act of 1989 eliminated the income and active participation restrictions specifically for LIHTC transactions and permitted individual LIHTC investors of any income and participation level to offset up to $25,000 of their income with low income housing tax credits.  Assuming the individual is not in the real estate profession and therefore able to benefit from tax losses due to depreciation, the tax credit benefits are effectively limited to $9,900 per year (assuming they are in the highest 39.6% tax bracket) down to $7,000 per year (assuming they are in the 28% tax bracket).  Since the credits are good for ten years, this results in a maximum investment size between $70,000 to $99,000.

Aside from the tax limitations, the challenges of funding with a project with $3,000,000 or more in equity needs with individual investors is a matter of scale. With limits on maximum buy-ins, there are a greater number of investors, creating a larger overhead when it comes to accounting. Crowdfunding platforms, however have developed technology to make the process more efficient without creating unnecessary burden on the project's cash flow.

To date, the only way an individual can invest in LIHTC is through an investment in a tax credit fund.  Issuing a tax credit fund is a complex and expensive process. By law, syndicators must offer prospectuses to potential tax credit purchasers, fully disclosing the terms and risks of the investment. Sales of tax credits to multiple investors in the general public are referred to as public placements and have the highest disclosure requirements. Private placements are sales to a few knowledgeable investors. They have lower disclosure requirements and sales costs.  As a result, it is always preferable to raise funds from fewer institutional investors. 

Under current securities regulations, “general solicitation” without filing an offering with the SEC is against the law.  The 2012 JOBS Act legislation effectively eliminates the ban on general solicitation for certain transactions, which will allow entrepreneurs to raise capital from wherever demand exists.  These new rules, combined with the capabilities of information technologies, will shrink financial supply chains from months to days.

Conclusion

The technology exists today to aggregate multiple individual investors without burdensome administrative costs.  In addition, new laws including the 2012 JOBS Act and tax law changes favoring LIHTC investing have laid the groundwork for the re-introduction of individual investors to the LIHTC market.  Individuals who are seeking social minded investments will provide an important supplement to current investor base, and provide a committed presence to underserved communities, primarily those located outside of Community Reinvestment Act (CRA) markets.

If you wish to join us as we are building out a pipeline of transactions, be sure to sign up on our web site to gain access to new LIHTC opportunities.