Nationwide, the U.S. has a shortage of 6.8 million rental homes that are both affordable and available to extremely low-income renters. With demand for affordable housing exceeding supply, it is not surprising that the time spent on waitlists can often be measured in years when new properties become available.
The federal Low-Income Housing Tax Credit (LIHTC) program aims to narrow this gap by creating and rehabilitating affordable housing across the U.S. Every year, the program finances the construction or restoration of approximately 100,000 units of affordable housing.
Since its inception, over 3.5 million units have been made available to 8 million economically vulnerable, low-income families, seniors, veterans and people with disabilities. Additionally, the program accounts for over 90% of all the affordable rental housing in the U.S. Despite these achievements, the housing shortage is still a large societal problem and the need for more units remains massive.
The government has leaned into this program in several ways. This week’s chart shows the growth in the allocation available to the 9% component of the LIHTC program. This offering is available to developers who finance projects without using tax-exempt bonds, and is allocated to states based on their population. The developers pass the tax credits to investors (mostly banks and insurance companies) that utilize the credits and tax losses generated from the properties to reduce their tax liabilities. In exchange, the investors provide the equity needed to develop affordable housing.
The chart shows the growth of this credit pool both in aggregate and on a per-capita basis. The omnibus spending bill passed by Congress in 2018 increased the amount of credits available. Additional allocations were included in the FY 2021 appropriations bill, and a further expansion of the program is part of the American Jobs Plan bill currently being debated in Congress. Additionally, the caps on Fannie Mae and Freddie Mac regarding low-income housing investments have been lifted. These companies can now invest up to $1.7 billion a year in LIHTC markets vs. the previous annual cap of $1 billion.
In addition to supporting the housing needs of the most vulnerable Americans, this program can also offer an attractive investment return for tax-credit investors. The fundamental supply-and-demand equation is favorable given the issues described above. Nationally focused LIHTC funds currently have a tax-equivalent yield between 5.75% and 6.5%, which is compelling when compared to many other yield-focused investments.
Investors often compare the yields on LIHTC to BBB-rated bonds. Depending on the opportunity, the yield pickup today is approximately 330-375 basis points. LIHTC has a cumulative foreclosure rate well below 1.0%, according to a 2019 CohnReznick study. Additionally, if the corporate tax increases being debated in Congress come to fruition, the value of tax benefits associated with LIHTC investments would increase, offsetting some of the impact on corporate bottom lines.
Key Takeaway
LIHTC addresses the lack of affordable housing for lower-income Americans, an important social issue. By investing in this asset class, investors can help alleviate the significant housing shortage and may simultaneously generate attractive yields on an absolute and relative basis. The market is dynamic as the supply of credits is likely to increase due to congressional action. The demand for credits from investors driven by both environmental, social and governance (ESG) and economic considerations appears poised to increase as well. By working with managers with long track records and strong developer relationships, investors can do well by doing good — representing a win for both communities and investors.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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