Episode #5: LIHTC Landscape: Market Shifts and Current Realities
Monarch Perspectives
Click here to listen and learn. Follow along with the transcript below.
Steve LeClere:
Welcome to Monarch Perspectives. I’m Steve LeClere, partner at Monarch Private Capital, focused on affordable housing.
Rick Chukas:
And I’m Rick Chukas, also a partner at Monarch leading our historic division. In this podcast series, we’ll talk with industry experts about important topics for tax equity investors, developers and owners. From affordable housing to renewable energy. We’ll explore trends and opportunities in federal and state tax credit programs. We hope to provide you with valuable insights to navigate the world of tax equity and impact investing.
Steve LeClere:
Hello and welcome to another edition of Monarch Perspectives. Today, Rick and I are thrilled to be joined by Josh Mandell with Gateway Companies — and future voice of the Alabama Crimson Tide. So Josh, welcome and please if you would introduce yourself. Gateway Companies is well known to Monarch and presumably much of our audience, but if you can give us a little rundown on who you guys are and what you do, we’d appreciate it.
Josh Mandell:
Absolutely, Steve, it’s great to be here. Appreciate you, Rick hosting me today. It’s a privilege to do this. I’ve always esteemed to have my own podcast one day, and so seeing what you guys have put together is really cool and it’s fun to do this with you. This is a great forum to go ahead and roll out that announcement about Alabama. Coach Saban has been very supportive of that and Coach Deboer has become a really fast friend, so thank you for that. We’re excited about ’24. And then about Gateway. So Gateway, Gateway Development, the Gateway Companies have been around for about 40 years now. In the world of affordable housing development, that is a lot of history. Our company is based in Alabama. We have a southeastern footprint. A company was founded by a gentleman named Alan Rapoon. Alan started that company shortly after the affordable housing tax credit, the low-income housing tax credit program, was enacted with the 1986 Reagan tax bill, Reagan Tax Act, and Alan just steadily built that company from the early nineties to today. And in that time we grew from a company that did a lot of smaller projects and smaller towns, which we still do today to larger projects, larger affordable projects, conventional multifamily projects throughout the southeast and small towns, medium and larger metros. Besides construction and architecture, we’re a fully integrated multifamily company.
Steve LeClere:
Great, thank you Josh. That fully integrated multifamily development company, and the longevity of the company, is one of the reasons we wanted to bring you on to talk about both the LIHTC program and multifamily development, generally.
2023 was a interesting year, if not just to come out and call it a challenging year for many of our clients, both on the historic redevelopment and certainly on the multifamily development side. So wanted to bring you on really to talk about not just what’s difficult about putting deals together right now, but where you’re seeing challenges on existing developments and stabilized assets within your portfolio. So with that, we’ll dive right in and when we focus on just new developments, projects that maybe you’ve put an application into a state agency on or maybe you’ve tied up a piece of land, what issues have come up in the last 6-12 months that have changed how Gateway is approaching a new development or a particular challenge in putting a development together? Obviously we were all drunk on cheap, cheap money and high tax credit pricing for many years and that may not be the reality anymore, and we’re having to adjust to this new normal. So how is Gateway approaching that?
Josh Mandell:
That is the root of this massive disruption, this massive change that we’ve experienced in our industry. And I’d say over the past 15 months or so, and so I would say in our team on our development and finance side, we have a really good team. We work very closely on all aspects from the time we identify a market and decide to pursue sites in a given market, or part of a market, to the time that we finance it, develop it, and deliver and stabilize it. What we noticed – going back to probably the fourth quarter of ’22 was until that time — we’re very proud of our history and reputation — but there are many larger companies that do what we do, especially in the conventional space. Yet we were still constantly pursued by lenders and investors to put capital to work for them, and we could not create the deal flow fast enough to satisfy those… and then, to support those assets.
And from — call it middle of 2020 until ’22 — we had put together a real game plan to bolster expansion with larger tax credit projects and conventional projects. We had a very good pipeline of projects delivering and of sites ready for financing. And then, in the fourth quarter of ’22, it’s like someone flipped a switch. All of the rate hikes that had been enacted in a four or five month period that virtually doubled interest rates, just turned everything off. It was not like a dimmer switch, it was like a light switch. And thankfully we were in a good position to react just because of timing and where we were with the development cycles of our projects. But a lot of us were ready for a gradual raise and interest rates, a moderate raise, but that really caught us off guard. We could react to construction inflation, labor inflation, other operating expense increases, but that was very difficult.
Steve LeClere:
Was that issue more pronounced in the affordable world or in the market rate world? I know a lot of the market rate equity dried up pretty quickly. As you said, it wasn’t on a dimmer switch, but given the length of time between when you identify an affordable site and when maybe you have that bond allocation or 9% award, did the market shift in interest rates have a more pronounced impact in market rate or in the affordable space for Gateway?
Josh Mandell:
Well, it certainly had a pronounced effect on both sides. On the market rate, it was drastic. As I mentioned, we had a nice pipeline of projects that had been financed, were under construction, and we felt very good about those. As projects are delivering now, and we like how those projects are unfolding. We immediately just dropped any future development sites because basically our equity was telling us, if you can’t hit these kinds of returns for us to adjust to new return profiles, it doesn’t work. And so we said, well, we need to recognize where our opportunity costs are and focus on affordable. And so what happened there is there was still a very meaningful impact in debt availability. We had to react to investors having a much higher return threshold offering less in proceeds for tax credits. And then we simply found that particularly with a lot of middle-sized growing metros that worked well when rates were not as elevated as they are. A lot of really attractive middle-sized metros just were not feasible for affordable development. A lot of states simply had to pull a lot of their development programs, affordable housing development programs.
Rick Chukas:
And Josh, to Steve’s earlier point, we saw the same thing on the historic side. I might front end your Q4 story. We kind of struggled in the last half at ’23 given where the Fed was headed with rates. So good quality projects couldn’t find financing and I mean you lived it firsthand. So, what are you dealing with now relative to any projects that are under construction or construction’s complete and you’re in lease up, so you got ’em financed, you got ’em put together, you’re either under construction or you’re trying to get projects leased up. What are the challenges there for you?
Josh Mandell:
I would say the first would be making sure that our construction scheduling is on time. Prior to this massive, quick spike in rates when your construction debt is in the 3% range and you’re running 2, 3, 4 months behind – or more – on construction scheduling because of lack of labor or materials or whatever, a lot of proformas could support that – a lot of deals could support that. That margin for error is not there today. It makes the attention on construction scheduling that much more acute. We feel good about the way our team and our construction partners have handled that. What we’re doing is continuing to watch our projects to make sure they maintain schedule. We are feeling the impacts of labor as we onboard our associates and then insurance is certainly a massive change that we’re all absorbing to.
Steve LeClere:
So to that point, Josh, and you and I attend enough affordable conferences, that insurance seems to come up in nearly every panel at those conferences these days. Is that impacting during construction lease up in the form of challenges to converting to the expected permanent financing because now all of a sudden you’re operating expense budget that was maybe carrying 500 bucks a unit for insurance now needs to carry a thousand bucks a unit for insurance, or are you seeing that as more of a pronounced impact on deals maybe you developed 8, 10, 12 years ago that had been operating one way for a long time kind of clipping along and now all of a sudden have had this kind of exogenous shock in the insurance market to how they had operated for the previous five, 10 years?
Josh Mandell:
We’re certainly seeing it on hits to our existing portfolio and how we operate those, but the timing as underwriters want to make sure they reserve for any additional costs with insurance, and taxes for that matter as well, property taxes.
Steve LeClere:
What else are you seeing impact the legacy portfolio? We’ve talked a little bit on the challenges of new developments, both in getting them financed and in getting them built on time to avoid exacerbating the ramifications of the interest rate increases in labor and material cost. What else are you seeing with this shift in the market that is impacting the legacy portfolio? Is it on opportunities for refinancing, or disposition, or is it more on the day-to-day operations?
Josh Mandell:
It’s day-to-day and it’s on the ability to refi or stabilize financing convert. As you guys probably see it is very market dependent, state dependent, even sub-market dependent, and so we all read a lot of industry news reports and data, LinkedIn, RealPage, Yardi, just key industry data providers. You see a lot about oversupply concessions, rental rates backing up – and we see some of that – but it’s not across the board at all. We are in a lot of markets right now that still have waiting lists, particularly on the affordable side. I think we’re really trying to understand where the market’s settling out, but we’re not seeing as grave of pullback in rental rates as some are reporting.
Rick Chukas:
All right. We’re not going to ask you, Josh about your prediction for the ’24 presidential election, but I do want to ask you trends in pricing, construction costs, labor, interest rates… where do you see things going for the duration of ’24?
Josh Mandell:
For us, we don’t see construction labor trailing off. We don’t see construction pricing, overall, moving much. And every time we’ve thought that we were at a top, certain cost components will drop like lumber and then others increase, say appliances. So, we kind of expect that construction pricing will be what it is, be fairly flat between now and then. Interest rates, gosh, I don’t know, maybe, I don’t know, 25 or 50 basis points up or down. I’m probably the last person that needs to answer that question for you. And, our concern is we felt like there was maybe a little bit of confirmation bias, a little bit of expectation that we’d see sharp drops in rates over the course of this year. And to us, that’s not necessarily a good sign because if we’re seeing steep drops in rates, then that may be a reaction to something that’s not good on a macro level. I’ll leave the presidential prognostication. I’ll flip that back on you guys.
Steve LeClere:
Yeah, I’ll leave that to others. We will ask you at the end how many wins the Tide will have in ’24. But, we’ve talked a bit about the problems that Gateway and the rest of the market has faced both in conventional multifamily assets and in affordable projects, I think maybe we can shift here and talk a little bit about the solutions and opportunities that we’re seeing in this market. I know there are a number of legislative efforts and policy initiatives, both at the local level and the federal level. One of which we sit here on January 24th… we know that a couple of key components of what had been called the Affordable Housing Credit Improvement Act have made it through the House Ways and Means Committee. So, that’s the restoration of the 12.5% annual 9% allocations that we lost a few years ago and a modification to the 50% test. So, would be curious for your thoughts on those two components in particular and if or how you’d expect that to impact the market. And then what else Gateway is watching at the federal level, or any policy initiatives, that Gateway is particularly interested in.
Josh Mandell:
Absolutely. Some of what I’ll say, Steve, Rick, you guys already know and you guys, I feel like stay very close to the pulse of what’s happening in Washington and the state houses where affordable housing issues are really vibrant conversations. We follow those issues through our trade associations and our friends like you guys. We feel like we are more connected to what goes on at the local level, at the county and city levels and the various markets we operate. To your point, while we’ve talked about a lot of challenges and headwinds that we faced in our industry over the last 15 months, this is one of the encouraging things in our industry. This is something that adds to the gratification of what we do as affordable housing developers. And make no mistake, we’re capitalists, we’re for-profit business people, but we get a ton of gratification out of seeing an affordable housing community come to life and to see the reactions of our residents and the work of our associates on the ground.
I’ve been in this industry for about 20 years – there are a lot of folks who’ve been around affordable housing for a lot longer than that – but a lot has happened in 20 years. That’s a long period of time in the industry that’s been around for 40 years. Earlier in my career, when you approached local officials, county commissioners, mayors, city councilmen, people like that, and you started talking about an affordable housing community that you wanted to propose, generally you were immediately met with skepticism or cynicism and that was not a very attractive idea. It was “how quickly can I get you out of my office?”
We’ve seen that mentality change over the last, particularly, 10 years. And, if you get two minutes to tell someone who’s a cynic about your industry, you may not get to the end of two minutes, but if you can get to the end of five minutes, it’s such a compelling idea, and it’s such a universally-needed element in our society and in our commerce.
And look, we’re in the south, so that’s important context, but whether we’re in a red, blue or purple kind of area, when you start talking about this being one of the most bipartisan programs and one of the most bipartisan initiatives in the country, the fact that this is a product of the Reagan Tax Act, which was a very bipartisan act almost 40 years ago, the way this follows workforce development, and the way this creates workforce housing where it doesn’t otherwise exist and the private market can’t deliver it, it’s a very fun, easy pitch to make. Again, if you can get past the first two minutes.
Rick Chukas:
Yeah, I think what you’re saying, Josh, the programs worked and served a variety of different constituencies. Being a historic rehab guy, none of our stuff on the historic side is ground up. It’s obviously rehab of an existing facility. So I’m curious, I’ve often wondered, when you’re looking at a piece of land, what are the factors that go into your decision to develop something as affordable workforce housing related or market rate? Are there particular drivers there?
Josh Mandell:
That’s a great question. It’s hard for one person to make that decision. And if you have four or five or six weighing in, which is how we’re structured, we’re able to, 99% of the time, reach a consensus because you do have to make a lot of judgment calls on unit count density. Should this be a larger bond, higher leverage type community or not, with financing being really tight with conventional projects right now, we’re leaning more towards 4% and 9% tax credit projects. And with debt cost being what they are, we’re leaning even more towards 9%. So, our goal has been to focus primarily on 9% over the last 15 months as we’ve reacted to this new normal, keep our leverage down. We want to keep a lot of dry powder right now. While there are challenges we see when very few people are finding ways to do deals, we see that as an opportunity and we’ve just got to figure out how to source more capital and more leads, and we feel like we’re able to do that. If you look hard enough, there’s a lot of capital out there, but we have to be resourceful.
Steve LeClere:
Josh, I think I’ll give you the last word here and let you touch on anything else you’d like to discuss. I won’t speak for Rick, but I can’t say when we scheduled this talk about the state of the LIHTC market, that I expected to hear such a hopeful reaction out of somebody. So, it is great to hear that in the face of the challenges and the headwinds, that groups like yours are saying, we still see opportunity in this market and these programs are too important to abandon and to shift the way that we do business. So I don’t know if there’s anything else you want to leave folks with, in terms of what you’re looking at for the next 15 months, what would have to change to maybe get Gateway to tiptoe back into conventional market rate projects or to shift back more towards 4% or really anything else you’d want to leave us with other than maybe it’s not as dark and dreary as we thought it was out there.
Josh Mandell:
We’ve got to focus on how we move forward and we’ve got to focus on where there’s opportunity, Steve. So, where we continue to find well located sites that have strong job growth, diverse, strong job growth, solid school systems, that’s just good fundamental real estate and we cannot control what state programs do. We can just simply try to be as tied into where they’re going and being in a position to move. And, one of the things that we are noticing and we’re hearing from various larger investment groups, they’re not able to put a lot of capital to work right now. They haven’t been. They keep waiting for opportunities that don’t exist. And so we’re seeing some of that capital loosen up because it’s got to get put to work. And then from a labor standpoint, as construction projects roll off and new construction projects are not replacing those at the same level that we saw over the last say five years, we’ve just got to figure out where to source those opportunities. We think that capital will have to loosen up. It has to over the course of this year. We just have to understand what the desires of that capital are.
Steve LeClere:
That’s great. Rick, anything else from you before I book a flight to Birmingham to make sure Josh doesn’t start a podcast and put us out of a job?
Rick Chukas:
I think that’s probably a fait accompli, Steve.
Josh Mandell:
Think your job security is just great after this.
Rick Chukas:
Appreciate you joining us today and interested in hearing your insights. So thank you.
Josh Mandell:
Hey guys, thanks for having me on. This been a treat. I know you could ask plenty of other folks to join you if you want to make the next one about politics or is it Penn State or Iowa? Iowa State’s going to land next year? Is it going to be the A CC that they end up in or the PAC 12? You tell me.
Steve LeClere:
I think that’s about as likely as Penn State ended up in the A FC East. So we will see what happens here. Okay. But thank you very much for coming on Josh, and we look forward to having you on again to see how well your predictions turn out.
Josh Mandell:
Alright, thanks a lot guys.
Steve LeClere:
Thanks for joining us on this episode of Monarch Perspectives. We hope you will follow and subscribe so you never miss an episode.
Rick Chukas:
Be sure to rate and review us wherever you get your podcast. To learn more about Monarch Private Capital, please visit monarch private.com.