Description

America First Multifamily Investors L.P. (ATAX) is a pure play on affordable housing (“AH”). AH is an attractive sub-asset class because of a structural supply/demand imbalance, non-economic behavior and government subsidies, and economic counter/non-cyclicality providing low-risk, stable cash flows.

TL/DR – Tax-exempt AH bonds are the lowest risk real estate asset class with sub 1% cumulative long term default rates, spreads greater than generic muni bonds (and corporate bonds), and attractive securitization opportunities to create long lived, 10%+ tax-exempt yield instruments. ATAX has an in-place portfolio to generate strong tax-exempt income and a pipeline to grow income over time.

ATAX was written up in 2014 as a short-term trade for some additional background.

AH Fundamentals

AH is chronically undersupplied, and demand is large and growing. This is a challenge for society in the U.S., but an opportunity for prudent lenders and investors.

• ·         CBRE estimates a 2:1 demand to supply imbalance due to limited new construction
• ·         No net regulated AH supply growth from 2008 through 2016
• ·         AH development typically only “pencils out” if subsidized by the Low Income Housing Tax Credit (“LIHTC”) program which is capped on a state by state basis
• ·         AH properties average 97% occupancy vs. 93% for market rate apartments
• ·         39 million U.S. households live in housing they cannot afford
• ·         Rents are growing faster than incomes

For all of these reasons, AH properties stay full regardless of broader economic conditions. In fact, AH properties become more in demand during recessions.

• ·         Historical vacancy less than 4%
• ·         Average occupancy stabilized at 96% during the financial crisis in 2008-09

LIHTC Dynamics

The LIHTC program has a rich history and is reasonably complicated. At its core, it is a subsidy to developers to encourage building AH properties. To that end, it has been reasonably successful over time and has bi-partisan support.

The basic case is tax credit investors will provide equity capital to a development project in exchange for tax credits that amortize over a 10-year period (e.g. $5 million of tax equity will provide $500k of tax credits per year for 10 years) plus any depreciation from the project. The net economic IRR to tax credit equity is ~3-5% and there is a large, liquid market for tax credit equity. Primary participants are banks. In addition to nominal economic benefits, banks generated Community Reinvestment Act (“CRA”) credits. CRA credits are required to operate in certain geographies.

In total, tax credit equity can be 30-40% of the capital stack for a development. The tax credit equity amortizes to zero and the developer/GP ends up with 100% ownership in the property (residual) after the tax compliance period – this isn’t technically correct but is functionally true with a lot of nuance.

If tax credit equity is available, then the developer can go to a local/state housing authority and try and get a LIHTC bond allocation to fund the balance of development cost. Bond allocations can be competitive (capped at the state level) and properties that “score well” for social benefit tend to get allocations. The LIHTC bonds are typically tax-exempt since they are issued by a municipal authority.

The catch is that if the property does not perform (built on time, fully leased up, debt default) then the IRS comes knocking to recapture up to 10 years of tax benefits. Banks don’t like that and there are a lot of structural protections/belt and suspenders put in place to service the debt and fill the property.

• ·         Reserve accounts are set up to provide ~6 months of debt service assuming 0% occupancy. Functionally these can cover years of ~80% occupancy which would be a crushingly underperforming property
• ·         Personal guarantees from developers to build on time and on budget
• ·         Tax credit equity can provide more equity to prevent default

The main point is that the U.S. government is happy to give away tax credits if AH is built and used. If not, trouble. And the results are pretty clear. AH properties rarely default and go through foreclosure. Also note that foreclosure doesn’t necessarily result in loss given the ability to reposition the property and 1^st lien position at ~60% LTV. The cumulative foreclosure rate for AH from 2000-2016 was 0.71%.  

Pricing

Interestingly, with AAA like risk profile, the LIHTC muni bonds yield 3-5% currently. A huge pickup versus munis, government bonds, or corporates. One potential reason is the heterogenous nature of each bond – every property, city, county, and state have different affordability limits, covenants, and structure. Nuveen can’t come in and drop $100 billion for a fund and compress spreads. The market functions more like a private lending market. A second reason is that developers are fine paying a nominally higher spread to get the property built in order to access upfront “developer fees” and a back-end residual value. Since the tax-credit equity is incredibly low cost (compared to say 20-30% cost of capital for market rate), there are “extra economics” to go around.

Securitization

Steady cash flows with wide spreads and near zero default rates are ripe for securitization. And Freddie Mac has a shelf dedicated to LIHTC bonds. Given Freddie’s mandate to support AH, it seems likely that this shelf will stay open. Indeed the largest AH securitization of all time happened in 2008 in the middle of the financial crisis. Freddie takes a fee of 50-100 bps to guarantee the collateral and the A-piece buyers are happy to take 2-3% for AAA rated tax-exempt paper. So, all in cost on the debt is 2.5-4%. The A-pieces are 80-90% of the capital stack providing 4-9x leverage to the residual B-piece. You can do the quick math, but net/net/net the B-pieces end up yielding ~10% tax-exempt.

Origination

So how do you get these bonds/b-pieces? There is no liquid market. Ask your bond manager to go buy some for you. Citi is the biggest player and keeps all bonds and b-pieces on balance sheet (which tells you how attractive this paper is).

America First Multifamily Investors L.P. (ATAX) has been active in the space for a long time and has an in-place portfolio of B-pieces and an ongoing origination platform. ATAX recently “re-levered” via issuance of notes to Mizuho. ATAX pulled out ~10% of the then market cap in cash with line of sight to pull out quite a bit more while lowering cost of capital.

Other Assets

ATAX does have some hair. ATAX owns student housing in San Diego that is underperforming. The property is unlevered but is delivering no cash flow. This property should be sold once San Diego State reopens and the property fills up. ATAX also owns student housing in Lincoln, but that property is operating fine. Long term strategic value is probably not there, but no real issues with that asset.

AH Development

ATAX has an interesting relationship with an AH developer and has set up the “Vantage” JV’s to provide equity capital for development. The capital is drawn done during construction, in place through stabilization, and then sold once the properties are stabilized. Returns on this program have been outstanding over time. ATAX recently sold a property in Memphis. The financial statements show each Vantage entity, development status and you can more or less back into when the properties are likely to be sold in the future as well as how they’ve done on those investments in the past.

Dividend Cut and Increase

Partly due to COVID and partly due to a “gap” in Vantage sales, ATAX cut the dividend in mid-2020. The stock price was already reeling at that point, hitting the lowest price in since the early 1990’s. The dividend was cut to a level that could be fully covered by the bond/b-piece portfolio. With improved line of sight on the Vantage program and better handle on COVID (the AH properties stayed full throughout), ATAX increased the dividend in March 2021. There is still room for another increase (especially after the Mizuho deal) and/or special distributions on the sale of more Vantage equity and/or student housing recovery.

Valuation and Yield

ATAX yields 5.6%, mostly tax-exempt. Use your own tax rate to get the tax-equivalent yield backed by rock solid AH assets. P/B is 1.1x seems reasonable. I believe if you took the b-pieces to market you’d get a large premium to book value. Upside can come from the Vantage assets and any new programs initiated by new CEO, Ken Rogozinski, and Greystone the new GP with a large platform. The stock was pound-the-table cheap (like everything) in mid-2020. Now it offers attractive tax-advantaged income and potential for continued appreciation back to 2019 levels in the $7-8 range.

Disclosure

1.       I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise may hold an investment in the issuer's securities.

2.       Certain economic and market information may be published from other sources, may not be updated in a timely manner and are believed to be reliable. We do not assume responsibility for accuracy or completeness of information.

3.       Not a recommendation for any security and should not be construed as investment advice, or as an offer to buy or sell securities.

4.       This information is for informational purposes only.

5.       Forward looking statements may not come to pass as described herein.

Catalyst

• Dividend increase and/or special distribution from AH equity sales