Buy or Sell?

7 min read

Asset Managers On Current Portfolio Trends

Odd as it sounds given the events, the U.S. property market had a banner year in 2020, and its upward streak continues. The Case-Shiller National Home Price Index, which measures single-family home prices, is up 12 percent since February 2020. The average housing price for a single-family home at the end of 2020 was $340,000, a 13.4 percent increase from that time last year. predicts that 2021 will see a nationwide price increase of 5.7 percent. This presents rental property owners with an age-old investment question: hold or sell? That is, should they hold out for their properties to reach even higher prices, while continuing to collect rental income, or cash in on a hot market by selling their units as condos right now?

For multifamily Low Income Housing Tax Credit-financed properties, the question is a little more complex due to the IRS’ built-in protocols. Owners of LIHTC property have a 15-year compliance period where they are required to rent units at below-market rates, or else credits can be recaptured. In the following 15 years, owners can, depending on the laws in their state, either continue to rent the units at below-market rates (but with less enforcement) or sell them to a qualified applicant. After 30 years, the buildings can be converted to market rate. Historically, according to HUD research, most LIHTC properties stay under the same ownership after this 30-year period, and continue to be affordable even without price caps, likely due to where they’re located and the downward filtering that occurs with older units.

But in this hot market, have the economics skewed less towards holding LIHTC properties (whether after 15 or 30 years) and more towards selling them? To answer this, it’s worth looking at trends in the broader market, and how they relate to LIHTC properties specifically.

The Case for Holding
Housing price growth has been consistent for the last several decades, with the Case-Shiller metric nearly quadrupling since 1987. This means the final sticker price of any given unit will likely continue increasing in the foreseeable future, usually well above inflation rates. Price increases are caused by low inventory and a general lack of equilibrium in the market; in April, Freddie Mac pegged the nationwide home shortage at 3.8 million single-family homes (and likely several million more multifamily units). The shortage is especially pronounced in certain areas, with some analysts estimating California’s home shortage alone at 3.4 million.

Given those realities, the case for holding multifamily LIHTC properties is generally strong, says Nancy Morton, a public accountant for Dauby, O’Connor & Zaleski, who has worked on LIHTC transactions. She notes that affordable projects have high occupancy rates. Spencer Hurst, a Seattle-based broker and vice chairman for CBRE Affordable Housing, echoed this sentiment.

“You cannot create suburban affordable housing fast enough to keep up with the demand,” Hurst observes. Thus, whether in an environment of high home costs or in a downturn, LIHTC property owners are pretty close to having a guaranteed consistent cash flow via rental income.

Bolstering the “hold” argument are the subsidies made available by various levels of government to low-income renters. Morton says that while perfect compliance is impossible, the majority of managers have had success by being “very diligent about keeping track of their tenants and encouraging them to pay their rent.”

Anti-eviction rules spurred by the pandemic—the federal ban has been extended until the end of June—also helps ensure high occupancy rates.

The situation is somewhat parallel to the post-recession period early last decade. During this time, LIHTC sales fared well, according to John Fioramanti, with the tax credit group of Marcus and Millchamp, because the cap rate on LIHTC properties was higher than for market-rate housing. Morton sees a similar trend now, believing that the hold vs. sell question may have a different answer than in the case of market-rate housing.

“There have been risks holding LIHTC deals. However, there’s been a lot of really positive mitigations in the past year, including rental assistance, including the fact that physical occupancy has continued to be high, the management companies have been very on top of helping their tenants get as much rental assistance as they can,” she says.

The Case for Selling
That said, the robust market caused by home shortages and building supply backlogs could make a strong “sell” case.

Among those arguments for selling, the first is the threat of inflation. In April, the inflation rate soared to 4.2 percent, the highest since the buildup to the Great Recession. This will likely cause the Federal Reserve to raise interest rates, which will increase mortgage rates, which will make borrowing more expensive and less frequent, which could cool demand for housing and lower prices. (Of course, an alternative line of thought says that inflation causes home prices to rise, and is thus a good hedge against it).

The second case for selling now is the potential doubling of the capital gains tax rate for high earners under President Biden’s proposed tax reform. This would increase the burden on sellers, she says, and bonus depreciation may be cut in half. Morton also notes that the 1031 exchange, wherein owners swap one property for another, has historically been a method of delaying capital gains obligations, and could be eliminated. Prior to Biden’s tax hike proposal during the 2020 campaign, the Tax Cuts and Jobs Act of 2017 placed limitations on what qualifies for this exemption.

A third reason to sell now, says Hurst, is that prospective LIHTC property buyers recognize the availability of financing and will make offers accordingly. Speaking to a hypothetical seller, “70 to 75 percent of the capital stack of the purchasing entity for your 100-unit building is gonna be debt financing, most typically from Fannie and Freddie.”

Morton agrees that selling can be favorable in individual circumstances, mainly two cases: distressed rural markets where the building stock suffers from high vacancy rates, and for investors who plan on retiring soon, and won’t want to incur potential setbacks from a capital gains tax hike. Another option, Morton counsels, is refurbishing to sell.

“It’s not uncommon that [LIHTC property owners] resyndicate these projects at some point in time.” A nine percent credit is available for retrofitting, while some states will be more inclined to issue bonds.

Investor Terrence Doyle, who is active in the Denver market, recommends owners interested in refurbishment find an independent backer rather than taking a loan from a financial institution, in order to engage in multiple refurbishments, whereas working with a bank entails bringing “between $250,000 to $300,000 to the closing table, because we would be responsible for the down payment of 20 to 25 percent.”

Doyle continues, “Ultimately, we sell these smaller multifamily properties to investors who are looking to park their money somewhere in a turnkey property.”

Bottom Line
The question of whether to hold or sell is complicated – one of the long-time quandaries in housing finance, or any other type of investing. “It’s hard to know what the future holds,” stresses Morton.

But my view of the overall housing market is that property owners, whether single-family or multifamily, LIHTC-financed or not, should hold off on selling. This is particularly true for long-term owners.

As housing analyst Logan Mohtashami told Bloomberg in late April, “We just do not have a lot of homes, and that’s the main issue.”

I agree: supply constraints are the main issue, and the main argument against selling. Particularly in inelastic markets, homeownership is low because supply is constrained, and this makes homes there more expensive. The average annual home value increase for the last ten years is 6.9 percent in San Francisco and 4.7 percent in Washington, DC – not including the high rents that can be collected over that time. But even in elastic markets, the rate of return can be high, standing at 5.9 percent the last ten years in Houston and eight percent in Atlanta. As long as this mix of unit price appreciation and rental cash flow is a staple of owning and managing properties, there is little reason to sell them.

This article featured additional reporting from Market Urbanism Report content staffer Ethan Finlan.

Story Contacts:
Nancy Morton, Partner, Dauby, O’Connor, & Zaleski

Spencer Hurst, Vice Chairman, CBRE Affordable Housing