Returns Up to 10% on Low-Income Housing Lure Google, Kroger

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By Prashant Gopal
October 6, 2010

Google Inc., Kroger Co. and Waste Management Inc. are investing in low-income rental housing as companies are lured to a field long dominated by financial firms with returns that have doubled to almost 10 percent since 2006.

About $7.5 billion of investor equity will flow into U.S. residential projects for the elderly and working poor this year, according to Fred Copeman, who tracks the market at accounting firm Reznick Group in Bethesda, Maryland. That's up from $4.5 billion in 2009 and the first increase in three years, based on estimates by consultants Ernst & Young LLP.

The investments are attracting nonfinancial companies seeking to offset taxable income that is climbing as the economy recovers. The deals, which help make affordable housing more available, also provide an alternative to record-low yields on government and corporate bonds.

"The surprise isn't that Google invested," said David Smith, chairman of Recap Real Estate Advisors, a Boston-based firm that focuses on multifamily properties. "The surprise would be if anyone in the Fortune 100 with reliable earnings is not investing in this environment."

Investor returns, which vary based on terms of individual deals, are derived from federal credits and depreciation deductions that reduce tax bills. Investors make money primarily by paying less than a dollar for a dollar's worth of tax credits. The transactions are usually best suited to companies with consistent profits and a long-term outlook because the tax credits are meted out over 10 years and equity can be tied up for 15 years.

25% Discount

In a typical deal at current pricing, each $1 of credit might be sold for 75 cents, up from low-60-cent range a year earlier, Reznick's Copeman said. When applied to the investor's tax bill, that discounted credit and depreciation could generate an average annual after-tax yield of about 10 percent over the life of the investment.

The yield on the 10-year U.S. Treasury note is about 2.47 percent, down from 3.22 percent a year earlier. The yield on U.S. investment-grade debt is 3.64 percent, according to Bank of America Merrill Lynch index data.

Corporate investors are helping fill a gap left by mortgage companies Fannie Mae and Freddie Mac, which together accounted for about 35 percent of the market before the housing collapse wiped out their profits and forced them to pull out in 2008. Banks, which use investing in affordable housing to help meet their obligations under the federal Community Reinvestment Act, cut back after the financial crisis amid losses on mortgage securities and leveraged-buyout loans.

Low-income housing tax-credit investments peaked at $8.9 billion in 2006, according to Ernst & Young. Yields that year were about 4.25 percent.

Google Seeks Good

Google, whose motto is "Don't Be Evil," put $86 million into a tax-credit fund managed by a unit of U.S. Bancorp, which will direct equity to 480 affordable rental units in the West and Midwest, the Minneapolis-based bank said in an Aug. 30 statement. In a separate deal earlier this year, San Francisco- based UnionBanCal Corp. said it will manage and syndicate a $25 million investment from Google in projects in California.

Jane Penner, a spokeswoman for the Mountain View, California-based search-engine company, didn't return calls seeking comment. In the August statement, Google Treasurer Brent Callinicos said the investment "allows us to further our goal of providing relief to people who otherwise may not have access to quality housing."

$60 Million

Waste Management, North America's largest trash hauler, acquired a stake in a limited-liability company in April that invests in low-income properties, the company said in a filing with the U.S. Securities and Exchange Commission. Its $221 million infusion includes an upfront payment of $6 million.

The Houston-based company expects a net cash benefit of about $60 million over the next decade, said Jim Alderson, director of investor relations.

"We're able to offset our tax liability by making this investment," Alderson said. "It has the added benefit of supporting affordable housing."

Kroger Co., the largest U.S. grocery chain, invested about $40 million this year in a tax-credit fund, said Jack Casey, vice president at Meridian Investments Inc. in Potomac, Maryland, which has structured and helped sell $9 billion in affordable-housing transactions. Meridian tracks industry transactions. Meghan Glynn, a spokeswoman for Cincinnati-based Kroger, declined to comment.

Fannie, Freddie Depart

Fannie Mae and Freddie Mac, the largest U.S. mortgage- finance companies, had accumulated at least $8.4 billion in credits before halting investments in 2008 when the federal government took control of the government-sponsored enterprises.

"When Fannie and Freddie went out of the business, it cut the pool of investors nearly in half," said Brian Lawlor, commissioner of New York state's Division of Housing & Community Renewal. "It took a good year for syndicators to beat the bushes to find other investors."

Lenders such as Bank of America Corp. and JPMorgan Chase & Co., securities firms including Goldman Sachs Group Inc. and Morgan Stanley, and other financial institutions still account for about 75 percent of the market, Meridian's Casey said. Insurers make up an additional 20 percent.

The recovery in deal volume and entrance of new investors may provide states, which manage the allocation of credits, with funding for hard-to-finance rural projects, Reznick's Copeman said. Banks tend to focus on densely populated areas where their branches are concentrated and demand for affordable housing is high.

Market Distortions

Developments in rural areas and some inner cities can generate higher yields. That's because developers have to offer better discounts on tax credits to attract investors.

Renewed interest in low-income housing may distort the market, said Kirk McClure, an urban planning professor at the University of Kansas in Lawrence. Too much money is going to sparsely populated areas where affordable-housing rents are not much different than already low market rates. In some cases, new projects are competing for tenants with existing federally subsided projects, he said.

The arrival of new return-focused investors could send the syndicators who put together deals in search of even more unnecessary projects, according to McClure. The federal government should consider allowing states where housing is relatively cheap to use the subsidies for other purposes, he said.

Started in 1986

"For states, it's use it or lose it," McClure said. "Their attitude is that they don't want federal dollars to leave the state."

The low-income housing tax credits program, created in 1986, gives state authorities the ability to issue credits for acquisition, rehabilitation or new construction of rental housing, primarily for poor workers and seniors.

While industrial and consumer companies were among the initial institutional investors, they began to drop out as yields declined in the mid-2000s. That left banks, which have a lower cost of capital and community-reinvestment responsibilities, and mortgage companies and insurers.

The discount on the credits vary based on location, investor demand and the track records of the developer and syndicator. Developers are able to charge below-market rents because the equity infusions lower their debt costs.

The most popular locations for credit investments are typically heavily populated areas with a lot of banks, such as New York and Los Angeles, and where market-rate rents are high.

New York, Michigan

"We have a weird situation where if you have a housing credit deal in New York City, as a developer, you can command 95 cents on the dollar," Reznick's Copeman said. "But if your job is in Michigan, it will be in the low 60s. There's an enormous spread between CRA hot, and CRA not."

Projects rarely fail because demand for the housing is strong, especially in expensive cities, said Percy Vaz, chief executive officer of AMCAL Multi-Housing Inc., a developer based in Agoura Hills, California.

The portion of Americans living in poverty rose to 14.3 percent in 2009, the highest level in 15 years, from 13.2 percent a year earlier, the Census Bureau said Sept. 16.

"When we build a building, even in the worst part of a recession, we would fill up instantly," he said.

Business Is Booming

Joe Hagan, chief executive officer of National Equity Fund, a Chicago-based syndicator, said his company expects to be involved in $700 million of affordable-housing investments in 2010. In 2009, it brokered $350 million in private-investor deals. Hagan's concern is that the popularity of tax credits could work against it.

"What keeps me up at night is that because of our success, returns start coming down to the point where the new investors step out of the market," Hagan said. "Then we're back to the drawing board."

Meridian's Casey said that while nonfinancial corporations are jumping in, more would do so if accounting rules were changed so that the credits didn't reduce reported pretax profits, a measure tracked by investors and analysts. Investment returns are based on the reduction of taxes, which increase net income.

Casey and Copeman said they discussed that idea with officials at the U.S. Treasury Department and the Housing and Urban Development last month during a meeting with industry professionals.

"You'll have everybody from railroads to utilities to service companies coming in," Casey said.

To contact the reporter on this story: Prashant Gopal in New York at
To contact the editor responsible for this story: Kara Wetzel at

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