To laymen, the affordable-housing industry has long been mired in regulatory complexity. But institutional investors, especially banks, have figured out that tax credits - the "carrot" established by Congress in 1986 to facilitate construction and rehabilitation of privately owned affordable rental housing-are an increasingly attractive investment.

Though yields on housing credits have fallen to historic lows, they remain more than 300 basis points higher than comparable long-term, fixed- income investments.

Housing credits today yield about 8.5% after taxes, compared with a mere 5% for triple-B municipal bonds. Dramatically declining tax credit yields over the past few years point to investors' growing comfort with tax credits.

Such institutions as BankAmerica, First Union Corp., BankBoston Corp., Banc One Corp., Fleet Financial Group, and PNC Bank Corp. have all recently invested in housing credits. Major credit-card concerns such as Advanta Corp. and MBNA Corp. are active too.

What's the attraction? Simply, housing credits offer a strong relative rate of after-tax return and low volatility. By reducing tax liability, credits can also improve a company's earnings per share.

In contrast to conventional real estate investment, tax credit returns depend only indirectly on a property's performance.

Instead of relying on real estate cash flow or sales, tax benefits continue as long as the property operates and serves qualified residents. Investors, therefore, look for stable operations throughout the period (generally 15 years) during which the tax benefits are provided.

Strong yields complement a second role of tax credits in a bank's portfolio, namely, helping to meet the requirements of the Community Reinvestment Act.

By investing in tax credits in a certain location, a bank can fulfill part of its local CRA requirements. Tax credit programs are often tailored to pinpoint certain states, regions, or even cities where a bank may need CRA help.

Interest in housing credits has been growing steadily during the 1990s. Recently, Congress stopped requiring annual reauthorization and made housing credits a permanent program. This action prompted many institutional investors, including some large banks, to consider tax credits for the first time.

Since then, funds have poured in at an average rate of $1.5 billion per year, double that of the 1980s. Nearly 75% of all funds raised for affordable housing now come from institutional investors, a reversal from the 1980s, when retail investors ponied up most of new equity.

Unlike individual investors, corporations are not limited in the amount of benefits they can use. Many companies invest $20 million a year in affordable housing, and some commit even more.

Still, tax credits remain fairly low-profile. One reason is that they don't fit neatly into any particular investment category. Tax credits offer steady yields like bonds, but with equity-like returns and real estate as the underlying asset. Not surprisingly, this profile creates some confusion.

Additionally, tax credits are not risk-free. Properties must comply with certain rental restrictions.

Also, if the real estate does not perform, there is always a possibility of foreclosure. In that event, the federal government "recaptures" a portion of the tax credits, and the investor loses future tax benefits.

Another risk is the market's limited liquidity. However, since the demand for tax credits is currently strong, because there is only a fixed amount available, investors who want to sell have readily found buyers.

To acquire well-structured tax credit investments, investors typically seek out a seasoned sponsor, who assembles the real estate portfolio and monitors its performance and returns.

Experienced sponsors know how to navigate this niche; how to evaluate the property's market, management, and development teams; and how to structure capital pay-in schedules, holdbacks, and reserves to produce the expected performance at both the property and portfolio level.

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