A Grand Time for Funding
By Timothy Leonhard
10 min read
Full Menu of Debt Products and Low Interest Rates
Debt financing in most cases is the most important component of the capital stack on nearly all affordable housing developments (as is the case in most any type of real estate development.) The average Loan to Value on affordable housing development ranges from 80% to 90%. The housing finance reform debate may continue in Washington with no end in sight. However in the interim, one constant in all discussions on the topic of reform is that any Federal government involvement in housing finance must have as one of its core missions support of multifamily affordable housing.
Of course, supporting affordable housing is a mission which has always driven the U.S. Department of Housing & Urban Development’s (“HUD”) activities, and in recent years the Federal Housing Financing Agency (“FHFA”), the regulator and conservator of Fannie Mae and Freddie Mac, has made the support of affordable housing a major goal of the two government-sponsored enterprises (“GSEs”).
With HUD, the GSEs, and countless CRA motivated banks competing for affordable housing finance opportunities, along with a generous supply of overall liquidity in the marketplace, there has never been a better time to borrower funds to finance affordable housing.
In 2015, the FHFA set the annual production volume caps for multifamily loan production for Freddie Mac and Fannie Mae at $30 billion each. But, just as in 2014, the FHFA will not count multifamily affordable housing towards these caps, thus leaving the GSEs room to fund as many multifamily affordable housing loans as they deem prudent. After a fast start to 2015, apparently the GSEs have gotten too far ahead of their quotas/caps for market rate multifamily loan production, as they have already slowed down that production volume by increasing market rate multifamily debt pricing and by tightening of credit terms. But look for the GSEs to focus even more on multifamily affordable housing as 2015 progresses.
With the emphasis on affordable housing in Washington, and with interest rates still very low, multifamily affordable housing developers will benefit from a very favorable financing market for their properties. Below is a brief review of the debt products available from HUD and the GSEs:
HUD
In recent years, HUD has shown initiative by taking its long time products (221(d)(4), 223(f), 223(a)(7)) and having them address more recent needs in the marketplace through ongoing initiatives inside of HUD. These initiatives include the following:
The Tax Credit Pilot Program (“Pilot Program”)
The Pilot Program provides streamlined processing for existing 90% project-based rental assistance properties for recently built and stabilized, low income housing tax credit (“LIHTC”) properties which need permanent financing, and for the re-syndication of existing LIHTC properties. While standard 223(f) lending parameters generally apply for the Pilot Program, the program allows for moderate rehabilitation with up to $40,000/unit in hard costs, fees and contingency costs. The program requires a new 20-year HAP contract for rental assistance properties and places limitations on the underwritten rent increases and expense decreases for the non-assistance programs.
Processing times for the Pilot Program are targeted at 45 days for commitment issuance versus up to 120 days for a standard conventional 223(f) financing. Given that the rate for the 223(f) program remains near 3.00% (plus MIP), the Pilot Program is a very attractive option for developers of affordable housing.
The Rental Assistance Demonstration Program (“RAD Program”)
The RAD Program provides a way in which Public Housing Authorities (“PHAs”) and private owners of other types of HUD-assisted properties can move tenant held voucher units onto long-term project-based contracts. The RAD Program converts PHA voucher units and other HUD-subsidized voucher units into project-based subsidies which have a more reliable income stream, and thus are more appealing to a lender and LIHTC investor. The FY 2015 Federal Government Appropriations Bill provides for the conversion of up to 185,000 units under this program. This year, to date, just over 13,000 units have closed under the RAD Program, with another 45,000 with approvals granted. RAD has become a big part of affordable housing preservation since the inception of the program several years ago.
Section 202 Properties
HUD has a long history of providing direct loans to finance the construction of structures which serve as supportive housing for very low income elderly persons and which provide rent subsidies for these projects. Most of these properties are now in need of significant rehabilitation. HUD provides specific guidance regarding the refinancing of these Section 202 properties through Section 223(f) or 221(d)(4). Regardless of which Section of the National Housing Act is utilized, for those projects with Section 8 contracts, a new 20 year HAP contract is awarded as part of the refinancing. If the project sponsor is refinancing the direct loan for the first time, the current Section 8 rents are exempt from being marked down to market, a very important feature for these aging properties in need of recapitalization.
Interest Rate Reductions (“IRR”) – Note Modifications
Typically, an existing HUD borrower has used HUD’s Section 223(a)(7) program to refinance its existing HUD loan in order to take advantage of lower interest rates. A much more streamlined approach to dropping the interest rate is to simply take advantage of HUD’s Interest Rate Reduction (“IRR”) Program. Current FHA insured loans which are outside of prepayment lockout restrictions are eligible. The interest rate reduction must result in a DSC of greater than 1.05x. A new physical needs assessment is not required for loans with final endorsement occurring within 10 years of the IRR, and no other third party reports are needed. HUD guidance states the IRR application will be processed within 20 business days and HUD has been keeping to those timeframes with regularity.
The basic HUD programs (Section 223(f), Section 221(d)(4), and Section 223(a)(7)) which have been in place for years, have been the tried and true workhorses of the FHA affordable housing support. Below is brief background on those programs:
Section 223(f)
The FHA Section 223(f) refinance and acquisition program touts some of the best loan and lending parameters in the industry, with characteristics including maximum loan term of up to 35 years, full amortization, non-recourse, fixed interest rate, up to 83.3% LTV (1.20x DSCR) for market rate and up to 87.0% LTV (1.15x DSCR) for 90%+ rental-assisted. This financing is an excellent opportunity to refinance or purchase a project for the long-term holder.
Section 221(d)(4)
The FHA Section 221(d)(4) program provides construction to permanent financing for new construction or substantial rehabilitation in one loan. The financing is non-recourse with a fixed interest rate, throughout its term. Underwriting parameters differ depending on the level and type of each project’s affordability component, but generally they are as follows: a) project-based Section 8 covering greater than 90% of the units – 1.11x DSC and 90% of replacement costs; b) affordable housing projects (generally those projects meeting the LIHTC affordability parameters) – 1.15x DSC and 87% of replacement costs; and c) market rate projects – 1.20x DSC and 83.3% of replacement costs. A 221(d)(4) loan is constrained by HUD-eligible costs, not appraised value.
Section 223(a)(7)
The FHA Section 223(a)(7) program was originally designed to quickly refinance existing FHA-insured properties resulting in a reduced interest rate and debt service savings for the borrower. The program has a maximum loan amount calculated based on the lesser of: a) the original loan amount; b) 100% of eligible refinance costs; and c) debt service coverage of 1.11x on the new Loan. The new Loan is generally coterminous with the original Loan, however an extension up to 12 years beyond the original loan term may be achieved. Ideal opportunities include projects financed with FHA Insurance in the last 15 to 20 years which have not yet refinanced and for those projects which have debt service coverages below 1.00x and need to extend their term in order to achieve a 1.11x DSC.
Fannie Mae and Freddie Mac
As previously mentioned, both GSEs continue to have strong appetites for affordable housing and continue to provide competitive structure and interest rate quotes. Both continue to work vigorously to enhance their products, seemingly in lock-step, in order to provide more attractive executions, especially in the tax-exempt bond space and for properties in lease-up.
Fannie Mae recently announced its first issuance of a mortgage-backed security (MBS) that will serve as collateral for tax-exempt bonds. This execution is referred to as the MBS Pass-Through. One of the great benefits of this structure is the note rate is some 50 to 60 bps lower as compared to standard housing agency bond credit enhancement. The structure also creates a 2% to 3% transactional cost savings when compared to traditional bond credit enhancements or cash collateral bond structures. Freddie Mac offers a similar alternative structure to tax-exempt bond credit enhancements named the Tax-Exempt Loans execution (“TEL”). This product is a more efficient and more cost effective alternative to tax-exempt bond credit enhancements with 4% LIHTC, requiring fewer documents, and fewer participants than traditional bond transactions, thus reducing the cost of issuance by up to 40% and a note rate commensurate with that of the Fannie Mae MBS Pass-Through Program.
Fannie Mae also recently announced its “Streamline Early Rate Lock” product which allows a borrower to lock interest rate upon application, as well as its “Near Stabilization” product which allows borrowers to lock interest rate at 75% physical/60% economic occupancy, with the expectation that the property will be fully stabilized within 120 days of rate lock. Fannie Mae has also enhanced the conversion feature of its Structured ARM product to provide the ability to convert from floating rate to a new fixed rate loan with a 30 year amortization, pricing at market at the time of conversion, and allowing for cash proceeds with streamlined underwriting.
Freddie Mac recently announced that Targeted Affordable Housing (TAH) cash and bond loans are now eligible products under its Lease-Up Loan product, which they have renamed to “Refinance Lease-Up Loan” and “Acquisition Lease-Up Loan,” which allows a borrower to interest rate lock at 50% physical occupancy.
Interest Rates
Again, interest rates remain extremely low. For many of the products and innovations mentioned above, below are recent indications of interest rates that can be achieved:
FHA/HUD – Taxable New Construction or Sub Rehab Loan Parameters [Section 221(d)(4)]
DSCR: 1.11 to 1.20
LTC: 83% to 90%
Rate: 3.55% (plus MIP)
Loan term: Up to 40 years
Amortization: Up to 40 years
FHA/HUD – Taxable Acquisition or Refinancing Loan Sizing Parameters [Section 223(f)]
DSCR: 1.15 to 1.20
LTV: up to 87%
Rate: 3.05% (plus MIP)
Loan term: Up to 35 years
Amortization: Up to 35 years
Fannie Mae/Freddie Mac Taxable Acquisition or Refinancing Loan Parameters (without new LIHTC)
DSCR: 1.20 to 1.25
LTV: 75% to 80%
Rate: 3.95% to 4.85%
Loan term: 5 to 30 years
Amortization: 30 years
Fannie Mae/Freddie Mac Taxable Acquisition or Refinancing Loan Parameters (with new LIHTC)
DSCR: 1.15
LTV: 90%
Rate: 4.55% to 4.85%
Loan term: 15 to 30 years
Amortization: Up to 35 years
Fannie Mae/Freddie Mac Taxable Adjustable Rate Acquisition or Refinancing Loan Parameters (without new LIHTC)
DSCR: 1.20 to 1.25
LTV: 75% to 80%
Rate: 2.45% to 2.60% over 1M LIBOR
Loan term: 5 to 10 years
Amortization: 30 years
Note: All rates quotes above assume a full leverage transaction. Transactions with LTV of 70% or less can generate interest rate savings of between 15 bps and 40 bps.
