Debt Financing Still Plentiful for LIHTC Projects; Opportunities Available
By Caitlin Jones & A. J. Johnson
13 min read
THERE IS STILL PLENTY OF DEBT available for new low-income housing tax credit (LIHTC) projects, despite the turmoil in the capital markets, according to lenders and other LIHTC program participants recently interviewed by the Tax Credit Advisor.
In fact, a number cited attractive debt financing options currently available to finance new construction and substantial rehabilitation projects.
LIHTC developers are being impacted more now by the sharp recent drop in pricing for housing credits, which will mean sponsors will need to try to raise additional dollars from other sources — hard or soft debt, other subsidies, etc. — to close the resulting funding gap for new projects, particularly 9% credit deals.
Syndicator Ryan Sfreddo, of Centerline Capital Group, New York, said typical credit pricing for new deals has probably fallen to the mid-80s to low-90s (in cents per credit dollar), a drop of 5 to 8 cents from six to nine months ago.
Some market participants are being even more conservative in their price assumptions. Austin, TX-based mortgage lender Ginger McGuire, of Lancaster Pollard Mortgage Co., said she is generally underwriting loans for new projects assuming credit pricing of 82-85 cents. Her firm is certainly reflective of a more careful approach by capital sources in underwriting new loans for LIHTC projects. “We are being very cautious, particularly about location and potential risks,” she said. “We’re trying to be very realistic about what the property can realize in the way of income.”
Lancaster Pollard originates mortgages for LIHTC projects, including FHA-insured loans and Rural Development Section 538 loans.
Despite the turmoil in the capital and credit markets, and persistent uncertainty and fears about the future course of the economy, permanent mortgage rates at attractive rates from various sources under different executions are now available to LIHTC developers.
Tom Booher, executive vice president, PNC MultiFamily Capital, San Francisco, estimated, on 1/9/08, that the combination of variable-rate bonds paired with an interest rate swap would generate a current synthetic fixed “all-in” borrowing rate of about 5%; fixed-rate tax-exempt bonds, around 6% or the “low 6s”; and an FHA loan, about 6.70% to 6.80%. PNC. Booher said the current permanent mortgage rate (fixed-rate, 15-year term) would be about 6.75% to 6.90% under his firm’s proprietary program offering both construction and debt financing for 9% credit projects.
PNC Multifamily, like nearly all the other lenders interviewed for this article, originates mortgages using Fannie Mae, Freddie Mac, and FHA programs both for 9% and 4% LIHTC projects.
Those interviewed by TCA pointed to a number of recent trends, developments, and current opportunities in debt financing for tax credit projects.
Favorable Index Trend
Sfreddo and others reported that the current yield on 10-year U.S. Treasury obligations — a popular index for setting mortgage rates for fixed-rate permanent mortgages for 9% LIHTC deals — has been declining. It was 3.66% the week ending 1/18/08, compared to 4.78% a year earlier. This decline has been offset, though, by an increase in the risk premium or “spread” that lenders add to the index rate.
Sfreddo said the decline in the 10-year Treasury yield “certainly helps offset rising credit spreads, so that your all-in rate has not changed that materially. The cost of debt is still relatively inexpensive, by historical standards.”
Interest rates on variable-rate bonds, or “low floaters,” are no longer around 1% as they once were but are still attractive at less than 4%. Moreover, rates could fall as the result of the Fed’s recent cuts in short-term rates.
Migration to GSEs
Another trend has been a major shift to Fannie Mae and Freddie Mac — the two major government sponsored enterprises (GSEs), or “agencies” — as paramount sources of permanent debt for 9% and 4% new construction and substantial rehab projects, said Chris Tawa, of MMA Financial LLC. “Right now, in the industry, the agencies are really in control of debt financing,” he said. “That’s where the source of capital is, that’s where the best price is, that’s where the best appetite is, that’s where the best underwriting is.”
Fannie Mae and Freddie Mac each offer a variety of programs under which they, through approved lenders, offer permanent financing with or without construction financing for 9% and 4% tax credit projects, in which they can provide credit enhancement including on bonds. Their programs enable a borrower to lock in the permanent mortgage rate in advance of its origination.
Tawa said the GSE have become pre-eminent as debt sources for several reasons. These include liberalization of certain of their mortgage underwriting standards to make their programs more competitive and attractive to developers; the exit or curtailment in volume of many of the “conduit” lenders that were debt sources largely for 9% deals; and the curtailment of a number of “private placement” bond programs. The latter are programs, offered by major financial institutions, Wall Street firms, and others, in which they purchase unrated taxexempt bonds, proceeds from which are used to fund the multifamily mortgage. Much of the reason for this retrenchment is that many providers have had their capacity eroded from reduced liquidity or profitability.
Christine Hobbs, of Freddie Mac, and Sarah Garland, of Fannie Mae, reported to TCA that their companies are witnessing robust volume in their multifamily debt programs including for affordable housing developments. Hobbs said an increasing amount of Freddie Mac’s multifamily lending business is being done through its delegated program for affordable housing lenders.
Hobbs noted two of Freddie Mac’s most widely used financing options today for LIHTC projects are its 4% bond credit enhancement program and its immediate funding moderate rehabilitation product for both 9% and 4% credit projects. She reported Freddie Mac for the 4% bond program recently reduced the minimum debt service coverage ratio to 1.15 from 1.20, and increased the maximum loan amortization period to 35 years from 30. Tawa said Freddie Mac is even going to 40 years on strong deals.
Garland said Fannie Mae’s bond credit enhancement for 4% credit deals continues to be its leading product for LIHTC projects, with variable-rate bonds preferred over fixed-rate bonds.
Under the agencies’ 4% bond programs, Fannie Mae and Freddie Mac provide credit enhancement for tax-exempt bonds issued to fund the mortgages. If variable-rate bonds are issued, the borrower must either purchase a rate cap or enter into a rate swap to hedge interest rate risk. A rate swap allows the borrower to exchange his or her obligation to make a variable-rate payment for a fixed-rate payment, usually for the term of the LIHTC compliance period. Advantages to a developer with this execution are lower borrowing costs, increased project cash flow, and greater mortgage proceeds.
Those interviewed said the costs of rate caps, particularly longer-term caps, have fallen to very attractive levels.
Garland said Fannie Mae’s major changes in 2007 to its 4% variable-rate bond product was to come out with its swap policy, and to modify how its underwrites the variable-rate bonds when a rate cap is purchased to effectively increase loan proceeds by roughly 7%. For 9% credit deals, she said Fannie Mae brought back in enhanced form its “unfunded” forward product, under which Fannie Mae funds the permanent loan but the borrower gets their own construction loan.
Banks, HFAs, FHA
Banks continue to be popular sources of construction and permanent financing for 9% credit projects. They can also provide letters of credit to provide credit enhancements for bonds. Banks have a strong motivation to provide debt and equity for LIHTC projects because they can get credit for these activities under the federal Community Reinvestment Act (CRA).
Bank debt, in fact, is the typical debt source that developer Rod Lockwood, Jr., Lockwood Group, Bingham Farms, MI, seeks to finance his 9% LIHTC projects. For instance, he said on a recently closed deal — around $6 million total cost, 40 units, new construction — he obtained a conventional first mortgage from a bank sized a little below $1 million with a fixed rate around 7%. Lockwood said for 4% credit projects he typically obtains tax-exempt financing from the Michigan State Housing Development Authority, as he did for a recently closed 160-unit acquisition/rehabilitation project.
Lockwood anticipated utilizing these same debt sources for future 9% and 4% deals. But he noted he is making changes in planning new projects. Lockwood said he will be assuming much lower credit pricing for new deals in an acknowledgement of changing conditions, and begin to explore finding “CRA oriented” lenders offering soft debt. He added he will also be “scaling back” unit sizes and amenities in new construction projects, and offer less to purchase existing properties for acquisition/ rehab deals.
Many state housing finance agencies (HFAs) like Michigan, as well as local issuers, can issue tax-exempt multifamily housing bonds to provide mortgage financing for LIHTC developments.
Mid-Atlantic nonprofit developer Nancy Rase, of Homes for America, Inc., Annapolis, MD, said the hard debt her firm has typically obtained for new LIHTC projects has been permanent loans funded by tax-exempt bonds, or FHA-insured Section 221(d)(4) mortgages. Like Lockwood, she anticipates primarily tapping these same debt sources for future projects. Still, she noted “we’re underwriting more conservatively” on mortgage rates and tax credit pay-in rates for new projects. “In most cases,” Rase added, “we are asking for more subordinate financing from state and local governments.”
Boston CPA John Mackey, of the Reznick Group, said “HUD is back to being an option,” particularly its Section 221(d)(4) program. Such loans have attractive rates and 40-year amortization, and “a lot of the other [debt] products that were out there”¦aren’t necessarily there anymore,” said Mackey, who said he’s primarily working on structuring acquisition/rehab LIHTC deals.
Still, sources said that FHA mortgage processing times vary widely among HUD field offices and can be lengthy, so developers need to take this into account particularly if they have timing issues. “FHA is a viable option as long as you have a good understanding of how the process works,” said lender Keeley Kirkendall, PNC/ARCS Commercial Mortgage Co., Calabassas Hills, CA.
One note about FHA is that loans are always fixed-rate. FHA financing doesn’t accommodate variable-rate bonds.
McGuire said the RD Section 538 loan program can provide attractive mortgage financing for LIHTC projects, with the interest rate at the Applicable Federal Rate on the first $1.5 million of loan amount, and a 40-year amortization period. The program, though, is limited to rural communities of 20,000 or less.
Other Sources
Another viable option for LIHTC is so-called “one-stop shopping” — one source for both debt and tax credit equity. Many of the major LIHTC syndicators in addition to equity also offer debt, either directly, through an affiliate, or through arrangements with other debt providers. Centerline Capital Group, MMA Financial, PNC MultiFamily Capital, Boston Capital, and The Richman Group are just some of these.
Advantages of the one-stop or “seamless” financing route are usually the same individual or team underwriting the debt and equity, convenience, and lower transaction costs.
“For beginning developers, one-stop shopping can be a good option to simplify the transaction,” says lender Jim Gillespie, of Red Stone Partners, New York City. “However, the more sophisticated developers may want to shop around to try to negotiate the best deal in the market.”
A number of lenders and capital sources still have proprietary mortgage programs and private placement programs that can be used for LIHTC projects. Representatives of MMA Financial, PNC MultiFamily, and Red Stone Partners all said they operate programs for private placement of bonds.
Gillespie said his firm’s fixed rate private placement product has been the most popular over the past 12 months, but expects most interest by borrowers going forward — based on recent inquiries — will be for enhanced or unenhanced variable- rate bond executions paired with a rate cap or synthetically fixed through an interest rate swap.
Advice for Future
Those interviewed by TCA uniformly advised developers, as they seek the best debt financing for new LIHTC projects in the current market, to make certain they choose a proven lender that will be able to actually close the loan and do so on time.
Gillespie also urged developers to make sure they know in advance what their mortgage rate is actually going to be; what specific index their borrowing rate will be pegged to; and what their options are to lock in the mortgage rate prior to closing.
Tawa said developers should “explore more options” in view of the changing conditions and find a lender with a variety of financing options. He advised developers against merely lining up the same debt sources they have always used, out of habit. “Whatever the developer had been doing the past few years is not necessarily the best financing technique that the developer should be doing this year,” said Tawa. “Things have changed.”
Mackey advised developers to be creative. For example, he said one developer planning to build an LIHTC project and install solar equipment on the roof was able to persuade the state agency to increase the size of the bond financing for his deal, after the agency agreed to consider the projected substantial utility cost savings forecast in an engineering study.
