Patience, Creativity and Strong Communication with Partners
By Pamela Martineau
8 min read
What it Takes to Close Deals in a Shifting Economic Landscape
Rapidly rising interest rates, increasing construction costs and supply chain snags have helped to create one of the most challenging environments in decades to close affordable housing deals, industry experts report. Those experts recommend patience, creativity and strong communication with business partners as ways to help move deals across the finish line.
“It is absolutely the case that it is as challenging now as, I think, it has ever been in my career to get transactions closed given the confluence of cost increases, especially with construction, and sharply rising interest rates,” says Dan Rosen, an attorney at Klein Hornig, LLP. “I have seen few, if any, transactions outright stop and die. I have seen a lot of transactions struggle and delay.”
Industry experts advise those hoping to close deals to be realistic about timelines and to plan for a financial cushion in the event of rising interest rates and construction costs. Stay organized on all of the moving parts of a deal, since permitting and inspections are often delayed. And keep partners aware of all of a deal’s challenges and delays.
“Be realistic about closing timelines and be in frequent communication with your investor or syndicator about how things are progressing so that all parties are ready to move to close when the deal is ready,” says Ben Stehouwer, senior vice president of business development for Cinnaire.
Rising Interest Rates and Constructions Costs
The days of interest rates under three percent have given way to interest rates over seven percent – all in less than nine months. The rapid rise in rates is unparalleled and is putting pressure on developers to close deals as quickly as possible before rates rise again. Experts say the desire to move swiftly is understandable, but difficult to achieve in an environment where permitting, construction and appraisals are taking longer.
“In a rising interest rate environment those delays can be even more costly because they can cause you to lose your rate lock,” says Beth Mullen, an accountant with CohnReznick. “Having a slip in your closing date can have a significant financial impact.”
Still, due diligence must be completed.
“There is a real push for people to want to close quickly or they have a false sense they can close quickly once deals line up,” cautions Stehouwer. “But we still have the same amount of due diligence now that has always been required in the past.”
Developers need to stay abreast of delays through increased organization and planning. They also need to more frequently update all parties of the deal on where things stand, adds Mullen.
“One of the most important things to getting a deal closed is for the developer or sponsor to be organized. They need to understand what items may take a long time to get. It could be building permits or appraisals, things that are out of the developer’s control,” says Mullen. “Anything that has a long lead time, look back at when you want to close and figure out which things need to be started earlier than later.”
Stehouwer advises that developers build a financial cushion into their deals should interest rates and construction costs continue to rise and the entire deal costs more.
“Plan for those increases so your deal still works should those increases continue,” says Stehouwer.
Mullen says some developers are finding it challenging to hold onto their construction contract price in light of deal delays.
“Prices are not going down,” says Mullen. “If you lose the contract price, you may find a gap in your funding. You are going to have to scramble around for additional sources.”
Bryan Shumway, president of Wishrock Housing Partners, says increased insurance costs on projects also are a growing problem.
“Insurance is having a significant impact on our portfolio,” says Shumway. “We see it today and who knows what the future impact will be with climate change.”
Funding Deals
Rosen finds it promising that funds from the American Rescue Plan Act, or ARPA, are increasingly being used on deals and state and local fiscal recovery funds are “finally starting to work their way through the system and get awarded this fall.”
Rosen says there have been some inevitable “logjams” throughout the system as funding agencies push to get the funds out the door.
Chrystal Kornegay, executive director of MassHousing, says public funders of projects are committed to seeing deals come to fruition and are “working really hard to figure out ways to fill gaps.”
“At least in Massachusetts, I will say that particularly the public funders are committed to seeing that deals happen.”
Kornegay advises developers to be “resilient and patient” and also to scrub deals for cost savings.
“Do some value engineering,” says Kornegay. “Look at your construction budget. Look at materials and other ways to save money in construction.”
Stehouwer advises developers to choose their deal types wisely because some are more reliant on construction costs and interest rates.
“There is more volatility in construction pricing on new construction deals because there is more cost allocated to construction,” says Stehouwer. “Acquisition rehab deals are less volatile because their construction budget is often not as high with more of the cost in the acquisition.”
Stehouwer advises lowering expectations for equity pricing in non-Community Reinvestment Act deals that are projected to close in 2023 that do not yet have a committed investor.
“For non-CRA deals, pricing may go down in 2023,” he says. “These deals will likely need to be priced lower for an economic investor who now has other investment opportunities that provide higher yields because of the rise in interest rates.”
Stehouwer adds, now that Average Income Test (AIT) regulations have been announced, “some deals in some areas may look to average income to help provide additional funding. This will not be the case for all deals but as investors become more comfortable with AIT it may be part of the solution.”
“Also work with your housing authority,” Stehouwer advises. “There may be gap financing or other tools available to help get deals done.”
Stehouwer says the Michigan State Housing Development Authority “really stepped up” and provided additional credits to nine percent deals and gap financing on four percent deals to get deals to the finish line.
Patience and Advocacy
Shumway, of Wishrock Housing Partners, stresses the importance of communication among entities in a deal. Patience is also key.
“Some of the things that are helping us get through are patience and communication. These simple things really are best practices. We had one deal we were selling that fell out of contract. We found ourselves almost working hand in hand with a buyer to brainstorm solutions to a regulatory problem,” Shumway says. “Notwithstanding the ultimate outcome, in the past, it has been such a sellers’ market that we probably wouldn’t have felt compelled to put in that effort; buyers would have been lined up waiting to step in and close the deal.”
Shumway says the shift in the market should be accompanied by a shift in how people view their roles.
“As we enter these new times, thinking about our roles differently than we have in the past is important,” he explains. “We need to think about our end goals and not be as rigid as we have in the past as to who does what and what our positions are on certain negotiating issues. Always be thinking about whether your actions and positions are advancing your end goals.”
Shumway says it is important that all entities work together on deals.
“The way to get through these challenging times is by working together,” he says. “You can’t work in a silo, and you can’t go it alone. The companies that act as good partners are the companies that will succeed. That will become an important differentiator.”
Kornegay and other experts also advise developers to advocate for an increase in tax credits and funding for affordable housing.
“Developers should be advocating, particularly on the federal level,” says Kornegay. “State and local entities have recovery funds to help close the gaps, but they are not forever funds. Developers have to be advocates now, more than ever… At a time when housing in general and affordable housing, in particular, is becoming a crisis nationally, it’s not about just what the states can do. The federal government has to do something.”
Rosen says a possible legislative fix would be reducing the 50 percent test on tax-exempt bonds.
“I think that would be a terrific step forward to add more subsidies to the system.”
What’s Ahead
Nearly all of the experts contacted for this story say deals are still closing, they are just taking longer to close.
“I am not really seeing deals fall apart,” says Kornegay. “It is just taking longer for deals to close.” Rosen agrees.
“We are seeing more deals now than usual where people are conceding that an end-of-the-year closing is not going to happen, and things will shift into next year. This is especially true with deals seeing multi-million-dollar gaps,” says Rosen. “I am confident they will close, but probably in the first quarter of next year.”
Mullen says people are closing deals by being creative.
“People are figuring out how to make things work in a challenging situation,” she says. “People are getting creative. They are sharpening their pencils and figuring out how to make a deal work.”
