Silicon Valley Bank provided equity and debt financing to help Mercy Housing start construction in December 2013 on 70 affordable housing units in a new, eight-story, mid-rise building at Block 6 of the massive Transbay Transit Center in San Francisco. PHOTO: Courtesy Silicon Valley Bank
Lenders fought hard against stiff competition to make loans to affordable housing properties in 2013. Among those competitors, commercial banks once again crowd the top of affordable housing finance’s annual list of the biggest lenders.
The largest institutions benefitted from their ability to package different types of financing. Some combined debt with low-income housing tax credit (LIHTC) equity. Others mixed taxable and tax-exempt financing. Some have even returned to the business of financing large “80/20” tax-exempt bond properties that mix affordable housing with market-rate apartments.
For affordable housing owners and developers, the competition to lend, and the variety of loan products available, helped offset some of the pain of rising interest rates and cuts to housing programs.
“The LIHTC business is very well banked,” says Ed Sigler, head of community development real estate at JPMorgan Chase.
Rising interest rates
Nearly all the lenders contacted say rising interest rates affected their business in 2013 and that rates are likely to rise again in 2014.
“The biggest thing we had to face last year was the tick up in interest rates,” says Tracy Peters, managing director of Red Capital Group.
Interest rates leapt up a full percentage point in early summer after the Federal Reserve first hinted it would “taper” off its program to purchase mortgage-backed securities.
Rates are expected to rise again in 2014, though hopefully without the suddenness of the increase last year.
“We expect an uptick on rates in the latter half of the year,” says Peters. Developers are building into their financing plans the possibility that rates might rise as much as another point. “Folks are a little better prepared,” says Peters.
It helps that federal officials have become clearer in their statements about federal interest rate policy.
“Last year, there was more mystery,” says James Spound, president of Red Stone Tax Exempt Funding. “This year, the Federal Reserve seems to be very explicit on what it plans to do.”
U.S. Bank provided $118 million to help Dominium create 251 units of affordable housing for artists at the historic Pillsbury A-Mill in Minneapolis. The financing includes $92 million in construction and bridge financing and another $26 million in state historic tax credit equity. Construction started late last year. PHOTO: Courtesy U.S. Bank
Competition to close deals has also helped lessen the pain of rising rates. “There has been some competition on loan spreads, some competition on the origination fee,” says Chase’s Sigler.
Rising interest rates cut into the amount of debt a property can afford to carry. Developers are trying to make up the difference with subsidized, soft financing. But many housing programs that provide soft financing have suffered budget cuts and are making smaller loans, if they’re lending at all. “There’s more pressure to find additional soft sources of financing,” says Red Capital’s Peters. “There are more layers of soft debt that we are having to deal with.”
Some plans to develop or redevelop affordable housing no longer work. “Fewer and fewer deals are feasible,” says Christine Carr, manager of community development finance for Silicon Valley Bank.
Housing advocates are hopeful that fewer budget cuts will disrupt housing programs in 2014. Many local governments are no longer fighting budget deficits, and Congress has rolled back some of the federal “sequester” budget cuts.
“I would say we’re not filled with gloom like before,” says Richard Froehlich, acting president and general counsel for the New York City Housing Development Corp. (HDC). “But funding is still below where it was.”
Lenders tailor deals to borrowers
As the list of sources and uses grows longer for many affordable housing properties, lenders are offering developers an opportunity to trim the number of financing sources they use by packaging together debt and equity.
“It’s a priority for us to do the debt and equity together,” says Maria Barry, who runs the community development banking division for Bank of America Merrill Lynch. More than half of the lender’s 2013 debt deals also included bank equity.
Some lenders feel they need to offer equity to compete for deals—even if their rates are already far below the competition’s. For example, Silicon Valley Bank’s low cost of capital allows it to offer fixed rates of less than 2 percent on two-year loans. “But that hasn’t been enough,” says Carr. “I have to provide debt and equity … it makes it easier for the project sponsor.”
Other top lenders are looking to offer more choices to affordable housing borrowers. Bank of America recently joined the family of lenders that offer Department of Housing and Urban Development (HUD) loans, by getting approved in 2013 as a Federal Housing Administration (FHA) Multifamily Accelerated Processing lender.
“With subsidy sources being sometimes more challenging, it’s really important that the client has options,” says BofA’s Barry.
FHA loans are also becoming more attractive to affordable housing borrowers. The FHA’s new LIHTC pilot program is meant to provide a quicker execution and relatively low interest rates to deals using housing tax credits.
“Clearly, HUD and FHA have made affordable housing more of a priority,” says Dan Lyons, managing partner for Rockport Mortgage Corp.
FHA interest rates spiked up in 2013, even compared with rates for other financing types. Since then, the FHA’s interest rates have dropped significantly, though no one expects rates for the FHA’s very long-term financing to drop back below 3 percent in 2014.
Lenders are also expanding their business by financing public housing redevelopments through HUD’s growing Rental Assistance Demonstration (RAD) program.
The new program, a central piece of HUD’s strategy to preserve at-risk public and assisted housing, has created a new source of capital by allowing housing authorities to borrow against the steady stream of rental subsidies that come to public housing properties.
“We’re seeing that as a significant business area,” says Red Capital’s Peters. “We have a number of deals lined up for 2014.”
Like the old HOPE VI redevelopments, these deals mix residents earning different levels of income and several different types of subsidies. “The finished product tends to look fantastic,” says Red Stone’s Spound.
Many flavors of tax-exempt bond financing
The competition to make deals extends to affordable housing rehabilitations financed with tax-exempt bonds and 4 percent LIHTCs. These deals have become much more feasible as prices for 4 percent LIHTCs have recovered.
However, tax-exempt interest rates are still paradoxically higher than the interest rates on loans funded with taxable bonds. That’s because of a problem that emerged more than a year ago in the part of the capital markets where tax-exempt bonds are traded.
Eventually these interest rates will get back to normal. In the meantime, many lenders offer borrowers a “cash-collateralized” financing structure that lets them get both the 4 percent LIHTCs that come with tax-exempt financing and the lower taxable interest rates. The cash-collateralized structure uses tax-exempt bonds to effectively fund a short-term loan that is replaced after the construction period with permanent Fannie Mae, Freddie Mac, or FHA financing.
A cash-collateralized structure can slice 75 basis points from the interest rate of a tax-exempt bond development for the life of the property’s permanent financing.
“All the 4 percent deals we’re doing are this cash-collateralized structure,” says Red Capital’s Peters.
Other tax-exempt bond lenders offer a more traditional private-placement structure. “With complexity comes expense,” says Kyle Hansen, executive vice president for U.S. Bank Commercial Real Estate, which offers both private-placement and cash-collateralized structures. “We saw more of the traditional private-placement structures in 2013.”
Very few lenders offer tax-exempt bond financing in which the bonds are credit enhanced, a structure that used to be relatively common. New York City’s HDC is one of the very few exceptions.
“We have our own captive mortgage insurance fund,” says HDC’s Froehlich. These credit enhancements are a big part of the reason HDC is No. 2 on our top lenders list.
However, even though HDC credit-enhances its tax-exempt loans rather than using the popular cash-collateralized structure, the organization’s tax-exempt borrowers still avoid paying higher, tax-exempt interest rates for most of their permanent debt. That’s because HDC’s bond projects receive so much subsidized permanent financing through HDC’s programs. “The tax-exempt bond loan is not such a large part of the permanent financing,” says Froehlich.
HDC then recycles the tax-exempt bonds that borrowers return to the agency into new developments. These recycled tax-exempt bond deals don’t include a fresh set of 4 percent LIHTCs, but they can be helpful in refinancing older Sec. 236 properties that don’t need much heavy renovation and have residents who earn more than the LIHTC income limits.
80/20 deals are back
A few of the biggest affordable housing lenders also increased their volume in 2013 by financing large “80/20” tax-exempt bond transactions. These developments reserve 20 percent of their housing units for low-income residents, while the remaining 80 percent rent at market rates.
“Our East Coast volume is up. A lot of that is due to mixed-income deals,” says BofA’s Barry.
U.S. Bank’s affordable housing lending volume also increased in 2013, in part due to mixed-income 80/20 deals that were largely developed in coastal markets in California.
Some housing advocates have complained that these 80/20 deals don’t always make efficient use of affordable housing subsidies. In response, agencies including New York City’s HDC and the New York State Housing Finance Agency have begun to create mixed-income housing deals in which the properties are broken into separate condominiums, so that the tax-exempt bond financing and tax credits can be focused on the affordable part of the property.