Good Times: Varied Debt Options, Low Borrowing Rates

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9 min read

It may be hard to believe. But the present probably offers some of the most favorable borrowing rates ever for affordable rental housing developers and owners seeking debt for new projects or to refinance existing properties.

For low-income housing tax credit projects, the current combination of lower borrowing costs and high credit prices help offset the reduced supply of gap or soft funds and enable new projects – if they need it – to support more hard debt.

Borrowing rates are even lower than early 2012. On January 23, for example, rates on new Fannie Mae and Freddie Mac permanent mortgages with terms of 15 to 30 years to acquire or refinance properties with housing tax credits ranged from 4.75% to 5.50%, a bit higher than last fall but still down from 5.35%-5.95% in mid-March 2012. For HUD Section 221(d)(4) mortgages, the rate was 2.70% plus the mortgage insurance premium (MIP), down from 3.80% plus the MIP last March. (See chart)

The primary debt options for LIHTC and other affordable multifamily rental housing developments are programs of Fannie Mae, Freddie Mac, and the U.S. Department of Housing and Urban Development’s Federal Housing Administration (FHA). Banks, though, are a traditional source of construction financing and sometimes also permanent financing, and some major syndicators directly or indirectly offer debt financing. For rural housing projects, USDA’s Rural Development (RD) Section 538 guaranteed loans are a possibility for new LIHTC projects. Tax-exempt financing is available nationwide.

Factors Guiding the Decision

The debt options and best fit for a particular deal are determined by:

• The type of transaction (new construction, acquisition/ rehabilitation, acquisition only, refinance);

• The property’s size and location;

• Competition in the state for 9% housing credits;

• The time needed to close (i.e., any pressing deadlines);

• The availability of gap financing; and,

• The developer’s financial strength and track record.

“Location is going to drive the availability of your options, or the amount of available options,” says Timothy Leonhard of Oak Grove Capital, a Fannie Mae, Freddie Mac, and FHA lender.”

The greatest number of options are for projects in high-demand “CRA” markets where major banks compete aggressively to provide equity and debt for new LIHTC projects, especially 9% deals, in large part to meet their obligation under the Community Reinvestment Act. Besides buying the tax credits, banks will often provide construction and sometimes permanent loans as well. Some banks provide equity and debt in smaller CRA markets, too.

Leonhard says national and regional banks are probably the most popular source of construction and permanent debt today for 9% new construction LIHTC projects, while Fannie Mae and Freddie Mac are most popular as debt sources for 9% acquisition/rehab projects. Fannie Mae and Freddie Mac programs providing forward commitments for permanent financing for 9% new construction or substantial rehab projects are not competitive on rates and transaction costs.

FHA Programs

If a developer can afford the time it takes to get the loan, FHA-insured mortgages are attractive. They are non-recourse loans with terms and amortization periods of up to 40 years that provide both construction and permanent financing at a fixed rate usually below that on Fannie Mae and Freddie Mac loans. These products include Section 221(d)(4) loans for new construction or substantial rehab projects; Section 223(f) loans (acquisition or refinancing); and Section 223(a)(7) loans (to refinance an existing FHA mortgage).

The main drawback to FHA loans is the potential long processing time, which varies among HUD field offices. “The rates are extraordinary, and demand is very high,” says Leonhard. “It all comes down to: Do you have the time to get your deal done with HUD? They’ve tried to do a lot of things to improve their timing, but it’s still a six- to twelve-month process depending on when you start the clock and what type of deal you have.”

Heavy loan volume has been one challenge. In Fiscal Year 2012, which ended September 30, 2012, HUD’s Multifamily Hubs issued or reissued commitments for $6.72 billion worth of Section 223(f) mortgages for 725 affordable- and market-rate multifamily projects (106,133 units), up sharply from $4.05 billion (502 projects, 68,554 units) in FY 2011. Volume declined a bit for Section 221(d)(3) and (4) loans, to $3.08 billion in FY 2012 (184 projects, 29,645 units), and for 223(a)(7) mortgages, to $4.83 billion (552 projects, 85,806 units).

Marie Head, HUD Deputy Assistant Secretary for Multifamily Housing, said the Department has improved processing times dramatically for all of its multifamily loan programs. “We’ve seen a 75% decrease in time frames over the last year,” she noted.

HUD hopes to spur greater 223(f) volume with its new pilot program that aims to cut the processing time to 60-90 days for 223(f) loans for transactions involving housing tax credits. This program, which permits a larger than usual per-unit rehab amount funded in the 223(f) mortgage, is now open to projects nationwide with a larger number of participating lenders. Head, when interviewed on January 11, said the pilot program’s first three mortgages were scheduled to close by month’s end and 15 projects were in the pipeline.

Fannie Mae, Freddie Mac Programs

Fannie Mae and Freddie Mac, through their approved lenders, offer much quicker execution while being competitive on rate and mortgage proceeds. Their debt products generally don’t provide construction financing and have shorter loan terms than FHA loans but offer amortization as long as 30 to 35 years. For 4% credit deals, the two government-sponsored enterprises provide credit enhancement for fixed-rate tax-exempt multifamily housing bonds issued by state or local housing agencies. Freddie Mac also credit enhances variable-rate bonds hedged for interest rate and remarketing risk, but these are usually utilized for “80/20” projects.

In the affordable housing space, the sweet spot and greatest volume in the debt markets today is for preservation transactions.

“Preservation is the name of the game right now,” says Jeff Englund of Greystone, a Fannie Mac, Freddie Mac, and FHA lender.

Much of Fannie Mae’s and Freddie Mac’s current business is funding loans or providing credit enhancement for bonds for the acquisition or refinancing of existing affordable rental housing properties (e.g., LIHTC, Section 8), including with moderate levels of rehab with tenants in place. In some cases new 9% or 4% housing credits are being used; in other cases the property is being refinanced to take advantage of lower current rates with the notion of a new tax credit transaction down the road.

Fannie Mae’s Bob Simpson and Freddie Mac’s Kim Griffith noted a significant portion of this current activity involves LIHTC properties in Years 11 to 15 of the 15-year tax credit compliance period. These may be situations where the existing general partner is buying out their limited partner with an aim to re-syndicate with new tax credits after Year 15, or is purchasing a non-LIHTC property for an acquisition/rehab project using tax credits for the first time.

In the affordable housing space, Simpson said Fannie Mae’s most popular debt product is its standard 10-year fixed-rate loan product for preservation deals. Also popular, he added, is its seven-year adjustable rate mortgage (7/6 ARM), as well as its program to credit enhance long-term fixed-rate tax-exempt bonds for acquisition/rehab transactions using 4% housing credits.

Similarly, Griffith noted Freddie Mac’s popular cash mortgage programs today for preservation deals, including transactions involving a modest level of rehab, are its 7- to 10-year fixed-rate mortgages and 7-year ARM.

Benefits from Fannie Mae’s and Freddie’s ARM products are a very low floating interest rate and prepayment flexibility.

Freddie Mac and Fannie Mae credit enhance long-term fixed-rate tax-exempt bonds to finance new construction and substantial rehabilitation projects that utilize 4% housing credits. In addition, Freddie Mac credit enhances long-term variable-rate bonds hedged for interest rate and remarketing risk. Griffith indicated that increasingly popular for these offerings, and usually for “80/20” multifamily housing projects, is a Freddie Mac five-year liquidity product that assures that the bonds will adjust weekly in rate and remain outstanding for five years.

Bond Financing

A variety of tax-exempt financing structures are available for new construction or acquisition/rehab projects, said investment banker John Rucker III of Merchant Capital LLC.

He noted that so-called cash-collateralized transactions are still popular. In these, one- to three-year, high-rate tax-exempt bonds are issued that provide extremely low-rate construction financing and minimize negative arbitrage on the bonds during the construction period. Once the project is built and placed in service, the bonds are redeemed and the permanent financing comes from a permanent mortgage – often a HUD 221(d)(4) or 223(f) loan.

There also continued to be issues of long-term, fixed-rate tax-exempt bonds – providing construction and permanent financing – that are credit enhanced, such as by Fannie Mae or Freddie Mac, and are rated by one or more of the national ratings agencies.

Another option for developers and owners is private placements – direct purchases of rated or unrated tax-exempt multifamily housing bonds by banks or by specialized buyers such as funds. Advantages are quick execution and low borrowing rates due to fewer transaction costs.

New York-based Red Stone Partners, for example, buys unrated, non-credit enhanced, long-term, fixed-rate tax-exempt multifamily bonds issued to fund new housing projects or refinance existing multifamily bonds, and places them in funds that have institutional investors. Jim Spound, President of Red Stone Tax Exempt Funding, said the funded mortgages typically have terms of 15 to 17 years and amortization periods of 35 to 40 years. As of early January, the current all-in borrowing rate under Red Stone’s program was in the low 5% range, Spound said.

Standard & Poor’s Corporation has a program under which it rates tax-exempt multifamily housing bonds without credit enhancement.

Outlook for 2013

HUD’s Marie Head said the Department doesn’t plan to make any significant changes to its FHA multifamily loan programs in 2013 nor introduce any new debt products.

Bob Simpson said the same regarding Fannie Mae. Simpson and Griffith indicated that Fannie Mae and Freddie Mac will be focusing in 2013 on further improving the execution period under their programs.

Leonhard predicts, “I think the availability of financing for affordable multifamily housing – the market liquidity, is going to remain really attractive. There’s a lot to choose from: Fannie, Freddie, and FHA are going to be there.” Leonhard felt that taxable borrowing rates may rise a little bit. But he added that tax-exempt rates may fall, due to potential greater demand for tax-exempt bonds from higher-income individual taxpayers whose tax deductions have been curtailed by changes made by the recently passed American Taxpayer Relief Act.