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APARTMENT FINANCE TODAY • November/December 2009

Transit-oriented development and workforce and student housing are poised to capture a tidal wave of Echo Boomers.

BY jerry ascierto

The conventional wisdom in the multifamily industry is that rents and occupancies are declining, and that nothing is getting built these days. And that’s true, as owners struggle through lean times and financiers continue to hunker down and wait out the recession.

But three unconventional sectors—student housing, transitoriented development (TOD), and workforce housing—are poised to become viable alternatives to standard market-rate developments.

While these sectors have also been affected by the recession, demographic trends suggest that all three will play an increasingly larger role in the industry over the next decade. And all three sectors hinge on the choices of coming generations.

Student housing has shown a resiliency throughout the recession due to higher enrollment trends. And a younger workforce is increasingly migrating toward cities, where TODs are pointing the way to a new urban future, providing a natural fit for the growing workforce housing sector. Despite their promise, however, none of these sectors are without their challenges—from both a logistical and financial standpoint.

All Aboard

School Days: In the fall, Walker & Dunlop closed a $34.4 million Fannie Mae acquisition loan for the 241-unit Cottages of Lubbock located near Texas Tech.
(Photo: Campus Living Villages)

U.S. Department of Housing and Urban Development (HUD) Secretary Shaun Donovan has strongly signaled his support for TODs as part of a larger “smart growth” initiative that will see increasing federal resources made available for communities located near transit.

One of Donovan’s first moves was to strike a partnership with the Department of Transportation to work on spurring TOD developments. And Donovan tapped Shelly Poticha—former CEO of Reconnecting America, a nonprofit that focuses on the link between transit and community development—to serve as senior advisor for sustainable housing and communities.

Like “workforce housing,” the definition of a TOD varies. Some developers cite proximity to a transit station as the qualifying factor, while others only consider communities built in conjunction with transit agencies as the “pure-play” TOD.

While TODs can lower a renter’s transportation costs and offer environmental benefits, one of the best reasons to consider TODs is long-term value. Multifamily buildings in close proximity to transit are more valuable than non-TOD developments, according to a report by the Center for Transit-Oriented Development, which distilled the findings of dozens of research reports conducted over a 30-year period. Each study showed higher multifamily property values near transit, though the increases ranged wildly. A 2002 study by UC Berkeley found a 45 percent increase in multifamily property values for apartments located a quarter-mile from Santa Clara County’s Light Rail system. On the lower end, a 2002 study by the Urban Land Institute found a 4 percent value increase for apartments located within a half-mile of San Diego’s Trolley System.

Developer High Street Residential and REIT AvalonBay Communities are two TOD trailblazers. Since 2002, AvalonBay has focused its TOD efforts on the West Coast, beginning with Dublin Station, a community about 150 yards from the local Bay Area Rapid Transit (BART) station. “We found that a third of our residents used BART on a regular basis, which told us that it’s a pretty compelling amenity,” says Stephen Wilson, senior vice president of development at Alexandria, Va.- based AvalonBay.

Last July, the firm broke ground on Avalon Walnut Creek, a $400 million mixed-use project in a public/private partnership in Walnut Creek, Calif. About $135 million for the housing came from tax-exempt and taxable bonds allocated by the state, which covers most of the $160 million housing price tag.

AvalonBay often partners with transit agencies, counties, and redevelopment agencies on TODs. At Dublin Station—and another development under construction in Pleasant Hill, Calif.—AvalonBay was tapped to build out the infrastructure and replacement parking structures. “Many of these agencies are financially challenged right now, and they’re looking for the private sector to do a lot of heavy lifting,” Wilson says. “It’s a high-barrier, long-term process. You’re building for two years before you lift a shovel on the apartments.”

The involvement of municipalities often means that a portion of the units will also be set aside as affordable housing. At Pleasant Hill, the company is reserving 20 percent of its units (about 85 units) for those earning up to 30 percent of the area median income (AMI).

Unfortunately, few programs exist to help TOD developers provide affordable or workforce housing. California allocated $285 million from 2007 to 2009 to a TOD Housing Program, which uses loans and grants to encourage housing development within a quarter-mile of transit stations. In Portland, Ore., a TOD property tax abatement helps to reduce operating costs for affordable housing owners and developers through a 10-year property tax exemption. And earlier this year, Denver created a TOD fund with a goal of creating or preserving 3,000 affordable TOD units over the next decade.

Still, in some cases, affordability requirements can also be a deal breaker. “If they try to force an unrealistic set-aside, a lot of times we won’t do the project,” says Art Lomenick, managing director of Dallas-based High Street Residential.

High Street, a subsidiary of Trammell Crow Co., was created six years ago and has since delivered or is working on a dozen TODs in various Texas markets, as well as in Denver, Atlanta, the Washington, D.C., area, and Pasadena, Calif.

Earlier this year, the company opened the first phase of Midtown Commons in Austin, Texas, a mixed-use development that connects to a train station and a bus station. The first 300 rental units, as well as 60,000 square feet of office and retail space, were delivered in March, timed to coincide with the opening of the train station. But the trains aren’t yet running to the site, which has stalled the leasing of the retail and office components.

High Street had to work with the city on a zoning ordinance and with the transit agency to locate and design the train station. While the transit agency designed the station, High Street built a transit plaza, a public gathering area that’s often a feature of pure-play TOD developments.

All told, the development process is probably three times as long as a conventional deal. “That’s why it’s taken so long for American developers to get used to it; it’s difficult, long, and risky,” Lomenick says. “But as the public sector demands it more, then it will really explode. But that could be a decade away.”

Given the complexity of pure-play TOD deals, developers looking to break into this space would do well to start with proximity-based TODs. “The first thing is to really understand what the city’s goals are and their willingness to build and maintain the public realm,” Lomenick says. “I would be careful doing one building next to a train station if there’s no plan for the neighborhood area around it.”

Working It

Workforce housing is another term without a solid definition. Many see this segment as serving those earning from 60 percent to 115 percent of the AMI. A pure-play workforce housing development is one in which a major employer works with the developer on the community’s construction. Elsewhere, “workforce housing” is often used as a marketing term for new Class B properties.

While many federal and state resources exist for apartments serving residents earning below that 60 percent AMI line, there are only scant resources available for workforce housing.

“If you’re going to do workforce housing, you’re going to have to be extraordinarily creative,” says R. Lee Harris, president of Overland Park, Kan.-based developer Cohen-Esrey. “And you’re going to have to have the patience of Job.”

Forging long-term partnerships with local employers is a great step: The developer agrees to build the housing, and the employers agree to subsidize it, either by direct ownership, rent subsidy, or an equity stake. Getting municipalities involved—to purchase city-owned land for a nominal fee or to pursue property tax and sales tax abatements, for instance—is also a good strategy, since it may open up the ability to get Community Development Block Grant funds.

Federal and state historic tax credits can be effective tools, and some states also offer historic preservation grants. And the FHA’s Sec. 221(d)(4) construction/permanent loan program is a great source of debt for such developments, offering 1.11x debt service coverage ratios (DSCRs) and 90 percent loan-to-value (LTV). Another source to offset costs are energy-efficiency tax credits and weatherization grants from HUD. The energy-efficient commercial building tax credit offers up to a $1.80 per square foot tax deduction, and the energy investment tax credit allows up to a 30 percent tax credit to help offset the cost of purchasing energy-efficient systems. “You start putting in these various programs, and you can defray a significant portion of the expense,” Harris says.

Enterprise Community Partners recently took a step toward providing debt for workforce housing. In September, the Columbia, Md.-based company expanded its Fannie Mae DUS license—which previously only covered affordable housing deals—to help fund developments that serve up to 115 percent of the AMI.

“That middle spectrum, which falls between affordable and higher-end properties, has much fewer financing options,” says Lamar Seats, a senior vice president in Enterprise’s multifamily mortgage finance program.

Enterprise has also been active in trying to get more workforce housing off the ground through a partnership with the Urban Land Institute’s Terwilliger Center for Workforce Housing that began about two years ago. Melinda Pollack, who leads the initiative in Denver, says that they started by focusing on TODs since Denver is undergoing a large public transportation system expansion. In Denver, households earning $55,000 or less spend almost 60 percent of their income on housing and transportation costs.

Pollack and her team started a sitemodeling program, which worked with three market-rate developers to show how workforce housing units could pencil out in the capital stack of their upcoming TODs. The only problem was the units weren’t penciling out. “When the market really fell out from under us toward the end of last year, we decided to suspend the program because we were finding that nothing really worked,” Pollack admits.

Head of the Class

Student housing has been a bright spot for the multifamily industry this year: Both Fannie Mae and Freddie Mac are on pace to increase their student housing volume this year.

Fannie Mae entered the student housing industry in 2001. But it wasn’t until last year that Freddie Mac rolled out its dedicated student housing mortgage, processing about $580 million in 2008. The company is on a similar pace this year.

“They came into the space and put slightly more aggressive loan offerings than Fannie Mae,” says Bill Hyman, executive managing director at New York-based Centerline Capital. “You have greater flexibility on Freddie Mac’s part on underwriting and university size.”

The classification of student housing deals varies. Fannie Mae considers a student housing property as one where more than 20 percent of the occupants are students. Freddie Mac sets the bar higher, at 50 percent. Yet Freddie is more willing to consider funding projects at smaller schools, those with at least 8,000 students, while Fannie Mae targets schools with enrollments of 20,000 or more.

CWCapital recently ran up against Fannie’s 20,000-student requirement. The company was working on a deal for a moderately-leveraged student housing property near a university with 17,000 students. The sponsor was very strong, and the property had a great history, but Fannie Mae said it doesn’t want the deal because the school has less than 20,000 students. So the deal went to Freddie Mac.

A variety of factors will determine which GSE is the best fit for a particular student housing deal. “The bottom line is you’ve got to ask both of them and see what they’re going to come back with,” says Will Baker, a vice president at Bethesda, Md.-based Walker & Dunlop.

In late September, Baker closed a $34.4 million Fannie Mae loan for the acquisition of the 241-unit Cottages of Lubbock, located near Texas Tech. The seller was Birmingham, Ala.-based Capstone, and the buyer was Houston-based Campus Living Villages. According to Baker, Fannie Mae was more flexible on this particular deal. At issue was the project’s age: It was completed in July, but Freddie Mac wanted to see some rental history, at least a year, on the property.

The Washington, D.C.-based National Multi Housing Council recently took up the question of whether student housing was really recession-proof in a survey released in September. The survey looked at freshman application and total enrollment data across 63 of the nation’s biggest colleges and universities. The verdict? Enrollments are up or flat at most universities, except for those in states whose education budgets have been slashed substantially. Of the 63 schools surveyed, 64 percent saw their total enrollment rise in the fall semester.

“There are states where the marketrate business is very soft, but the student business is very solid,” says Frank Lutz, a vice president at Washington, D.C.-based Fannie Mae.

Yet, Fannie and Freddie have reined in their underwriting on student housing deals this year. Freddie raised its DSCR to 1.35x in late August and also moved the LTV ratio to 75 percent earlier this year. Fannie has similarly tightened up: The new ceiling is 75 percent LTV, and partial interest-only periods are not offered.

So, why would lenders approach the sector with trepidation? Part of the reason is a lack of current, reliable data.

“The theory that this segment is recession- resistant makes sense on paper and in theory,” says Mitch Kiffe, vice president of sales at McLean, Va.-based Freddie Mac. “But there is still a lack of visibility with what’s really going to happen. The industry broadly needs to get better at collecting and disseminating data.”