FINANCE

FREDDIE MAC

Rehab Takes Center Stage in 2008

BY JERRY ASCIERTO

AFFORDABLE HOUSING FINANCE • FEBRUARY 2008

Acquisition-rehabilitation deals are expected to take center stage in 2008, and Freddie Mac is hoping to share a piece of the spotlight.

The government-sponsored enterprise (GSE) began offering two new acquisition products in October, one for those seeking light upgrades and another for those looking to do more substantial rehabilitation on existing multifamily properties.

A perfect storm of capital providers growing more conservative in their underwriting and high land and construction costs will force many developers to favor repositioning deals over new construction in 2008.

“A lot of developers are seeing acqrehab as a more cost-effective way to produce more affordable housing, and we’re definitely seeing an awful lot of interest in those products,” said Tom Booher, executive vice president at PNC MultiFamily Capital.

Freddie Mac began working on the products in the fourth quarter of 2006, when competing lenders were mounting an aggressive challenge for such deals. “We think that with these acquisition-rehab products, we will take those loans off the street sooner than anybody else, at what appear to be very aggressive terms,” said Mike May, Freddie Mac’s senior vice president of multifamily sourcing.

Bridge lenders were aggressively pursuing acq-rehab deals at the time, making loans for the shorter-term “as is” portion of the deal and then providing the permanent mortgage themselves. Or, as was often the case back then, borrowers would procure conduit loans for the longer-term portion of the loan once the property was stabilized. Either way, Freddie Mac was losing the business.

The new products basically combine a bridge loan with a permanent loan. “Freddie Mac figured out a way to tap into that bridge market and create in essence a bridge loan product to roll into their permanent loan product,” said Phil Melton, senior vice president at Grandbridge Real Estate Capital. “Freddie Mac is setting itself up to become its own bridge loan feeder with these products.”

The products should offer developers several advantages over other bridge loan offerings on the market, especially when coupled with Freddie Mac’s pricing structure.

Freddie Mac sets its interest rates using the Treasury bills. By contrast, most bridge lenders use the London Interbank Offered Rate (LIBOR) as a benchmark. As of mid-December, Freddie Mac was quoting typical acquisition-rehab deals at around 180 basis points over the Treasuries, adding up to pricing in the low-6 percent range. Bridge lenders in that same period were adding as much as 350 basis points to LIBOR for such deals, leading to rates in the mid- to high-8 percent range, industry watchers reported.

But the terms of the products themselves should also catch a developer’s eye. Since rents for most acq-rehab deals are low during the first portion of the loan, Freddie Mac has included an interest-only option for the “as is” phase of each loan. The interest-only options feature lower debt-service coverage ratios (DSCRs) than the 30-year permanent loan portion of the financing package, as low as 1.10x and 1.15x, respectively.

Under the hood

The first of the new products, known as an Acquisition Rehabilitation Mortgage, is aimed at substantial rehabilitation efforts such as those in repositioning deals. The product is capped at $30,000 per unit or 30 percent of acquisition cost, with a minimum cost of $10,000 per unit.

The Acquisition Rehabilitation Mortgage offers borrowers a loan-to-cost ratio of up to 80 percent, with a DSCR of 1.10x for the interest-only part of the loan in the “as is” phase, and 1.15x with a 30- year amortization schedule once the property is stabilized. This product goes beyond new finishes and fixtures: It’s aimed also at funding more significant improvements to roofing, boilers, brick pointing, or parking lots.

The Acquisition Rehabilitation Mortgage is a good fit for high-cost, high-occupancy coastal markets like New York or Los Angeles, Booher said. With a minimum cost of $10,000 per unit, the product may not play well in more mainstream markets where strong rent growth is not in the cards.

The second product, Freddie Mac’s Acquisition Upgrade Mortgage, is aimed at cosmetic improvements, or light rehabilitation, which could include deferred maintenance items. The product is capped at either $10,000 per unit or 20 percent of the acquisition cost, with a minimum cost of $3,000 per unit.

The light rehabilitation funded by the product is generally limited to upgrades to interior or exterior finishes, such as new kitchen and bathroom cabinets and fixtures. The product offers borrowers financing of up to 86 percent loan-to-value and 80 percent loan-to-cost. The DSCR is 1.15x for the interest-only portion of the loan (in the property’s “as is” phase), and converts to 1.20x with a 30-year amortization schedule once the property is stabilized and leased.

The upgrade product has a broader applicability than the Acquisition Rehabilitation Mortgage and fits well with low-income housing tax credit properties undergoing moderate rehabilitations of $3,000 to $7,000 per unit. Many properties built in the 1980s and early ’90s will continue to come out of their compliance periods and onto the market in 2008, and many of those properties only need light rehabilitations, according to Grandbridge’s Melton.

Small loans pilot program update

Lenders in Freddie Mac’s Program Plus delegated network expected the company to test a new approach to small loan production through a pilot program beginning in the fourth quarter of 2007, as reported in the October 2007 issue of AFFORDABLE HOUSING FINANCE.

The program would have offered better terms and quicker deals by delegating more authority to lenders. But the pilot program has been put on hold as the company deals with the increased production it has seen in the wake of the conduit meltdown.

“We were just about ready to push [the small loan program] forward and go live, and we’ve put that on hold,” May said. “We’ve redirected those resources just to process the opportunity in front of us.”