Most who work in the affordable housing industry would agree that the low-income housing tax credit (LIHTC) is the most important resource for creating affordable housing in the U.S. today. Since its inception, the LIHTC has financed more than 2.7 million affordable rental homes. Each affordable housing development that utilizes LIHTCs has a 15-year compliance period. When a property reaches the end of that compliance period, its ability to provide affordable units to tenants with incomes at or below 60 percent of the area median income is compromised as units begin to deteriorate and major systems need repair. According to the Department of Housing and Urban Development (HUD), approximately 1.5 million units, in more than 20,000 LIHTC properties, were placed in service from 1995 through 2009, meaning the majority will reach their 15-year mark between now and 2024.
At the end of the initial compliance period for their affordable housing property, developers must decide how to address the rehabilitation needs of a 15-year-old property. Broadly speaking, the three most common options are:
- Refinance. Developers who choose to refinance can take advantage of rate savings or replace potentially maturing debt while also using equity to perform minor to moderate rehabilitation;
- Resyndicate. Reapplying for tax credits can provide repair dollars for a property that requires substantial rehabilitation, but developers can face stiff competition for this limited resource; or
- Sell. In certain circumstances, a developer can dispose of the property by selling either the partnership stake or the property itself.
Assuming that the developer has decided to hold on to their affordable housing asset and the development is not competitive for a new LIHTC allocation, a refinance should be considered. Some developers may be concerned with prepayment penalties on existing permanent debt, which can be substantial. However, by Year 15 the cost-benefit analysis may indicate interest savings coupled with available equity for repairs outweigh any penalty payments. If the property is only in need of minor-to-moderate maintenance and capital needs, a refinance is likely the best option.
Despite persistent predictions of an imminent rise in interest rates, rates still remain below historical averages. As such, developers with a property that is reaching the end of its compliance period in the next six months may want to seek a refinance to lower its interest rates and generate debt-service savings that can be used to revitalize the property. As long as interest rates remain low, developers may find that there is no need to recapitalize with new LIHTCs and, instead, they can accomplish their goals with existing equity in the property coupled with additional cashflow generated from a refinance.
Refinance with FHA
The vast majority of loans insured by the Federal Housing Administration (FHA) are wrapped into a Ginnie Mae mortgage-backed security. This security then carries a AAA rating and is a highly marketable debt instrument which ultimately reduces the cost of financing for the borrower. The fixed-interest rates for FHA programs are some of the lowest available in the market. In addition, FHA insurance programs offer amortizations and corresponding insurance commitments of up to 40 years. The debt is nonrecourse and assumable, providing a borrower flexibility to accommodate future financing or divestiture plans. An overview of FHA programs that can be used to refinance affordable housing properties at Year 15 is below:
- FHA Sec. 223(f) program. The purpose of the Sec. 223(f) program is to provide for the acquisition or refinance of multifamily rental properties. Based on the affordability restrictions associated with the property, the program allows for loan-to-value ratios between 83.3 percent and 90 percent at debt-service coverage levels between 1.11x and 1.20x. For refinance transactions, loans under this program can fund up to 100 percent of the costs to refinance. The term can be up to 35 years and to be eligible for financing under the Sec. 223(f) program, the property must have been constructed or substantially rehabilitated at least three years prior to the date of the application for mortgage insurance. The program allows for the funding of moderate repairs, but has limitations on both the dollar amount, based upon location and number of units, and types of repairs that can be undertaken. Additionally, an initial deposit to the replacement reserve for the future capital needs of the facility can be funded through the mortgage.
- FHA Sec. 223(a)(7) program. The Sec. 223(a)(7) program was put in place to facilitate the refinance of affordable multifamily housing properties that are already financed with an FHA-insured loan. Under this program, as much as 100 percent of the cost to refinance can be borrowed up to the original principal balance of the existing FHA-insured loan. Debt-service coverage is limited to at least 1.05x for nonprofit borrowers and 1.11x for for-profit borrowers. The term of the new mortgage typically cannot exceed the remaining term of the existing mortgage, however the HUD director may approve a term of up to 12 years beyond the remaining term of the existing mortgage (not to exceed original term) if it is determined that the longer term and resulting debt service savings is necessary to ensure the economic viability of the development.
Refinance with Freddie Mac
The Freddie Mac Cash Loan program provides for the refinance of stabilized affordable multifamily properties. Stabilized is defined as 90 percent occupied for 90 days. Typically, the minimum debt-coverage ratio is 1.25x and an 80 percent loan-to-value is required. These thresholds change to a 1.15x debt-coverage ratio and 90 percent loan-to-value with HUD Risk Sharing. The loan may be amortized at a fixed or variable rate over the maximum term of 30 years. Freddie Mac also offers other Targeted Affordable Housing program loans for preservation of 9 percent LIHTC developments with at least seven years remaining in the initial compliance period and rehabilitation of properties with new LIHTCs. These loan products are assumable.
Refinance with Fannie Mae
The Fannie Mae Multifamily Affordable Housing program is a versatile and timely financing option with competitive pricing and term flexibility. There is a $1 million minimum loan size through the program and a minimum term of five years. Amortization of the loan cannot exceed 30 years, loan-to-value is limited to 90 percent, the debt-coverage ratio can be no lower than 1.15x, and the interest rate is determined as a spread over the corresponding U.S. Treasury security (as compared to the term of the loan) adjusted for loan term, debt-service coverage and loan-to-value ratio.
When approaching Year 15 and seeking to refinance, a thorough understanding of the options available can help ensure that a developer makes the best decision for not only the financial future of the facility, but for the well-being of the residents as well.
Lisa Vecchietti is a vice president with financial services firm Lancaster Pollard. She is based in the firm’s Austin, Texas, office and works with clients in Arkansas, Louisiana, New Mexico, and Texas. She has 11 years of affordable housing experience.