The good news is, debt for affordable housing is expected to remain readily available next year. The bad news is, other factors, such as rising construction costs and interest rates, will make many transactions increasingly difficult to pencil out.
That’s the message from finance leaders as they look ahead to 2016. They’re carefully eyeing several trends that could alter financing conditions next year.
“Rising construction costs are making transactions less feasible, especially when you’re talking about a property that’s being financed with tax-exempt bonds and 4% low-income housing tax credits [LIHTCs],” says Frank Baldasare, senior vice president at Walker & Dunlop, a commercial real estate finance company.
These deals have typically required a few sources of subordinate debt to bridge the gap between the first mortgage and the tax credit equity, but the budgets for many subordinate programs have been cut at the federal and state levels.
“The gap is still there and getting bigger, but now there are fewer sources of subordinate debt to help fill the gap,” Baldasare says. As a result, developers will need to be increasingly careful about construction costs.
In the past year, high LIHTC prices have helped offset the increased costs. But, at some point, there could be a possible correction in equity pricing, notes Baldasare.
Interest rates are also expected to finally start to rise.
“The message may be: Now is a good time for those who have an adjustable rate to think about switching to a fixed rate,” says Benson “Buzz” Roberts, president and CEO of the National Association of Affordable Housing Lenders (NAAHL).
“If interest rates rise, we want to keep an eye on what happens with tax-exempt bond rates,” he says. “Will they continue to be upside down as they have been for several years, or will higher rates mean that tax-exempt bonds now become more competitive?”
Developer R. Lee Harris, president and CEO of Kansas City–based Cohen-Esrey Real Estate Services, has been working on more 4% LIHTC and bond transactions, an area he expects to pursue further in 2016.
He and other developers also will still have to take a multilayer approach to financing, assembling several sources of funding for each project. “There’s no magic bullet out there,” Harris says.
At the same time, demand for affordable housing will be pushed by a strong multifamily housing market.
Apartments are expected to show consistent rental rate growth above the 20-year average of 2.7%. Rents are expected to rise by 4.6% this year and then 3.5% in 2016, according to the latest Urban Land Institute Consensus Forecast, which is based on a survey of the real estate industry’s top economists and analysts.
Apartment vacancy rates are expected to rise slightly, to 4.8% next year and 5% in 2017, according to the forecast. These figures remain below the 20-year average.
Paul Woodworth, president of SunTrust Community Capital, also, is keeping an eye on the supply of market-rate apartments coming on line. “We think the fundamentals for market rate are still strong on a global basis, but there are some markets where we’re starting to see some overbuilding,” he says.
That has an effect on the affordable housing market. If there are high concessions on the market-rate side, such as two or three months of free rent, then those apartments can start competing with affordable apartments.
“For the most part, the market-rate product coming on line is absorbing,” Woodworth says. “We’re just cautious. There’s a lot of capital in that space today, a lot of inventory coming, and it looks like there’s quite a bit in the pipeline.”
Banks, agencies, investors, developers, and owners will all be paying increased attention to affordable housing, according to Robert Likes, national manager of community development lending and investment at KeyBank.
In addition to construction loans, he expects there to be more equity bridge loans and more bridge-to-resyndication loans for Year 15 deals. The bridge-to-preservation deals will allow a developer to acquire a property, do a short-term bridge loan, and then have time to create a plan to bring in new financing such as 4% tax credit equity to resyndicate and preserve a property.
“Affordable housing is becoming a major asset class as demand continues to grow,” Likes says. “It makes a lot of sense to see the focus continue to get ramped up and elevated.”
Government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac will continue to fight with the Federal Housing Administration (FHA) and banks for deals next year.
“Fannie and Freddie are being pretty aggressive,” says NAAHL’s Roberts. “I expect that to continue. It’s helpful that loans for affordable multifamily don’t count against the GSEs’ multifamily cap,” he says. “They’ve also been focusing more on smaller-balance loans.”
Baldasare agrees there has been a lot of activity coming out of Fannie and Freddie. “We’re seeing enhancements with existing programs, and there have been new programs that have come out,” he says.
For example, Freddie Mac came out with its tax-exempt loan program in 2014, which was originally aimed at properties that had income in place and could immediately fund the tax-exempt loan at closing. Now, the program can be an “unfunded forward” for up to 36 months for new-construction projects, according to Baldasare.
“They have that feature now, and I think that’s gaining traction in the markets, especially when used in conjunction with their Bridge-to-Resyndication loan program,” he says.
At Fannie Mae, officials have been credit-enhancing the GSE’s tax-exempt bond program with its mortgage-backed security (MBS) instead of doing a cash-collateralized model. The hope is that investors that have typically bought taxable MBSs will see a greater benefit in buying a tax-exempt bond that’s credit-enhanced by their MBS, resulting in receiving tax-exempt income and increasing the MBS investor’s tax-equivalent yield, says Baldasare.
This is another program that could gain momentum in 2016.
“We are excited for 2016, as we will be refining and expanding both our taxable and tax-exempt products and building upon GSE relationships to access new and enhanced products available to affordable housing developments,” says Maria Barry, community development banking executive. “We are also growing our FHA multifamily business with a particular focus on preservation opportunities. At the same time, we are expanding opportunities to provide term financing for charter schools available direct and through institutional partners.”
At the FHA, officials recently announced the Small Building Risk Sharing initiative, which invites certain lenders to partner with the agency to provide long-term fixed-rate lending products to multifamily property owners with mortgages of $3 million, and up to $5 million in high-cost areas.
In return for assuming 50% of the risk, approved lenders in the program underwrite and service the loans subject to minimum standards, which can reduce processing times relative to traditional FHA mortgage insurance programs. The FHA’s willingness to assume half the risk can free up lenders’ balance sheets and allow them to increase their lending activities without an additional federal subsidy or new regulations.
High-capacity Community Development Finance Institutions (CDFIs), other nonprofit lenders, public and quasi-public agencies, and for-profit lenders approved as FHA Multifamily Accelerated Processing lenders were invited to participate in the program.
“The main idea is a lender can utilize its own underwriting policies and do its own underwriting and processing in return for taking on a share of the credit risk,” Roberts says. “It can be quite attractive for smaller loans that can’t carry the time and expense of going through FHA underwriting and processing.”
The benefits are likely additive. So, it may be more advantageous for borrowers looking for a long-term fixed rate rather than a short-term or adjustable-rate loan, Roberts says.