As the tax credit allocation season gets under way, developers will find a much friendlier market for construction debt than this time last year.
Increased competition in the banking sector has sent all-in interest rates down across pretty much every market. But in high-barrier major markets, Community Reinvestment Act (CRA)-motivated banks are growing particularly aggressive again trying to win deals.
“As more banks return to profitability, so too have they returned to lending," says Kyle Hansen, an executive vice president in the commercial real estate group at Minneapolis-based U.S. Bank. “We've seen significant competition in the coastal markets as well as the major metros in the rest of the country. Pricing has probably come down at least 50 basis points (bps) over the last year."
The London Interbank Offered Rate (LIBOR), which is used as a benchmark in pricing construction loans, has stayed consistently low for a couple of years. But a LIBOR rate of 30 bps didn't do tax credit developers any good last year— most lenders were instituting interest rate floors of 1 percent or 2 percent.
On top of that, spreads as high as 400 bps weren't uncommon, leading to all-in rates that could push 6 percent. But today, interest rate floors are disappearing, especially in primary markets, and spreads over LIBOR are ranging from 250 to 325 bps, leading to all-in rates in the 3 percent to mid-3 percent range.
Interest rate floors are still instituted in many secondary and tertiary markets, but most industry veterans expect those to fall away as competition increases. Tertiary markets and rural areas—anyplace outside of the big CRA footprints— continue to have a challenging time finding well-priced construction debt. But the bottom line is, developers are in a stronger position to negotiate construction debt than this time last year.
“You've seen a gradual erosion of spreads,” says Steven Fayne, managing director for New York-based Citi Community Capital. “Last year, lenders had the upper hand for the first time in awhile, and now the competition is beating it back again."
The relationship role
As the multifamily industry builds on its recovery, many banks have gone back to an old model: Relationships mean everything, once again. Banks are much more inclined to lend construction debt to developers that do all their banking with them.
On the flip side, this relationship can benefit the borrower in the early innings of a cycle as well, allowing better access to, and better pricing of, construction capital.
“This last financial downturn has helped banks and developers alike realize that long-term relationships are key. Developers are more concerned with access to capital than the last 25 bps in pricing,” says Hansen. “And banks are willing to price loans more favorably if they enjoy a broad-based relationship with the developer."
When the market became too overheated in the last cycle, many larger banks threw this dynamic aside. Deposits were still important, of course, but sometimes not as important as winning deals in major metros and filling up their CRA buckets.
“The larger banks became very focused on building their real estate portfolio, their loan base—it was a different dynamic,” says Phil Melton, managing director and head of affordable housing debt at New York-based Centerline Capital Group. “Now, across all the spectrums, it's a critical component."
But not every construction lender focuses on bundling their services. Consider Citi. The community development arm of Citibank is housed in the company's municipal securities division, not in the consumer banking division. So Citi doesn't emphasize cross-selling the way many other banks do and is open to one-off deals. “We're an open shop,” says Fayne. “We don't do any tying."
4 percent deals
The New Issue Bond Program (NIBP) helped many deals get off the ground last year and this year, but the program is ending in December and the pipeline is slowing down. It's now up to the private sector to pick up the slack, and there are some early positive indications that investors are gaining interest in 4 percent low-income housing tax credit (LIHTC) deals.
“A lot more equity is being raised in 2010 and 2011 than in the couple years prior. All of that equity is having a hard time finding a home in 9 percent deals,” says Hansen. “So naturally some of that demand is spilling over into 4 percent deals."
Even so, there hasn't been much traction on the new construction side of tax-exempt bond deals. In-place acquisition- rehabs using 4 percent LIHTCs are much more preferable for many lenders and investors, especially since there's no lease-up risk involved.
“The new construction side is still tough, unless you're doing NIBP, but acquisition-rehab is becoming much more in vogue,” says Melton. “I'm seeing a number of Sec. 8 transactions mixing with 4 percent deals, where you're getting new 20-year HAP contracts."
As federal regulators mull updating CRA legislation, lenders are hopeful that meaningful changes are afoot. Currently, CRA rules focus on “assessment areas," and for the largest banks, these areas are confined to one or two parts of each state, called “CRA hot spots.” This dynamic leaves many secondary and tertiary areas in the lurch.
The law, written in 1977, needs to be updated to reflect technology. For instance, CRA requirements are based on where banks take their deposits, yet, online deposits are now much more commonplace.
And online deposits coming from anywhere in the nation count toward a bank's retail footprint, the bricks and mortar branches. This artificially inflates the CRA requirements in those “hot spots."
Why should borrowers care? Because a change in how these areas are assessed would allow banks to more evenly distribute their lending across more markets.
“We play primarily in primary markets, and if CRA gets changes and banks have the ability to spread out their lending, then those secondary markets start coming into play, and borrowers will have a better time of it in those ”˜flyover' states,” says Fayne.