A creative financing solution has set the table for the future of Colony Park Apartments, a 130-unit affordable housing community in West Palm Beach, Fla.
Built in 2002 with proceeds from tax-exempt bonds and low-income housing tax credits (LIHTCs), the property was purchased out of financial trouble by SCA Properties. The firm, which brought in new management, also wanted to refinance the existing debt on the property.
With Colony Park nearing the end of its 15-year LIHTC compliance period, the owners found a way to take advantage of today’s low interest rates while still preserving the ability to resyndicate the transaction with 4% credits at the end of the initial compliance period in 2017.
SCA Properties was able to achieve both goals with the help of lender Lancaster Pollard and Eichner Norris & Neumann PLLC, a law firm that specializes in bond financing. The first part of the complicated transaction involved the team securing a $10.5 million Federal Housing Administration (FHA) Sec. 223(f) loan.
“The unique part of it is being able to lock in a permanent mortgage rate when still in a record low-interest rate environment for a tax credit deal that’s not going to happen for over a year,” says Brian Coate, vice president at Lancaster Pollard. “It’s a way for a long-term owner to plan for the future. It’s a way to mitigate interest-rate risk today for future deals.”
The team considered other structures for the bonds, but this ended up providing the lowest cost of capital to preserve the asset, according to Coate.
At the same time, the team needed to make sure Colony Park would still be eligible for 4% LIHTC and tax-exempt bond financing upon year 15. In order to qualify for this future financing, the project has to meet the 50% test, whereby at least half of the aggregate deal amount must be financed with tax-exempt bonds. To help facilitate this, current partners formed a new entity that is expected to purchase the project at the end of the 15-year compliance period in early 2017.
After working with the intended municipal issuer of the bonds, Palm Beach County, on passing an inducement resolution for the future bond issuance, Lancaster Pollard helped the new entity obtain a $9 million bridge loan from Bank of America Merrill Lynch on the same day as the FHA loan closing. The bridge loan proceeds were used at closing as a deposit on the future purchase of the project. Lancaster Pollard was also able to provide funds to assure the interim loans were fully cash collateralized and didn’t have clawback provisions.
“All the pieces were put in place so that when the current owner completes their 15-year tax credit compliance period in early 2017, the tax-exempt bonds (expected to be issued by the issuer), the transfer of the project to the new borrower, and the admission of the new tax credit limited partner will all take place simultaneously,” says Kent Neumann, a partner at Eichner Norris & Neumann. “The tax-exempt bonds, when issued, will be used to pay off the bridge loan and be 100% cash collateralized with funds that will ultimately be used to redeem those bonds once the rehabilitation is completed and the project is placed back in service.”
The borrower will use 4% LIHTC equity to cover the rehabilitation cost of the project.
The transfer of the project with the FHA loan in place will allow the borrower to benefit from today’s low rates without waiting for another year to lock its mortgage rate.
Neumann expects to see more deals like this in the future as a growing number of LIHTC properties approach the end of their tax credit compliance and look for ways to lock in permanent financing rates as soon as possible and recapitalize.
This can also allow developers to acquire properties still in their initial compliance period instead of waiting for the 15 years to expire, according to Coate.
Although SCA Properties took a bit of a risk because the transaction is modeled on a tax credit deal that won’t be completed for over a year and had to cover certain costs associated with the financing, the team feels good that the housing tax credit market will remain strong into next year.