The construction debt market has swiftly moved from fear to exuberance over the last year, a trend that should continue in 2012.
A year ago, the strongest borrowers were seeing spreads of 325 basis points (bps) over the benchmark LIBOR, though most deals were at least 50 bps higher than that. And banks were using interest-rate floors of about 4.5 percent anyway, putting a brick wall on negotiations.
But what a difference a year makes. Lenders were quoting spreads of 250 bps over LIBOR as of early November, and there are no more floors in most markets. Lenders don't expect any dramatic change in LIBOR next year—a rate that has proven to be remarkably resilient. In early November, the 30-day LIBOR was just 25 bps, exactly where it was one year ago.
As more banks return to profitability, they've returned to lending. Throughout the credit crisis, the joke was that the only people who could get a construction loan were the ones that didn't need it. But the balance sheet isn't being reserved for the most well-heeled borrowers anymore.
After a few years of heavy caution, there's a tremendous pent-up demand for banks to start getting money out again.
“It's a much more competitive environment than it was last year—banks are coming back into the market in a pretty vociferous way,” says Phil Melton, who leads affordable housing debt production for Centerline Capital Group. “The banks are looking for different ways to get capital out the door, and construction lending is a big hot button for them right now."
But this gold rush isn't being enjoyed in every pocket of the nation—it's still a tale of two cities. The Community Reinvestment Act (CRA) is one of the primary drivers of affordable housing investment and lending in the country, but the legislation has its limits.
The CRA focuses activity on the nation's largest markets, or what's called “CRA hot spots,” one or two areas in each state where financiers fiercely compete.
Many industry stakeholders feel that the law, written in 1977, needs to be updated to reflect today's technology, such as the prevalence of online banking. Online deposits could be coming from anywhere in the nation, yet they increase the CRA requirements for banks only in their brickand- mortar retail locations, artificially inflating the need to lend in those hot spots.
Meanwhile, secondary and tertiary markets continue to beg for attention.
“Those secondary and tertiary deals remain challenging—there's not a lot of competition for them, and they're going to be pricier,” says Steven Fayne, managing director at Citi Community Capital. “Not until there are changes in CRA legislation will you see flyover states access the market in a meaningful way. The idea that the five major banks have to slug it out in New York City is wonderful for borrowers there, but it really hurts the rest of the country."
Federal regulators have been mulling changes to the CRA for the last two years, but so far no changes have been announced. Yet, where would the industry be without the CRA? Beyond banks, the choices for construction debt are pretty limited.
The Federal Housing Administration's (FHA) Sec. 221(d)(4) program offers unbeatable rates and terms, with pricing around 5 percent in early November, an incredible rate for 40-year nonrecourse money. But its deal cycle times are still much too long. A best-case scenario for securing a Sec. 221(d)(4) loan is nine months, though a more realistic timeline is a year, an unworkable delay for most affordable housing developers.
“If developers can find another route," says Jay Blasberg, executive vice president and national production manager of Alliant Capital, “they will find another route."
The FHA has been trying to implement a Tax Credit Pilot Program, whereby tax credit deals would be given the fast track to a green light, much like the agency's LEAN program for health care loans. The sense in the industry is that the pilot will begin next year. At the very least, there's hope that processing times will improve once the FHA finally digests the mountain of business it has received since the credit crisis began.
On the 9 percent tax credit side, Fannie Mae and Freddie Mac are really no help in terms of new construction deals. The 9 percent forward commitment programs at the government-sponsored enterprises (GSEs) continue to be prohibitively costly and nonrealistic, with pricing over 8 percent. On the 4 percent side, though, the GSEs have been busy with forward commitments through the New Issue Bond Program (NIBP).
The NIBP provided another shot in the arm for new construction and rehab deals in 2011, breathing life into the bond market. But the program sunsets in December, leaving the bond market to its own devices in 2012. While there's some talk about state housing finance agencies extending the program by taking some of the unused single-family money and porting it over to multifamily next year, that's all it's been so far, just talk.
While the NIBP, which offered rates below 2 percent, will be missed, there should be enough momentum in the taxexempt bond world to pick up some of the slack. “The market has started to come back in general, but I think the bigger issue is whether there's going to be a depth of tax credit investors that want to do bond deals,” says Melton. “But we also think the private-placement market is coming back and will continue to come back next year."
Still, the tax-exempt bond market for new construction or substantial rehabilitation will have its share of challenges in 2012. Concerns about the lack of available gap financing, as well as the bump up in rates that are inevitable when the NIBP goes away, will likely reserve bond activity to only the nation's strongest markets.
Indeed, capital for new construction and substantial rehab came back in a meaningful way in 2011, and that stream should gain strength and carry the affordable housing industry in 2012 as well.
“As the economy goes, so goes our business, but right now, I see no slowdown—it seems like credit prices are so high that deals are penciling,” says Fayne. “You're still going to see a pretty healthy stream of affordable housing new construction deals next year. We're feeling good about 2012."