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,” said 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.”
Unlike the 10-year Treasury, 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 much 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 have disappeared, 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 being 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 they were this time last year.
“You’ve seen a gradual erosion of spreads,” said 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.”
4 percent deals
The New Issue Bond Program (NIBP) has 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 starting to gain 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,” said Hansen. “So naturally some of that demand is spilling over into 4 percent deals.”
Tax-exempt bond deals are slowly starting to get more viable, though the new construction side remains challenging. In-place acquisition-rehabs using 4 percent LIHTCs are 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,” said Phil Melton, senior vice president of Charlotte, N.C.-based Grandbridge Real Estate Capital. “I’m seeing a number of Sec. 8 transactions mixing with 4 percent deals, where you’re getting new 20-year HAP contracts.”
Note: For an expanded version of this article, see the upcoming June edition of Affordable Housing Finance.