After a depressing 2009, the affordable housing industry needed some cheering up. And several encouraging trends did emerge this year.
Construction financing got a little more accessible. Interest rates on immediate fundings hit historic lows. Equity investors began to re-engage the low-income housing tax credit (LIHTC) market. And some tax-exempt bond deals started to pencil out again.
But in many ways, the federal government held the market together. Stimulus programs like the Tax Credit Exchange Program, the Tax Credit Assistance Program (TCAP), and the New Issue Bond Program (NIBP) had a tremendous influence on the volume of deals that were able to close in 2010.
The government acted as a rainmaker for a parched landscape. And the industry seemed to improve bit by bit, a little more each month as the year progressed.
That slow progress is expected to continue next year, as interest rates on permanent debt remain low, access to construction debt improves, and the NIBP continues to fuel more bond transactions.
“We're making incremental progress off the bottom,” says Kim Griffith, vice president of multifamily affordable sales and investment at McLean, Va.-based Freddie Mac. “It foreshadows a year that is maybe one step better, but not radically better.”
But it's a precarious state. With TCAP set to expire at the end of December—and questions about whether the tax credit exchange will be extended into 2011—many wonder whether the industry is ready to take off the training wheels and ride on its own.
“Absent more legislative intervention, you're going to see another significant disruption in the affordable housing world in late 2011 and 2012 because gap financing is going to dry up,” says Tim Leonhard, who heads the affordable housing debt platform of St. Paul, Minn.-based Oak Grove Capital. “As soon as that soft money is gone, deals are going to be incredibly difficult to get done.”
So, the industry enters 2011 like a tightrope walker nervously looking down to make sure the safety net is still below.
The government's influence is even greater if you consider Fannie Mae and Freddie Mac as extensions of federal housing policy. Together, with the Federal Housing Administration (FHA), the agencies continued to fuel the affordable housing debt market this year. And in the process, all three made radical changes to the way they approach deals.
In a move to refocus on its core mission, the FHA changed its underwriting criteria in the 221(d)(4) and 223(f) programs to make them less favorable for market-rate deals, leaving affordable transactions largely unchanged and, in some cases, with better terms.
“The FHA is really attempting to incentivize subsidized projects,” says Nick Gesue, a senior vice president and director at Columbus, Ohio-based Lancaster Pollard. “Anything that has a LIHTC setaside is basically the same, and if you're 90 percent subsidy or better, you can borrow more under the same program than you could before.”
Fannie Mae reorganized its affordable housing division, centralizing its operations to speed up process times and enact more consistency in credit decisions. In the past, affordable deals were processed in a more regional manner, which sometimes led to inconsistencies in the way deals were underwritten.
And toward the end of 2010, Freddie Mac began offering immediate fundings through its securitized Capital Markets Execution (CME) program. The CME program will allow Freddie Mac to offer lower rates on preservation deals than it could for much of 2010. But Freddie Mac also had to transition its Targeted Affordable Housing network of lenders from a delegated to a prior-approval model as a result, slowing down processing times.
All three agencies say that preservation deals will be their focus in 2011. And the rates being offered on immediate fundings are expected to stay low in 2011.
The FHA was quoting all-in rates of 4.25 percent through its 223(f) program in late October, while the government-sponsored enterprises (GSEs) were coming in at around 5 percent. Still, it typically takes the GSEs two months to turn around a deal, while a 223(f) loan could take five months.
Freddie Mac made one underwriting change this year that should increase its competitiveness on preservation deals in 2011. The agency began allowing properties with long-term Sec. 8 contracts, and loan terms of 10 years or more, to use above-market Sec. 8 rents when sizing a loan. In the past, underwriters had to use the lowest of LIHTC, Sec. 8, or market rents, but this new approach allows for higher proceeds. Fannie Mae is considering a similar change for 2011.
Duty to serve
Fannie Mae and Freddie Mac will see some changes to their affordable multifamily divisions next year through the “Duty to Serve” provisions in the Housing and Economic Recovery Act of 2008. The bill calls for the GSEs to increase liquidity for low-income housing through manufactured housing, affordable housing preservation, and rural markets.
At press time, the specifics were still in flux as the GSEs readied plans and awaited approval from their conservator, the Federal Housing Finance Agency. But the focus on underserved markets suggests that the agencies will strike new relationships and expand their network of affordable housing lenders to extend their reach.
“It might be in smaller markets, it might be originated with smaller lenders,” says Griffith. “Part of our focus is going to be working with new lender sources of business to find ways to comply.”
A wave of bond business
Though Fannie now offers a faster process, Freddie Mac seems to be offering the best underwriting and rates on many executions, such as taxexempt bond credit enhancements.
The Treasury Department's NIBP made a big splash this year. The program— a collaboration between the Treasury Department, the Department of Housing and Urban Development, and the GSEs—gave state and local housing fi- nance agencies the ability to provide very low-rate debt on fixed-rate bond deals.
And Freddie Mac has been on the receiving end of much of that business, credit- enhancing about $175 million in bonds though September, with a large wave of new business in the fourth quarter. In fact, Freddie has been so inundated with business in the fourth quarter that it began asking its lenders if they could hold off on some deals until the new year.
“Freddie came out so aggressively with their terms,” says Leonhard. “And for the past three or four years, Freddie was the only one doing variable and doing 35- or 40-year amortizations. People forgot about Fannie as an option.”
Things are getting a little better for 4 percent deals in the private sector. About a quarter of Freddie's bond credit enhancements are conventional, not going through the NIBP program.
For the last several years, borrowers heavily preferred Freddie Mac's variablerate execution; it was much cheaper than what was being offered on the fixed-rate side. But due to Freddie Mac raising its liquidity fees, and the falling yield on the 10-year Treasury, fixed-rate executions are now running neck and neck with variable. That trend is expected to continue in 2011.
“The end market for tax-exempt bonds is improving, and I think that's going to drive down the coupon to a point where they do remain competitive,” says Gesue. “The appetite for tax-exempt fixed-rate deals is going to be an area of opportunity in the coming year.”
As the banking sector continues to lick its wounds and return to health, the access to construction debt should also slowly improve next year.
The largest banks continue to lend, yet are often more interested in funding deals in which they are also the equity investor. Indeed, the availability of construction debt is driven by the Community Reinvestment Act (CRA). In the strongest markets, it never really went away—but it's still an endangered species in secondary and tertiary markets.
The strongest borrowers were seeing spreads on construction loans of 300 to 350 basis points over LIBOR in late October, but most deals were 75 to 100 basis points higher than that, often with interest-rate floors around 4.5 percent.
Unlike some of its competitors, Citi Community Capital doesn't tie its construction debt to its equity investments. The company also stopped using interest rate floors on its construction loans.
“We will compete fiercely on pricing, but what we won't loosen is our underwriting standards,” says Steven Fayne, a managing director at Citi. “We're more than willing to do debt alone, without our equity. But if we need equity to attract the debt, we have it, and we'll use it.”
Though the FHA offers great rates and terms through the 221(d)(4) program, it's inefficient for tax credit deals. The first issue is that permanent loans for 9 percent deals are often quite small, and given the overhead it takes to make and service a (d)(4) loan, most FHA lenders prefer deals over $3 million. But processing time is the main issue.
“The question is, does it make economic sense to go through essentially a year's wait to get HUD on board?” says Phil Melton, who runs the FHA platform for Charlotte, N.C.-based Grandbridge Real Estate Capital. “If they come up with a mechanism for expediting those deals, then OK, maybe there's a possibility. But until they do that, people just don't have a year to wait.”
And forward commitments from the GSEs for 9 percent transactions are basically a nonstarter. Rates on GSE forwards fell in 2010 from the mid-9 percent to the mid-8 percent range. But the lower rates are mainly due to the yield on the benchmark Treasury falling this year, as spreads remain 600 to 650 basis points over the 10-year Treasury.
Relief on forward rates isn't expected any time soon. There has been talk in the industry that Fannie Mae is thinking of charging a higher rate lock fee—currently, an unfunded forward charges 3 points up front, and funded forwards charge 2—to help bring the rates down.
“They're worried about a deal not delivering, so they're adding a lot of basis points to cover that risk, as well as the unpredictability of where rates are going to be in three years,” says Fayne. “Those rates tend to be in the 8s, and that just results in a gap in your financing.”
The past year was markedly better than 2009, and the market's momentum will likely be maintained at least through the first half of 2011. Yet, the sunsetting of TCAP—combined with the continued struggles of state and local governments— means that gap financing will be much harder to find next year.
If the exchange program isn't extended, the industry may find itself right back where it started, and secondary and tertiary markets will be especially hard hit.
“Without the exchange program, you won't have true markets there,” says Andy Ditton, a managing director at Citi. “You'll have the few local CRA investors picking off the best deals, and that's that. You'll have deals go uninvested in, which is what happened in 2008.”
The Treasury's NIBP will continue to help make bond deals pencil out, and many in the industry believe that the exchange program will eventually be extended.
But how long will the affordable housing industry live on life support? And what happens when the plug is pulled?
“If we're having this discussion same time next year, we'd be talking about what it's going to be like after NIBP,” says Freddie Mac's Griffith. “The program will continue to help out the multifamily world next year. But then, what's next?”