For affordable housing deals to pencil out, it’s critical that developers secure the best debt option available for their projects.

It’s been especially important this year, and could be in the future, as well, if low-income housing tax credit (LIHTC) prices decline and developers need to borrow more money to make up the difference.

“There’s an increasing need for affordable housing as market rents continue to rise while household incomes for middle America remain stagnant,” says Frank Baldasare, managing director at Walker & Dunlop. “Increasing construction costs, coupled with a drop in tax-credit pricing from pending tax reforms, and a reduction in funding of subordinate loan programs that promote development of affordable housing projects, are all exerting a significant impact on affordable housing development.”

These factors are affecting the state of the affordable housing market as well as the needs, goals, and methods developers are using to evaluate debt options, Baldasare says.

He and other finance leaders from Citi Community Capital and Lancaster Pollard share 12 best practices to help developers weigh their debt choices:

1. Maintain a Working Knowledge of the Options

A solid understanding of LIHTCs, debt financing, gap financing, and subsidies is essential, says David Lacki, managing director at Lancaster Pollard. Some questions include: Can agency enhancements be used? Is it a good time for bank financing? How do you combine LIHTCs with Federal Housing Administration, Fannie Mae, or Freddie Mac funding? What state-level options are available?

2. Identify Priorities

“When determining a strategy for evaluating and executing on debt options, it’s also important to know what elements of the loan terms you’re most sensitive to—lower interest rates, net proceeds, length of term, timing, etcetera,” says Heather Olson, assistant vice president at Walker & Dunlop.

3. Provide the Lender With as Much Information as You Can

Generally, the following questions should be addressed for all affordable housing transactions, to ensure the process is on the right track, Lacki says.

• Is there an executed engagement letter from a construction lender that explains deal terms? from a permanent lender?

• Is there a letter of intent (LOI) from an equity investor that explains deal terms? Has the letter been provided to the construction lender so the lender can model the timing of the equity entering the deal, to ensure there are no gaps during the construction period based on the proposed draw schedule?

• Are there term sheets representing all the funding sources? Do they describe at what point in the deal the sources become available?

• Are there additional use restrictions, construction requirements, or guarantees? If so, have those concerns been shared with the construction, permanent, and equity investors?

• Does everyone understand how the developer’s needs impact the transaction? What are the developer’s top priorities (such as proceeds, rate, term, amortization, prepayment flexibility)?

• Have any potential underwriting issues been identified that may present a risk to the transaction?

4. Give Yourself Enough Time

“Every project requires a full set of third-party reports—environmental, appraisals, and engineering—which can only be ordered after the lender and developer agree to basic terms and conditions,” says Richard Gerwitz, co-head of Citi Community Capital. “Credit processes differ throughout the industry, and legal documentation varies from institution to institution. Understand the time frames and plan accordingly based on your own deadlines. Allow some room for the unexpected.”

5. Understand That Interest Rates Aren’t Static

The time from package submission to closing for a complex affordable project financing with multiple subsidy sources and public agencies involved is typically measured in months, not weeks. “Be conservative in your interest-rate assumptions, leaving room for rate increases, when constructing the capital stack,” Gerwitz says. “[That way], if rates rise, you’ll be protected. If they remain the same or decline, you’ll have more [of the developer fee] paid.”

6. Realize That Lenders Care About the Exit

Developers are often looking to maximize loan proceeds, whereas lenders are concerned about the likelihood the project can be refinanced at maturity. Among the drivers of the analysis is the income–expense ratio: The lower the ratio, the better the exit analysis, as lenders will run scenarios that inflate expenses faster than income, explains Gerwitz. That’s not to say a lender will accept an artificially low ratio; rather, the lender will look at the developer’s history with the lender or with other, like properties in similar markets to assess the submission.

7. Prepare for Contingencies

Developers should be prepared for higher hard-cost contingency requirements for acquisition–rehab projects, particularly where there’s a fear that unknown conditions may exist. More-extensive destructive testing can help determine the likelihood of running into problems during the rehab. Adaptive-reuse projects will be viewed very carefully, and a full explanation of how the project will be redeveloped to attract tenants is critical, Gerwitz says.

8. Ensure You’re Conforming to Statutes


Make sure you’re confirming to statutes and receive legal opinions and approval on key issues and considerations, such as tax abatements, ahead of time, says Baldasare. “Doing so will protect you from having to confront a no-longer-feasible project and lost proceeds,” he says.

9. Observe Gaps Between Affordable and Market Rents

Typically, at least a 10% gap is ideal. However, the higher the gap percentage, the higher the market-absorption rate. Increased absorption rates signal faster and more-complete lease-up potential for a given property,” says Olson.

10. Prepare a Crime-Management and Prevention Plan


“[Because] many affordable housing projects tend to be located in urban areas with higher crime statistics, lenders require a vetted plan to confront, prevent, and address crime issues, along with proven performance and a track record of successful accomplishment of similar tasks in the past when approving affordable housing financing programs,” Olson says.

11. Share the “Hair”/Put Your Worst Foot Forward


If the project has issues, or “hair,” the developer should raise them with the lender as soon as possible, says Matt Bissonette, Northeast regional director for Citi Community Capital. “This leaves time to address them,” he says. “And, in the event they’re issues with which the lender isn’t able to get comfortable, it avoids spending time and money only to have the deal not receive lender approval.”

12. Consult Experts in Areas in Which You Lack Expertise

Of utmost importance is assembling an experienced finance team, says Lacki. “Teamwork is especially important, because each member of the finance team, in conjunction with their respective counsels, will need to work in a unified manner over the course of several months. The destination is the same for everyone—the closing table,” he says. “And the path there will be much smoother if the team is able to work together in a harmonious manner with that shared goal constantly top of mind. Experience and relationships play a vital role in this context, as prior experience working together and/or intricate knowledge of the affordable housing industry will undoubtedly aid the process.”