When Jonesboro Investments Corp. went looking for a $7 million construction loan to fund its 60- unit Magnolia Glen community in Florence, Ky., the availability of capital was the easy part.
“It was an efficient transaction,” says Kyle Hansen, executive vice president for U.S. Bank, which provided the loan. U.S. Bancorp Community Development Corp. also provided $9.8 million for the 9 percent lowincome housing credits (LIHTCs) associated with the project.
It was a transaction with few, if any, surprises. With interest rates and underwriting relatively consistent over the last year, construction financing has been available for 9 percent LIHTC projects.
The bigger concern was timing— the timely payment of construction draws, the schedule of equity pay-ins, and the speed with which a development burns off its loan guarantees.
Once a development financed with 9 percent LIHTCs has found an equity investor, a construction loan is usually not far behind. Often debt and equity are arranged in a single package, with one entity providing both.
“Construction financing is readily available—subject to having permanent commitments,” says Dan Falcon, senior vice president for affordable housing developer McCormack Baron Salazar (MBS). “And the market is skewing toward combined debt and equity.”
However, even if the equity has already been sold, most banks are still very willing and able to make construction loans. “Not every deal is joint,” says Hansen.
The availability of financing is a welcome change from 2009, when both debt and equity were hard to find.
“In 2011 the spigot opened, and 2012 has been a free-for-all,” says Steven Fayne, Citi Community Capital managing director. “Banks have an appetite to lend: You can find a lender to do a deal in any part of the country.” Citi is on track to complete in excess of 200 deals to provide construction financing to 9 percent LIHTC projects, a 20 percent increase from 2011.
Quick on the draw
With financing in hand, borrowers are putting their energy into negotiating for a more timely release of construction draws. “It has become more cumbersome,” says Richard Barnhart, CEO of Pennrose Properties.
Construction contractors usually bill for the completed work at the end of each month. That bill goes to the bank, which then has to send an inspector to examine the work to make sure it was completed. The bank also checks for liens against the developer and makes sure there will be enough money left after the draw to complete the project.
In short, it all takes time.
“Optimal is five days. ... Horrible is 30 days,” says Barnhart. “We work hard to make sure that it's less than 10.”
Indeed, lenders know they have to work hard to meet these deadlines to remain competitive in an increasingly aggressive market. U.S. Bank promises to fund these draws on construction loans “within time frames that are acceptable to customers,” says Hansen.
Borrowers and lenders also negotiate over the timing of payments of tax credit equity into a project. Developers often would like the equity more quickly. In contrast, when equity investors and lenders are part of the same company, they usually prefer a good chunk of the equity to come in at the end of the construction period. That allows the construction loan to earn more interest.
The game changes when the lender and equity investor are separate entities. “We would then like to see 15 percent or more of the equity in up front,” says Hansen. That early equity pay-in gives the tax credit investor an incentive to stay in the deal even if construction turns up an expensive surprise.
Borrowers also spend time negotiating the performance milestones written into a loan, which specify that the lender may stop distributing funds if a project misses specific targets. In addition, borrowers negotiate and renegotiate the schedule in which they burn off the loan guarantees that they provide.
“Everyone is looking for full guarantees from us,” says Barnhart.
Interest rates and underwriting are oddly not a big part of the negotiation over construction loans. “Lender underwriting has stayed at the crash level. It hasn't loosened with equity levels,” says MBS' Falcon. Lenders still look for long track records and significant reserves. The local rental market should also show a healthy difference between market-rate rents and subsidized rents.
Debt-service coverage ratios range from 1.10x to 1.20x, and interest rates range from 200 to 300 basis points over LIBOR, depending on the size and complexities of a particular transaction.
“We've gotten less than 200,” says Barnhart. Pennrose also makes sure a floating-rate loan does not limit the potential interest rate upside. One lender offered Pennrose a “floating” rate that could not fall below 4 percent. “It was a nonstarter,” he says. “It's important to get no floor.”
MBS often purchases a cap on the floating interest rate of a construction loan. “We've always found them available,” says MBS' Falcon. “The cost of a cap is a very reasonable hedge for us.”
Swaps are less popular with MBS, though “[they] always come up as an option,” says Falcon. “With rates still declining, we could end up on the wrong end of a swap.”
Citi doesn't employ a complicated structure to hedge interest rates, such as interest rate swaps or caps. “We put a big cushion in there for our interest reserve,” says Fayne.
