On a July afternoon, Caleb Roope stepped into a conference room to close the tax-exempt bond (TEB) financing for Sonoma Gardens, an affordable housing property under way in Santa Rosa, Calif.
An hour and a half later, the closing done, the seven people sitting around the table shook hands and went home.
“There was a large debate whether we should do it through the mail,” says Roope, principal of The Pacific Cos. (TPC), an affordable housing owner and developer in the West.
That's a huge difference from typical TEB closings just a few years ago, where dozens of attorneys, bankers, and bond experts would spend entire days to close deals. TPC made the transaction more efficient by privately placing the bonds with Union Bank, which also bought the 4 percent low-income housing tax credits associated with the deal.
Private-placement deals have become a leading method to handle TEB financing for new construction deals. In many parts of the country, private placement is much more efficient and cost effective than other options, offering very low all-in interest rates often below 5 percent, experts say.
“The business in a lot of parts of the country has gone almost exclusively to private placement,” says Richard Gerwitz managing director of Citi Community Capital. TPC builds about 15 affordable communities each year. Close to half of its projects are financed with privately placed TEBs.
The up-front fees to close a privateplacement deal usually add up to 2 to 4 percent of the bond issue, compared with 3 to 5 percent for TEBs creditenhanced by Freddie or Fannie, according to Wade Norris, partner with Eichner Norris & Neumann, PLLC.
“It's an incredibly efficient execution with none of the significant costs of issuance,” says Richard Barnhart, CEO of Pennrose Properties, which has fi- nanced six communities with privately placed TEBs over the last two years.
However, borrowers only have a few choices for private placements—it's often the larger banks that have the capacity to close these types of deals.
Geography is another limiting factor. Because the biggest players are major banks driven by the Community Reinvestment Act (CRA), most privateplacement bond deals are built within the depository footprint of the banks, often on the coasts or close to major metropolitan areas. “You try this in Des Moines, Iowa, good luck,” says Norris.
However, for the sake of a relation ship, banks will sometimes make taxexempt loans far outside of their CRA areas. “If one of our developers wants to develop outside of our footprint, I'm going to follow him,” says Citi's Gerwitz.
In other areas, private-placement deals are less common because state and local agencies offer a strong alternative.
States like New York and Maryland have agencies that take an active role in issuing and guaranteeing TEBs, according to Gerwitz. However, for mixed-income housing in markets like New York City, private placements are still common.
Experts also are bringing TEB financing to rural areas. Merchant Capital is attempting to pool TEBs for the acquisition of 37 projects in Georgia to sell to bond investors, according to John Rucker, executive vice president.
Even greater efficiency can occur if the lender and bond investor also buy the tax credits associated with a development, as Union Bank did for TPC's Sonoma Gardens. However, that's still unusual. A federal prohibition called the “substantial user rule” says an entity cannot receive both tax credits and the tax benefits of TEB financing.
The difference between tax-exempt and taxable bond financing is so small that Union Bank was willing to act as both lender and equity investor.
“It used to be a 200- or 300-basis point interest-rate advantage, but there is not much of a premium now for the tax-exempt instrument,” says Roope.
Other options
Private-placement deals are filling in for less competitive structures, at least for now. The New Issue Bond Program financed 10,000 units of housing, but changes to the program have made it less competitive on pricing.
Credit enhancement is still available from Freddie and Fannie, though their pricing is often not competitive, according to developers. But there are other options. Many developers benefit from Federal Housing Administration (FHA) loans. In this structure, an FHA permanent loan and equity from 4 percent tax credits replace a tax-exempt construction loan.
“If you have the time, FHA is the best out there,” says Roope. However, it can take a year to close a deal. Also, for new construction, an FHA loan will trigger Davis-Bacon requirements, which force developers to pay construction workers a prevailing wage close to the cost of union labor.
The Michaels Development Co. privately placed TEBs to finance the first phase of The Plaza at Centennial Hill, a 129-unit public housing redevelopment in Montgomery, Ala. But for the smaller second phase, Michaels went to FHA to provide a $3.5 million permanent loan. The execution made sense—as a public housing redevelopment using federal funds, the development was already going to trigger Davis-Bacon.
