The 4 percent low-income housing tax credit (LIHTC) market is often overshadowed by the more dynamic 9 percent credit.
But as prices for 9 percent LIHTCs continue to climb, and yields continue to drop, more investors are considering 4 percent credits as viable alternatives.
“The 4 percent market has made a resounding comeback, both in terms of credit underwriting and pricing,” says Mark Dean, managing director for New York-based Citi Community Capital. “In the last 12 months, we've seen incredibly aggressive pricing on bond and 4 percent deals.”
Pricing has climbed about $0.10 in the last year, with many 4 percent credits selling in the high $0.80 to mid-$0.90 range for deals in major markets. And the debt side is heating up. Fannie Mae, Freddie Mac, and the Federal Housing Administration (FHA) have been busy, but the privateplacement market is gaining traction as well.
“We're out on the market right now putting a private-placement program together,” says Phil Melton, who runs the affordable housing debt side of New York-based Centerline Capital. “We believe that's a market that's very available now and will have a high level of appeal.”
The agency horse race Fannie and Freddie continue to battle it out on the fixed-rate side of the creditenhancement market. But Freddie's ability to provide floating-rate executions continues to be a distinct competitive advantage, particularly for borrowers looking for a greater degree of cash flow. And by using a swap execution on a new construction deal, Freddie can significantly reduce negative arbitrage.
Investors have warmed to the floating-rate deals as well. “A year ago, we wouldn't have seen demand for the variable-rate product much at all,” says Dean. “But there are investors who will look at 4 percent credits in conjunction with variable-rate bonds, or low floaters, and we haven't seen that in forever.”
Another distinct advantage for Freddie: Fannie Mae has a much more restrictive policy around which banks are qualified to provide letters of credit on a new construction deal. Many fi- nancial institutions have seen their ratings downgraded since the recession, and as those banks lost their AA ratings, Fannie Mae whittled its list down to just a couple of banks.
“It's become much more challenging to find a qualified bank for a letter of credit for Fannie Mae, because of the criteria they have,” says Melton. “I think that's going to hinder and hamper their ability to compete potentially on the new construction side.”
That letter of credit issue doesn't come up with the FHA. And as the FHA dedicates more resources to affordable housing, an increasing number of LIHTC developers are turning to the agency. Its Sec. 221(d)(4) program is a fixed-rate execution and is pretty much the only source of non-recourse construction- to-perm loans on the market.
“The debt financing is a little more difficult to find right now,” says Bill Witte, president of developer Related California. “You have to find either an insurer or a lender who can provide at least a AA-rated letter of credit to guarantee the bonds. And that's harder to find, unless you use FHA.”
Many agency lenders now offer a “tax-exempt bond to Ginnie Mae” loan structure that gives the borrower a lower rate while taking advantage of the LIHTCs.
Basically, a developer will go for taxexempt bonds to get the LIHTCs and then replace the bonds with a taxable Ginnie Mae loan. The bond proceeds are released to pay for project costs, while a similar amount is drawn under the taxable loan—so the bondholders continue to be 100 percent cash-secured.
By using this structure, developers can take advantage of a much lower interest rate—taxable Ginnie Mae's are quoting around 4.25 percent, while the tax-exempt rate might be 5.75 percent— and can do so while generating LIHTC equity.
But using the FHA comes with its own challenges. “It's a very good deal, but it's a very rigid deal,” says Witte. “There are timing issues to deal with, and you have to pay prevailing wages, which in many parts of the country, that would put you at a distinct cost disadvantage.”
The FHA also doesn't offer a floating- rate execution. But the reason fixed-rate deals are in vogue now is that, given the lack of soft funding available today, many developers need to maximize proceeds, and the FHA's leverage levels are more generous than what's often found in the market.
The Village at Santa Monica In February, Related California broke ground on the $350 million Village at Santa Monica, a 318-unit mixedincome and mixed-use development that utilizes 4 percent LIHTCs and taxexempt bonds.
When the developer won the RFP in 2006, it was given affordability parameters by the city: Roughly half of the 318 units had to be affordable.
To make the deal work, the company decided to develop the other half as high-end condominiums—a decision that made a lot of sense in 2006.
“At the time, for-sale housing was literally riding into the boom, so the residual land value for condominiums was much greater than for apartments,” says Witte. “The way to make this project fi- nancially work was to pay the city for the land in a sufficiently large number that they could take the proceeds and use them to subsidize the affordable units.”
But that decision set them back a couple of years. The company finally found a 65 percent leverage loan from Wells Fargo and HSBC on the condos this past winter, with 35 percent equity coming from the development team.
Scoring the LIHTCs and tax-exempt bonds was the easy part, though.
Construction of the affordable units is being financed with nearly $34 million in tax credit equity and a nearly $45 million construction loan from Wells Fargo. Related is partnering with nonprofit Community Corporation of Santa Monica on the affordable units and The Resmark Cos. on the condos.
