Rising interest rates have hurt some affordable housing deals as the rate of defaults on single-family home loans rises out of control and lenders tighten underwriting standards or turn away from many types of real estate.
In the wake of the subprime mortgage crisis, interest rates have risen for many types of permanent financing funded by the sale of bonds. The safest tax-exempt bonds guaranteed by Fannie Mae and Freddie Mac have also seen rate increases, though bonds without guarantees have seen comparatively larger interest rate increases.
Between July and early September, interest rates for synthetic fixed-rate, permanent tax-exempt bond mortgages that were credit enhanced by Fannie Mae or Freddie Mac rose by about five basis points, leaving these rates in the 6 percent range, said Evan Williams, assistant vice president of commercial real estate for Centerline Capital Group.
So-called “synthetic” loans typically include an interest rate hedge, such as a swap, cap, or collar to fix the interest rate. The cost of interest rate hedges has not increased significantly since the credit crunch began in late July, Williams said.
Since the credit crunch began, rates for privately placed, non-guaranteed tax-exempt bond loans have risen 35 to 40 basis points to about 5.9 percent from typical interest rates of roughly 5.5 percent previously, experts said.
Higher interest rates increase the debt-service payments at affordable properties, shrinking the size of the loans these projects can support.
Still, interest rates remain historically low. Most fixed-rate mortgages base their interest rates on the yield on government bonds like the 10-year Treasury, which at press time was 4.5 percent, close to its low for the year. Between the late 1960s and late 1990s, the 10-year note never fell below 5 percent, and at one point surged as high as 15 percent.
As interest rates on tax-exempt bond financing have risen, it may become easier for developers to win reservations of tax-exempt bond cap from state officials, since some states may use less of their bonds to finance home loans, said Lamar Seats, senior vice president of multifamily mortgage finance for Enterprise Community Investment, Inc.
Loans to 9 percent tax credit deals
Interest rates also rose for taxable, fixed-rate permanent loans creditenhanced by Fannie Mae and Freddie Mac. Developers often combine these loans with equity from the sale of 9 percent low-income housing tax credits (LIHTCs) to finance affordable housing developments.
From late July to late August, typical interest rates on these loans rose by 20 to 30 basis points, sending typical interest rates up to more than 6.5 percent.
Non-tax-exempt loans are especially important to tax credit deals today because many developers need extra financing to make deals work, especially with tax credit prices down by roughly 10 cents in the last year and development costs still high.
To get loans, projects need to prove that they are financially sound. Lenders will be very cautious as they confirm that income from rents at an affordable housing project will be able to support a mezzanine loan, syndicators say. “Look to your market study,” said Paul Cummings, senior vice president of tax credit syndication for Enterprise. “More so now than any time before.”
Bank predevelopment loans hard to find
Economists warn that affordable housing developers who depend on local banks for pre-development financing may be hurt by the housing crash. Smaller banks are less likely to differentiate between loans to develop affordable rental housing and other types of real estate loans. These banks are also likely to have a surplus of real estate loans on their balance sheets, Cummings said.
He warns that banks also are likely to lend for shorter periods: six months compared to two years. Banks will be pickier about the strength of the borrowers that they lend to and will probably demand more security than the land itself to guarantee the loan.
In contrast, pre-development loans from syndicators are just as available as ever, according to developers that access these loans.
Tax credit prices still on the decline
Although debt costs for affordable housing have risen only slightly, the increases come at a time when equity proceeds from housing tax credits have been squeezed.
LIHTC prices have dropped significantly over the last year as investors rebelled against yields so low they approached the level of 10-year Treasury notes. LIHTC yields have recently pushed up to a range of 5.1 percent to 5.5 percent, according to Doug Able, senior vice president for capital markets for Enterprise.
“We haven’t seen the increase in yields that we thought we would see,” Able said. He puts a healthy tax credit yield at about 100 basis points over the yield on 10-year Treasury bonds.
“We expect yields to move higher in the first half of next year,” Able said. If yields go up, that would mean prices would go down.
Long-term effect: Fundamentals more important
Over time, however, the real estate crash could have a negative effect on affordable housing, especially in weak markets.
In markets where the price of a market-rate rental apartment is close to the rents at affordable housing properties, an overall drop in the value of real estate could hurt affordable housing, because the two would be competing with each other. Declining incomes could make it more difficult for lowincome families to afford even subsidized LIHTC rents.
But in relatively strong real estate markets, where the gap between marketrate rents and affordable rents is wide, the subprime home mortgage crisis may improve occupancy rates at affordable housing communities. Homeowners who lose their homes to foreclosure will have to live somewhere, Cummings reasoned, and at least a few will probably move into affordable housing developments.
With fundamentals increasingly important, investors will be especially careful when they underwrite affordable housing properties. “We might like to have some cushion between the tax credit rents and the market,” Cummings said.
