Considering the unprecedented challenges faced in 2020, the affordable housing industry managed to do pretty well. Projects still got built, capital continued to be available for new deals, and, perhaps, new light was even shined on the importance of a place to call home.
Having weathered economic downturns and market turmoil before, the industry once again found its footing after the initial gut punch of the COVID-19 pandemic and the subsequent shelter-in-place orders that began almost a year ago.
Developers will have to continue to overcome the immense obstacles brought on by the global pandemic in the coming months. Even as vaccines are being distributed nationwide, COVID’s presence still casts a long shadow.
“Is there any doubt that the COVID-19 won’t continue to be the biggest issue in 2021?” says Richard Gerwitz, co-head of Citi Community Capital. “The impact on tenants and landlords, the continuing local budget crises, the increased need for shelters and supportive housing. As eviction moratoriums end, and the infection rate has increased, the beginning of the year in particular may be the most challenging time for us as yet.”
In spite of all the issues the industry is confronting, the number of projects seeking low-income housing tax credit (LIHTC) or private-activity bond allocation has continued to rise, according to Gerwitz.
“The availability of 9% LIHTC allocation has almost always been a challenge, but now private-activity bond allocation availability is also being fully utilized in an increasing number of states,” he says. “With an emphasis on building new units, allocation plans and decisions are concentrating on new construction, making it more difficult to finance the preservation of at-risk units.”
Lenders are also being more cautious, particularly in terms of underwriting commercial income, either by requiring a master lease, discounting rents significantly, or not considering such income at all. Mixed-income has been a trend, and lenders are being similarly cautious about how market-rate unit rents, or the rents for units with limits above tax credit unit rents, are underwritten, he says.
A Resilient Asset Class
Despite the vast challenges that remain, affordable housing finance leaders have a positive outlook for the financial markets in 2021. The Federal Reserve has made assurances that it won’t raise interest rates in the near term. A new stimulus bill was approved at the end of 2020. And, vaccines offer hope of stopping the spread of COVID-19.
“The need for affordable housing continues to grow. In addition, the asset class is strong,” says Maria Barry, national executive, community development banking, at Bank of America. “That’s helpful heading into the new year. We’ve seen affordable housing do well in previous downturns, but 2020 was unique. The fact that we’ve seen the continued strength of the portfolio demonstrates the strength of the asset class.”
In 2019, Bank of America’s community development banking team provided $4.88 billion in debt and equity and was on pace to surpass that for a record year in 2020. The bank started the year with a strong pipeline and continued to work closely with clients to ensure they were able to address COVID-related risks to get to closing, according to Barry.
To mitigate risks, Barry and her team looked at several areas. For example, if construction was delayed or halted, they examined if a project had enough reserves to carry the financing.
“We also looked at take-outs to ensure there was enough cushion so if there was a delay, the take-out wouldn’t be jeopardized,” Barry says. “We also asked about how changes or delays would be reflected in project contracts. We also asked for additional assurance for the subsidies and when they were going to be coming into a project. Ongoing dialogue was critical to make sure that the developer would be successful if something happened during COVID.”
“Until COVID is behind us, we’ll continue to ask the same questions and possibly additional questions depending on what we see happening in the market and in the deals in our pipeline,” she says.
KeyBank was also on track to have a record year in 2020, according to Rob Likes, national manager of the bank’s Community Development Lending and Investment platform.
Like many other financial providers, KeyBank stepped up its underwriting and due diligence to understand the fluid nature of the market as well how clients were addressing COVID-related risks.
“We took a close look at the impacts clients were seeing to their portfolios and the steps they were taking to address any challenges,” he says. “For example, with every client we kept in constant contact about whether they were seeing construction delays, how lease-ups were going, rental collections, and the COVID protocols they were following to maintain the health and safety of tenants and employees.”
As long as COVID is still around, those measures will continue to be in place, he says.
At the same time, the debt market should remain strong, according to Likes. “The agencies have increased the allocations for affordable housing, so we’ll continue to see a strong focus on the sector with plenty of available capital,” he says.
Similar to the market crash of 2007 and 2008, the government-sponsored enterprises (Fannie Mae, Freddie Mac, and the Federal Housing Administration/Department of Housing and Urban Development) played a key role in providing financing and filling a void created when private lenders hit the pause button or tightened their credit box, adds Jim Gillespie, executive vice president at Bellwether Enterprise Real Estate Capital.
“I expect the agencies to remain competitive into 2021-2022 and continue to develop more creative debt solutions for affordable and workforce housing,” he says.
Paul Weissman, senior managing director and head of affordable housing production at Lument, agrees. “Even with the new caps, we expect Fannie and Freddie to continue to be aggressive in what I would call the true or ‘capital A’ affordable housing space,” he says. “They will look to expand business across tax credit transactions and increase Section 8 volume. I’m fairly optimistic that there’s likely not much change that’s going to happen there.”
One key change last year was the agencies all implemented some form of debt-service reserve requirements to reduce risk.
“Those requirements were generally waived for Section 8 and tax credit transactions involving new credits, but for the most part, debt-service reserves are now required on a lot of the refinancing of affordable and conventional communities,” Weissman says. “If residents aren’t able to pay rent for some period of time, those reserves will help carry properties through a rough patch.”
Section 8 and new LIHTC deals were generally not required to have debt-service reserves because the investors who were putting significant capital into those assets were taking into consideration potential softness for some period of time and because LIHTC properties typically have operating reserve requirements and operating deficit guarantees from developers, he says.
This year, developers may see an easing of the debt-service reserve requirements. “If the agencies were requiring a six- or nine-month debt-service reserve, that may start to go away as concerns surrounding the pandemic recede and jobs start to come back at a higher velocity within hospitality and other sectors,” Weissman says.
Lument’s affordable division was up close to 25% in loan volume compared with the prior year as of early December. This was in part due to a number of refinancings of existing transaction to take advantage of lower interest rates, according to Weissman.
In addition to navigating a tumultuous market, the firm had a busy year combining Hunt Real Estate Capital, Lancaster Pollard, and Red Capital Group to create Lument.
The Good (and the Bad) News
Heading into the new year, the Federal Reserve has said it expects to keep interest rates low until the economy continues to improve. That’s good news.
The affordable housing industry also scored a major victory at the end of 2020 when Congress approved a 4% fixed LIHTC rate, which will help more deals pencil out.
On the other side, the challenges that developers faced before the pandemic remain, and the health crisis continues to be volatile.
The pandemic could put a strain on the availability of funds at local and state levels due to the drop in tax revenues, which will put a strain on their ability to provide critical subordinate financing on affordable housing projects, says Gillespie.
“Tax credit pricing could fluctuate or decrease if investors’ (corporations’) earnings drop, and the need for credits is lessened, another uncertainty,” he says. “Thankfully, our industry is filled with very smart and creative individuals who are committed to finding capital solutions to build or preserve affordable housing.”
Others share similar concerns. “There’s potential that some state and local budgets could be affected due to the need to redirect funds toward COVID,” Barry says. “That could have an impact on housing subsidies.”
Looking at changes that developers may see in deal terms, she says they may need to build in a little more room into their projected schedules. “A lot of it is related to time, giving a little more time, a little more cushion, to work through any unforeseen delays and ensure other deadlines like placed in service are met,” Barry says. “Some of this we started to see pre-COVID with construction delays. When you add COVID into it, everyone needs to make sure they have enough time.”
Developers may also be asked to put more in the interest reserve, ensuring they have a cushion for bumps in the road.
“I have concerns about the expiration of support, especially before people begin to feel safe again,” adds Weissman. “People who work in restaurants and the hospitality industry represent a large swath of renters across the country. I’m concerned that stimulus protections may end too early, and I’m concerned that interest rates will start to go up. I’m also concerned about stagnation in rent growth. If we start to see rents stagnate or decline and interest rates increase at the same time, that could have a meaningful impact on valuation. I think that’s more pronounced at the higher end of the spectrum than the lower end because there’s just not much housing available at the lower end.”
On the positive side, affordable housing has performed well at a time when the hotel, office, and retail sectors have become struggled. This resiliency as well as an emphasis on social-impact investing is expected to keep capital in the market.
Gillespie also anticipates new opportunities in workforce housing through the continued expansion of debt products designed specifically to finance the product. “This, combined with plentiful private capital targeting this product type and the fewer regulations relative to the LIHTC, should result in an increased focus and expansion of the workforce housing market,” he says.
