Affordable housing developers are leaving no stone unturned in their search for construction debt.

The government-sponsored enterprises (GSEs) have all but abandoned their forward-commitment programs, pricing them so high that, in effect, the programs are a nonstarter. Regional and national banks are employing a targeted approach to fill their Community Reinvestment Act buckets, and many are scaling back their balancesheet exposure to real estate.

And the Federal Housing Administration (FHA) is making underwriting changes to its flagship Sec. 221(d)(4) program for the first time in decades. The changes mostly affect market-rate deals, but low-income housing tax credit (LIHTC) deals will also see tougher restrictions.

In the past, the (d)(4) program offered a 1.11x debt-service coverage ratio (DSCR) and a 90 percent loan-to-cost (LTC) ratio across the board. But under the proposed changes, market-rate deals seeking 221(d)(4) loans would be underwritten to a minimum 1.20x DSCR. Projects with subsidy levels of 95 percent or greater would still enjoy a 1.11x DSCR, but LIHTC deals would be bumped up to a minimum 1.15x.

LTC ratios would also be adjusted under the new rules. Projects with rental assistance, however, would still qualify for 90 percent LTC, but LIHTC deals would tap out at 87 percent and marketrate deals at 83.3 percent.

The underwriting changes probably won't have a big effect on tax credit deals. Most syndicators are requiring a 1.15x DSCR anyway, and a 3-basis point change in the LTC ratio is not a dramatic shift. But the changes will certainly have an effect on workforce housing, that ill-defined space that isn't affordable and isn't luxury. If a project's rents were affordable to those earning up to 70 percent of the area median income (AMI), for instance, the FHA would classify that as market rate.

The bigger question concerns mixed-income developments. It remains unclear if the FHA would treat a deal that had some affordable set-asides— say 40 percent affordable to 60 percent of the AMI—as pure market rate, or if those deals would be underwritten more like LIHTC or subsidy deals.

“That's still a question being posed,” says Phil Melton, a senior vice president and head of FHA production at Charlotte, N.C.-based Grandbridge Real Estate Capital. “Oftentimes, municipalities have a preference to do mixed incomes as opposed to 100 percent market- rate. So, it's serving a need, and you'd hope that workforce housing or minimum set-aside properties will still get treated at the 87 percent, 1.15x level.”

To classify a mixed-income deal, a secondary test needs to be applied, which hinges on a commitment to long-term affordability, such as a 15-year promise to keep rents affordable for projects getting refinanced.

“There has to be a recorded regulatory agreement in place that regulates the rents to affordable levels,” says Doug Moritz, associate vice president of multifamily at the Washington, D.C.-based Mortgage Bankers Association. “So, it has to have either a regulatory agreement, have 90 percent of the units supported by rent subsidy or Sec. 8 contracts, or be a tax credit deal. Outside of those three affordable tests, it would be market.”

The grandfathering issue is also a concern. The new changes are expected to be announced in June. The indication from FHA is that new pre-applications, or submitted pre-applications that have not yet been issued an invitation letter, have within 60 days of the rule change to use the old underwriting standards. Projects with outstanding invitation letters have up to 120 days of the rule change. And new applications for a firm commitment have a 90-day window after the rules come out to be eligible for the old underwriting.

Another proposed change would increase the minimum required amount of working capital funds. In the past, developers had to put up 2 percent of the total loan amount in a working capital escrow fund, but that figure will be 4 percent under the proposed rules. Another change would increase the required operating deficit reserves from three months of debt service to four months.

Constipated pipeline

The FHA is struggling with a pipeline that grew too fast too soon for the agency to handle. In fact, Sec. 221(d)(4) loan volume in fiscal year 2009 was $1.6 billion, a figure that the FHA had already passed as of late April when there were still five months left in fiscal year 2010.

“Unfortunately, its delivery process is even more problematic at the moment given that their product is so attractive,” says Tom Booher, who leads the multifamily platform for Pittsburgh-based PNC Real Estate. “They're just completely constipated at the moment.”

Beyond timing, another problem for tax credit deals looking for a (d)(4) loan is the size of the transaction itself. Given the large amount of tax credit exchange funds and other subsidy money going into tax credit deals, the debt component is a small part of the capital stack. FHA lenders are much less inclined to do loans of less than $1.5 million given the overhead required to process and service a single loan.

Spotlight search

Still, the FHA continues to offer the best rates and terms in town, especially given the lack of other sources. A 221(d) (4) loan can be had at a 6.2 percent interest rate (with 40-year amortization no less), whereas Fannie and Freddie are offering forward commitments in the 9 percent to 9.5 percent range, as of mid-May.

The GSEs just don't like the forward product and are intentionally pricing themselves out of the market. Part of the problem is history—too many tax credit deals have taken too long to lease up. The average time for getting a deal stabilized under Fannie Mae's horizon is not 24 months, the program's window, but more like 36 to 42 months, lenders say.

But the GSEs' reluctance is striking, especially given their mission. Local banks, or consortiums of banks, are happy to fill some of the void and can often provide mini-perm loans that are hundreds of basis points cheaper than what the GSEs are offering. But finding that bank, with the wherewithal and interest to fund your loan, is another story.