Despite Challenges, Lenders Upbeat for 2019

Although last year brought rising interest rates and a new normal post tax reform, affordable housing lenders overall were pleased with their 2018 volumes. And despite political and economic uncertainty, they’re generally optimistic for the year ahead.

“What was notable in 2018 was the normalcy that returned to the market. For the first time in a couple of years, we weren’t focused on, or overly concerned about, the potential negative impact of an election or major legislation,” says Richard Gerwitz, co-head of Citi Community Capital. “That allowed us to get back to business as usual. While rising interest rates and reduced tax credit pricing made it more challenging for many projects to pencil, transaction volumes actually stayed relatively consistent with prior years.”

Maria Barry, community development banking national executive at Bank of America Merrill Lynch, agrees. “2018 performance exceeded our expectations given the pricing volatility in the low-income housing tax credit [LIHTC] market post tax reform as well as higher interest rates during the past year.”

With the enactment of the tax bill and reduction in the corporate rate, several syndicators sat on the sidelines at the beginning of 2018 or withdrew their letters of interest on deals. “However, as the year progressed, tax credit equity pricing eventually stabilized. It’s a reduction in tax credit pricing but not as great as first envisioned,” adds Frank Baldasare, managing director at Walker & Dunlop.

Overall, the AHF Top 25 affordable housing lenders lent an impressive $35.2 billion to affordable housing developments with formal income restrictions, including permanent and construction loans, in 2018. This is up from the AHF Top 25 lenders’ $30.5 billion in 2017 and $27 billion in 2016.

Once again, Citi Community Capital leads our list, having lent just over 
$6 billion to affordable properties in 2018. That’s up from $4.71 billion in 2017.

Wells Fargo remained No. 2, lending $5.3 billion in 2018, followed by Bank of America Merrill Lynch, KeyBank Real Estate Capital, and Stifel, Nicolaus & Co.

Industry threats

While the Federal Reserve is watching the economy carefully and says it will be patient about future rate hikes, interest rates are still a major concern for lenders. Several lenders expect interest rates to remain fairly steady in 2019, while others are concerned about increases.

“The volatile political environment has left uncertainty in the financial markets and in interest rates,” says Heather Olson, vice president at Walker & Dunlop. “If interest rates rise again, that can adversely affect how much debt developers can afford to place on their properties, leaving some developments with large gaps in their capital structure.”

Dan Smith, senior vice president at U.S. Bank, says he thinks the threat from increased interest rates is down slightly from 2018. “The growing threat—still remote—is in unforeseen events like the recent government shutdown impacting capital flows to a highly subsidized industry.”

Others are concerned about transaction viability and filling funding gaps caused by a combination of lower LIHTC pricing, rising construction costs, and the lack of subordinate soft debt.

“Material increases in the costs of land and construction in all markets in desperate need of affordable housing will reduce the overall amount of transactions that are viable,” says Tim Leonhard, managing director of affordable housing at Jones Lang LaSalle (JLL).

Tracy Peters, senior managing director of affordable housing at Red Mortgage Capital, adds that due to rising costs and insufficient sources of soft funds, “there will be the need to identify financing structures that will maximize loan proceeds.”

Sarah Garland, director of affordable housing debt and structured finance at CBRE Affordable Housing, agrees that there’s not a lot of soft money out there.

“It’s a problem between rates potentially going up, construction costs going up, and not having any soft funds,” she says. “You can only defer so much developer fee.”

Phil Melton, executive vice president and national director of affordable housing and Federal Housing Administration (FHA) lending at Bellwether Enterprise Real Estate Capital, adds that because of the lower LIHTC prices and lack of soft funds, he’s starting to see deferred developer fees creep up over 50%, with a couple hitting 80%. “That’s nerve-wracking for syndicators and lenders,” he says. “That’s one thing for developers to keep an eye on and not erode their fees that make their transactions look a little riskier.”

Other lenders are keeping a cautious eye toward reform of the government-sponsored enterprises (GSEs) and changes to Community Reinvestment Act (CRA) enforcement and the threats each could pose to the lending industry.

2019 forecast

U.S. Bank’s Smith says he believes capital will remain widely available this year. “I think some of the larger affordable developers will need to branch out to find more construction lending channels as exposures with existing lenders grow due to increased activity industrywide,” he adds.

Citi’s Gerwitz also says the competition is greater in the affordable housing sector. “Competition has increased in our market as this real estate cycle has matured. Certainly, Fannie Mae and Freddie Mac have been much more active, but other financial institutions have entered the market or stepped up their activity relative to prior years. Inevitably, as competition increases we tend to see more aggressive underwriting in the market. We do everything we can at times like this to maintain our focus on risk while making sure we’re serving our clients’ needs.”

He adds that because interest rates have increased and the yield curve has flattened, more clients are starting to move toward or at least exploring fixed, rather than floating-rate, construction loans.

Alice Carr, head of Community Development Banking at Chase, also says to look for even more bond transactions this year. “With most markets still experiencing strong apartment demand and tax credit equity prices normalizing near historical highs, we expect the increase in bond transactions seen over the past few years to continue.”

Affordable products offered by Fannie Mae and Freddie Mac will continue to be popular this year.

“In 2019, anticipate continued support by the GSEs for affordable housing product through competitive pricing and no volume caps,” says Jeff Englund, senior managing director of multifamily affordable housing at Greystone. “The GSEs will likely see continued growth in this sector along with expanding their focus to workforce housing product. In addition, expect to see a focus on products that enhance the GSEs’ tax credit equity investment position in LIHTC transactions.”

The Freddie Mac Tax-Exempt Loan (TEL) program and Fannie Mae’s MBS Tax-Exempt Bond (MTEB) structure continue to gain popularity, especially with the forward-rate lock financing for 4% tax credit transactions.

“Borrowers are seeking loan products that will allow them to lock in interest rates as early as possible,” adds Red Mortgage’s Peters.

JLL’s Leonhard adds that Fannie and Freddie fixed-rate taxable loans will be key for acquisitions or refinancing. “For bond financing, [I expect to see] a combination of bank direct placement bond loans in high-demand CRA markets as well as Fannie Mae MTEB and Freddie Mac TEL on a more nationwide basis,” he adds. “For 9% LIHTC new construction, bank financing will dominate the market as it has for many years now.”

Peters also says the FHA program will continue to be popular, as it offers the greatest amount of leverage for tax credit transactions, and the Department of Housing and Urban Development 
is working to improve processing time frames.

“With volatility in the market, we think there will be a push toward FHA,” adds Dan Lyons, managing partner at Rockport Mortgage Co.

Barry also says Bank of America Merrill Lynch anticipates growth for its FHA platform. “We anticipate our clients will increasingly turn to FHA to finance both LIHTC and workforce housing developments, given the attractive terms of this financing.”

Red Stone Tax Exempt Funding president Cody Langeness says his firm continues to see increased interest in bridge financing as the market for multifamily real estate assets remains competitive. “In order to compete on a timing basis with nonaffordable developers, our clients are often seeking the short-term facilities.”

Trends to watch

Workforce housing and mixed-income developments will attract even more attention in 2019, according to lenders.

“We expect to see more interest in workforce housing transactions for both new construction and preservation, especially in high-cost markets,” says Greystone’s Englund.

Walker & Dunlop’s Baldasare adds that several of his firm’s clients, both for-profit and nonprofit, have been investigating how to develop workforce housing. “It’s a class that’s grossly underserved. Middle America is being missed.”

Vince Toye, head of community lending and investment at Wells Fargo, says the bank is working with developers to be creative with financing that meets the need for affordable housing by, for example, focusing on mixed-income developments.

“I think the big trend we’ll see is mixed-income. We’re seeing more deals with income averaging to meet the bottom end of the workforce,” Toye says. “That’s going to be the hot-button issue this year. I think developers will be thinking more about it.”

He says that with the tax law changes enacted last year, adding workforce housing for households earning 80% to 120% of the area median income (AMI) to an affordable housing development can be beneficial by helping fill the funding gap.

Carr says mixed-income projects are a priority for Chase. “We also anticipate more mixed-income projects, both incorporating market-rate units with traditionally defined affordable units [less than 60% of the AMI] and projects mixing in units targeted to tenants earning between 60% and 120% of the AMI.”

Citi Community Capital, also, is seeing more focus on workforce and mixed-income units. “Municipalities are seeing larger numbers of people in their communities having a hard time finding adequate housing that fits their budget, and they’re trying to find ways to help those families whose income puts them above LIHTC income limits,” Gerwitz says.

He also says Citi expects to see a continued focus on increasing the number of units for the homeless population and a continued emphasis on Rental Assistance Demonstration projects.In addition, preservation is expected to be another hot topic this year.

“We think preservation and acquisition opportunities will continue to expand, and more portfolios will come to market,” says Bellwether’s Melton. “A number of transactions rolling off of Year 15 will have significant viability in the marketplace. More and more people coming into the affordable housing space are viewing it as an investment of choice instead of an investment of last resort, because they’re starting to understand the value-add, operational success, and safety relative to stable operations and low default rates.”

Top 25 Lenders of 2018

Company	2018 (in millions)	2017 (in millions)
1. Citi Community Capital	$6,015.5	$4,709.1
2. Wells Fargo	$5,279.4	$4,305.5
3. Bank of America Merrill Lynch	$2,796.0	$2,832.0
4. KeyBank Real Estate Capital	$2,459.0	$1,761.0
5. Stifel, Nicolaus & Co.	$1,557.0	$1,079.0
6. Chase	$1,417.5	$1,477.9
7. Capital One	$1,309.0	$1,277.0
8. Jones Lang LaSalle	$1,228.4	$1,291.0
9. Greystone	$1,169.8	$1,457.7
10. Merchants Capital*	$1,096.9	$445.1
11. Berkadia	$1,079.0	$1,851.0
12. Walker & Dunlop	$1,029.0	$1,729.2
13. Rockport Mortgage Co.	$930.0	$838.0
14. Bellwether Enterprise Real Estate Capital	$919.8	$1,169.9
15. CBRE	$831.5	$512.3
16. U.S. Bank	$798.0	$735.0
17. R4 Capital Funding	$684.7	$401.2
18. PNC Real Estate	$663.4	$968.6
19. TD Bank	$657.2	$316.0
20. SunTrust Bank — Commercial Real Estate	$627.7	$992.0
21. Red Mortgage Capital	$624.8	$448.6
22. Red Stone Tax Exempt Funding	$617.2	$580.8
23. RBC Capital Markets	$612.5	$383.2
24. Hunt Real Estate Capital	$466.2	$275.9
25. Dougherty Mortgage	$321.5	$260.5