Demand for tax-exempt bond financing is likely to jump in 2008, partly as a result of the subprime lending crisis that rocked capital markets over the summer and sent spreads on conduit loans soaring, bond professionals say.
“As this credit crunch is happening, I would anticipate that more developers would look at bond financing again,” said Tuan Pham, a partner in the San Francisco office of Goodwin Proctor, and a specialist in tax-exempt multifamily housing.
As market-rate developers see the balance sheets on their projected deals get out of whack due to climbing rates on conventional loans, more of them will turn to lower-priced tax-exempt bonds as a way to make their deals pencil out, said Pham. Other bond experts agreed, with officials in California and Florida saying they expected to see an increase in applications for bond financing in the coming year.
The result: More affordable units are likely to be built next year as marketrate developers who wouldn’t have otherwise been required to build them include such units as part of their projects, and as states use more of the total volume cap of tax-exempt bonds available to them.
“As capital is harder to come by, interest rates will climb and the spread between what you can get conventionally and [the rates on] bond financing make it more attractive to developers,” said Pham. “If what I’m hearing about conventional rates is accurate, I think we’re moving back toward the oversubscription that we were seeing in 2000.”
Rising rates for taxable debt
As of late September, the rates available for 10-year, fixed-rate conduit loans had climbed to 200 basis points or more above the yield on the 10-year Treasury note, more than double the 85- to 90-point spread available just six months earlier. Fannie Mae and Freddie Mac were pricing loans at 150 to 170 basis points over 10-year Treasury yields.
Luckily, that didn’t hurt borrowers quite as much as it would have in June, when Treasury yields rose above 5.2 percent for the first time in a year. By late September, yields were back at about 4.6 percent.
Meanwhile, the average yield to maturity of 40 municipal bond issues tracked by The Bond Buyer fell to 4.75 percent on Oct. 1 from 4.95 percent a month earlier, indicating that rates on tax-exempt debt were declining at the same time that rates on taxable transactions were climbing.
“The issue that drives people to use tax-exempt bond financing versus conventional is the difference between the two [rates],” said Keeley Kirkendall, an executive vice president with ARCS Commercial Mortgage, a division of the PNC Financial Services Group, Inc.
Still, even if current credit conditions were to prompt more developers to consider using tax-exempt bonds to fund their projects, “I’m not convinced you’re going to see a tremendous shift for another six to 12 months,” he said. “The gestation period is at least six months for a project, so even if it’s going to have an impact, it’s going to be months down the road.”
The key zoning question
Another big consideration for developers in deciding whether to sacrifice market rents for lower tax-credit rents on a portion of their units is the local jurisdiction’s zoning requirements, according to Drew Hudacek, a senior vice president with the Sares-Regis Group of Northern California, L.P., a developer and manager of multifamily and single-family properties.
In cities that have no inclusionary zoning rules or rules which require 10 percent or less of units to be set aside for affordable housing, it’s generally more advantageous for a developer such as Regis to simply go with market-rate financing, he said. “If you’re in an area that already requires 15 percent affordability or greater, then the bond deal is very competitive.”
Sares-Regis recently completed the second phase of a two-phase mixedincome project in San Bruno, Calif., that tapped tax-exempt bond financing. San Bruno has a 15 percent affordable housing requirement in its redevelopment area.
The first phase of the Sares-Regis development, known as The Crossings, has 300 units, and was completed in 2004 and leased up in 2005. It was financed with $65.7 million in taxexempt bonds issued through the Association of Bay Area Governments, in a deal that also included a $3 million taxable tail.
The second, 185-unit phase was completed last year. It tapped $49.6 million in bond financing, and was sold in March, three months after Phase One was sold and before construction was even completed, according to Hudacek. Both properties targeted 20 percent of their units to households earning no more than 50 percent of the area median income, thereby meeting the minimum set-aside required to qualify for the usage of tax-exempt bonds.
“We’re very interested in tax-exempt bond deals,” said Hudacek. “We always have been; I wouldn’t say that our appetite is any different because of what’s going on [in the capital markets].”
Virginia Aims to Restrict Bond Burning
Virginia is aiming to limit a practice that officials say can result in the waste of precious tax-exempt bond authority and limit the benefits the bonds provide for low-income residents.
A proposal issued in September by the Virginia Housing Development Authority (VHDA) would sharply restrict “bond burning,” as the practice is known. It occurs when developers apply for allocations of tax-exempt bonds in an effort to gain access to the 4 percent lowincome housing tax credits (LIHTCs) that can automatically accompany the bonds.
Instead of leaving the bonds outstanding for the full term of the mortgage on the property, developers engaging in bond burning pay off all or some portion of the bonds as soon as the development is constructed and the credit period has begun. In essence, developers have used the practice as a way to avoid the tight competition for 9 percent LIHTCs.
“Because the credits are automatic, they get the benefit of the [4 percent] credits, but they pay off the bonds with some other type of financing, “ said Cara Wallo, a tax credit allocation officer with the VHDA.
“If you issue bonds and immediately retire them, the value of the bonds has been lost,” said Jim Chandler, LIHTC director for the VHDA. That’s because once the bonds have been retired, the interest-rate subsidy they provide, which can help project owners keep rents lower for a longer period, is gone. “When [the bond cap] is wasted in that way, it is a loss of a valuable resource for affordable housing projects that need the bonds,” Chandler told Housing and Development Reporter in September.
Also, some of the developments engaging in bond burning are high-cost projects which would not have scored well enough on tests of their financial efficiency to have won awards in the competition for 9 percent tax credits, according to Judson McKellar, general counsel for the VHDA.
The authority started seeing signs in the last six months that developers were using the practice, VHDA officials said. “It may make economic sense in some cases, but we want to make sure that overall on a statewide basis, that we’re able to use the scarce resources in the most effective way possible,” said Wallo. The VHDA has already awarded all its available bond cap this year, officials said.
The VHDA’s proposal would restrict tax-exempt bond-financed developments from receiving tax credits if more than half of the bonds are going to be retired within the first seven years of the debt’s issuance. Developments with existing Sec. 515 loans that expect to use bond amounts of less than $3 million for rehab would be exempt from the restriction.
The goal is to push developers of affordable housing projects to get the most value out of the subsidy they’re receiving, said McKellar. “We have a very heavy demand at this time for the tax-exempt bond cap from housing issuers as well as other issuers.”
The VHDA said it was accepting comments on the proposal until Oct. 23, and would consider them at its Nov. 7 meeting, where it will finalize its 2008 qualified allocation plan.
