While the ultra-low interest rate environment is prompting many owners to deleverage, the market’s volatility is forcing much more conservative underwriting, said panelists at “Choosing the Best Debt Financing Strategy in an Unpredictable Market” at AHF Live: The 2010 Affordable Housing Developers' Summit.
A few years ago, developers were looking to maximize leverage, and 1.15x debt-service coverage ratios (DSCRs) were the norm. But now, the need to assume flat rents for a period of time, and factor in the rising costs of utilities, has forced many borrowers to build a cushion into their deals.
“A lot of developers are no longer here because they used to ride the wave of being in very tight markets with a 1.15x DSCR on really tight rents,” said Rob Hoskins, managing principal of developer The NuRock Cos. “But the landscape has changed. We’re going to see a lot more conservatism in the marketplace.”
The good news is, there’s never been a better time to refinance. Given the rock-bottom yield on the 10-year Treasury, rates on 10-year loans from the government-sponsored enterprises (GSEs) and the Federal Housing Administration (FHA) are in the 4 percent range, sometimes below.
Rates are expected to remain low next year as well, presenting owners with an opportunity to lock in bargain rates for the long term and deleverage.
“People are starting to rethink their debt, not just on new projects but looking at their portfolios,” said Mark Ragsdale, a senior vice president at PNC Real Estate. “I don’t think anybody modeled this type of an interest-rate environment two years ago, five years ago, seven years ago.”
The agencies
Today’s low rates are also helping to make many acquisition deals pencil out. Cohen-Esrey Real Estate Services recently used the FHA’s Sec. 223(f) program to purchase an existing low-income housing tax credit (LIHTC) deal, scoring a sub-4 percent interest rate.
“In the 35 years I’ve been in the business, I’ve never had an interest rate, all-in, at 3.6 percent,” said Lee Harris, president and CEO of Cohen-Esrey. “These are phenomenal times, and this kind of financing obviously opens up an awful lot of opportunities for us.”
Processing times are getting better at the FHA as it refocuses on its core affordable housing mission. In fact, the FHA will start a pilot program next year, modeled on its LEAN program, to expedite the processing of tax credit deals.
The FHA will also expand the Sec. 223(f) program next year to allow for more rehab dollars. Currently, the program taps out at around $16,000 per unit in hard costs, forcing many developers to go through the more time-consuming Sec. 221(d)(4) program. But the FHA plans to model the retooled 223(f) on Freddie Mac’s Mod Rehab Program, which can go up to around $45,000 a unit.
Another welcome development at the Department of Housing and Urban Development (HUD) is the revival of the Partial Payment of Claim program. In the past, HUD was much more inclined to just sell the note on troubled properties. But owners who find themselves underwater now have the opportunity to work with HUD on partially paying down their loan amount.
“If you can demonstrate that it was the market, and not the fault of the developer, and you can also show you made a good-faith effort to fix the problem, you may be able to get a partial payment of claim,” said Carolyn McMullen, a vice president at Walker & Dunlop.
The GSEs have also been a steady hand in the affordable housing debt markets. Rates on tax-exempt bond credit enhancements have remained favorable, and the GSEs’ mod-rehab programs have stayed in the market, and even been upgraded, throughout the recession.
There’s also been a concerted effort at both Fannie and Freddie to bolster their positions in the preservation world. Freddie Mac made an underwriting change this year that allows for above-market Sec. 8 rents to be used when sizing a preservation deal, for instance. And Fannie Mae has grown more willing to offer 35-year amortizations, which Freddie has steadily offered. And DSCRs still remain as low as 1.15x.
Lender requirements
Lenders across the board are taking a much closer look at borrower liquidity and REO schedules than they ever have before. A strong track record is key, meaning those just entering the business will find a very tough row to hoe.
But it goes beyond just assessing a developer’s ability to deliver construction on time. “It’s not just about where they’ve been and where they are currently, but also projecting forward at pending pitfalls,” said David Leopold, senior vice president and tax credit originations executive for Bank of America Merrill Lynch. “It’s important right now to look holistically at the real estate portfolio and understand where the maturities are so you can eliminate those variables.”
Given the state of the market, lenders are realistic. They know that every active developer or owner is going to have some problems somewhere in their portfolio. So it’s not about whether problems exist, but what you’re doing to correct them.
“For every 10 deals, there are going to be one or two that don’t do what they’re supposed to,” said Hoskins. “Overall you’ve got to be prepared to explain the plan to get them back on the right track. Just submitting an REO schedule that doesn’t have any supporting information is a thing of the past.”
