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Long-term affordable housing providers continue to see tough competition from new players in the sector, fueled by ongoing investment capital from private equity funds and REITs. By using private capital rather than seeking financing through government sources these new developers can lock up sites faster and close deals more readily than traditional developers in the sector. But experienced affordable housing providers don’t have to throw in the towel. By going the extra mile to secure a public/private partnership, providers can get to the closing table with higher leverage and lower-cost debt than any private execution.

This message from John Gilmore, Vice President and Senior Relationship Manager at KeyBank Real Estate Capital, in discussing the state of affordable housing finance on a New York City Bisnow Affordable Housing panel still resonates as the market continues to wait for the new administration to enact change. “It can be difficult to get HUD deals done, but there’s no other product like it—developers of affordable housing can get a high leverage non-recourse construction loan, and lock in a low interest rate for a 40-year term,” he said.

Private equity investors haven’t been interested in affordable housing deals in the past, but current market conditions favor the sector. According to the “State of the Nation’s Housing 2016” report released by Harvard’s Joint Center for Housing Studies, the number of renters paying more than 50 percent of their income for housing jumped from 2.1 million households in 2008 to a record 11.4 million in 2014. While affordable housing is a universal problem among the lowest-income households, the market is starting to take notice that the problem is spreading among moderate-income households, too, particularly in expensive coastal markets. “We continue to see a very low-yield investment environment, with a lot of money in the system that needs to generate a return,” Gilmore said. Affordable housing provides opportunity for investors seeking yield considering the asset class is more stable and less volatile than market-rate assets.

Affordable housing properties on average trade for higher cap rates as compared to market-rate properties, although demand for affordable housing is much greater than the demand for Class A market-rate properties. Plus, investors concerned about the possibility of an economic downturn as we move along this economic cycle have extra reason to turn to the affordable housing category. Cap rates on high-end apartment properties are predicated on high rent levels, which might not be sustainable in a recession.

“Class A apartments have very little margin for error, while affordable housing produces very predictable returns,” Gilmore said. Affordable housing is always fully leased because there are many more renters in need than affordable units to accommodate them. According to the National Low Income Housing Coalition, the US has a shortage of 7.4MM affordable rental homes resulting in 35 affordable and available units for every 100 low income households. Every major metro area in the US has a shortage of affordable and available units. Gilmore cited an example where 284 new affordable units received over 82,000 applications from renters, adding: “That’s not a unique situation.” If the economy or the multifamily rental market hits a rough patch, upscale apartments will be under the greatest pressure, while affordable properties will be unaffected.

The combination of low risk and relatively high yield is what attracts investors such as private equity funds and REITS to the sector. Facing this new wave of competition, traditional affordable housing providers are having difficulty competing for sites as the new entrants into the marketplace turn to existing committed sources of conventional financing to get deals done faster, enabling investors to put their capital to work quickly. A large portion of the new entrants to the industry acquire Low Income Housing Tax Credits (LIHTC) properties for cash flow versus resyndication. But with the uncertainty of what the new administration will be able to accomplish around current regulations along with talk of GSE reform, there is new uncertainty in this space.

Public/private partnerships through HUD usually require the issuance of (LIHTC) and tax-exempt bond financing, which in theory enables borrowers to get higher leverage, lower debt service coverage requirements and lower financing costs. But HUD also adds time and complexity to deals.

Removing Barriers to HUD

In spite of what happens with the new administration, HUDs' streamlined application process and relaxed requirements will continue to help investors compete more effectively. HUD cut insurance premiums essentially in half as authorities recognized that the risk of defaulting on affordable housing loans is minimal. Also, HUD centralized its operations over several years in an initiative called Transformation, establishing a single multifamily underwriting model, and adding clarity and transparency to the process. Although Transformation is a definite improvement, deals can still take up to a year to complete in some cases, and rarely approach the speed of the conventional mortgage market.

Securing construction financing has become an additional challenge for affordable housing providers who work with HUD. Banks have cut back on their overall construction loan volume in recent months, as they contend with the impact of Dodd-Frank regulations and prepare for the possibility of an economic downturn. To the extent that banks are making construction loans to the affordable housing sector, many favor deals that are within their respective CRA Assessment Areas, which in turn can limit options for developers.

While REITs and private equity players are emerging as viable options, Key has a national affordable housing platform that goes well beyond its CRA requirements. As such, KeyBank has found it valuable for its borrowers to maintain a strong commitment to financing public/private partnerships via HUD, Fannie Mae and Freddie Mac. One popular program offered by Key is bridge-to-permanent financing, which allows developers to acquire properties quickly while providing the time necessary to resyndicate the tax credits and lock in a long-term permanent solution.

"For developers, bridge-to-permanent financing is a way to meet all their debt needs in one transaction, ‘Gilmore said. “It’s also a great execution for investors who are actively acquiring affordable housing, and need short-term bridge loans to acquire properties and make improvements." Another option for providers is to secure a line of credit through Fannie Mae or a revolving line of credit through Freddie Mac. Each of these sources has its own advantages, and both can provide higher loan-to-value ratios and lower debt service coverage ratios than private lenders.

It's all about having options

The bridge-to-permanent structure and lines of credit are part of Key’s integrated lending platform, which also includes balance-sheet financing. Gilmore noted that Key is a top underwriter of multifamily loans via HUD, Fannie Mae and Freddie Mac. “We originally got into affordable housing as part of our Community Reinvestment Act efforts, but over time our commitment has evolved and strengthened because it is integral to the mission of who we are as a corporation,” he said. Key’s broad product offerings complement its relationship approach to lending, resulting in repeat business from active clients and strong connections to HUD and the GSEs. Affordable housing providers who have worked with Key in the past because of its expertise and commitment to the category are reaping the benefits of that relationship now that the pressure is on to compete for deals.

To learn more, contact:
John Edward Gilmore IV, Vice President, Senior Relationship Manager, 212-424-1813