Rescuing the Rescuers: Solutions for Affordable Housing Professionals
Affordable housing developers and owner-operators are dedicated to helping families and individuals that might otherwise have no viable place to live. To do that, financing must be made available to make strategic acquisitions and new developments happen. It sounds simple — but given recent changes in the market, affordable housing organizations may be faced with a capital crunch.
On everyone’s mind is the probability that the federal government will make changes that could negatively impact critical programs that support the housing crisis fight. The uncertainty around the administration’s next move, and the details of its impact on tax obligations, have reduced investors’ appetite for participation in the Low Income Housing Tax Credit (LIHTC) program, one of the primary sources of equity for new properties and substantial rehabs of existing properties.
Uncertainty about tax reform is at the center of the hesitancy. Under LIHTC, corporations gain federal tax benefits for 10 years in exchange for investment in affordable housing projects as approved by state housing authorities. Now that investors believe their tax burden may be reduced, but don’t know the extent of the reduction or when it will start, they can’t tell how many credits they’ll need over the next 10 years. Credits are still valuable, but their exact value is unknown. As a result, affordable housing deals that have taken years to structure could be in danger of unraveling.
This hiccup in the LIHTC market isn’t the only challenge for affordable housing developers seeking capital. Interest rates increased by about 50 basis points in the last half of the year. Consequently, permanent loan proceeds have fallen by 5-8%, and new projects need 7-10% more equity today than a year ago. The fact that all commercial property types are equally affected by these trends is of little comfort to affordable housing players facing lower proceeds and higher development and construction costs.
In short, there have been plenty of challenges for the sector lately. But even in this environment, there are financial strategies to complete affordable housing deals, from new development to re-syndication to Year 15 financing.
Yes, there is still capital for affordable housing
While many investors are taking a wait-and-see approach to tax credit investment, some are as active as ever. For example, many banks (including Key) must still meet Community Reinvestment Act (CRA) requirements. And investing in affordable housing — as a supplier of debt, equity or both — is an effective way to fulfill that mission.
Additionally, banks that underwrite affordable housing deals through Fannie Mae, Freddie Mac, and HUD have additional reasons to buy credits in those deals. Direct investment provides control over the end capital, and due diligence only needs to be performed once. In Key’s case, we also recognize the intrinsic value of maintaining long-term client relationships, and forming new ones whether there are market disruptions are not!
Filling the gaps (debt and equity both matter)
Developers and owner-operators have a variety of ways to fill the gaps in tax-credit equity and permanent debt. They can put more cash into deals, take on subordinated debt, or find a way to increase cash flow from properties. To understand all their options, they need to work with a financial partner that offers integrated solutions, uses its balance sheet when necessary, and corresponds with all the major funding sources: the Federal Housing Administration (FHA), Freddie Mac and Fannie Mae.
For ground-up construction and substantial rehab deals, one of the most attractive debt executions is the FHA-insured 221(d)(4) program, which offers non-recourse, fixed-rate loans with 90 percent leverage and 40-year amortization. In addition to significantly higher proceeds and interest rates that are 50 to 70 basis points lower than conventional financing, the FHA program provides up to a three-year interest-only period for construction, which extends the loan to 43 years.
Borrowers typically don’t use FHA financing to acquire properties, because the time needed to work through the process is too long. Instead, acquirers often get a bridge loan to close deals quickly, and then go through the process for FHA financing and/or new tax credits if and when the time is right. In cases where proceeds are still tight, Key’s balance sheet can be used to provide letters of credit that offset cash requirements so developers can still access FHA financing.
Freddie Mac can also provide “bridge-to-syndication” floating-rate loans in cases where borrowers expect to apply for new credits in the short term. The program offers up to 85 percent leverage with no recourse and features a one-year lockout provision and then no prepayment fees if the loan is converted to a Freddie Mac permanent loan. Freddie Mac’s program is popular for its two-year interest only feature, minimizing owners’ carry costs.
Balance sheet financing in a pinch
Affordable housing owners also have to consider their option when the tax credits compliance period runs out. LIHTC deals include 10-year amortization on the credits, but owners must maintain compliance with affordability status for an additional five years. Owners should be considering their Year 15 strategy well in advance of expiration, and in most cases, this will mean a sale of the property so investors can exit their involvement. Buyers may be private organizations or preservation funds set up specifically to acquire these properties and maintain their affordable status. If the Year 15 property needs to be rehabbed, the owner may apply for resyndication tax credits, but in many cases, owners forego tax credits and maintain affordability standards to qualify for favorable Fannie, Freddie, and FHA financing. Whatever path owners choose, Key executives have an abundance of experience to provide the best advice and financial assistance.
No matter what happens with tax reform, or with the new Administration’s housing policies, no one envisions an end to the LIHTC program. Since their inception in 1986, low-income housing tax credits have always had strong bipartisan support, as they are favored by housing advocates and corporate interests alike. Government sponsorship of affordable housing strategies is here for the long term — and in the short-term, there are definitely strategies to cut through the uncertainty.
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