There’s a human factor when it comes to working in the affordable housing industry. Kelly Frank, senior banker at KeyBank, recalls attending a ribbon-cutting ceremony for a scattered-site housing development where a woman came up to her in tears expressing how grateful she was to have a home in a safe neighborhood setting.
The ability to make such a positive impact on someone’s life is one reason Frank loves the affordable housing business.
“A lot of work is being done to bring affordable housing to every community,” says Frank. “Everybody’s eyes are on it because it’s a resounding theme throughout the country that there’s just not enough affordable housing.”
The United States is short 7 million rental units that are affordable and available to extremely low-income renters, according to the National Low Income Housing Coalition. These renters have household incomes that are at or below the poverty guideline, or 30 percent of their area median income.
The silver lining is that Cleveland-based KeyBank and other lenders have a large toolbox of financing mechanisms available to combat the affordable housing crisis and facilitate the development and preservation of affordable units. Many loans are processed through agencies, including government-sponsored enterprises such as Fannie Mae, Freddie Mac and the Federal Housing Administration (FHA).
For example, Fannie Mae has a popular product right now called mortgage-backed security as tax-exempt bond (M.TEB). The mortgage-backed security is sold as collateral for tax-exempt bonds. Proceeds are used to fund new construction or rehabilitation. What’s more, the borrower receives a lower interest rate and savings over the life of the loan on a forward basis, says Frank.
There are very few forward commitments for market-rate properties, according to Frank. But in the affordable space, Fannie, Freddie and FHA will provide long-term, fixed-rate commitments up front, which provides certainty of execution to the project owner and equity investor. Given the lower risk profile of the industry, interest rates are very favorable for borrowers, she explains.
“The overall lack of affordable housing in the country means that these projects lease up quickly and stay close to 100 percent leased,” she says. That’s good news for investors, as the assets reap a dependable revenue stream due to high occupancy and strong demand.
Jeff Englund, senior managing director at New York City-based Greystone, says that a larger pool of investors is interested in buying mortgage-backed securities than tax-exempt bonds. The M.TEB program provides the borrower with a more favorable interest rate and higher loan proceeds.
“The affordable space is one area where agencies have stepped up with products to help prop up that part of the market,” says Englund. “In the market-rate space, they’re really not offering forward commitments or forward rate locks.”
This summer, Greystone, a real estate lending, investment and advisory company specializing in multifamily and healthcare finance, provided $70.4 million in permanent financing through Fannie Mae for Morningside North Apartments in Chicago. Financed under the M.TEB program, the borrower received tax-exempt financing from the Illinois Housing Development Authority in the form of long-term bonds.
Under a 20-year Section 8 Housing Assistance Payments contract, all of the units at the 256-unit community are reserved for residents earning up to 60 percent of the area median income (AMI). The Chicago AMI for a one-person household is $62,400, according to the city of Chicago.
For Englund, it is critical that developers and lenders stay focused on the affordable sector. “On an annual basis, we’re losing affordable units,” he says. “Preserving those is something myself, Greystone and other lenders take very seriously.”
How the capital stacks up
Merchants Capital, a multifamily, affordable housing and healthcare lender, has closed $38 million of Fannie Mae M.TEB transactions over the past six months. In southern Indiana, the company secured $21.4 million for the renovation of Carriage House of Evansville, a Section 8 housing development.
“Our bank structured the construction loan as tax-exempt, which provided a streamlined, cost-efficient execution,” says Michael Dury, president of Carmel, Indiana-based Merchants Capital.
Dury adds that the financing options are quite attractive for the preservation of affordable units, given renewed commitment from government-sponsored enterprises. In addition to the M.TEB financing for the Evansville project, PNC Bank provided low-income housing tax credits (LIHTC).
Most developers within the affordable housing space are heavily dependent on LIHTC for project financing. The program is the most significant form of providing equity to fund affordable projects in which the units are reserved for 60 percent AMI and lower, says Charlton Hamer, senior vice president with Chicago-based Habitat Affordable Group, the affordable housing division of The Habitat Co.
“Credit investors receive a dollar-for-dollar offset of income tax liability with the purchase of credits,” he says. “The credits are claimed over a proportional share during a 10-year period.”
There are two types of LIHTC — 4 percent and 9 percent. The 4 percent program delivers a subsidy equal to roughly 30 percent of the value of a project’s qualified basis while the 9 percent provides 70 percent.
The Annex Group, a developer based in Indianapolis, focuses predominantly on the 4 percent credits because they are easier to obtain than the 9 percent credits, which provide more financing but are in high demand, according to CEO Kyle Bach.
Annex prefers to enter markets that have higher-than-average HUD rents and that are either designated a qualified census tract (QCT) or a difficult development area (DDA), which is an area with high land, construction and utility costs. These types of sites provide additional equity to help make the project financially feasible, says Bach.
Another way to make the numbers pencil out is to partner with municipalities that are willing to provide various incentives. These can be tax abatements, tax-increment financing or waivers of building permit fees, says Bach.
In Bloomington, Indiana, Annex is developing a 146-unit project that is situated within a QCT. According to Data.gov, a QCT refers to any census tract in which at least 50 percent of households are earning less than 60 percent of the AMI. For this project, Annex sold the tax credits to national affordable housing investment firm R4 Capital, which provided the debt. Additionally, Annex received $1 million in grant funding from the city of Bloomington and a 10-year, 100 percent tax abatement, which was the first of its kind in the city.
Bach says that securing the financing for an affordable housing project takes at least double the amount of time it takes to receive financing for a market-rate project. “The capital stack can come from a variety of different sources,” he says. “You’ve got to have more patience on these projects.”
Cities help out
Steve Minn, vice president and chief financial manager at Lupe Development Partners, says he can complete three market-rate deals in the same amount of time it takes to complete one affordable housing transaction. For example, it took about three years to secure the financing and approvals for an affordable project in the Lyn-Lake area of Minneapolis. Lupe has since broken ground on the project, which received multiple sources of subordinate lender funding in addition to tax credits.
A bond issue from the city of Minneapolis for $13.5 million of tax-exempt housing bonds was expected to generate a little more than $9 million of syndicated equity, according to Minn. Like Annex’s project, the tax credit investor was R4 Capital, which says it is committed to ensuring stable and safe affordable housing.
One advantage of working in Minneapolis is that the city has a dedicated affordable housing trust fund whereby projects receive subordinated dollars based on the number of units reserved for residents at 50 percent AMI, according to Minn. The trust fund will provide loans amortized over 40 years for producing lower-income units, says Minn. “These are critical dollars because there are inherent costs working in the city.”
Examples of these additional or unforeseen costs associated with infill locations include cleaning up dirt or relocating power lines and underground utilities.
Phase I of Lupe’s project is slated for completion in September 2020. It will include 111 units, nine of which will be set aside for homeless veterans. To be eligible, residents must have an annual household income that ranges from $30,000 to $42,000.
In Phase II of the project, Lupe expects to introduce income averaging. This means that some of the units will be as low as 9 percent AMI while others will be as high as 80 percent AMI, according to Minn. The third phase will likely be market-rate units to help cover infrastructure costs. “These are creative choices we have to make as it gets harder and harder to build affordable housing,” says Minn. “We have to embrace income averaging.”
Unfortunately, rising construction costs are met with what sources say is a crisis level in terms of the supply of affordable housing. “There is unmet demand in both market-rate and affordable housing, but the affordable need is at crisis level,” says Minn. “Frankly, every major metro area in the nation is in the same bucket.”
— By Kristin Hiller. This article originally appeared in the November 2019 issue of Heartland Real Estate Business.