Recent and Projected and Affordable Housing Share Multifamily Rental Housing Starts

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1 Western Mortgage Advisory Council (WMAC) Annual Western Lender s Conference April 15-17, 2015 The Curtis Hotel Denver, Colorado Recent and Projected and Affordable Housing Share Multifamily Rental Housing Starts R. Wade Norris, Esq. Eichner Norris & Neumann PLLC th Street, N.W., 7th Floor Washington, D.C Phone: (202) Fax: (202) website:

2 HISTORIC AND PROJECTED MULTIFAMILY HOUSING STARTS (THOUSANDS) (FOR RENT) **** * 2013** 2014** *2013 & 2014 Estimated Data from The State of the Nation's Housing, 2013 & 2014, Joint Center for Housing Studies of Harvard University **Estimate based on rental = 90% of 340,000 total multifamily starts from Freddie Mac, Multifamily Research Perspectives, Multifamily Mid-Year Outlook 2014, July 31, 2014 According to Harvard Studies, yearly multifamily rental housing starts averaged 230,000 units per year R. Wade Norris Eichner Norris & Neumann PLLC

3 HISTORICAL MULTIFAMILY COMPLETIONS AND PROJECTED DEMAND Harvard Studies estimates that pent up demand, if satisfied, would drive total multifamily rental housing demand as high as 400,000 to 470,000 units per year for the next decade. R. Wade Norris Eichner Norris & Neumann PLLC

4 Source: Wells Fargo Securities, LLC, Economics Group, U.S. Outlook R. Wade Norris Eichner Norris & Neumann PLLC

5 Of the total multifamily rental apartment starts each year, roughly one-third are affordable, i.e., 100% of the units rented to tenants with income 100% at 60% of AMI (for a family of 4, adjusted for family size).* For example, in 2012, 94,000 (37.6%) of the 250,000 rental units started in the U.S. were affordable. These units come from the two major Low Income Housing Tax Credit ( LIHTC ) programs: 9% LIHTC. Very powerful subsidy Borrower can syndicate to cover 70% of Total Development Costs ( TDC ); he or she gets a small bank loan, and that s it not attractive to FHA lenders too small. 9% LIHTC accounts for roughly one half of all affordable units. Over subscribed 4 or 5:1. 4% LIHTC. Borrower can syndicate to cover approximately 30-35% of TDC; requires at least 50% of eligible basis to be funded with tax exempt private activity bonds, as described below. Accounts for roughly one half of affordable units. Larger loan more attractive to FHA lenders. Private activity volume wildly available (outside of NY state). Under either program, rents charged on affordable units cannot exceed 30% of the applicable income limit for the affordable units. E.g., if project is 100% 60% of AMI, and AMI for family of 4 is $80,000, then income limit for family of 4 is 60% of $80,000 or $48,000 and monthly rent limit is 30% of $48,000 which is $14,400 per year or $1,200 per month. *Tax exempt bonds may also be used on projects where 20% of the rents are set aside for persons at 50% of AMI; usually large urban projects which often use different debt financing structures. R. Wade Norris Eichner Norris & Neumann PLLC

6 Very different from market rate apartment developments. Developer gives up a lot of the ups -gain on sale or refi after stabilized occupancy Project must remain affordable rental project, generally for years. Restricted rents plus low income occupancy reduces NOI, but tax credits fund 30-40% of TDC. Developer gets substantial up-front development fee (5-10% or slightly more); plus construction contract if project has a related contractor, plus annual management fees, assuming Developer has related management company. Major industry perhaps 50,000 units per year presently for 4% LIHTC plus tax exempt bonds. R. Wade Norris Eichner Norris & Neumann PLLC

7 Western Mortgage Advisory Council (WMAC) Annual Western Lender s Conference April 15-17, 2015 The Curtis Hotel Denver, Colorado MAJOR TAX EXEMPT BOND OR LOAN EXECUTIONS FOR AFFORDABLE MULTIFAMILY RENTAL HOUSING PROJECTS R. Wade Norris, Esq. Eichner Norris & Neumann PLLC th Street, N.W., 7th Floor Washington, D.C Phone: (202) Brian H. Dale Citi Community Capital 1801 California Street, Suite 3700 Denver, CO Phone: (303)

8 YOU!!! are an affordable housing (100% at 60% of AMI) developer.* You are mad (see picture) because you applied for 9% LIHTC and they were oversubscribed. How do you structure the tax exempt bonds required to prime the 4% LIHTC you now must have in order to finance your deal? *Tax exempt bonds may also be used on projects where 20% of the rents are set aside for persons at 50% of AMI; usually large urban projects which often use different debt financing structures. 8

9 ALTERNATIVE TAX EXEMPT BOND EXECUTIONS Since the 2008 financial crisis, in some government or quasi-governmental debt markets, taxable rates are lower than tax-exempt muni rates. For example, rates on taxable GNMA securities are lower by basis points ( bps ) than rates on longterm municipal bonds rated AA+ or Aaa backed by the same GNMAs. That s Crazy!!! you say. You pay federal and state income tax on the interest on Ginnies (40+% of your return if you are a high bracket tax payer), which, you keep if you instead purchase the long-term municipal bond backed by the Ginnie. How can the rates on the taxable Ginnies be lower? We live in a crazy world. Since 2008, the world trusts U.S. Treasury Bonds, GNMAs, and to a degree, Fannie Mae and Freddie Mac long-term debt securities, and not much else (relatively), including even AA- and Aaa-rated bonds. The world still thinks that the reliability of rating agencies is quite questionable; if they were that reliable they would have never rated hundreds of billions of paper AA and Aaa prior to 2008, which became worth 10 or 15 or nothing. So if I can do a simple taxable conventional FHA loan at a lower rate, why would I use muni bonds? 9

10 LONG TERM RATE COMPARISON: 30-YEAR MMD (TAX EXEMPT) VERSUS 10-YEAR CONSTANT MATURITY TREASURY (TAXABLE) 9.00% 8.00% 7.00% Early 2008 Taxable US Government Securities Rates Fall Below Tax Exempt Municipal Rates 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 30-Yr MMD 10-Yr US Treasury 10

11 6.00% LONG TERM RATE COMPARISON: 30-YEAR MMD (TAX EXEMPT) VERSUS 10-YEAR CONSTANT MATURITY TREASURY (TAXABLE) JANUARY 1, PRESENT 5.00% 4.00% 400 BPS 153 BPS 3.00% 2.00% 1.00% Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul Year MMD 10-Year US Treasury 11

12 ALTERNATIVE TAX EXEMPT BOND EXECUTIONS To be sure your project is worthy of the subsidy inherent in 4% LIHTC, Congress piggy-backed on the states private activity bond volume allocation systems. If your project is good enough to get an allocation of private activity bond volume then it will qualify for 4% LIHTC (almost automatically, but you do have to fill out the forms). Thus, the 50% Rule: To be eligible for 4% LIHTC, you have to finance at least 50% of eligible basis plus land (basically, total development cost less any commercial component) with volume limited tax-exempt private activity bonds under Section 142(d) of the Code and keep them outstanding until the project s placed-in-service date (roughly, completion of rehab for a mod-rehab project or certificate of occupancy for a new construction/sub-rehab project). So, if your project is affordable, you will be using at least some tax-exempt private activity bonds! (Remember: No tax exempt bonds = No 4% LIHTC = No affordable housing project.) 12

13 SHORT-TERM CASH BACKED TAX EXEMPT BONDS HOW IT WORKS Issue short-term tax exempt bonds equal to 50% of project s eligible basis plus land* with a maturity roughly twice the targeted placed-in-service date (to provide for construction delays). Two funds established under Bond Trust Indenture and invested in same AA+ rated investment vehicle: A Project Fund in which all the tax exempt bond proceeds are deposited, and A Collateral Fund in which FHA lender advances or GNMA or Fannie Mae MBS proceeds or Freddie Mac loan proceeds are deposited. Financings structured so that as each dollar of tax exempt bond proceeds is disbursed from the Project Fund to pay project costs, an equal amount of replacement proceeds must be simultaneously deposited into the Collateral Fund. The principal of the Bond issue thus remains 100% cash collateralized. *Note: This may be greater than or lower than the taxable loan amount. Most developers aim for 52-55% of eligible basis to provide a cushion. The short-term cashed backed bond structure often produces a lower bond amount, which lowers bond financing costs. 13

14 SHORT-TERM CASH BACKED TAX EXEMPT BONDS HOW IT WORKS (CONT D) In addition, at Bond closing, the interest which will accrue on the Bonds through the stated maturity date (eg., 0.90% x 2 years or 1.8% of the tax exempt bond amount) is deposited (in bankruptcy remote funds) into a capitalized interest account of the Bond Fund, securing the full payment of the maximum amount of interest which can accrue on the Bonds through maturity. This cash collateralization of principal plus interest enables the financing to obtain an AA+ rating on the short-term Bonds from Standard & Poor s, based on the rating of the underlying investments (often a highly rated money market fund), without other credit enhancement. When the project loan has been fully funded, rehabilitation or construction has been completed and the project has been placed in service the tax exempt bonds are redeemed. Any excess prefunded capitalized interest is returned to the Borrower and the Project s only remaining debt (except for certain subordinate loans often used for affordable housing projects) is the taxable FHA insured mortgage loan, or the taxable Fannie Mae or Freddie Mac affordable housing loan. 14

15 SUMMARY OF RELATIVE ALL-IN BORROWING RATES Short-Term Cash Backed Tax-Exempt Bonds + Taxable Loan Sale Long-term (18, 35 or 40-year) Tax- Exempt Bonds Backed by FHA/GNMA, Freddie Mac or Fannie Mae Estimated Approximate Savings in All-in Rate FHA Insured Section 223(f) (Acq/ Mod Rehab) 3.75% v. 4.40% 0.65% Section 221(d)(4) (New Cons/ Sub Rehab) 4.25% v. 4.50% 0.25% Plus: Dramatic Reduction in Construction Period Negative Arbitrage; 1%-1.5% v. 8-10% for Longterm Bonds. * Fannie Mae Moderate Rehab Loans About 4.50% v. 5.00% 0.50% 15

16 SHORT-TERM CASH BACKED TAX EXEMPT BONDS OTHER ADVANTAGES Borrowers who are willing to price to a 12-month mandatory tender in public offerings, can drive the bond coupon down to bps (the lowest we have seen is 28 bps), and limit the capitalized interest deposit required at closing to 12 months. This involves some potential remarketing expense, if required, and some interest rate risk upon the remarketing. However, there is almost no history of 12-month remarketing rates on AA+ rated tax exempt paper ever exceeding 1.0% over the past two decades. Total issuance costs are lower on short-term cash backed bonds than on long-term municipal bond financings using these FHA and Fannie Mae platforms. Another potential major advantage of short-term cash backed tax exempt bonds elimination of ongoing administrative fees after Bonds are redeemed. Where ongoing fees are high (e.g. issuer fees of 25 to 40 or 50 basis points per year), this can be a major advantage. These issues involve an average of 11 months of ongoing fees or slightly more versus 15 years of ongoing fees. 16

17 THE MAIN COMPETITION TAX EXEMPT BOND OR TAX EXEMPT LOAN PRIVATE PLACEMENT CRA Impact on Affordable Housing Finance. Especially if the developer has a project in a major urban market (e.g., Boston, New York, Washington D.C., Miami, Chicago, San Francisco, Los Angeles), there may be another competitive execution. Large banks are required under the Community Reinvestment Act ( CRA ) to do a certain dollar volume of public benefit lending activities and a certain dollar volume of investment activities in the markets where they have a presence, or they risk severe limitations on their future activities (e.g., new products, mergers, etc.). Thus, large banks are huge buyers of both tax exempt bonds or loans (and 9% and 4% LIHTC) in markets where they have a presence. This substantially lowers tax credit yields and tax exempt all-in borrowing rates in CRA driven markets. Starting in the late 1990 s, to satisfy CRA goals, banks began to buy non credit enhanced bonds, backed only by a first deed of trust and certain pre- Conversion General Partner guaranties (e.g., completion, payment). They buy the tax exempt bonds or fund the tax exempt loan (the nomenclature depends on the type of CRA credit sought) on a draw down basis, as loan advances are made. This eliminates negative arbitrage on a sub rehab or new construction loan (similar to forward delivery funding on an FHA 221(d)(4) loan). Moreover, for sub rehab/new construction loans, the Banks offer very low all-in construction period borrowing rates (e.g., SIFMA (.02%) or 1-month LIBOR (0.15%) plus %) before the loan reaches Conversion, or stabilized occupancy (e.g., 1.15 DSC for 90 consecutive days; 90% LTV). 17

18 TAX EXEMPT DRAW DOWN PRIVATE PLACEMENT BOND OR TAX EXEMPT LOAN FINANCING STRUCTURE MOD REHAB, SUB REHAB OR NEW CONS Underwriting Mod Rehab Sub Rehab/New Cons Bond Rate Construction: SIFMA N/A 0.02% Plus: Spread 2.25% to 2.50% = Bond/Loan Interest Rate 2.27% to 2.52% Bond Rate Permanent: 16 to 18-year LIBOR Swap Floating* 2.24% 2.28% Plus: Spread 1.80% to 2.00% 2.10% to 2.40% = Bond/Loan Interest Rate 4.04% to 4.24% 4.38% to 4.68% Credit Enhancement N/A N/A Servicing Fees Remarketing Agent N/A N/A Issuer Trustee Total Fee Stack Total Permanent Mortgage Rate (Underwriting Rate and Actual Permanent Borrowing Rate) 4.19% to 4.39% 4.53% to 4.83%** Upfront Fees (est.) Origination % App Bond Costs of Issuance % *Add 15 basis point fee stack below for all-in construction period borrowing rate. ** Most bond private placements funded on draw down basis, which eliminates construction period negative arbitrage. Estimated Rates as of 04/10/2015; 35-year loan amort.; DSCR; 80-90% LTV. If not in a part of Bank CRA footprint, some banks product may only be available at somewhat higher rates and somewhat tighter underwriting terms. 18

19 COMPARISON OF PRIVATE PLACEMENT TO SHORT TERM CASH BACKED BONDS + FHA FHA insured loan is only available credit enhancement which is non-recourse during pre-conversion phase all others (Private Placement, Fannie Mae, Freddie Mac) require deep pocket General Partner guarantees during this phase. FHA offers greater prepayment flexibility closed for 2 years to 108% decreasing 1% per year thereafter v. yield maintenance of 12% or higher declining over a longer period (e.g., 15 years) Private placement sponsors will generally bridge tax credit equity payments through larger first deed of trust secured construction loans paid down at perm phase; with FHA no lien on real estate permitted to secure a tax credit bridge loan. 19

20 COMPARISON OF PRIVATE PLACEMENT TO SHORT TERM CASH BACKED BONDS + FHA For sub rehab/new construction private placement deals there is a new loan underwriting and possible loan downsizing based on DSC or LTV at Conversion; unlike an FHA 221(d)(4) loan (which only requires cost certification). The very low perm rates are locked at closing (e.g., 4.20 to 4.40% including third party fees on fully funded mod rehab loans or 4.50 to 5.00% for a draw down construction/perm loan); and the structure readily accommodates a loan pay down at Conversion from other funding sources. The perm rate will generally be somewhat higher (20-50 bps) than a 221(d)(4) rate and the loan will have a 35 year amortization to a 16 to 18 year balloon (versus 35 or 40 year loan amortization and no balloon on FHA); but no Davis Bacon wages, possibly more flexible/quicker loan underwriting and multiple banks competing in many CRA-driven markets. Private placements may also be available from non-bank financial institution sponsors in some markets. Freddie Mac has recently introduced its Tax Exempt Loan or TEL structure with many of the same features and terms. Possibly even lower perm rates and potentially available in all markets, not just CRA, but much less tested at this time, especially for sub rehab/new construction loans. 20

21 OTHER TAX EXEMPT BOND EXECUTIONS There are a few other options, eg. An 18-year credit enhanced Freddie Mac or Fannie Mae Bond issue for sub rehab / new construction or the new Fannie Mae monthly tax exempt MBS passthrough structure, but the two major options outlined above, (i) short-term cash backed bonds with a taxable FHA 223(f) or FHA 221(d)(4) or a Fannie Mae mod rehab loan and (ii)tax Exempt Bond or Loan Draw Down Private Placements probably comprise 80-90% of the market and generally the most competitive terms for affordable housing loans. 21

22 SUMMARY OF BORROWING/UNDERWRITING RATES Estd. Actual All-In Borrowing Rate Underwriting Rate 1. Short-Term Cash Backed Tax Exempt Bonds with Taxable Loan Sale FHA/ GNMA 223f (Mod Rehab) 3.75% 3.75% FHA/ GNMA 221(d)(4) (Sub Rehab / New Cons) 4.25% 4.25% Fannie Mae or Freddie Mac Mod Rehab (Freddie deemphasizing see TEL Structure Below) 2. Private Placement 4.50% 4.50% -Mod Rehab 4.20% to 4.40% 4.20% to 4.40% -Sub Rehab/New Cons Cons Period 2.25% to 2.50% Floating 2.25% to 2.50% Floating Perm Period 4.50% to 5.00% 4.50% to 5.00% 3. New Freddie Mac TEL Program (Mod Rehab, Sub Rehab, New Cons) *May be attractive on non-tax credit deals. (Cons Period; SIFMA or LIBOR ) Perm 4.10 to 4.50% (lower end for mod rehab) (Cons Period; SIFMA or LIBOR ) Perm 4.10 to 4.50% (lower end for mod rehab) 22

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