By Sam Adams
The need for affordable housing in the United States has never been greater, but supply is not keeping up with demand. High costs of construction and insurance, as well as elevated interest rates, make it difficult to get affordable housing development deals completed in the current environment. As a result, developers and finance leaders are looking for innovative strategies to close budget gaps and get deals done.
Financial market conditions are likely to persist for the foreseeable future. However, with the right knowledge, persistence and a little creativity, affordable housing developers are finding the financing they need to move forward with their projects.
Creative Approaches to Financing can Make or Break a Deal
In a typical deal environment, funding development projects is a complex task, and understanding basic financial blocking and tackling is a necessary first step. But in a challenging deal environment, recognizing the opportunity to take a more creative approach to financing can be the key to making a deal work. That may mean structuring the deal in an unusual way or looping in a partner who can turn an idea into reality because they’ve done similar deals.
For example, developers may secure more tax-exempt debt by collecting recycled volume cap to incorporate in a deal alongside new volume cap, which allows them to access tax credits. New volume cap is a state’s allocated tax-exempt bond issuance capacity for private companies or developers in a calendar year.
Recycling the volume cap refers to reusing a portion of previously issued volume capacity by taking the tax-exempt bonds from repaid bonds and “recycling” them in new projects. It takes forethought to find that recycled volume cap and bring it into your deal, but it can be an effective way to drive down the cost of capital, especially for larger projects.
Tax-Exempt Debt Has Greater Appeal When Interest Rates Are High
Tax-exempt debt is an important element of an affordable housing developer’s finance toolkit. Broadly speaking, tax-exempt financing is often 20 percent lower than taxable financing — a benefit that was effectively not worth the trouble to developers when interest rates were in the 2 percent range, and the relative benefit was even lower due to perceived illiquidity by investors.
But now, securing tax-exempt financing can provide significant financial benefit to a project. In the affordable housing world, most projects either meet the qualifications for tax-exempt debt or can get there through a nonprofit or government partner, recycled cap or new volume cap, if available. Securing that tax-exempt debt supports the ability to generate proceeds and additional cash flow and it drives more affordability by making the project operate more efficiently.
Cash-collateralized Bonds are Best-Suited to New-Development Projects
Affordable housing developers are also turning to cash-collateralized bonds to round out their financing toolkit in the current environment. Given the shape of the yield curve, there are some advantages that are particularly effective in the complex calculations associated with new construction, 4 percent low-income housing tax credits (LIHTC) projects.
Cash-collateralized bonds — which use cash instead of revenues from the housing project as collateral — are most frequently used for new construction projects that meet the qualifications for 4 percent LIHTC. Incorporating the bonds can add complexity to the deal process, but it also provides additional economics by allowing the developer to secure supplementary credits without deploying more money out of pocket. While cash-collateralized bonds can also be used for affordable housing rehabilitation projects, they are less common in those deals because they don’t offer the same value as they do for new construction.
Partnerships with Municipal Institutional Investors Are on The Rise
Affordable housing developers are increasingly exploring partnerships with municipal government partners with a keen interest in affordable housing to serve as strong guarantors. A city, county or state is not necessarily focused on generating a return so much as providing financial support and generating proceeds toward a project in ways that do not involve issuing subsidies or writing a large check.
Lenders are working with cities throughout the United States to expand affordable housing. Their budget doesn’t allow them to hand out a $10 million check, but most of them are double- or triple-A rated entities. Providing a guarantee on a huge project can provide a lot of value and can theoretically be applied to any kind of financing. This is most commonly considered for differing forms of low-income and workforce housing to meet the social goals of a local municipality.
Challenging The Status Quo Is Critical To Success
Challenging orthodox financing approaches and assumptions based on past experience is crucial to alleviating affordable housing shortages. Affordable housing is difficult to develop, and many start their next deal based on the thing that worked last year. But the current market conditions, and the rapid pace at which they are evolving, demand a more open-minded approach.
It helps to challenge your assumptions and stress test the things that you assume have always been true. Developers are finding that evaluating a few different options, rather than defaulting to what has worked in the past, is a more productive approach in this environment.
Navigating the Affordable Housing Market
Securing financing to support affordable housing development, whether for new construction projects or to rehabilitate existing properties, is a complex process. Elevated interest rates, high insurance costs and other current market conditions can make it challenging to get deals across the finish line.
As a result, developers and finance professionals need to expand their financing toolkits. With affordable housing shortages plaguing communities all over the United States, it’s more important than ever to tap into creative approaches and avoid relying too heavily on past experience when structuring deals in this dynamic and essential segment of the commercial real estate market.
The right financing team should provide the information needed to consider all available tools and make a wise decision, so the developer is positioned to remain healthy and competitive.
Sam Adams is a managing director, affordable housing public finance, for KeyBanc Capital Markets.