Mortgage Lenders Are Key To Financing Stacks

Options Abound

Mortgage lenders make a couple of different kinds of loans to LIHTC developers. They make construction loans to get shovels in the ground. And they make permanent mortgages. Then, too, there is a hybrid of the two, called a construction-to-permanent loan, that covers both bases. In addition, banks often buy LIHTC equity in the deals to reduce their tax burdens and to get Community Reinvestment Act credit for their investments.

What is the Low-Income Housing Tax Credit? It’s complicated. For starters, renters in any property funded at least in part with tax credits must have incomes at or below 60 percent of the area median. Those with higher incomes must live elsewhere.

Since the LIHTC is a tax credit, the process starts out at the Internal Revenue Service, which doles out authority to state housing finance agencies based on population. (California gets a lot of LIHTC allocation. Delaware, not so much.)

Developers apply to state HFAs for their projects, which, if they earn enough points, are funded. But the successful developer doesn’t use the tax credits for himself. He has to hire a capital markets firm called a “syndicator” to locate investors who want to purchase the tax.

Some firms have no need for tax breaks, so they aren’t targets. But banks and insurance companies are big investors. The government-sponsored secondary market enterprises, Fannie Mae and Freddie Mac, aka the agencies, traditionally have been big buyers as well.

And the deals vary based on market rates. So, depending on how the market is performing, an investor may be able to buy a dollar’s worth of tax credits for less than a dollar and realize a second benefit on the transaction. In yet another complication, the investor in the equity can be either a single investor or a group that has banded together. Finally, there are two kinds of LIHTC deals, called 4 percent and 9 percent transactions.

Big Results

Whew! But though it’s complicated, the HIHTC has been a workhorse program for building new and rehabbing existing low-income multi-family properties. Since its inception in 1986, the tax credit has been responsible for about 100,000 units per year, or 3.55 million through 55,000 projects as of 2021, according to the latest figures from the Department of Housing and Urban Development.

Here’s a recent example of a typical LIHTC deal: Queen Manor, a public housing project in Dover, Del., was combined with a nearby LIHTC property (Owens Manor) into a single 110-unit development in a $29 million transaction, through HUD’s Rental Assistance Demonstration program. A first mortgage from Citibank came to $4.8 million, or about 16 percent of the financing.

But there’s more, way more. Nine layers of financing, in fact. Hence the lasagna moniker. Without them, Queen Manor would have been well-short of what was needed:

Sources of Funds, Queen Manor :

• $4,800,000 First Mortgage from CitiBank
• $11,083,051 in LIHTC tax credit equity from Cinnaire
• $4,091,879 Seller Note/Take Back Financing
• $1,000,000 HOME funds
• $6,500,000 from the Delaware State Housing Authority (DSHA) Development Fund
• $400,000 from the State of Delaware American Rescue Plan Act Fund
• $500,000 in deferred developer fees
• $320,000 in interim income during the construction period
• $485,142 from the pre-existing reserves at Owens Manor

Developer Cruz offers this short tutorial on the complicated ways lenders are involved in LIHTC deals:

“Banks have multiple roles they can play,” developer Cruz says in explaining the ways lenders can become involved in LIHTC deals. It all depends, he says, on whether the debt is taxable or tax exempt.

“If it’s tax exempt, it means they purchased the bonds that were issued within the state under the state’s volume cap. Those bonds allow us to access credits which we sell as equity. If it’s on the taxable side, typically it’s a 9 percent deal. It would be a taxable mortgage at the bank’s then-current lending rates.”

On a recent Cruz LIHTC project called Michael E. Haynes in the Boston area, the tax-exempt lender on a 4 percent deal, Rockland Trust, also purchased some of the equity in the deal.

“They’re definitely part of the team,” Cruz says of mortgage lenders. “You can’t do anything without them. Without a mortgage lender, you don’t have a deal. But the debt is not the highest percentage of sources in an affordable housing deal.

“A tax-exempt deal has a certain amount of tax-exempt debt that has to be in the deal. It has to be more than 50 percent of the eligible cost. So, you can have a tax-exempt construction loan and a tax-exempt permanent loan. The loan will act as a bridge until completion of construction, and then that becomes permanent.”

Because of the way agency funder MassHousing worked, financing on the Haynes project was even more complicated, with tax-exempt series A and B binds and a taxable construction loan.

Building Plans

Construction loans are shorter term than permanent loans, and the funds are not disbursed all at once, but throughout the construction period. They often — but not always — have lower interest rates as well. On the Haynes property, the construction loan was for 30 months, while the permanent loan was for 17.5 years.

How does a developer plan for a loan, and when does the bank come in? According to Cruz, “We do a pro forma in house.

“We know what the square footage costs are and what our costs are. And then we look at the soft costs and determine a total development cost. Then we see how much debt we can support. We use the tax credit rents for years one, two, and three. We have a rough range of what the expenses are per unit. We factor that in and come to an NOI, the net operating income. We use that to size the debt.”

But since equity and hard debt alone won’t finance a project, more debt has to be stacked, one on top of the other. That’s where soft money from a municipality or state come ins. And if all that is not enough, state tax credits can be used as a gap funding source.

At another Cruz project — 135 Dudley, also in the Boston area — the permanent debt came to $5.5 million on a $52 million deal, or about 10.6 percent of the financing. “It ranges a bit, but ten to 15 percent is probably fair to say,” Cruz said.

Fannie Financing

About 85 percent of the investors in LIHTC are commercial banks which can achieve Community Reinvestment Act credit when investing in low-income projects, according to the CohnReznick advisory firm in Washington. Another big-time investor, Fannie Mae has committed to $3.2 billion in credits for projects in 49 states and several territories since 2018.

Fannie Mae has a Congressionally-mandated “duty to serve” affordable housing preservation, manufactured housing, and rural areas, including American Indians on their homelands, and LIHTC equity counts toward its DTS mandate.

The agency describes its involvement in tax credits this way: “We provide a reliable source of capital to support the creation and preservation of affordable rental housing and have invested in hundreds of properties since re-entering the market in 2018, working closely with syndicator partners, developers and housing experts.”

My associate Mark Fogarty contributed to this report.