Creative ways to encourage development in an unsettled affordable housing market

The dual shock of inflation and the Fed’s efforts to tame it sent waves of volatility rippling over the economy in the past two years. As the inflation rate in the U.S. shot up from 1.4% to 7.5%¹ in 2021, the Federal Reserve responded by raising interest rates in March 2022 – up to 4.1% by December, from near zero less than a year earlier². That turbulence led many affordable housing capital providers to pull back on lending, and many have yet to come back to the dealmaking table. In 2023, the inflation rate has continued to decline, and the Fed has slowed the pace of rate hikes, indicating that the dust is settling. As the view ahead clears, affordable housing stakeholders can see they are operating in a financing landscape that’s unrecognizable from the “easy” days of 2021.

At the recent Bisnow Los Angeles Affordable Housing Summit, Hector Zuniga, Vice President, Community Development Lending & Investment at KeyBank, participated in a panel discussing creative ways to access debt and equity, investment strategies and incentive programs to encourage development in this calmer-but-still-unsettled environment. Joining Zuniga on the panel were Juan Aguilar, Chief Investment Officer at Alliant Strategic Development; Mark Dean, Head of Affordable Production at NewPoint Real Estate Capital; Keith Harris, EVP, Investments at Avanath Capital; and Jeffrey Jaeger, Co-Founder & Principal at Standard Communities. Tom Noble, COO & SVP at Archway Capital moderated the panel.

The discussion started with an overview of where the panelists see interest rates – and the affordable housing development market – headed in the second half of 2023.
 

Rising interest rates challenge deals, but opportunities will emerge for those with patience

The high interest rate environment continues to make it difficult to get deals done, and the consensus among the panelists was that the situation would get more challenging before it starts to improve.

“We’re probably going up 50 basis points before the end of the year,” said Zuniga. “In addition to raising rates, the Fed is adding more restrictions on bank capital requirements. The regulators want banks to pump the brakes on lending, strengthen their balance sheets and build up their deposit base. That makes it tougher to put a construction loan together or fund acquisition dollars.”

We’re probably going up 50 basis points before the end of the year. In addition to raising rates, the Fed is adding more restrictions on bank capital requirements.

Panelists shared their views, including that the Federal Reserve is waiting for some component of the economy to reach a breaking point before it allows the federal funds rate to level off, making it a good time now for firms to start preparing to take advantage of the many opportunities expected to emerge at that juncture.

It was suggested that the economy had at least one more big dip to endure before things started looking up - that downturn would “purge the market” of marginal developers and lenders.

 

Creativity should pay off in the long term

There was a lively discussion in response to the higher rates and uncertainty about future rate hikes. One firm is focusing on non-conventional and tax-exempt bond financing. Another pointed out that long-term capital “flattens out the curve,” meaning that deals that may not seem sensible now will produce value over time. Some creative approaches highlighted include lenders extending their amortizations, adopting a greater interest-only (IO) loan period in their perm debt and even allowing developers to fill the IO period with some sub-debt.

There was caution however, that lenders need to make sure investors are on board with these kinds of creative approaches before starting a transaction, particularly when it involves the Low-Income Housing Tax Credit (LIHTC). For those willing to think outside the box, there are numerous ways for affordable housing sponsors to construct a deal that pencils.
 

Favorable funding programs can push deals over the finish line

The affordable housing space is unique because, in addition to traditional banks and alternative lenders, stakeholders can take advantage of state and local government programs to help sponsors get deals done.

Zuniga pointed to the California Housing Accelerator as one example of a program that’s being included in sponsors’ capital stacks. The program, launched in 2021, expedites the development of multifamily affordable housing by helping shovel-ready projects close funding gaps. “The accelerator program in California has been a huge source of capital for some of the deals that we're working on, both Low-Income Housing Tax Credit (LIHTC) and non-LIHTC,” said Zuniga.

Outside of California, one panelist pointed to the availability of what they called “but-for” funding: But for the money from non-profits and companies like Microsoft, Amazon, and Kaiser Permanente, affordable housing projects wouldn’t happen. This “social capital” is not easy to discover, yet for those willing to put in the time to identify it, employer funding can help fill gaps.

Finally, the 80/20 financing was cited as a big factor in one firm’s ability to continue doing deals. This structure allows LIHTCs to be syndicated from mixed-income buildings that are financed by tax-exempt private-activity bonds with 80% of the units at market rate and 20% subsidized³.
 

Bringing projects to fruition despite uncertainty

When I started lending 25 years ago, the prime rate was 6.5%, and we made it work. Certainly, deals have gotten more expensive. But at some point, the debt curve will de-invert, rates will plateau and there will be a new norm, or rather a return to the norm as we knew it 25 years ago. So, it's not all gloomy — we just we need to live with it.

While the turbulence the market experienced in 2022 has subsided, the conditions for doing affordable housing acquisition and construction deals are far more challenging than they were in 2021. What’s more, uncertainty about how much higher interest rates will go has forced many investors and lenders to the sidelines. But in the affordable housing development sector, there’s more than one way to skin a cat, and stakeholders are deploying creative approaches and embracing new funding sources to bring projects to fruition. As Zuniga pointed out, this environment may not be ideal, but it’s also not unprecedented.

“When I started lending 25 years ago, the prime rate was 6.5%, and we made it work,” he explained. “Certainly, deals have gotten more expensive. But at some point, the debt curve will de-invert, rates will plateau and there will be a new norm, or rather a return to the norm as we knew it 25 years ago. So, it's not all gloomy — we just we need to live with it.”

To learn more, email our affordable housing expert, Hector Zuniga, or visit key.com/affordable.
 

About KeyBank Community Development Lending and Investment

KeyBank Community Development Lending and Investment (CDLI) finances projects that stabilize and revitalize communities across all 50 states. As one of the top affordable housing capital providers in the country, KeyBank’s platform brings together construction, acquisition, bridge-to-re-syndication, and preservation loans, as well as lines of credit, Agency and HUD permanent mortgage executions, and equity investments for low-income housing projects, especially Low-Income Housing Tax Credit (LIHTC) financing. KeyBank has earned 10 consecutive “Outstanding” ratings on the Community Reinvestment Act exam from the Office of the Comptroller of the Currency, making it the first U.S. national bank among the 25 largest to do so since the Act’s passage in 1977.