LIHTC housing units are set to transition to market-rate in the next decade
Stacie Nekus:
I think one of the reasons for that is just that the credit standards have remained so strong. In affordable housing, the foreclosure rate tends to be, I think, 0.03% historically. So I think that strong credit culture continues today.
Geoffrey Metz:
Hello everyone, and welcome to our latest installment in the Thought Leadership podcast series, hosted on GlobeSt.com and presented by today's sponsor, KeyBank. I'm Geoffrey Metz. In this episode, Stacie Nekus and Kyle Kolesar of KeyBank's Commercial Development Lending, and Investment team talk about the creative financing solutions that are available to affordable housing developers today. Affordable housing developers are facing many of the same headwinds as their market rate counterparts - challenging rate environment, supply chain issues, and labor shortages, among others. That's created difficult situations to financing and building the capital stack, but not insurmountable difficulties, with the right amount of creativity and flexibility, today's guests tell Kelsi Maree Borland. Let's join their conversation as they break down the current environment and discuss what they've seen and done to get projects through development.
Kelsi Maree Borland:
Hello, I'm Kelsi Maree Borland, a reporter with GlobeSt.com, and I'm excited to welcome Stacie Nekus and Kyle Kolesar from KeyBank's Community Development, Lending, and Investment team, to give us their insight into the construction lending market. Thank you so much for joining me.
Stacie Nekus:
Thanks for having us.
Kelsi Maree Borland:
This year, new construction starts are down about 14%, and the slowdown has been attributed to a challenging lending market and higher interest rates. Stacie, from your vantage point, what challenges are developers facing today in securing capital for new projects?
Stacie Nekus:
I'd like Kyle to jump in here as well, but I think developers have been facing a lot of the same challenges that they've been facing over the last year to year and a half. The supply chain issues continue, and I think that that's broadly across the country. I think they continue to see rising interest rates, in a very rapidly rising rate environment. And the other piece of this is that, with those rapidly rising interest rates, from an equity perspective, the expectations on investor returns have increased really dramatically. Like investors, for instance, are looking for rates, like even in CRA areas like California, they're expecting to see a 5.75% return on their equity investments.
And some of them are going as high as 7.5%. This is relating to probably pricing somewhere in the 82 to 89 cent range, which is a drastic change from what it used to be. But those investors are having to compare their investments to other private equity investments that they can invest in. So it's just been extremely challenging from that perspective. Kyle, you are way more involved in working through the capital stack. I typically focus on the equity piece of it. Can you talk a little bit about all of the challenges that you're seeing?
Kyle Kolesar:
Yeah, thanks, Stacie. I think you're kind of spot on in a lot of the challenges have somewhat had a snowball effect together, in really the wrong direction, in terms of creating affordable housing supply, whether through construction or preservation. Going back to the earlier days of COVID, when we saw cost increases and labor challenges, those really have not ultimately cooled back to where they were pre-pandemic. So you're still seeing elevated costs of both labor and materials. And as much as everyone agrees that the supply of affordable housing needs to increase, unfortunately, the cost of lumber is the cost of lumber. It doesn't really matter what you're building, it doesn't price in the fact that you're building affordable housing. So our clients have really been faced with challenges to provide materials, provide general contracting, that fits with where a capital stack can be put together today to really get construction done.
Obviously, the elevated rate environment is challenging for everyone. You have short-term rates that have gone up over 500 basis points in a very short period of time remain elevated. You'll see today how elevated they are forecasted to remain and what the Fed decides there. So borrowers are combating that with construction costs on their construction loans. And then, you also have long-term rates elevated with the 10 Year Treasury at a five-year high. So there's a lot of headwinds there. I will say, our sponsors and developers that we work with continue to be resilient and creative in working with us and be solution oriented to get deals done.
Kelsi Maree Borland:
And in addition to the costs, are you also seeing any constraint in terms of liquidity availability, either on the debt side or the equity side?
Kyle Kolesar:
I think, on the debt side, it's definitely a different market than it was, even in March of this year. If you're talking about true conventional Class A housing, I think the capital available is very restricted right now, particularly from the bank side. And that's a culmination of a lot of things, the regulatory environment, banks working to forecast and manage their balance sheets going into what's going to be a new regulatory environment over the next few years. And then, I think, the supply, on the true market rate side, there's more units to be delivered in the coming years than I think in the history of multifamily development.
So I think people are monitoring that closely. I think it is different for the affordable business. We're continuing to see liquidity available. It looks and feels a little different. I think the credit environment is heightened a bit, and people are looking for more protection from their sponsors and from the deals. And pricing has ultimately elevated. I think a lot of banks felt some challenges coming out of March and really had to just change the way that they deploy capital into the markets. But I still say that, in the affordable housing space, there's as much liquidity going into that development as really any other business that's out there right now, which I think is one of the positives of the takeaways of the affordable housing space.
Stacie Nekus:
Kyle, I would totally agree with you, and I think one of the things that has helped affordable housing, at least on the equity side, last year, it was a 25 billion industry. I would expect it to be the same this year, if not a little bit higher. We have seen some new entrants into the market. I think one of the reasons for that is just that the credit standards have remained so strong. In affordable housing, the foreclosure rate tends to be, I think, 0.03% historically. So I think that strong credit culture continues today.
I think one of the things that, to me, is really important in this world is determining who your partners are. And I think at Key, one of the things we really focus on are who our partners are, in both the investor side, as well as on the developer side. We have a lot of levers that we can pull, and I think, when challenges occur, because they do, everybody's facing this new world, where you're putting a deal together, that starts two years ago, and now, you're in this interest rate environment, that's extremely high, your capital stack has to change it up. And I think working with partners that have a lot of different options that they can bring to the table is really important, and it's really important for us to pick who our partners are as well. We want to deal with our top developers, and they've been wonderful to work with.
Kyle Kolesar:
And I'll just add, part of the Agencies' real mission, outside of the affordable housing preservation, Fannie, Freddie have $150 billion cap for 2023, 50% of that is to be mission-driven, but really, the other part of their mission is to provide liquidity through challenging economic cycles. I think a lot of the takeaways from the '08, '09 market, where that there was really no liquidity, and I think those agencies have done a good job of making sure that, in a time like this, where bank capital has elevated costs or maybe different parameters, that they're there to be able to provide liquidity, particularly to housing. I think that's one of the benefits we have at Key is that, not just we have our own balance sheet and platform, but we do have that GSE lending platform that's been able to be leaned on at times when it's needed.
Kelsi Maree Borland:
Absolutely. And so, I'm curious, what is your advice to a developer that is looking to secure financing in today's market or even trying to navigate through some of these challenges that we're talking about?
Kyle Kolesar:
For me, I really think it comes back to relationships and broad relationships. Where we've seen our clients and clients in the market be successful is financing partners that have been in this business through cycles, not left the market, and brought more than one tool to a financing or capital stack. I think that where we've seen our clients challenged is, if you pick partners that potentially only bring one piece of a capital stack, and it may not be as fluid, versus a lender or investor, who can bring three, four, or five pieces of the stack together and maybe pivot and move some of those things around, in terms of pricing or pay in schedules or creativity, that's where we've seen people be able to get really tough deals done and lean in together. And ultimately, the banks and the other lending groups reciprocate that back with our partners. So I think that's where we've seen people be able to really get deals to the finish line through this environment.
Kelsi Maree Borland:
Great. And we're talking about the development market here, but of course, Kyle, earlier, you mentioned affordable housing preservation as also being important to this conversation. Are there different tools available to investors looking to secure capital, also kind of dealing with some of the same challenges that we're talking about?
Kyle Kolesar:
Yeah, I think preservation remains incredibly important. I think, a lot of the times, we talk about creation of affordable housing, which obviously has to be through construction, but if you look across the country, the amount of units that are eligible to become market rate in the coming 10 years is somewhat significant and concerning. And I think, when you think about the industry as a whole I guess a couple of things that most people agree on, one is that there is an undoubtable affordable housing issue and crisis across the country, but secondarily, most people agree that more supply is the best answer to try to help with this problem. But you can't just create supply and then, lose existing stock. So for preservation, that's something that we've been extremely focused on, I would say, over the last five years. It's been a really competitive market for sponsors acquiring properties to preserve and then, lead to new tax credit deals, new investments, and really new refreshed units, that are safe and quality.
I think the capital there continues to be available, though different. We saw some really aggressive capital over the last two to three years in the preservation space. I think it's been tempered a little bit, just given the environment, but I think that's a space where it's very different from a developer perspective. We have a lot of clients that really want to build and create their own housing and development. They built it, they know what it is, they know what they're going to own. But we also have a lot of sponsors we work with who are very dedicated to that preservation space and have made really complex deals work from acquiring really existing and somewhat challenged, whether it be the quality or the tenancy, existing housing stock, and be committed to preserving that affordability for the next 15 to 30 years.
But I think, both a debt, and more recently, and Stacie could probably touch on this, preservation equity capital being available, I think, is something that we'll continue to see, that is a market that, just based on cap rates and interest rates and the normal volatility of real estate and multifamily trades, has cooled a bit. But I do expect that we'll see more activity there probably going into next year.
Kelsi Maree Borland:
Yeah. Stacie, I'd love to hear your take on the equity side.
Stacie Nekus:
On our end, so just to give you a little background on our equity platform, we've been investing in affordable housing since, I think, 1988, if I'm not mistaken. We have a $4 billion portfolio, and we invest in low-income housing tax credit deals. We invest in preservation funds, SBICs, impact funds, and we also recently have a division that was created that's solely focused on CDFIs. So we feel that... Well, and to broaden that out, we also invest directly with investors. We invest with syndicators, and we also created our own syndication platform. So we try to bring every tool that you can possibly imagine in the affordable housing space to the toolbox to create a one-stop shop. And we're also creating that same one-stop shop for investors as well. I think that's the piece that we added recently. We started in 2021. And what it allowed us to do is go across all 50 states and invest in all 50 states.
Prior to having the syndication group, we were limited to only being able to invest in our CRA footprint. On Kyle's side, we've been able to invest in all 50 states for some time now, right? So we've been lending across the country, but now, we're also investing across the country. And it's really allowed us to lean in. And I think, in preservation alone this year, we probably will invest about $50 million into equity funds, that are strictly focused on preservation. We realized the importance of preserving that, and we'll do probably about $600 million investing in low-income housing tax credit deals.
Kelsi Maree Borland:
That's really incredible. I'm wondering if either of you can share some examples of deals that you've done, that are implementing these solutions and really helping to get developers or investors in affordable preservation to push those deals across the finish line.
Kyle Kolesar:
Yeah, I think there's some great examples out there of preservation, really start to finish financing. The way that we've developed, our preservation strategy is to be there early on for the clients acquiring the properties. And typically, what we've seen happening is the bank providing a acquisition financing loan for a short duration period of time, understanding that really the repayment source of that loan is not necessarily the increase in NOI through the term or improvements at the property, but really, a resyndication through the tax credit channel. So we've had a really strong success of being able to provide really competitive acquisition financing for, call it, 12 months.
And then, at the end of that 12 months, in that interim period, our borrowers working with us to put together the equity, with Stacie's team, the debt with our team, the agency financing, typically, through our own commercial mortgage group, and then, some other financing pieces that we can bring to the table, whether it be through our bond underwriting team, who can publicly underwrite and issue short-term bonds or long-term bonds, and bringing all that together, ultimately, to that resyndication, which then now preserves those units and then, renovates them for improvement for the next 15 year period. So we've been very successful in that sort of start to finish through the end debt and equity capability. And I think we've got a lot of great examples, whether they're Keeler, which Stacie mentioned, which is an incredible project in New York, or many others across the country that we've been involved in.
Kelsi Maree Borland:
And Stacie, did you have an example as well?
Stacie Nekus:
Well, I could, but I think Kyle managed it, but I was just going to talk about, we had another deal that was outside of our footprint, where three years ago, we wouldn't have been able to invest in. And it's a deal with a group called the Pacific Companies, who is one of the top tier developers on the West Coast. It's building 48 units for low-income families in Plumas Lake, California. And we were able to do $18.2 million in total equity, $23.8 million in construction lending. We did a perm loan, and then, we turned around and were able to syndicate that opportunity as well. So I think, again, that's just something where we were able to bring the entire breadth of a partnership to a developer and to an investor.
I joined Key in 2020, but what I really love about KeyBank is that we do focus on these strategic partnerships, and when we're out there talking to, whether it's developers or also investors, being able to create mutually beneficial relationships with them, where we're bringing the entire breadth of what we have to what they're looking for. And I think, no matter what it is that someone's looking for, we're able to find a solution, and I think we're very creative and entrepreneurial, which I think is unique to our organization.
Kelsi Maree Borland:
Absolutely. KeyBank is really known as a relationship banker, and I think, when you see challenging capital markets like this, that's when you really need to lean into those relationships. And I think that we've talked about a lot of challenges for developers today, from construction pricing to supply chain issues, but I think the capital market's challenges are definitely at the top of mind for most developers. So I really thank you both so much in giving us your insights into some of the tools and solutions and partnerships that developers can form to really navigate through this market and get deals done. So thank you both so much for your time.
Stacie Nekus:
Thank you.
Kyle Kolesar:
Yeah, thank you for having us. We appreciate it.
Kelsi Maree Borland:
Once again, we have been talking with Stacie Nekus and Kyle Kolesar from KeyBank's Community Development Lending and Investment team. Thank you again.
Geoffrey Metz:
That concludes this episode brought to you by KeyBank and hosted on GlobeSt.com. I'm Geoffrey Metz. Thanks for listening. For the latest news and insights on everything commercial real estate and other episodes in the Thought Leadership podcast series, go to www.GlobeSt.com.
Despite healthy affordable housing development, the industry is losing units as 30-year LIHTC deals struck in the 1990s are set to expire.
This podcast and article were created in partnership with Globest.com and are being used with permission.
Affordable housing is in an undeniable state of crisis. According to estimates from the National Low Income Housing Coalition, the US has a shortage of 7.3 million units of affordable housing units for extremely low-income households alone. Now the industry faces a new challenge: Many affordable housing units are about to become market rate, as the rent cap stipulations in the earliest LIHTC deals reach their 30-year expiration.
This has put a renewed emphasis on affordable housing preservation, say Kyle Kolesar and Stacie Nekus of KeyBank’s Community Development Lending and Investment Team. But the two note that capital is available to keep the country’s affordable stock from dwindling.
The importance of preserving affordable housing
The 30-year requirement will expire for nearly 500,000 LIHTC housing units by 2030. That number represents half of the current affordable housing stock. “If you look across the country, the number of units that are eligible to become market rate in the next 10 years is somewhat significant, and that is concerning,” says Kolesar.
To address the affordable housing crisis, the primary objective has been to develop more affordable units. It seems to be, according to Kolesar, the one solution that everyone can agree on. Yet, with the potential to lose so many affordable units in less than a decade, preservation is proving to be equally as important. “You can’t just create more supply and lose existing supply,” adds Kolesar. “That is really a problem.”
KeyBank has seen appetite for both new affordable housing development as well as preservation, but the latter takes a very different type of investor. Developers really want to build their own project. They understand it, and they know what they are getting. There is more control. On the preservation side, investors must be willing to make a really complex deal work, explains Kolesar. They have to be willing to commit to preserving affordability for the next 15 to 30 years.
Equity and debt capital is available
KeyBank has invested in affordable housing since the 1980s, but in the last eight years, it has become a core objective of the bank. With a global pandemic that required people to stay home and rampant housing affordability issues, investors also have an increasing appetite for affordable deals. “Affordable housing preservation has been a really competitive market for sponsors,” says Kolesar. “It leads to new tax credit deals, new investments and really new, refreshed units that are safe and quality.”
Today, there continues to be both debt and equity capital available to make a deal work, although Kolesar admits that the market has tempered somewhat given the macroeconomic headwinds and elevated interest rates. Still, KeyBank’s affordable housing equity program expects to invest $50 million this year into equity funds strictly focused on affordable housing preservation. “We try to bring every tool that you can imagine in the affordable housing space to create a one-stop-shop,” adds Nekus. “That has really allowed us to lean in.”
To learn more
Connect with our affordable housing experts Stacie Nekus, Kyle Kolesar, or visit key.com/affordable.
Read more fresh insights on maximizing the opportunities available for affordable housing.
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.
This article is designed to provide general information only and is not comprehensive nor is it legal, accounting, or tax advice. All credit products are subject to collateral and/or credit approval, terms, conditions, and availability and subject to change. All rights reserved. Banking products and services are offered by KeyBank N.A.