Real Estate Equities, a St. Paul, Minn.-based firm, broke ground last week on a new affordable housing complex in Rochester, Minn. Technology Park Apartments marks one of the first new development projects to be funded with a new loan product offered by Freddie Mac that provides a forward commitment to projects that do not use low income housing tax credits (LIHTCs).
The product, named the non-LIHTC Forward, is creating quite a buzz among the broader workforce/affordable housing sector. Effectively, it eliminates interest rate risk when stabilized projects transition from construction to permanent financing, improving the financial feasibility for developers to build more rent-restricted units. It also gives the construction lender greater confidence to make loans on affordable projects knowing that the permanent financing is already in place.
“I have so many people calling on this, because people want to hit that workforce component, and in a rising interest rate environment, they are hesitant to do so without knowing where interest rates will be at stabilization,” says Michael Dury, president of Merchants Capital in Indianapolis. Taking that “unknown” off the table allows developers to restrict the rents, hit a different renter profile and promote that workforce housing that everyone has been looking to do, he says.
Merchants Capital provided the construction financing for the 164-unit Technology Park Apartments through its parent company, Merchants Bank, and also helped to secure permanent financing for the project with a 10-year Freddie Mac Non-LIHTC Forward commitment loan. The developer was able to lock in the rate on the Freddie Mac loan in September at the same time it closed on its construction loan, well ahead of its target completion date at the end of December 2019.
Non-LIHTC Forward loans are available for new construction and major rehabs, as well as being open to for-profit developers and owners and non-profit groups. Projects do have to meet certain rent or income restrictions. However, those requirements are not as stringent as traditional LIHTC deals that set thresholds at 60 percent of the area’s annual median income (AMI). So, developers who are trying to provide at least some affordable or workforce housing units benefit from the non-LIHTC Forward product where there are some pricing and term advantages that make the project more viable.
“People have been looking for a way to hit this middle ground, the workforce component, and Freddie has stepped up and provided this unique financing vehicle to help solve that gap,” says Dury. Forty percent of Technology Park Apartments will be rent-restricted for individuals earning 60 percent of AMI; 35 percent will be set aside for individuals earning 80 percent of AMI; and the remaining 25 percent will be priced slightly below the current market value, about $200-$300 less than similar apartments in the area.
Eliminating interest rate risk
The typical route for market rate apartments, including the class A properties being built today, is that a borrower takes out a construction loan, builds the project and then secures a permanent loan once the property is stabilized. “For rent-restricted properties, that is a tough calculus, because if interest rates go up, your deal might not work,” says David Leopold, vice president, targeted affordable sales and investments, at Freddie Mac. “So, the key thing that this product does is it protects the borrower against interest rate risk.”
The rising interest rate environment has fueled interest in the product. But an even bigger driver is a spike in developers trying to build rent-restricted projects without LIHTCs. In 2018, there was a large number of new subsidy programs or tax abatement programs that were rolled out by state and local governments as a means to stimulate workforce housing and address the housing shortages that existed in their communities, notes Leopold. Oftentimes, those projects focused on mixed-income rents or were only partially rent-restricted, which didn’t meet the qualifications for the existing Freddie Mac LIHTC Forward loan program.
Freddie Mac expects to provide more than $300 million in non-LIHTC Forward financing during the first 12 months of the program. Since the product officially launched last August, Freddie Mac has announced five transactions, all of which are under construction. In addition to Technology Park Apartments, those projects include:
Salish Flats, Airway Heights, Wash.;
The Chocolate Factory, Mansfield, Mass.;
Villages of Wintergreen—Workforce Housing, Keystone, Colo.;
Lake Vue at Red Berry Estates, San Antonio, Texas.
Incentive to add affordable units
Real estate services firm CBRE assisted its client, Red Leaf Development, in lining up the bank construction loan and the Freddie Mac non-LIHTC Forward financing for The Chocolate Factory. The developer is converting the former chocolate factory into a mixed-use property that will include 130 apartment units and about 34,000 sq. ft. of commercial space. Ten percent of those units will be restricted to 80 percent AMI or less, while 90 percent of units will be restricted to 130 percent AMI or less.
“We were able to take advantage of Freddie Mac’s interest in doing more workforce housing by insuring that our project restrictions fit within their targeted affordable housing requirements,” says Todd Trehubenko, a senior vice president with CBRE in Boston. “As a result, we really unlocked some benefits that we wouldn’t have been able to get elsewhere,” he says.
The $26.7 million Freddie Mac loan is a 36-month forward that will convert to a fixed-rate, 10-year term after the project is completed. Essentially, the financing allowed the developer to lock in the rate for their permanent financing last summer—three years ahead of anticipated completion. “In this type of financial environment, that was very valuable to the developer,” says Trehubenko. Other advantages included better loan-to-value and debt service coverage that allows for an 80 percent max LTV and 1.25x minimum DCR than what is currently available through bank financing.
“For our particular project, this product was perfect because the forward commitment aspect was very important due to the very long redevelopment period given the nature of the asset,” says Trehubenko. The former chocolate factory, which once produced Oh Henry! bars among other products, closed in 2011 and is now on the National Register of Historic Places. “So, to find a way to get certainty for the permanent loan terms and interest rate was incredibly valuable to the developer, as well as the construction lender,” he says.
It’s also important to note that this product is part of a larger effort at Freddie Mac to bring innovation and improve liquidity for workforce and affordable housing, notes Leopold. “What I’m most excited about is that this allows us to go a little further in not only preserving what’s there, but influencing the development of new units,” he says.