Community Developments Investments (May 2015)
Surprise! Most Affordable Rentals Are in Small Buildings
Source: Community Investment Corporation, Chicago.
This property is an example of the small multifamily properties that Community Investment Corporation finances.
John G. “Jack” Markowski, President and CEO, Community Investment Corporation
When most people hear the term “affordable housing,” they may think of housing built or made affordable by various forms of government financial assistance. They may think of public housing, project-based section 8 developments, or housing built with financing provided by low-income housing tax credits, tax-exempt bonds, and HOME Investment Partnerships Program funds. To many, it comes as a surprise that 76 percent of the low-cost rental housing in the United States is privately owned and privately financed with no form of public assistance, not even section 8 rental vouchers, for its residents (see figure 2).
Figure 2: Unsubsidized Units Account for Three-Quarters of Low-Cost Rental Units
Source: America's Rental Housing: Meeting Challenges, Building on Opportunities, Harvard Joint Center for Housing Studies (April 26, 2011).
Note: Subsidized renters include those who reported living in public housing or other government-subsidized housing, receiving a rent voucher, or being required to certify income to determine their rent. Rent does not include tenant-paid utilities.
Overall, about 90 percent of rental housing in the United States is privately owned and privately financed. Another surprise is that nearly 90 percent of rental housing is contained in buildings with fewer than 50 units. The irony of this last point is that the programs and entities created to provide financing for rental housing (i.e., Fannie Mae, Freddie Mac, and the Federal Housing Administration) are largely focused on developments with more than 50 units.
For the most part, buildings with fewer than four units are adequately addressed by the existing financial system—owner-occupied one- to four-unit properties can be underwritten as single-family properties, originated by local lenders, securitized, and sold into the secondary market.
But buildings with five to 49 units are left to fend for themselves. Neither fish nor fowl, they are not pooled with owner-occupied housing in mortgage-backed securities and do not have significant access to the secondary market. Instead, they have largely been financed by local lenders who underwrite each building as a unique business transaction and then hold the loan in portfolio. It is exactly this kind of portfolio lending that has declined most precipitously since the financial crisis in 2008, particularly in low- and moderate-income communities.
Why It’s Important
Buildings with five to 49 units account for more than one-third of the rental housing in the United States (see table 1 ). Generally privately owned and without government assistance, rent restrictions, or income restrictions, these buildings nevertheless provide a major portion of our affordable rental housing supply. Clean, secure, and well-maintained apartment buildings help set the tone for entire neighborhoods. These buildings protect property values, including those of single-family homes, and they contribute to a safe environment where families can sit outside and children can walk to school.
Table 1: Role of Small Multifamily Properties in Rental Market (Rental Units by Building Size, 2012)
|Number of units
||Cook County, Ill.
|2 to 4
|5 to 49
|50 or more
Source: 2012 American Community Survey, (5-Year Estimates) Tenure by Units in Structure, 2008–2012, Data Element B25032; Institute for Housing Studies at DePaul University.
The people who live in five- to 49-unit buildings are typical of the renter population in the Chicago area. Renters are usually younger and less affluent than the population at large. In Cook County, Ill. (the county in which Chicago is located), 68 percent of the people younger than 35 are renters. (Overall, 43 percent of the households are renters.) The median income for renter households in Cook County is $33,000; for owner-occupied households, that figure is $72,000. Renters fill a wide variety of positions in our workforce, including teachers, construction workers, health care professionals, drivers, and retail clerks.
Small rental housing is economical for renters and owners. Across the country, rents in small rental housing tend to be lower than rents in larger buildings (see figure 3). In the Chicago area, the all-in costs for acquisition and rehabilitation of a small rental property are about $40,000 to $60,000 per unit in many communities compared with $300,000 to $400,000 per unit to create new rental housing with low-income housing tax credits.
Figure 3: Median Monthly Rents per Unit by Development Size
Source: Rental Housing Finance Survey, tables 2a, 2b, 2c, and 2d (August 5, 2014).
Small rental housing is generally owned by “mom and pop” entrepreneurs. According to the 2012 Rental Housing Finance Survey, 58 percent of five- to 49-unit properties are owned by individuals, households, or estates, compared with just 8 percent of larger properties. These small property owners may own five units or 1,000; they may be pursuing real estate ownership as a side venture or as a full-time career. Generally motivated by cash flow, the potential for property appreciation, and the opportunity to be their own boss, these “hands-on” entrepreneurs are classic small business owners. They provide a valuable service, they invest their own time and money, they typically hire and buy materials and supplies locally, and they are committed to their community. In many neighborhoods, the owners of apartment buildings are among the strongest and most stable local businesses.
Challenges of Financing
It is relatively easy to bundle and sell loans for owner-occupied one- to four-unit housing to the secondary market because there are only a few variables to consider in the underwriting: appraised value of a property; borrower’s income, assets, and credit score; and debt-to-income ratio.
Underwriting multifamily rental transactions, however, is much more complex, and every building is unique. While it is important to evaluate a borrower’s financial strength and creditworthiness, it is even more important to fully understand and evaluate the business transaction being proposed, including the following:
- “As-is” value of the building from both a market sales perspective and from a cash flow perspective.
- “After rehab” value of the building (from both perspectives as previously noted).
- Scope of work and the cost of construction to meet building code requirements and provide good living conditions.
- Ability of a proposed contractor to complete construction on time, within budget, and with good quality.
- Market rents in a neighborhood and likely vacancy rates.
- Projected operating costs (including repairs, maintenance, management, taxes, insurance, utilities, security, etc.).
- Track record and experience of the owner and manager, their familiarity with the type of building and the neighborhood, their ability to manage all aspects of construction and operations, and their ability to meet income and expense projections.
These underwriting considerations are essentially the same for a six-unit building or a 600-unit development. The analysis is somewhat subjective and requires specific knowledge of the neighborhood, the building, and the people involved (and their capabilities). Because every transaction is unique, loans for small multifamily buildings cannot be easily bundled and sold to the secondary market. Instead, each loan stands on its own merit and pro forma.
The typical pro forma components for a 20-unit rental apartment building in Chicago are shown in tables 2, 3, 4, and 5. Table 2 shows the sources and uses of funds. Table 3 lists the value before and after rehabilitation. Table 4 shows typical rents for various-sized apartments. Table 5 shows the loan profile and cash flow of such an investment.
Table 2: Sources and Uses of Funds for a 20-Unit Apartment Building
||Fees, escrow, other
Source: Community Investment Corporation.
Table 3: Appraised Value
Source: Community Investment Corporation.
Table 4: Affordable Rents in Chicago and Cook County
Table 5: Loan Profile and Property Cash Flow
Source: Community Investment Corporation.
*Rents affordable in Chicago/Cook County.
||Annual cash flow
||Effective gross income
|Loan to value
|Loan to cost
||Annual debt service on loan
||Debt coverage ratio
Source: Community Investment Corporation.
**Expenses include repairs, maintenance, taxes, insurance, utilities, management, miscellaneous, and reserves.
Over time, loan originators have typically found that it is generally too costly and too time consuming to underwrite multifamily loans less than $3 million (typically about 100 units in a low- or moderate-income neighborhood in Chicago) for individual presentation to the secondary market. As a result, local banks—with an immediate knowledge of the properties, neighborhoods, and individuals involved—have typically been the primary source of financing for small rental housing, and these banks have held the loans for the long term in their portfolios.
In general, the pre-2008 housing bubble was caused by ill-advised single-family lending, not by lending for multifamily properties. But when the crash occurred, the repercussions spread throughout communities. Many lenders were caught with outstanding loans on multifamily properties that had suffered great devaluation. They had to re-value their portfolios and pull back on their lending operations. Many banks were forced to close because of losses in this sector. Cook County had more than 40 percent fewer active small lenders in 2013 than in 2005 (see figure 4 illustrates the shift in the number of small lenders).
Figure 4: Change in Number of Active Multifamily Lenders in Cook County, 2005–2013
Source: Institute for Housing Studies at DePaul University analysis of Home Mortgage Disclosure Act (HMDA) Loan Application Register Data, 2005–2013.
As the real estate market has begun to recover, some return to normalcy in lending for small multifamily buildings has occurred. In Chicago, some banks are making short-term loans to strong borrowers in strong neighborhoods. But in the low- and moderate-income communities of the city, multifamily lending has continued to lag. According to DePaul University’s Institute for Housing Studies, lending for small multifamily buildings (loans under $3 million) in these low- and moderate-income communities has dropped from its peak by up to 61 percent (see figure 5) at the same time that lending to middle- and upper-income communities has increased by more than 55 percent for loans greater than $3 million.
Figure 5: Change in Cook County Multifamily Loan Dollars by Loan Size and Neighborhood Income Level, 2005-2013
Source: Institute for Housing Studies at DePaul University analysis of Home Mortgage Disclosure Act (HMDA) Loan Application Register Data, 2005–2013
Is it because lenders, chastened by the recent experience of the real estate crash, no longer want to hold long-term real estate debt, especially in low- and moderate-income communities? Is it because lenders still perceive great risk in these communities? Is it because recent legislative and regulatory requirements regarding capitalization and reserves that were intended to strengthen our financial system have inadvertently discouraged lending for small multifamily properties? Is it because these markets are still very depressed with very little borrower demand?
The truth lies somewhere in the midst of these questions. It is clear, however, that without an adequate supply of credit, it is impossible to rehabilitate and preserve multifamily housing and reinvigorate communities across the country.
To fully address the credit needs of small rental housing and to begin to approach the level of credit available before the real estate crash, progress needs to occur on many fronts. Here are some of the ideas that are being discussed or implemented in housing circles across the country.
- Lending consortiums: An idea that dates to the 1970s, a lending consortium is a way for banks to pool their risks and resources to address areas of need that the banks recognize but do not want to address alone. In Chicago, Community Investment Corporation (CIC) was formed by local financial institutions in 1974 and is now capitalized by more than $400 million in commitments from 40 banks. CIC’s unique niche is privately owned rental housing. CIC is able to offer more resources and expertise than a small bank and more personal attention than a big bank. As the Chicago area’s leading multifamily rehabilitation lender, CIC has provided more than $1.2 billion in financing for buildings containing more than 55,000 rental units since 1984. CIC has provided its investor banks with a reasonable rate of return and has suffered very few losses in its portfolio. (Community Investment Corporation of the Carolinas has more recently formed a bank loan pool that you can read about in this newsletter of Community Developments Investments.)
- Community development financial institutions (CDFI): U.S. Department of the Treasury certified community development financial institutions (CDFI) are organizations dedicated to financing community development. Many local banks and lending consortiums are CDFIs. Investments in CDFIs by the Treasury Department’s Community Development Financial Institutions Fund and other sources of “social capital” help CDFIs attract private capital to meet local financing needs.
- Risk sharing: The U.S. Department of Housing and Urban Development has proposed an expansion of its section 542(b) Risk-Sharing Program to work with experienced affordable housing lenders to make risk-share loans to refinance, rehabilitate, and recapitalize small rental properties (properties with five to 49 units). The idea is that the agency would underwrite the affordable housing lender and its lending policies and procedures rather than individual buildings, then take 50 percent of the risk on the lender’s loans, thereby facilitating and expanding access to capital. See sidebar on the proposed program.
- Community Reinvestment Act: Since the financial crisis, most regulatory attention has been directed at ensuring the safety and soundness of banks. With the firming of the recovery, however, many believe that the time is right for a renewed emphasis on the Community Reinvestment Act. Banks should be encouraged to participate in lending consortiums and invest in CDFIs to meet the credit needs of low- and moderate-income communities. Most importantly, banks should be encouraged and given the latitude to make loans for small rental housing and hold the loans in their portfolios for the long term.
Ideally, there is a combination of responses that together ensure readily available credit for small rental housing to preserve affordable housing and revitalize communities across the country.
For more information, e-mail Jack Markowski.
Source: Community Investment Corporation.
The Community Investment Corporation finances small rental properties like this one through its bank consortium.
Bank Consortium Financing
Jack Markowski, President and Chief Executive Officer, Community Investment Corporation
Through Community Investment Corporation (CIC), a CDFI Fund certified community development financial institution, banks in Chicago have formed a consortium to provide financing for otherwise difficult-to-serve needs. Since 1984, CIC has specialized in financing the acquisition and rehabilitation of multifamily rental housing in low- and moderate-income communities throughout the Chicago area. With more than $417 million in commitments from 40 banks, CIC has developed resources and expertise to fully serve the multifamily marketplace, but it has also retained a close, personal relationship with its borrowers. Since 1984, CIC has provided more than $1.2 billion to finance more than 55,000 units of affordable rental housing.
Banks participate in the CIC consortium by purchasing Limited Recourse Collateral Trust Notes that are issued by CIC and secured by individual mortgages on properties. To facilitate loan servicing and collections, CIC retains ownership of the loans and mortgages with individual borrowers.
A multiyear Note Purchase Agreement, signed by CIC and all of the bank investors, governs operations of the CIC loan facility. All loans are approved by a loan committee, the members of which must represent at least 51 percent of overall investor commitments.
The loan committee sets the interest rate and terms for the loans. A loan becomes eligible for sale to investors when construction is complete and rent-up has achieved a 1.1 debt service coverage ratio. Approximately once every three months, CIC pools eligible loans and conducts a note sale, in which each investor purchases a portion of the notes equal to its overall share of outstanding investor commitments. (Investor commitments currently range from $1 million to $72 million.)
Loan servicing is performed by CIC for a fee of 0.375 percent. Each month, CIC remits to investors their proportional share of loan repayments less the charge for loan servicing and a payment into the Investor Loan Loss Reserve (currently set at 1 percent). CIC reports to investors on a regular basis regarding delinquencies and the overall condition of the loan portfolio. Any loan loss is covered first by the Investor Loan Loss Reserve. To the extent that a loss exceeds the balance in the Investor Loan Loss Reserve, the loss would be borne proportionately by the investors on the specific loan. Since 2001, however, CIC has not passed on any losses to participating investors.
Currently, CIC is servicing a portfolio of $230 million in loans with notes sold to investors. In fiscal year 2014, the portfolio generated a net return of 2.6 percent (2.0 percent above the rolling three-year average for three-year U.S. Treasury securities). Investing in a consortium like CIC is a very effective way for banks to pool resources and prudently meet the financing needs of affordable housing and low- and moderate-income communities.
For more information, e-mail Tom Hinterberger.
Source: Ronald L. Glassman for the Community Preservation Corporation.
This 28-unit rental apartment building in Greenburgh, N.Y., received financing from the Community Preservation Corporation as well as private capital and public subsidies.
Community Preservation Corporation: Growing New York Neighborhoods
By Sadie McKeown, Chief Operating Officer and Executive Vice President, Community Preservation Corporation
In 1974, David Rockefeller and the NYC Clearing House Banks founded the Community Preservation Corporation (CPC) to be an active multifamily housing lender in New York City neighborhoods on the verge of abandonment. Over our 40-year history, our lending has generated over $8.4 billion in public and private investment in 157,000 units in New York state.
Today, the CPC is a leading not-for-profit affordable housing and neighborhood revitalization lender. In 2014, the CPC closed on a $400 million construction lending facility from a group of financial institutions led by Citi. This capital will be used for the acquisition, construction, rehabilitation, and preservation of affordable multifamily properties across New York City and state.
The CPC’s financing differs from standard bank financing because we look for difficult-to-finance properties, such as small properties and properties that may need a variety of complex financing sources.
Based on its success financing small and large properties across the city, the CPC expanded to cover all of New York state starting in 1988. Since that time, the CPC has provided a consistent source of capital to finance multifamily properties in the state’s underserved housing markets. The CPC’s investment in neighborhoods including Washington Heights, Harlem, and Crown Heights in New York City, and in the cities of Syracuse, New Rochelle, and Buffalo, has driven significant revitalization.
An essential part of the CPC’s mission is helping local developers build and preserve smaller multifamily properties. The CPC specializes in providing loans to owners of buildings with fewer than 50 units, the small buildings where most New Yorkers live. In New York state, 53 percent of the multifamily housing stock is in buildings with five to 49 units. The CPC’s success in this market is driven largely by access to the State of New York Mortgage Agency (SONYMA) insured 30-year fixed-rate permanent mortgage product, which is unique in the housing finance market for small properties. This fixed-rate product provides stability for owners and is critical for subsidized properties, where rent increases are restricted.
The CPC’s longstanding partnership with SONYMA has enabled a secondary market for its 30-year mortgages. The New York City Employee Retirement System and the New York State Common Retirement Fund have purchased over $1.5 billion in 1,350 SONYMA-insured loans. This investment financed over 43,000 units of housing. These pension funds offer a 24-month forward interest rate commitment so that the CPC can provide short-term construction financing for properties in need of construction or repair with the certainty of a take-out upon completion and lease-up.
Unlike other conventional lenders, which focus on all housing markets, the CPC’s approach is to identify the capital needs of the multifamily stock in distressed communities. Cities and towns across the state have government-sponsored community development offices, which share this common goal. The CPC uses its private capital, in conjunction with public subsidies available through these offices, to address particular goals of cities and towns for affordable housing and community redevelopment. The CPC’s collaborative approach is consistent in every market it serves.
During the 1990s, the CPC created a for-profit arm to do development and place equity in neighborhoods to complement its lending business. CPC Resources (CPCR) developed owned-occupied housing in emerging markets, took on large-scale deals that were difficult to develop, and worked to create mixed income communities. When the housing market collapsed, some of these projects were especially risky and difficult to sustain in the ensuing market conditions. As a result, CPCR had to slow down its business while the CPC has refocused on its core lending for rental properties.
The CPC’s lending in Beacon, N.Y., is an example of the organization’s success with small multifamily lending. Over an eight-year period starting in 1990, the CPC financed 20 small multifamily properties in the east end of the city totaling just over 80 residential units and 25 stores. The private investment of just under $5 million leveraged $2.3 million in subsidies and transformed the area into a thriving retail district. The average CPC loan was only $250,000. Conventional lenders don’t typically finance small properties at this scale, but such a targeted investment has significant impact in communities and draws in other investment afterwards.
In addition to providing private financing, the CPC serves as a “one-stop shop” that offers its project owners extensive technical assistance when needed to help them understand tax benefits, rent subsidies, and other public incentives. The CPC works with its customers to coordinate financing with government and other low-interest subsidy providers, as well as review the scope of work on rehabilitation projects and cost estimates. Bank members continue to support the CPC’s work with financial resources, and new partnerships with banks are always welcome.
As the CPC looks toward its future, the approach remains the same. The organization continues to be an important presence in the state and a crucial partner in the effort to build ahens and stabilizes healthy neighborhoods.
For more information, e-mail Sadie McKeown.
Source: Community Investment Corporation of the Carolinas.
This 60-unit residential property for seniors in Goldsboro, N.C., was financed by the Community Investment Corporation of the Carolinas.
A Bank Loan Consortium: Putting Private-Sector Equity to Work
David Bennett, Executive Vice President, Community Investment Corporation of the Carolinas
Nearly 25 years ago, the North Carolina Bankers Association (NCBA) determined that it could play a role in addressing the critical shortage of affordable housing across North Carolina. It was 1990, just a few years after the comprehensive tax reform efforts that created the Low Income Housing Tax Credit (LIHTC) Program. This legislation created a new method of attracting private-sector equity into the affordable housing development process. As a new housing industry began to take shape, NCBA hoped to leverage the financial capacity of its member financial institutions to provide a complementary source of loan capital for affordable multifamily housing developers.
The result was a new lending consortium, which has evolved over the years from a single-state lender to the multi-state entity now known as Community Investment Corporation of the Carolinas (CICCAR). Since its inception, CICCAR has operated as a mutually beneficial partnership of banks, with impressive results—$260 million in loans financing more than 300 properties to date, providing quality housing opportunities for 16,000 households across the Southeast.
CICCAR loans provide first-lien, permanent financing for multifamily communities with rents that are affordable to residents with incomes at or below 60 percent of area median income. Funding capital for CICCAR’s loans comes from its members, with membership open to any financial institution operating within the six-state operating footprint. With over 100 members, CICCAR is one of the largest affordable housing loan consortiums of its kind in the nation. The membership base is very diverse, ranging from some of the largest national and regional banks down to the smallest community savings institutions.
Members provide funding for each CICCAR loan on a voluntary, loan-by-loan basis. CICCAR staff members take applications from affordable housing developers, perform the initial underwriting, and submit requests to the consortium board for approval. Once a loan application has been approved by the board, all CICCAR members are provided an opportunity to review the request and decide if a particular loan is right for them.
Participation is never mandatory; members can select the loans and participation levels that best support their own particular lending goals. Because CICCAR loans meet the definition of community development under the Community Reinvestment Act (CRA), some institutions are motivated to lend primarily by a desire to meet CRA goals in the markets they serve. Other institutions choose to participate in CICCAR loans because they offer a relatively low-risk source of loan growth—with CRA eligibility providing a secondary benefit to the bank.
Following origination, CICCAR provides ongoing loan servicing, financial analysis, and asset management services that further ensure the successful operation of each property securing the loan portfolio. In addition to collecting and disbursing monthly payments to the participating banks, this means that CICCAR staff members perform a quarterly analysis of rent rolls and internal financial statements, an annual review of audited financial statements, and annual site inspections at all properties.
Benefits of Consortium Membership
The consortium model enables member financial institutions of all sizes to participate in community development lending efforts in a direct and meaningful way. Although loans financing LIHTC properties have a strong performance track record and an extremely low default history nationwide, the longer terms and other non-traditional loan characteristics that accompany these deals present a degree of credit risk that many banks are unwilling to take by themselves. By spreading that risk among a broad pool of banks, this critical source of affordable housing finance is sustained while limiting the risk exposure to each participating bank.
For more information, e-mail David Bennett.
Source: Massachusetts Housing Investment Corporation.
Canal Bluffs is in Bourne, Mass., a town known as the “gateway to Cape Cod.” It is the second of a three-phase development and consists of 45 units of affordable rental housing in a three-story building. The project was financed with a $3.75 million construction loan from Massachusetts Housing Investment Corporation.
The Saunders School project in Lawrence, Mass., for which Massachusetts Housing Investment Corporation provided a $2.1 million construction loan, involved the adaptive reuse of a vacant three-story historic school building to create 16 two-bedroom units of affordable rental housing. The development includes on-site and collaborative services to help families integrate into the community and achieve self-sufficiency.
Source: Massachusetts Housing Investment Corporation.
The Torrey Woods project in Weymouth, Mass., includes 20 new units of affordable rental housing for families. The project, a three-story building on 5.78 acres of wooded land at the Weymouth/Abington border, was built with a $1 million construction loan from Massachusetts Housing Investment Corporation. This was a joint venture between South Suburban Affordable Housing and Preservation of Affordable Housing.
Massachusetts Housing Investment Corporation: Filling the Financing Gap
Joe Flatley, President and CEO, Massachusetts Housing Investment Corporation
Massachusetts Housing Investment Corporation (MHIC) was founded by a consortium of banks in 1990 as a private nonprofit organization. MHIC began filling a critical gap in meeting the credit needs of affordable housing developers at a time when the real estate market was in turmoil.
Initially, MHIC focused on attracting investor capital for low-income housing tax credit properties and a loan pool for construction and acquisition lending. Its product lines expanded in 2000 to include the New Markets Tax Credit (NMTC) program, and again in 2008 with the Massachusetts Neighborhood Stabilization Loan Fund to address the mortgage foreclosure crisis.
Supported by an experienced and dedicated staff, MHIC has taken on difficult and complex projects with rigorous underwriting, attentive asset management, and timely reporting to provide investors with high asset quality and competitive returns. As of December 31, 2013, MHIC had raised more than $2.08 billion from over 37 institutional investors to finance the development of affordable housing and community development throughout New England.
Examples of these developments include Canal Bluffs, Saunders School, and Torrey Woods.
Under its lending program, MHIC provides construction financing, acquisition loans and pre-development loans, and bridge loans for historic tax credits to sponsors of low-income housing tax credit and NMTC properties. MHIC also offers lines of credit on a selective basis to customers with whom it has long-standing relationships. MHIC works with both for-profit and nonprofit developers and community-based organizations to finance property acquisition and new construction or rehabilitation of multifamily rental, homeownership, or mixed-use projects. MHIC has no minimum or maximum size of loans. Over the past few years, MHIC’s loans have ranged in size from $219,000 to $13.3 million.
Over the past 23 years, MHIC has lent over $592.5 million for multifamily projects, and the default rate has been under 1 percent. MHIC receives the financing it needs to operate its multifamily lending programs through the support of investors who commit long-term equity capital. This capital is then leveraged with lines of credit to increase lending capacity. Current lending capacity exceeds $60 million. MHIC typically lends only in situations where an investor member has not expressed an interest in providing a direct loan.
For more information, e-mail Joe Flatley, or visit MHIC’s Web site.
|Articles by non-OCC authors represent the authors’ own views and not necessarily the views of the OCC.