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Community Developments Investments (May 2015)

Financing the Survival of Small Rental Properties

This building is an example of a small multifamily property in Chicago. BMO Harris invests in buildings like this through the Community Investment Corporation loan pool.

Carl Jenkins, Managing Director, Community Investments, BMO Harris Bank N.A.

As a region built over the past two centuries to house millions of immigrants, job seekers, and the poor, metropolitan Chicago is heavily reliant on the availability of quality affordable rental housing. For Chicago-based BMO Harris Bank N.A., Community Investment Corporation (CIC) provides a highly effective tool for financing the preservation of such housing. Much of this rental housing exists in the form of apartment buildings with 50 units or less, and is owned and maintained by small entrepreneurs. While the new construction and maintenance of subsidized affordable housing in the Chicago region is critical to meet the continually growing need, the preservation of naturally occurring affordable housing in the unsubsidized private ownership market is critical to stabilizing many of the area’s communities.

Market Need

In 2012, DePaul University’s Institute for Housing Studies (IHS) completed an analysis of renter-occupied apartment buildings in Cook County, Illinois. Cook County, the most populous county in the region, and Chicago, within Cook County, contain a significant share of the housing stock. Nearly 38 percent of all residential units in Cook County and 52 percent in Chicago alone are in multifamily rental buildings. When categorized by building size, according to IHS, multifamily rental buildings with five to 49 units account for 15 percent of the housing units in Cook County and 19 percent in Chicago. Even more prominent in Chicago are two- to four-unit buildings (these are financed in the same manner and with the same tools as single-family residences), which account for 26 percent of the total housing units and 50 percent of multifamily rental units in the city. Combined, these small buildings play an outsized role in the rental markets of the region’s low- and moderate-income communities. In some neighborhoods, these building account for up to 70 percent of the overall housing units. Many first-time owners and potential investors looking to acquire and rehabilitate these properties have a customer and property profile that falls outside the standard underwriting framework of a traditional commercial real estate financing product offered by a bank. This is where CIC steps in.

BMO Harris’s Partnership With CIC

CIC, formed in 1974, is a 501(c)(3) nonprofit corporation certified as a community development financial institution by the U.S. Department of the Treasury. The organization was formed by Chicago’s major financial institutions (including BMO Harris) as a separate, self-sustaining nonprofit mortgage lender that allows local banks to pool their capital to effectively target underserved Chicago neighborhoods. These neighborhoods contain a significant number of what we call “naturally occurring affordable housing.”

While BMO Harris typically offers commercial real estate loans with five-year terms to qualified borrowers, CIC offers more flexible loan terms with maturities of up to 20 years. The mission, to provide long-term credit products for rental apartment buildings, requires a long-term, sustainable source of capital. Although many loan funds capitalize their lending activity using multiple sources of subordinate debt, this model is not scalable, and the maximum capacity for loan origination is quickly reached. To address this challenge, CIC, in partnership with local financial institutions, created a financial instrument to attract investors and provide the organization with a long-term source of capital that could work to expand its lending activity. The instrument, branded as the Resource Apartment Lending program (RAL), has allowed CIC to originate approximately 2,000 loans and finance the rehabilitation of over 50,000 rental units. Launched in 1984, CIC’s RAL program provides a unique and effective investment product for BMO Harris to finance naturally occurring affordable housing. In 1991, thanks in part to the success of its RAL program, CIC expanded beyond Chicago to the six-county metropolitan area.

Effective Community Reinvestment Act Investment Test Tool for BMO Harris

To meet its goals under the Community Reinvestment Act (CRA), BMO Harris must commit resources to qualified investments to achieve its goals under the Investment Test. Typical qualified investments available to banks are unsecured, involve economic returns in the form of a tax credit, or do not regularly amortize. The RAL allowed BMO Harris to make a $30 million commitment to purchase a series of notes collateralized by mortgage loans to independent property owners for the acquisition and rehabilitation of rental apartment buildings in low- and moderate-income census tracts. Essentially, the program is a privately placed mortgage-backed security that allows investors to share in the risks of a pool of mortgages.

With the BMO Harris purchase of a security backed by loans and not the direct purchase of whole loans, the bank can treat the instrument as an equity investment on its books, instead of as a loan. The original loans issued by CIC to apartment building owners remain on CIC’s balance sheet and are simply pledged as collateral to the investor’s security. Additionally, the RAL investor program is unique to a loan fund not only because of its collateral structure but also because the program provides a cash return in the form of monthly principal amortization and interest payments.

The RAL program has performed exceptionally well with manageable delinquencies, defaults, and charges-offs, despite a challenging real estate market. Since the RAL progam’s inception, charge-offs in the RAL pool have been covered by the loan loss reserve, and no charges have been passed through to investors since 2001.

Partnership Continues to Grow to Meet Neighborhood Needs

As the recent IHS study highlights, many poorer neighborhoods in Chicago contain a disproportionate share of two- to four-unit buildings. The recent economic downturn has had a particularly devastating effect on these rental buildings and their communities. The two- to four-unit properties, according to IHS, “have been disproportionately impacted by foreclosure and become highly distressed.” These buildings typically do not qualify for credit products designed for commercial buildings (five units or greater) and owners of these small rental properties face a number of challenges. CIC has recently offered a new pilot collateralized note program designed exclusively to target capital to buyers of one- to four-unit rental properties. The program is designed to support investors willing to buy distressed one- to four-unit buildings. Loans under this program are made only to investors willing to buy at least nine units that are located close together. BMO Harris understands the importance of getting capital to these properties and the important role these properties play in stabilizing many communities in Chicago. To date, BMO Harris has made a $4 million commitment to this program.

In addition to the CRA and economic benefits BMO Harris receives in exchange for its investment in CIC, the bank also leverages CIC’s ability to provide property rehabilitation training and technical assistance to first-time rental property investors. BMO Harris also works directly with CIC through board and loan committee participation. Furthermore, CIC provides a valuable resource for BMO Harris to direct potential investors who may be ineligible for traditional banking credit products but may be able to achieve their objectives with a loan from CIC. Finally, CIC clients often use BMO Harris for their cash management and operating account needs.

For more information, e-mail  Carl Jenkins.

Articles by non-OCC authors represent the authors’ own views and not necessarily the views of the OCC.