Affordable Housing Bond Menu

7 min read

A diverse list to choose from 

The bond market is looking shaky. On December 3, 2018, an inversion occurred along the yield curve between two-, three-year and five-year notes, striking fear in traders that this could also happen between two-year and ten-year notes. That would signal a recession is near, since it shows a lack of investor confidence in the short-term market.

But one bastion of stability are the bonds related to affordable housing transactions. They are proving to be a reliable source of financing for developers who use four percent Low Income Housing Tax Credits, and a safe investment for financiers.

This was the recent takeaway, at least, at the National Housing & Rehabilitation Association’s Fall Forum in Boston, during a slideshow presentation moderated by Kent Neumann, a founding member of Tiber Hudson, a Washington, DC-based law firm that navigates complex affordable housing deals.

During the presentation, Neumann showed that the long-term yield curves for muni bonds are higher than for treasury bonds. As of October 2018, one-year MMD yields are 1.9 percent, and the 30-year bond yields are 3.4 percent. Neumann also discussed the advantages and characteristics of six different tax-exempt debt executions. The first one, he later clarified by phone, could be broadly defined as private placements. This is capital raised from a smaller number of investors, and does not need to be registered with the SEC. Private placements are popular in Community Reinvestment Act markets, and have faster execution time (90 to 120 days).

The other five bond products were all public offerings that can be sold to wider groups of investors, and tend to be longer-term. Here’s a breakdown of those five:

FHA Risk Share Loan Program
This is Section 542(c) of the Housing and Community Development Act. According to HUD’s website, the program,“ provides credit enhancement for mortgages of multifamily housing projects whose loans are underwritten, processed, serviced and disposed of by [Housing Finance Agencies],” with HUD also sharing in the mortgage risk. The loans, according to a slide in the presentation from Chuck Karimbakas of MassHousing, have a built-in structure to avoid Davis Bacon laws and excess negative arbitrage. The loan-to-value ratio (LTV) goes up to 90 percent; the debt service coverage ratio is 1.15; and it has a 40-year amortization.

FHA Risk Share Loan Program

  • FHA insurance program under Section 542(c) of the Housing and Community Development Act
  • Not eligible to be “wrapped” with GNMA Securities.
  • Can be used for construction and permanent financing; new forward structure available to avoid Davis Bacon and reduce neg arb.
  • Fast Execution Time: 90 to 120 days; HFA provides full underwriting.
  • Underwriting Terms: Up to 90 percent LTV; 1.15 DSCR; 40-year amortization/term (with possible balloon option; DSRF typically required.
  • Non-Recourse, Davis Bacon, Negative Arbitrage.

New Const/Sub Rehab – Perm Interest Rate Stack (est.)

Bond Rate:                                                                    4.00%
Mortgage Insurance Premium (MIP):                      0.25%
Mortgage Spread (varies based on insurer):          0.75%
Total: 5.00%

Freddie Mac Tax Exempt Loan & Bridge To Re-Syndication
This is used for buying or refinancing multifamily properties. The Freddie Mac Bridge Loan, according to a slide from Sarah Garland of CBRE, includes an 85 percent LTV, 1.15 DSCR, low-cost variable rate (2.05 percent spread to 30-day LIBOR), and up to 36-month term.


FHA/GNMA Taxable Loans
This was broken down in the presentation between Section 223(f) and Section 221(d)(4). The following characteristics for the former include – acquisition or refinance; non-recourse; fully amortized 35-year term; rehab limit of $42,217 per unit; no Davis Bacon wages; post-rehab rents/Pro forma operating expenses; 90 percent of acquisition costs/80 percent of value for cash-out; 420 percent (plus 25 bps MIP for affordable properties); six months from engagement to closing.

Meanwhile, Section 221(d)(4) loans have the following characteristics – new construction or sub rehab (under $42k per unit); non-recourse construction/permanent loan; rate locked upon issuance of commitment; IO during construction period/40-year amortization; Davis Bacon wages apply; 4.7 percent plus 25bps MIP for affordable property.


Section 223(f):

  • Acquisition or refinance
  • Non-recourse
  • 35-year term, fully amortizing
  • Rehab limit $42,217 per unit
  • No Davis Bacon wages
  • Post-rehab rents/Pro forma operating expenses
  • 90 percent of Acquisition Cost/80 percent of Value for cash-out
  • ~4.20 percent (plus 25 bps MIP for affordable properties)
  • ~Six months for engagement to closing

Section 221(d)(4):

  • New construction or Sub rehab (>$42K per unit).
  • Non-recourse construction/permanent loan.
  • Rate locked upon issuance of commitment and does not change upon conversion.
  • IO during construction period/40-year amortization.
  • Davis Bacon wages apply.
  • ~4.70 percent plus 25bps MIP for affordable property.

Tax-Exempt Seller “Take-Back” Note & Bonds describes take-back financing as, “when a seller wants to close a sale of real estate but the buyer is not yet in a position to fully fund the purchase, the parties can close the sale with the seller taking from the buyer a purchase money note and mortgage in lieu of an all-cash payment.” According to Neumann, this is common in Rental Assistance Demonstration projects, and “tax-exempt bonds in excess of the permanent financing are often required in these deals.”

Tax-Exempt Seller “Take-Back” Note & Bonds

  • Many four percent preservation deals include seller financing in the form of a subordinate “take-back” note (common in RAD transactions).
  • Due to the LIHTC 50 percent test, tax-exempt bonds in excess of the permanent financing are often required in these deals.
  • Several ways to address this issue with various bond structures.

Fannie Mae MTEB
This program, writes the Commercial Real Estate Finance Company of America, “provides credit enhancement for tax-exempt bonds issued to finance the acquisition, new construction, refinancing or moderate or substantial rehabilitation of multifamily properties.” According to a slide by Matt Engler of Wells Fargo, the Fannie Mae lender provides a forward commitment. A construction lender is needed before conversion. The bonds are initially secured by cash collateral and construction loan funds, and replaced at conversion with MBS. The AA+ ratings keep borrowing costs low. Additional loan proceeds generated can result in two to three times the upfront costs, due to low all-in mortgage rates.

According to Neumann, the market within affordable housing finance has been moving from short-term to long-term tax-exempt structures. The reduction of negative arbitrage, “has allowed us to implement new structuring opportunities for these deals that reduce certain costs and in some cases create more sources of funds.”  Despite the new federal tax cuts, “we have also continued to see strong demand for investment opportunities from banks and other investors.”

Neumann’s broad overview is that affordable housing finance instruments are a safe, sound investment. “Affordable housing financing deals over the last decade or so have a very low default rate,” he said. “There were some issues during the financial crisis…but it was very limited even there. And since then, as more products have moved to fixed-rate executions, there’s still a historically low default rate across any affordable deals.”

There are a couple of reasons for this, he says. The demand for affordable housing isn’t as subject to fluctuations as market-rate projects, meaning occupancy rates are higher and the cash flow better. But more importantly, there are multiple participants who have an interest in seeing that housing projects are properly executed – including the developers, investors, underwriters and LIHTC distributors. These parties, “are constantly observing, monitoring these transactions to make sure they’re in compliance,” he concludes.

This makes affordable housing debt safer, cheaper and higher-rated than other bonds, which matters in what increasingly seems like a perilous market.

Story Contact:
Kent Neumann
Founding member, Tiber Hudson