Multifamily Lending Is Getting Innovative With Financing

This article was published on in October 2018.

Housing in the U.S. continues to become less affordable for a growing number of Americans. In 2016, nearly half of renters were considered cost-burdened, spending more than 30% of their income on rent. The country needs 4.6 million new apartments by 2030 across both market-rate and affordable properties to meet demand, Curbed reports.

The increased need for affordable housing development has led to both new financing products and new investors in the asset class, Capital One Senior Vice President Evan Williams said. Williams is based in Capital One’s New York office, where he focuses on affordable housing and the origination through Fannie Mae Delegated Underwriting and Servicing, Freddie Mac Targeted Affordable Housing and Federal Housing Authority loans nationally.

Momentum around affordable housing development and preservation continues to grow, fueled by the growing availability of financing products from Fannie Mae and Freddie Mac, Williams said. Consequently, investors who have traditionally worked with market-rate apartments have also brought their experience raising capital to the burgeoning market.

From new loan products that expand the scope of affordable housing financing to encouraging healthier design, innovation has been at the center of new affordable housing trends and products. As more Americans struggle to find and afford quality housing, lenders and agencies like Fannie Mae and Freddie Mac are finding creative ways to encourage investors and developers to fill that need while still meeting their requirements for return on investment.

“We are at the point where affordable housing is large enough as an industry that it has become an investment class, and so there are more traditional market-rate apartment investors coming into the space,” Williams said. “Traditional affordable housing developers are also innovating how they finance their properties, like creating investment funds and other financing vehicles that were not a part of the landscape five or 10 years ago.”

Innovation Through Financial Structures

Earlier this year, Freddie Mac released two loan products designed to encourage the development and preservation of affordable and workforce housing. The first is a mezzanine loan product originated alongside a conventional Freddie Mac loan. Borrowers receive financing terms like 90% leverage and debt service ratio coverage as low as 1.05%. To be eligible for the loan, borrowers must agree to cap rent increases over the next 10 years.

Unlike previous products that focused primarily on affordable housing for households earning 60% or less of area median income, the mezzanine product includes properties that are already naturally affordable—where the rents are set at affordable levels but may not have any regulatory or deed restrictions tied to affordability levels—or existing market-rate developments where the rents qualify, Williams said.

The expansion of loan offerings into the market-rate arena will help encourage more workforce housing, which is defined generally as households making between 61% and 120% of an area’s median income but can be higher in more expensive markets. This class of affordable housing development is often overlooked by traditional affordable housing investors compared to affordable low-income properties.

Cheaper financing encourages multifamily investors to position properties as affordable because they don’t need a higher return on investment. Rather than focus on luxury upgrades, they can focus on cost-effective, high-quality building techniques.

“Developers may still do a renovation, but might not allocate it to high-end finishes that they would otherwise,” Williams said. “They can stay at an affordable level and provide quality housing because they don’t need a higher return.”

Capital One’s Community Finance team also finances affordable housing developments primarily through balance sheet debt products and Low Income Housing Tax Credit investments within Capital One’s footprint and often works with developers and government housing agencies to build cost-effective, high-quality affordable housing for residents.

In addition to its mezzanine product, Freddie Mac debuted a forward permanent loan commitment program. The program provides a permanent loan commitment prior to or during construction or substantial rehabilitation of market-rate or affordable housing multifamily building systems. It is another new form of financing that now is available for market-rate workforce housing, Williams said.

Encouraging Healthy Design In Affordable Housing Developments

While Freddie Mac has focused on creating new financing products for affordable housing, Fannie Mae has taken a less conventional approach to encourage housing preservation, Williams said. Fannie Mae offers pricing incentives for programs that will improve the lives of affordable housing residents. Those improvements range from installing energy-efficient appliances and HVAC equipment to using nontraditional building materials like low-volatile organic compound paint.

“Fannie Mae is seeing opportunities to put a national spotlight on upgrades that owners are doing independently and creating programs to make it commonplace,” Williams said. “And multifamily is a good place to do it because a single landlord can make this change across multiple units versus getting individual single-family owners to make those changes.”

Fannie Mae initially saw success with its Green Rewards program, which offers underwriting of 75% of the owner’s projected cost savings and 25% of the tenant’s projected cost for investing in energy- and water-cost reducing improvements, as well as up to 5% in additional loan proceeds. The agency later expanded this philosophy to form a healthy design program that includes affordable housing development.

Fannie Mae’s pivot toward incentivizing healthy design is part of a sea-change in how investors and developers look at affordable housing. The goal is no longer just to provide basic shelter. Affordable housing must improve the lives of its residents and provide quality living conditions.

The incentives program provides lower pricing, up to 15 basis points, for projects that meet wellness standards from organizations like The Center for Active Design and Fitwel. These groups work to improve indoor spaces, from creating communal areas to providing residents with natural light.

Williams, along with Capital One’s Multifamily Finance Team, used Fannie Mae’s Healthy Housing Rewards to provide a $23.1M Fannie Mae fixed-rate loan to fund the acquisition, renovation and expansion of Edgewood Court Apartments, a 204-unit, affordable rental community in Atlanta, Georgia.

This was Capital One’s first transaction completed under the program. It features playgrounds, fitness equipment, tobacco-free environments, green spaces and other amenities.

Quality Over Quantity

Built in 1950, Edgewood Court was last renovated more than 35 years ago. In addition to adding new amenities, the owner, Jonathan Rose Cos., plans to refresh building facades, replace roofs and gutters, update unit electrical and HVAC systems, renovate kitchens and baths and create a community garden. The firm has focused more on creating quality housing, rather than using these incentives as a way to circumvent housing restrictions.

“What’s really encouraging to see is the new players and forms of investment come into the market,” Williams said. “People are also prioritizing the quality of the product that goes onto the market. It’s the recognition that affordable housing has to provide more than just the basics, but should be of good quality. More people are investing in it the right way.”

The affordable housing crisis isn’t going to solve itself, and Capital One is working alongside borrowers and agencies to find new ways to foster innovation in affordable housing financing. With time, this investment in better spaces is intended to fuel further redevelopment and revitalization of much-needed quality housing across the country.

“We are positioning ourselves in a way to support these programs as a lender,” Williams said. “We offer the guidance and the expertise to put these products in place.”