More Options for Construction-to-Permanent Financing Abound

September 14, 2021

The COVID-19 pandemic put multifamily construction briefly on pause, but as the economic recovery continues, developers are ready to begin financing new ground-up construction to meet the demand for apartments. While developers and investors hope to take advantage of low interest rates and lock-in long-term financing, they also face some new challenges.

“Development costs and lumber costs are up dramatically, and deals are being structured a little differently now because of that,” says Barry Wolfson, chief FHA underwriter for Greystone. “We’ve seen a big uptick in demand for HUD financing.”

One particularly popular construction financing option currently is the fixed-rate Sec. 221 (d)(4) loan from the Department of Housing and Urban Development (HUD). Greystone saw a nearly 100% increase in HUD-insured construction lending in 2020 compared to 2019 and nearly a 193% increase in overall FHA financing volume during that same period.

HUD (d)(4) financing advantages – but not for every deal

The main advantages of a HUD (d)(4) loan are the higher leverage allowed compared to bank loans, along with fixed rates and long loan terms, says Wolfson.

“The HUD (d)(4) loans go up to 85% loan-to-construction cost for projects under $75 million,” says Wolfson. “Projects that are more than that require a higher down payment.”

Bank loans typically go up to just 60% to 65% of the development cost.

“The rates on HUD (d)(4) loans are fixed and long-term, which is a big advantage to developers,” says Wolfson. “You can fix the rate for the construction period plus 40 years.”

Currently, rates for HUD (d)(4) loans are as low as 3.1% with a mortgage insurance premium (MIP) of 25 basis points, compared to the MIP of 65 basis points that is common with bank loans.

“To get a 40-year fixed-rate loan at 3.35% all-in is definitely a benefit of this loan program,” Wolfson says.

Most important, for developers who plan to keep their property rather than sell it after construction is complete, the HUD (d)(4) has one closing and one rate lock for the construction loan and the permanent 40-year loan. Avoiding closing two loans saves time and money. Typically, bank financing requires a short-term construction loan followed by a permanent loan after a property is leased.

However, developers interested in a HUD (d)(4) loan should anticipate a long wait to finalize their financing.

“It used to take about a year, but now there’s a queue that takes at least another three months or so to get through for an approval. So, if you want to start construction next week, this option is not ideal,” adds Wolfson.

“The best time to apply for a HUD (d)(4) loan is when you’re considering buying land and have sketches of what you may want to build,” says Wolfson.

A second potential disadvantage of a HUD (d)(4) loan is a regional issue related to wages. Under the federal Davis-Bacon Act of 1931, contractors and subcontractors on federally funded or federally assisted projects must be paid the prevailing wage for the area established by the Department of Labor (DOL).

“In some states, the prevailing wage isn’t significantly higher than the non-prevailing wage, but in others, like California for example, the DOL wage is 30% higher than the prevailing wage,” says Wolfson. “Therefore, costs for a HUD (d)(4) project wouldn’t pencil out.”

The HUD (d)(4) loan program is used most frequently in Florida, Colorado, North Carolina, South Carolina and Texas, in part because of the Davis-Bacon prevailing wages issue, Wolfson says. 

“The HUD (d)(4) program is best for people who have done many deals before, with a team including the general contractor, architect and agent who have HUD experience,” says Wolfson. “Typically, these are used for more complex projects of $7.5 million and up.”

In addition, HUD (d)(4) loans don’t work well for a flip because the financing has a prepayment penalty on a sliding scale for projects that are sold in less than 10 years.

New construction-to-perm financing with Freddie Mac for Affordable Transactions

The pandemic pivot that so many companies were forced to do started a few months before the COVID-19 virus appeared for American First Multifamily Investors (ATAX), an affiliate of Greystone. Dominium, one of the country’s largest affordable housing developers, reached out to Greystone and ATAX in March 2020 with an urgent need for replacement construction and permanent financing for a multifamily development in Midland, Texas. The company’s bank financing was abruptly pulled because of concern about economic distress in the area due to heavy dependence on the energy industry.

“Dominium had just 45 days before several deadlines loomed to maintain the LIHTC credits for the development,” says Ken Rogozinski, CEO of ATAX. “We pulled together a new financing product that includes a construction tax-exempt loan from ATAX and a permanent Freddie Mac Optigo® Forward Tax Exempt Loan (TEL) from Greystone.”

What’s different about the new ATAX product is that the construction loan is financed with a tax-exempt loan rather than a bond. In addition, because the financing is designed to be transitioned into a Freddie Mac permanent loan, ATAX and Greystone developed documentation that matches Freddie Mac requirements.

“We built this product from scratch within 45 days to meet Dominium’s timeline and to make the process as seamless as possible for every affordable housing developer who wants a permanent Freddie Mac TEL,” says Jeff Englund, head of affordable housing lending at Greystone.

“While we never intend to begin a construction project under such complex circumstances, Greystone performed with grace under pressure. They have thought about the pain points affordable developers face, including tax credit timelines and financing gaps, and have a capital solution – short-term or long-term – for any need. We are thrilled with the outcome for the Midland project,” said Jeff Spicer, Vice President and Project Partner, Dominium.

While closing the construction-to-permanent loan in 45 to 60 days is one advantage of the new financing option, developers also benefit from the elimination of a second closing.

“Developers can save time and money with one closing instead of two,” says Rogozinski.

The product works best for new construction LIHTC developments, although it might also work for an acquisition and rehabilitation loan using LIHTC credits, he says.

“One important element of this program is that the developers must make a forward commitment to a rate-locked Freddie Mac TEL loan,” says Englund.

The combined ATAX construction loan and Greystone Freddie Mac TEL loan can finance 90% to nearly 100% of the development, says Rogozinski, which most traditional construction lenders do not generally offer.

“That’s why risk management is so important from our point of view,” says Rogozinski. “This loan product is designed for experienced affordable housing developers who we can feel confident will finish building on time and be fully leased up quickly.”

The construction loan product is a full recourse loan through stabilization.

“We’re bridging the loan against the tax equity and we’re going high up in the capital stack with this financing, so we need to be mindful of the execution ability and the financial strength of the developers,” says Rogozinski.

At the height of the pandemic, traditional lenders became risk-averse and conservative, even pulling back from LIHTC developments that have a low long-term default risk, says Rogozinski.

“There was no reason even during the pandemic not to have the capital available to something as low risk and as important as building affordable housing,” says Englund. “That’s one reason we worked so hard to develop this new product.”

One size fits all financing doesn’t work for every developer, Rogozinski says.

“There will either be markets or circumstances where people need somebody to stretch on something,” says Rogozinski. “We've got the ability to be nimble and to push where we can in order to help serve our clients.”