The current rate environment may pose challenges for affordable housing deals with maturing perm loans. Some Year 15 deals will smoothly refinance. Others may be strained. Imagine a Year 15 deal with a balloon due. The deal has been performing above breakeven but not by much. It has been running at a 1.05. Insurance and staffing costs and some PSH expenses have been higher than expected. The deal is OK but given the bank credit crunch and Fed policy, the deal won’t underwrite to a required DSC of 1.15 based on actual performance and higher interest rates. What are the options? Here is one approach:
***Get a 3 to 5 year mini perm with an interest only portion to pay off the balloon.
***Project cash flow should be more than sufficient to service the interest only payments. Explore funding a reserve with the excess cash flow that might pay you more than what you owe on your interest-only loan. You could use that reserve to pay down principal on the mini perm later or pay it off as you go.
***Buy an interest rate cap. This will protect you from further rate hikes as the Fed works through its last mile problem. The Fed is trying to squeeze the remaining inflation out of the system. They have taken inflation down from about 9% to 3% but still need to get to 2%. One great thing about a cap is you can deploy it for another project if you don’t need it for the subject.
***In Year 5 when the mini perm matures, the combination of less debt on the property plus hopefully some improved project performance and maybe even lower interest rates could enable the project to refinance on a longer term fixed rate amortizing basis.
I’m not sure how many banks would go for this structure (though it may be fruitful to explore with your favorite CDFI). This structure won’t work for all deals and surely there are other potential structures. Reach out to your trusted advisers.
Three factors are key. The Fed appears intent on keeping rates higher for longer. Banks face their own imposing challenges which may contribute to keeping your interest rate elevated. Some stabilized properties are struggling with higher costs due to inflation, insurance, and PSH.
Think ahead about how to manage an orderly refinance and proactively reach out to your lenders and trusted advisers to understand your options.