Commercial mortgage interest rates drifted slightly lower during the waning days of summer, according to the Barron's/John B. Levy & Co. National Mortgage Survey of major institutional lenders nationwide. The benchmark 10-year prime mortgage rate now sits at 7 7/8%, while the short-term five-year rate is attractively priced at 7 1/2%.
August is traditionally a hum-drum month for the commercial mortgage industry. The summer doldrums typically reach their peak during the latter half of the month, as virtually the entire industry seems to be on vacation. That certainly was not the case this year. Institutional lenders - primarily life insurers - were so inundated with loan requests that some loan originators were forced to cancel or postpone their previously scheduled vacations. Many survey members noted that their origination staffs were as busy as they had been during the 1986 business rush.
Because lenders were so busy on existing transactions, a number of large real estate borrowers were unable to obtain their preferred lender's attention toward their deal, leaving the borrowers in a state of extreme frustration.
Commercial mortgage lending is a fairly people-intensive business and does not lend itself to slight expansions and contractions. As a result, borrowers took their place in line to wait until their deal could be analyzed.
Survey members were almost euphoric about the quality of the loan submissions. In the late-'80s, the majority of submissions were for over-leveraged properties which would later have a devastating effect on the lender's net worth. It appears to be different this time around, however. One particularly large institution noted that their year-to-date debt-service coverage ratio - obtained by dividing pre-debt service cashflow by debt service - was in excess of 1.5%. in the "go-go" days of the 1980s, a 1.25% ratio would have been considered robust.
More than a handful of institutions have already met their production goals for the entire year and are merely processing deals which were previously in the pipeline. Because they are unwilling to entertain new business, the remaining institutions have seized upon this opportunity to raise spreads about 1/8%. This is particularly true for borrowers seeking a loan approximately 75% of the property's value. For loans below 65%, spreads are unchanged. Lenders seem every bit as aggressive for these deals and are especially interested in good-sized packages containing multiple loans, allowing them to put out a block of money with relative ease.
While a number of institutions sit on the sidelines and watch, the conduit industry has stepped in to fill the void. Several conduits have cut their spreads so they are almost in sight of life insurance company pricing. Apartment transactions conducted through conduits are available at spreads below 2% for properly leveraged transactions, while the spread for shopping center deals is between 2% to 2.25%. Both spreads are 1/2% less than they might have been just several months ago.
In order to increase the flow of business, several conduits have sought alliances with national and regional banks who want to liquidate part of their existing loan portfolio. The major player here is J.P. Morgan, whose conduit has formed an association with Bank of Boston among others.
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Fighting funding cuts in
federal housing programs
Housing advocates attempting to fend off deep cuts in funding for federal housing programs under the new Republican Congress have already suffered a major defeat with the rescission of over $6 billion in previously appropriated money.
In programs operated by the U.S. Department of Housing and Urban Development (HUD), the rescission legislation wiped out $1.956 billion in funding for incremental or additional Section 8 rental subsidy certificates and vouchers.
The measure also rescinded $1.177 billion in funding for the renewal of expiring certificate and voucher contracts. If the contracts aren't renewed, the low-income families using those certificates and vouchers will be forced to pay full market rent for their housing.
To cushion the impact of the rescission and stretch out the available renewal funds over as many units as possible, Congress authorized HUD to shorten the term of contract renewals to two years. Also, public housing agencies administering Section 8 contracts may use available reserve funds for renewals.
The rescission bill also eliminates $15.5 million appropriated to subsidize the cost of Section 515 rural rental housing loans. This cut reduces the volume of loans which the Rural Housing and Community Development Service can make by about $30 million.
Tenant purchase can end
tax credit use restriction
The Internal Revenue Service has ruled that the low-income housing tax credit program's extended low-income use requirement can be satisfied even if the use restriction will be terminated if a tenant exercises a right of first refusal to purchase the building.
Under the tax credit program, low-income use restrictions must remain in effect for a 15-year compliance period and, under Section 42(h)(6) of the Internal Revenue Code, for an extended commitment period established by the credit agency allocating the credit. Under Section 42(i)(7), the credit won't be denied to the project owner merely because the tenants have a right of first refusal to purchase the project after the close of the 15-year compliance period.
In Revenue Ruling 95-49, the IRS noted that Section 42(h)(6) and Section 42(i)(7) are both aimed at promoting the availability of housing for low-income persons beyond the 15-year compliance period, through continued rental in one case, and through tenant ownership in the other.
"Accordingly," the revenue ruling says, "under Section 42(h)(6) it is appropriate for an owner and a state housing agency to reference a right of first refusal to be granted by the owner to tenants (either initially or by later amendment) in a commitment between the owner and the agency."
The ruling says the requirement of Section 42(h)(6) will be satisfied even if - under the owner-agency agreement - the extended low-income use commitment will be suspended or terminated if tenants exercise a right of first refusal to purchase the project.
Rent adjustment factors
set for LIHPRHA
HUD has established operating cost adjustment factors (OCAFs) to be used in determining rent increases for Low-Income Housing Preservation and Resident Homeownership Act (LIHPRHA) projects receiving Section 8 rental assistance.
LIHPRHA projects are Federal Housing Administration-insured low-income housing projects - primarily Section 221(d)(3) below-market interest rate (BMIR) and Section 236 projects - whose low-income use restrictions have been extended beyond the 20-year period specified in the original documents. Many of these projects receive Section 8 assistance to support the continued low-income use.
The OCAF rent adjustments are designed to cover increases in project operating costs. Using Bureau of Labor Statistics (BLS) data on producer prices and wages, HUD has developed adjustment factors for metropolitan and nonmetropolitan areas in each of its 10 regions.
HUD will adjust contract rents by applying the OCAF to the portion of the rent attributable to operating expenses and making adjustments for an increases or decreases in non-operating costs, such as debt service.
If a project owner feels that the OCAF-based rents are inadequate, the owner can seek higher increase from HUD. department may approve higher rents in order to cover what it calls "extraordinary necessary expenses of owning and maintaining the project."
Fannie Mae forms new
investment fund
The Federal National Mortgage Association has announced plans to establish the Fannie Mae Housing Investment Fund, which will support affordable housing development.
When launched sometime in 1996, the venture capital fund is expected to have an initial capitalization of $100 million. Larry H. Dale, who has headed Fannie Mae's National Housing Impact Division, will be responsible for developing the fund.
The investment fund "will combine the best characteristics of a social investment fund and a for-profit business," says James A. Johnson, Fannie Mae's chairman and chief executive officer. "It will provide worthy, but hard-to-finance, affordable housing efforts with the flexible capital often needed to make these projects work."
At startup, the fund will be authorized to make equity, debt or hybrid investments in projects sponsored by nonprofit and for-profit developers. It can play a variety of roles, including limited partner, lender and credit enhancer, taking its return in the form of cash, equity interests or other financial assets.
As Johnson explained it, "the fund will bring to affordable housing all that is in the tool kit of corporate venture capitalists."