Bond Financing 101 & Industry Update

Bond issues have become an important part of the affordable housing industry in recent years and are an important asset in CAHEC’s growing portfolio. The Low Income Housing Tax Credit (LIHTC) was designed to subsidize either 30% of the project through the 4% program (bond financing), or subsidize 70% of the project through the 9% program.

Simply stated, the 4% program requires over twice the debt as the 9% program making the 9% program more desirable. But, experienced developers like the 4% bond program because it is non-competitive unlike the 9% program. Generally, State Agencies allocate tax credits in its competitive program to smaller projects and very often rural communities. Pursuit costs for chasing a 9% deal and failing to get allocated is tough.

Developers are closing more bond issues than ever. They are using bonds to finance larger projects in cities with significantly higher rents. The explosion in bond financing started in 2021. After years of lobbying by the affordable housing community, the Consolidated Appropriations Act of 2021 was signed into law effectively “fixing” the 4% low income housing tax credit program. The primary benefit was an increase in credits for bond financed projects represented by the value of the credit going from 3.07% to a fixed 4.00% resulting in a 30% increase in equity.

The gain in equity was substantial enough to move a number of projects from infeasible to feasible. During 2021, this increase in equity reduced the need for local gap funding. Previously, developments which only worked with highly competitive 9% credits, now work with bond financed projects through the 4% program.

Significant headwinds have emerged this year impacting the bond market. Each State has volume cap based upon its population, which is the maximum amount of tax-exempt private activity bonds that may be issued in a calendar year. With the dramatic increase in bond issues almost all states volume cap has become over-subscribed. This issue is a growing phenomenon.

Additionally, interest rates on bond financed projects have risen over 150 basis points in the last several months. When you factor in a significant explosion in construction costs, project budgets are extremely strained causing developers to need additional sources in order to have a viable project.

Like building blocks, capital is needed from a variety of sources to have a viable project. CAHEC is very active in Georgia and South Carolina. Both states have an affordable housing state credit which help provides the equity to fill in this gap. Other sources of funds have become recently available. Developers also often use HOME funds, CDBG funds, historic tax credits, housing trust funds, disaster relief money, or funds raised through tax-increment financing.

Tax-exempt bonds offer great opportunities for real estate developers. It is very important that developers work with seasoned professionals who have a proven track record, since debt structures are ever changing and all structures should be considered.