Market primed for return to rental development and 80/20 finance.

In New York City, an avalanche of new condominium development and conversions has created a potential oversupply of condominium product. In response, lenders have tightened restrictions on loans for new for-sale developments, concentrating on select projects by established developers.

This projected oversupply of condominiums, combined with steadily increasing rental rates, has revitalized demand for the development of rental projects, especially under the 80/20 financing program which provides developers with substantial advantages as compared with conventional projects. These advantages generally include:

* Very low cost financing;

* 421(a) tax abatement;

* Exemption from mortgage recording tax; and

* Low Income Housing Tax Credits.

For a new development to qualify as an 80/20 project, a developer must set aside 20% of the units for tenants whose income does not exceed 50% of area median income, which currently stands at $70,900. These units will be rented for approximately $10 per square foot as compared with $65-$75 per square foot for a comparable market rate apartment. This, of course, reduces the rental income the developer can receive for 20% of the apartments. This lost income must be compared with the financial benefits set forth above to determine if the 80/20 program is advantageous.

80/20 projects are financed through the issuance of bonds. HFA (which in recent years has been the issuer in the majority of 80/20 financings) issues tax-exempt low-floater bonds in an amount equal to up to 100% of total project development costs. The interest rate on these bonds is reset every 7 days. The portion of total project costs not qualifying for financing using tax-exempt low-floater bonds may be financed by taxable low-floater bonds. Both the tax exempt and taxable bonds must be 100% credit enhanced by a financial institution (generally a bank) with a high credit rating, which acts as the construction lender for the project and supplies a Credit Enhancement Instrument (CEI), including a Letter of Credit ("L/C") to enhance the bonds.

In the case of 80/20 projects, approximately 15% to 25% of the total CEI must be collateralized by back-up equity from the owner/developer, with the balance of the CEI provided on a non-recourse basis. The collateralized portion of the CEI can be supported by cash, an L/C or other collateral acceptable to the bank. In addition to requiring collateral back up for the recourse portion of the CEI, the financial institution providing the enhancement (which generally also acts as construction lender) will also require that the project's owner/ developer provide a completion guaranty and a limited repayment guaranty in connection with the construction loan.

80/20 projects have generally been developed by the premier owner/developers in New York and are usually of substantial size. Major lenders will compete for construction loans for these projects, but until recently these same lenders have not been willing to provide permanent financing, which traditionally was provided by Fannie Mae and Freddie Mac.

But times are changing, and a new generation of lenders is demonstrating that they are willing and capable of providing both construction and permanent loans for these owners. Banks are now beginning to offer 10-year permanent financing--with proceeds, structures and pricing that are highly competitive with the traditional lending agencies.

Banks are also becoming amenable to underwriting permanent loans in flexible, creative ways providing benefits not available with agency financings. Construction lenders are now willing to provide permanent loans for 80/20 projects at very competitive prices. As more banks enter this market, increased competition will generate ever more favorable loans for borrower/ developers of these projects. This trend towards arranging construction and permanent financing simultaneously for 80/20 projects will result in considerable cost savings for borrowers in the years ahead.

There is no doubt that times are changing in the residential development market, as lending institutions tighten their requirements and market dynamics evolve to favor new rental projects. However, low-cost financing for well-planned and well-located projects can readily be secured for quality developers with the assistance of a financial intermediary such as ourselves who is well-versed in the complexities of 80/20 financing.

By Richard Bassuk, president

The Singer & Bassuk Organization