(Bloomberg) — High-yield municipal bonds issued to finance housing for police officers, teachers and nurses in California are showing signs of strain.
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Mira Vista Hills Apartments, a 280-unit rental complex in the Bay Area city of Antioch, disclosed in a Friday filing that it didn’t meet a debt-service coverage ratio required by investors. At least four other complexes, known as “workforce housing,” have drawn on reserves since the start of 2023 to help pay their debt, according to securities filings.
About $8 billion to $10 billion of munis — all in a speculative category without a credit rating — have been issued in California to convert market-rate apartments into affordable housing for middle-income households, according to research firm Municipal Market Analytics. Seven of the nation’s 10 priciest housing markets are in the state, according to the National Association of Realtors.
Local agencies borrowed as much as 120% of the purchase price to fund capital expenses, fill reserves and pay deal fees, said Lisa Washburn, a managing director at MMA. In addition, the obligations assumed high occupancy rates to pay debt service and fees to property managers, project administrators and government agencies that issue the debt.
One reason they were able to load so much debt on these properties is that many of the workforce-housing bonds were sold between 2019 and 2022, when interest rates were at historic lows, especially after the pandemic struck. Local authorities have brought a few dozen of such deals to market.
“It’s a highly levered property that’s paying out a lot of fees, so it needs to generate enough revenue to cover all of that,” Washburn said.
Mira Vista, built in 1986, was 88.5% occupied as of June, according to a bond filing, down from 98.2% in June 2022. The offering document for $94 million of bonds issued in 2021 projected 95% occupancy this year and thereafter. Rising interest rates have also dampened prices for commercial real estate projects.
Mira Vista munis with a 4% coupon and maturing in 2056 last traded Aug. 6 at 63.5 cents on the dollar, down from above 70 cents in mid-2023.
Scott Carper, a program administrator for the California Community Housing Agency, which issued the Mira Vista bonds, didn’t respond to an emailed request for comment. A spokesman for Catalyst Housing Group, Mira Vista’s administrator, said the complex, like others in California, faced “unprecedented” financial challenges after the Covid-19 pandemic. Rent collections declined, while inflation raised expenses.
“Catalyst remains committed to partnering with ownership, management, residents, and the City of Antioch to ensure that Mira Vista Hills continues to provide high quality affordable housing serving Contra Costa County’s essential workforce,” Catalyst spokesperson Stefan Friedman wrote in an email.
A Morgan Stanley analysis of 20 California workforce-housing deals found the average occupancy for a workforce housing project was 95% in June and average net operating income covered 93% to 94% of that month’s debt service. Expenses have also exceeded projections.
National Shortage
With a national housing shortage, the need for affordable residences is acute. However, the workforce-housing model remains untested over a full business cycle, Mark Schmidt, a Morgan Stanley municipal strategist, said in an email.
The market for city and state debt has financed other efforts to provide affordable housing. Colleges, including the University of Vermont, and ski towns in Colorado such as Telluride have issued bonds to help house staff.
“As performance in California remains mixed, we have become more skeptical that there is a workforce housing 2.0 waiting in the wings,” said Schmidt.
Chad Farrington, co-head of municipal bond strategy at DWS Group, said workforce-housing deals shouldn’t be painted with a broad brush. The apartments’ condition, local rental markets and levels of reserves funded by the bonds varied, he said.
“We were a little more picky on what we purchased,” he said.
In these deals, a local bond-issuing agency, such as the California Community Housing Agency, enters into an agreement with a municipality where an apartment complex targeted for conversion to middle-income housing is located. The agency purchases the apartment with proceeds from the bond sale, while the municipality agrees agrees to forgo property-tax revenue it would have received from the complex.
The tax break subsidizes rents to make units more affordable for households earning a range of 80% to 120% of the area’s median income.
Unlike traditional municipal bonds that pay off debt over time, workforce-housing deals don’t promise principal repayment on a set schedule, MMA’s Washburn said. Excess income generated by the projects can be used to pay down principal, but bondholders are relying on the sale of the complexes at an appreciated value for repayment, she said.
Many projects wouldn’t meet debt-service coverage requirements without bond-funded reserves, she said. “They issued them in the most aggressive way possible.”
–With assistance from Boris Korby.
(Adds comment from apartment complex administrator in 10th paragraph)
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