Stress tests have become increasingly important for investors and syndicators as they evaluate affordable housing deals.
Before committing capital, these finance partners analyze how well projects can withstand rising operating costs, economic volatility, and other potential disruptions.
Affordable Housing Finance recently asked low-income housing tax credit (LIHTC) leaders how stress tests have changed in recent years.
“Stress tests have evolved and will continue to evolve with the changing market conditions,” says Matthew Reilein, president and CEO of the National Equity Fund (NEF). “With the recent fluctuations to tariffs, NEF has added a tariff stress analysis for all projects through which we review how a project’s construction liquidity and guarantor capacity could manage cost increases. Additionally, NEF continues to focus on operating expenses and stressing increases to expenses at a higher rate than the standard underwriting of 3%. NEF’s operating expense stress has evolved over time in conjunction with the historical operating expense trends of our portfolio. Given that actual operating expenses have a significant impact on both NEF’s portfolio and developers’ portfolios, the analysis of operating expenses is critical during underwriting.”
Others agree that the tests have changed to better analyze today’s risks.
“Historically, our underwriting sensitivities were largely focused on potential rent reductions and evaluating the downside of lower rent collections,” says Jason Gershwin, managing director at R4 Capital. “Now, in the period of continued inflationary pressure on expenses and some oversaturation of certain geographic markets, our stress tests are more primarily focused on analyzing the downside risk of higher expenses or greater vacancy factors. Currently, our most important stress tests are performed on operating expenses and what impacts higher OpEx will have on a property’s debt-service coverage ratio.”
Today’s approach incorporates a broader and more rigorous set of downside scenarios, from construction cost overruns and schedule delays to elevated operating expenses, insurance spikes, and constrained revenue assumptions, which are necessary to evaluate whether a deal can withstand real world volatility, adds Troy Pohlkamp, chief credit officer at Red Stone Equity Partners.
“Among these, the most important remains the construction cost stress test, which models materially higher project costs and often serves as the clearest indicator of whether a transaction has the resilience and structural protections needed to be completed without requiring additional sources,” Pohlkamp says.
Construction timelines and potential delays, real estate-owned schedules, insurance costs, and guarantor positions are other areas that syndicators are taking a close look at when reviewing deals.
PSH Projects Under Review
Permanent supportive housing (PSH) deals are facing particularly close scrutiny, according to several syndicators.
“Pathways to closing PSH investments have become increasingly narrow, and placement options remain limited,” says Josh Ghena, president of Cinnaire Equity Partners, noting that new guidance from the Affordable Housing Investors Council has provided helpful framework for these projects.
“Despite these challenges, Cinnaire believes PSH is an essential component of the affordable housing ecosystem, and we remain committed to finding viable ways to bring this critical housing to the communities we serve,” Ghena says.
Permanent supportive housing developments often rely on rental assistance or other government funding to pencil out. As a result, that could leave some deals vulnerable to federal cuts.
“Because of this, there’s been higher scrutiny on the operator to ensure resources are financially viable throughout the entire compliance period,” says Catherine Cawthon, president and CEO of OCCH. “Due to federal uncertainty, there have been more reviews associated with Section 8 and other government-funded rental programs.”
Steve Kropf, president and CEO of Raymond James Affordable Housing, also notes that investors continue to focus on stress-testing for the loss of rental assistance.
“In most cases, the result of a stress test for loss of rental assistance or service funding will indicate an operating shortfall,” he says. “We think that the mathematical result of a stress test is only one data point. The developer’s experience with the respective funding program or the service provider’s track record are important factors to put the stressed results into perspective. Further, the state agency’s flexibility related to a loss of rental assistance or service revenue is a key factor is evaluating the risk.”
Despite shifting priorities in stress-testing, the stability of the sponsor remains a constant in all projects.
“The most important focus for deals has been the strength and health of the operator, sponsor, and guarantor of the property,” says Cynthia Lacasse, executive vice president and chief program officer at Evernorth.