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Holly Knight 202-699-1998 holly@thebennettgrp

Holly Knight 202-699-1998 holly@thebennettgrp.net. Justin Brooks 336- 473-2515 justin@edgewatertexas.com. Hilton Head, SC August 26. 2014. Operating Subsidy Funding. 103%. 89.20 %. 82 %. 94.968%. 100%. 88.42%. Capital Fund Capital Funding Trends. Typical Expense Trends.

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Holly Knight 202-699-1998 holly@thebennettgrp

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  1. Holly Knight 202-699-1998 holly@thebennettgrp.net Justin Brooks 336- 473-2515 justin@edgewatertexas.com Hilton Head, SC August 26. 2014

  2. Operating Subsidy Funding • 103% • 89.20% • 82% • 94.968% • 100% • 88.42%

  3. Capital Fund Capital Funding Trends

  4. Typical Expense Trends

  5. Backlog of Capital Needs • Capital repair needs of $23,365 per unit • Needs at your PHA • Roof - $8,000 • 3 Bedroom 504 Compliance $25-35,000 • ADA Site compliance $10-15,000 • HVAC replacement -$4,000 • Water Heater - $350 • Site Soil Erosion- $20,000 • Appliances –Range $450 / Fridge $550

  6. Challenge and tools • CHALLENGE: • The Public Housing program has remained underfunded for more than 30 years, leading to ~$26 billion capital backlog • The nation’s Public Housing stock is struggling, and has significant capital repair needs • NEW TOOL: • Conversion to the project-based Section 8 programs provides an opportunity to invest billions into the public housing stock • The Rental Assistance Demonstration (RAD) allows PHAs to undertake this conversion for some units • HUD has achieved its goal of standing up this new tool, attracting many PHAs to participate • Only 60,000 units are currently able to convert; lifting cap will make the RAD tool available to all PHAs who want to use it. Lift the RAD Cap Coalition: website with resources

  7. What is the future? • Losing affordable housing • $26 Billion capital investment need • Unpredictable and insufficient funds • Limited investments in public housing • Aging housing stock: average PH is 43 years old • Marketability and curb appeal • Rules and regulations increasing • Under performing PHAs and consolidation • Funding trends decreasing • HUDs program consolidation goals

  8. PH Options

  9. Goal of RAD • In order to preserve the public housing stock convert its assistance to the project-based Section 8 platform, which will: • Stabilize funding • Create access to private capital • Streamline HUD programs • Enhance housing options for residents • In order to convert the entire public housing stock, HUD continues to ask Congress for authority and for funds.

  10. Percentage of Current PH Units by HUD Region that have Applied for RAD 15% 6% 7% 3% 7% 18% 16% 21% 22% 21% Note: This data reflects the percentage of PH units in each HUD region that have applied for RAD; note that units are considered public housing until the RAD closing is complete.

  11. Whole Portfolio Conversions • 76% of the PHAs with CHAP awards have proposed to convert their entire stock, including • 52 small PHA (<250 units) • 29 medium PHA (250-1,250 units) • 26 large PHAs (>1,250 units)

  12. RAD Cap Waitlist • Secretary Donovan letter 2/20 confirms HUD will review the ~ 685 applications above the 60,000 unit cap • Instruction from Secretary: • Review applications and prepare conditional approvals. • Next two weeks conditional CHAPs to be issued • When cap is lifted, HUD will issue CHAPs to all approved applications and process in order of the waiting list. • HUD will use the RAD Notice for these projects but will use FY14 funding levels to calculate the rents.

  13. ​ Lift the RAD Cap Coalition Agroup of public housing authorities, developers, lenders, businesses and other stakeholders across the country that have an interest in preserving affordable housing.  Visit the coalition website at: http://www.bennettgroupconsulting.com/lift-the-rad-cap-coalition Sign up to join the coalition and access talking points, FAQs, A Sample letter to Congress, op-ed and letter to the editor TEMPLATES, THE List of congressional targets AND MORE.

  14. RAD Update • HUD has asked for RAD cap to be lifted in 2015 budget RAD Application by

  15. RAD Application update

  16. Application Overall Sources of Funding

  17. RAD Application tax credits

  18. Why RAD • Builds on a more stable funding platform • Lock in funding • Better than Capital Fund Finance, Leveraged Op Sub, or EPC • Leverage private capital to address physical needs and preserve your units • Leverage 4% LIHTC get 30% project equity • Leverage 9% LIHTC get 60+% project equity • Leverage developer fees, seller take back finance, ground lease • Apply for grants HOME, Federal Home Loan Bank • Provides a great deal of regulatory and reporting relief • Saves in reporting to HUD, policies, and oversight more with board and PHA

  19. Why RAD • Procurement with developer partner is simplified • Expenses • Gives real estate opportunities • Can move HAP contract as needed • Can move out of flood zones/hazard zones/undesirable areas • Can use non federal funds to purchase properties or land • Benefits of partnering for expiring LIHTC, Home projects, HUD Multifamily developments • Best and highest use of assets • Feasibility, Marketability, and Sustainability

  20. RAD flexibility • Transfer assistance from unworkable units prior to conversion • Market accommodations in meeting 1-for-1 preservation (e.g., convert efficiencies to 1 bdrms; long-term vacant units) • Combine RAD & agency PBVs or SAC TPVs>PBVs • Flexibility to reduce densities, replace housing off-site, produce mixed income communities • Allows PHA to undertake renovations immediately or after conversion, as warranted • Demolition/New Construction allowed • Ability to “bundle” project applications for flexibility with initial contract rents

  21. Show the PHA the Money • • The RAD options: • • Modest rehab with no debt • • Modest rehab with debt only • • Moderate rehab with debt and 4% LIHTCs • • Major rehab or replacement with debt and 9% LIHTCs • • These are funding sources that are not conveniently • available to small PHAs • • A conversion of all LIPH units eliminates the HUD • requirements for: • • Procurement • • Annual and Five‐ Year Plans • • PHAS • • REAC (if…PBV) • • You Get to Keep the Money – no offsets, developer fees, seller take back financing, cash flow options

  22. PH Development Resources Note: Not listed PHA PBV at FMR, PHA Cost Center Funds, Admin Fees

  23. What can RAD do now? • 15-20 year, renewable contracts with use agreement • Predictable initial contract rent setting; annual operating cost adjustments for inflation (OCAF) • Established replacement and operating reserves; standard industry underwriting requirements • RAD HAP funding begins at construction closing • No limitations on use of project cash flow • PHA ownership/control similar to LIHTC practices • Long-term affordability ensured

  24. RAD Similar and Different to mixed finance • Similarities: • Real Estate Transaction same • Rent/Income • Reporting to 3rd parties • Physical needs assessment is a driver • Differences: • PHAs want to self manage • RAD PCNA tool • Complicated HUD regulations • Lower Income to project • Expenses higher may need to be adjusted • Type of 3rd party reporting HUD versus Investor • Benefits of PHA Partner • Invested in community • Familiar with social services • Knows the community partners • Has managed PH inventory on shoestring budget • Familiar with compliance

  25. RAD Transaction Concerns • Timing • Tax credit compliance versus HUD compliance • Rent calculation and income qualification • Boards and their role changes • Limited knowledge of mixed finance • Management • Ownership changes impact pilot and taxes • Investors and HFA unfamiliar with PHAs • RAD rents are low • HUD conversion requirements • PBV/PBRA • PHA Plan • Site and neighborhood • Elderly designation • Environmental • Relocation (URA) • Affirmatively Furthering Fair Housing

  26. Mixed Finance/Loans and tax credits • Traditional Public Housing follows complicated mixed finance rules • ACC formula for Capital Fund is based on current building type and DOFA • Can not move your ACC like a HAP • Must go through demo/dispo application with SAC to change ownership • Can use FHA and traditional public housing but difficult • Can leverage 4% and 9% tax credits • Can leverage debt but ACC amendment may not agree with lender requirements

  27. RAD financing • Availability of FHA 223(f) & 221(d)(3) insurance, with priority processing • Access to FHA LIHTC Pilot processing • Ability to tap 9% & 4% LIHTCs, including “short bond” structures • Ability to support transaction with public housing reserves and capital funds, including Replacement Housing Factor funds • Access to HOME and CDBG for development budgets • Available sales proceeds can support other affordable housing purposes

  28. Overview • Private Finance Paradigm: The Affordable Housing Development as a Stand-alone Small Business • Calculating Debt: Rental Income, Net Operating Income, and an Estimate of Debt • LIHTC Program • Calculating Equity • Organizational Structure: Roles and Responsibilities • Risk and Reward

  29. Private Finance Paradigm Affordable Housing Financed Like a Small Business • A stand-alone entity owns and operates a development • Estimates of income based on market potential of the product (quality, location, and appeal), use restrictions, and/or long-term subsidies • Operating expenses based on contemporary professional property management standards without below-market participation from affiliated interests • Staffing budgets • Back-office expenses covered by management fee • Ongoing replacement reserves deposits based on underwriting standards & project’s particular needs

  30. Private Finance Paradigm Where does the money come from? • Equity • Must-pay debt (predominantly private sources) • Soft debt (public and private sources) Equity expects a risk premium compared to debt

  31. Private Finance Paradigm • Equity provider is in risky position, thus requiring some control over operating decisions • No lien • Paid only from net cash flow after payment of all other obligations • Theoretically unlimited return • Debt provider is in a less risky position, thus lower return compared to equity • Lien on property • Loan/Value Ratio • Lower return compared to equity

  32. Private Finance Paradigm How is equity different for Affordable Rental Housing? • Standard private equity expects: • Cash flow after payment of all project obligations, • cash from sales proceeds, and • perhaps tax benefits • Tax credit equity provider expects: • Tax benefits e.g. LIHTC, Historic Tax Credit, and • “paper losses” e.g. depreciation • Note that cash flow from operations and sale are secondary considerations

  33. Private Finance Paradigm How much debt can my project support? • Use Estimates of income and expenses to calculate Net Operating Income (“NOI”) • Divide NOI by a cushion (Debt Coverage Ratio) • Use result to determine loan payment amount • Loan payment supports a certain amount of debt

  34. Calculating Debt Net Operating Income (NOI) is the engine supporting debt • NOI = gross income – operating expenses - reserves • Debt Coverage Ratio (DCR) is a factor intended to provide cushion in case NOI is lower than expected • Supportable debt = NOI / DCR Interventions for affordability impact NOI • Restrictions have the effect of reducing NOI • Subsidies often increase NOI compared to a market scenario Keeping housing affordable often means capping rents, which lowers NOI and supportable debt

  35. Calculating Debt • Example: • 50-unit development with rent of $600 per unit per month • 7% vacancy • Operating expenses of $4500 per unit per year • Required replacement reserve deposit of $350 per unit per year • Assume 1.20 debt coverage ratio • Assume first mortgage interest rate of 6.0% with 30 year amortization

  36. Calculating Debt • Gross Income: • $600 x 50 units x 12 months=$360,000 • Vacancy of 7%=$25,200 • Gross income=$334,800 • Expenses and Replacement Reserves: • Operating expenses=$4500 x 50 units=$225,000 • Replacement reserve=$17,500 • Net Operating Income • Gross income – expenses and operating reserves • NOI=$334,800-$225,000-$17,500=$92,300

  37. Calculating Debt • Net Operating Income=$92,300 • Assuming 1.20 Debt Coverage Ratio (“DCR”), allowable debt service shall be $76,917, or $6,410 per month. • Assuming a 30-year mortgage with a fixed rate of 6.0%, the project can support a first mortgage of $1,069,000 • This is equivalent to $21,400 per unit

  38. The Tax Credit Program • A housing subsidy program for low-income rental housing • Created within Section 42 of the Internal Revenue Code • A federal income tax credit that is allocated by each state’s housing finance agency • Each state receives an amount of credits annually in tax credits to allocate to projects, $2.15 per capita in 2011

  39. Tax Credit Program • Rental units with tenants earning no more than 60% of area median income • Investors earn dollar-for-dollar credits against their federal tax liability • Investors also get tax benefits from losses • Generally, tax credits are received over the first 10 years of operation • Some tax credits are recaptured by the IRS if the project does not comply for 15 years

  40. Tax Credit Program • Threshold Elections – Who can live there? 40/60 election 20/50 election All tax credit units must be within election parameters • Rent Restricted – How much can tenants pay?Rents and utilities – limited to 30% of threshold income Allowable rent based on size of unit

  41. Tax Credit • “9%” New Construction/ Rehab Credit - the standard kind of tax credit • “4%” New Construction/ Rehab Credit - used when project is financed by tax-exempt bonds • “4%” Acquisition Credit – may be applied to building acquisition costs with rehab project under certain circumstances (Substantial rehab, 10-year rule)

  42. Tax Credit Equity Overview: • Credits generated on the basis of “Hard Costs” (construction, rehab, building acquisition, and construction-related indirect costs) attributable to qualified low-income rental use • Such “Hard Costs” are also known as “Eligible Basis” • Result is known as the “Qualified Basis” • Qualified Basis is multiplied by the Tax Credit Percentage (commonly known as the 9% or 4% rates, but actually fluctuate) • Result is annual Tax Credit amount • Tax Credit amount is generated each year over a 10-Year Period

  43. TC Equity Tax Credit Equity = 10 years’ of tax credits multiplied by “Price” “Price” is determined by informal marketing of an individual project to investors and syndicators. It is customarily expressed in cents per dollar of credit generated over the 10-year period. Tax Credit and Equity Calculation Eligible Basis X Applicable Fraction X Basis Boost (if applicable) = Qualified Basis

  44. Tax Credit Annual Tax Credits X 10 (Years) = Total Tax Credits Total Tax Credits X Price (Cents per dollar) = Equity

  45. Organizational Structure Key Characteristics of Organizational Structure: • Project owned by new, single-purpose, for-profit entity • New owner is 0.01% owned by a general partner (GP), 99.99% owned by an investor limited partner (LP) • Sponsor controls or owns GP 0.01% interest, but controls and operates the entity • Passive limited partner invests equity in return for 99.99% ownership • Tax benefits run 0.01% to GP, 99.99% to LP

  46. Risk and Reward LP Underwriting Focuses for mitigating risk: • Experience, track record of development team: • Developer • General contractor • Property manager • Market analysis – are rents for the proposed product supportable in the market? • Loss run analysis: for subsidized projects, examining the financial results of lost operating subsidy • Development budget and construction contingency are sufficient to build the project • Operating budget and operating reserves support market-oriented operations • Guarantees • Asset Management oversight

  47. Risk and Reward Benefits from GP’s perspective: • Developer fee payable from sources and uses • Possible sales proceeds if purchased from related party • Future cash flow • Ability to purchase property at end of TC compliance period • Benefits to PHAs, in particular • Ability to preserve existing project • Potential to maintain management portfolio and earn property management fees • Ongoing control of property through GP, with limitations

  48. Risk and Reward Risk from GP’s perspective: • LP has ability to remove GP • Limits on control of property • Guarantees to financial partners • Construction completion • Credit adjusters • Compliance • Operating deficit

  49. Risk and Reward GP mitigates risk by: • Assembling a strong team • Proper setting of rents • Use of project-based operating subsidy • Design, construction, and management quality that is well-suited for intended population • Solid budgeting • Operating reserves, construction contingency, fixed price contract and payment and performance bond from contractor • Support from co-developer • Third party property management or third party compliance assistance

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