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WELCOME to Chicago!. Lender Underwriter Training: HUD Lean Section 232 Program Day 1: January 26, 2010. Introduction and Briefing on the FHA Commissioner’s Recent Meeting in Seattle. Chicago: What We Hope to Accomplish-1. Major Issues: Risk Mitigation Valuation issues
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WELCOME to Chicago! Lender Underwriter Training: HUD Lean Section 232 Program Day 1: January 26, 2010
Introduction and Briefing on theFHA Commissioner’s Recent Meeting in Seattle
Chicago: What We Hope to Accomplish-1 • Major Issues: • Risk Mitigation • Valuation issues • Enhanced Underwriting in Economic Problem Areas • Economic Useful Life Guidance • Market Studies/Economic Analysis • Asset Management • Underwriting Procedures • New Submission Procedures • Underwriting Deficiencies • Lender Monitoring
Chicago: What we hope to Accomplish-2 • Technical Guidance • Professional Liability Insurance • Accounts Receivable • Master Lease Requirements • New Construction Submissions • Portfolio Transactions • Closings • A(7)’s • Asset Management
232 LEAN Program Update (1/22/10) FY 2009 (4 mo)FY2010 • Applications 271 164 • Closings 88 65 • Commitments issued 132 54 • Commitments rejected 2 8 • Mkt Acpt/Pre App accepted 32 10 • Mkt Acpt/Pre App rejected 5 16 • Applications in Queue 60 139 • Assigned to Underwriters 48 81 • Ave time in queue (1/22/2010) 100 days; A7’s 28 days • Staffing: 53 Staff on board; Currently, no additional staff allocated
232 LEAN Program Update-2 • Processing Improvements (from December 2009 Kaizen) • OGC review of Closing process • Green Lane for 223 F’s • Separate Lane for A7’s • PreApp/market acceptance letter request process terminated and under review
December 14, 2009, Seattle Briefing for FHA Commissioner David Stevens and FHA Risk Manager Bob Ryan • Briefed Mr. Stevens, Mr. Ryan, Chris Tawa (MF), John Daly and Damon Smith(OGC) and others on LEAN Improvements for Section 232 Program. • OIHCF Senior Staff, UW and AM AE’s and Lenders and valuation appraisers participated. • Briefing included Lean Concepts, 232 Underwriting Process and Improvements, Risk Profile of Sec. 232 Portfolio, Monitoring and Risk Mitigation Improvements.
Seattle Briefing Takeaways: • FHA HQ leadership group understood and embraced LEAN concept. • OIHCF and Lenders made a convincing case for actual improvement in risk management under LEAN program, both underwriting and loan servicing. • OIHCF Senior staff made a strong case for need for additional staff/contract resources. • OGC is exploring ways to serve the program more efficiently.
Seattle Briefing : Results • Commissioner and senior staff are more knowledgeable about OIHCF programs and more open to proposals to meet resource needs. • Senior Staff understands that while there are risks inherent in these programs, OIHCF Staff and Lenders are aware of them and are mitigating the risks as effectively as possible. • This session in Chicago should enable OIHCF and Lenders to go the next step in dealing with both operational and market risks. • Momentum is gathering for application of LEAN processing in other areas of Office of Housing.
Appraisal Valuation Issues, Concerns, Experiences • Morning Appraisal Training Highlights • New Appraisal SOW • New Market Study SOW • Remaining Economic Life • Anatomy of a Sale • Geographic Markets • Appraisal by Section
Using Hypothetical Estimates • Under the Lean 223f program, it is generally not appropriate to assume stabilized operations if the property is in reality not at stabilized operations. • Appraisal Statement of Work and Lender Narrative Template have been updated accordingly.
Using Un-depreciated Replacement Costs as a Benchmark Risk Review
Un-Depreciated Replacement Cost vs. Value Conclusion Replacement Cost New (Equivalent Utility) • Direct Cost – Buildings • Direct Cost - Site Improvements • Indirect Costs • Land Value • Furniture, Fixtures & Equip. (FF&E)
Example • 4 year old, 45-unit Assisted Living Facility • Three Approaches to Value were Developed • Estimated Value: $6,100,000 Correlation of Value • Cost Approach $4,750,000 • Sales Comparison Approach $6,075,000 • Income Capitalization Approach $6,100,000
Cost Approach Summary • Direct Cost – Buildings $3,435,873 • Direct Cost - Site Improvements $290,000 • Indirect Costs $972,822 • RCN of the Improvements: $4,698,695 • Depreciation ($254,841) • Subtotal $4,443,854 • Land Value $130,000 • Furniture, Fixtures & Equipment (FF&E) $180,000 • Indicated Value – Replacement Cost $4,753,854 • Rounded $4,750,000
Un-Depreciated Replacement Cost (RCN) • Direct Cost – Buildings $3,435,873 • Direct Cost - Site Improvements $290,000 • Indirect Costs $972,822 • RCN of the Improvements: $4,698,695 • Depreciation • Land Value $130,000 • Furniture, Fixtures & Equipment (FF&E) $180,000 • Replacement Cost New $5,008,695
Reconsider Income & Comparison Approaches Against RCN of $5,009,000 • Sales Comparison Approach 45 Units x $135,000/Unit = $6,075,000 • Income Approach NOI $550,000 Capitalization Rate 9.00% Indicated Value $6,111,111 Rounded $6,100,000
Questions are Raised • Is the RCN correct? • If the RCN is reasonable and indicates that • the cost to build NEW is significantly less than the estimated Value….. • Is there a problem with the Sales Comps or Adjustments? • …Cap Rate too Low? • Rents too high? • Etc., etc…. a small change can make a big difference Should the conclusion be revised?
Definitions • Economic Life: The period over which improvement to real property contributes to the property value1. • Remaining Economic Life: The estimated period during which improvements will continue to represent the highest and best use of the property; an estimate of the number of years remaining in the economic life of the structure or structural components as of the date of the appraisal; used in age-life method of estimating depreciation2. ____________ 1 The Dictionary of Real Estate Appraisal, 5th Edition 2 ibid
More Definitions • Effective Age: The age of property that is based on the amount of observed deterioration and obsolescence it has sustained, which may be different from its chronological age3. • Useful Life: The period of time over which a structure or a component of a property may reasonably be expected to perform the function for which it was designed4. ___________ 3 ibid 4 ibid
Life – Age = Remaining Economic Life (REL) • The economic life may exceed the useful life since the building may cease to provide utility for the intended original use, but it may be economically feasible to renovate and/or convert the building to a different use. Economic Life Less Effective Age Approximates Remaining Economic Life • Of course, the remaining economic life can be extended through timely and strategic capital replacements and improvements that reduce the effective age.
SNF Life Expectancy According to Marshall Valuation Service, the life expectancies for newly erected nursing facilities (“convalescent hospitals”) are as follows. Economic Life Expectancy for Nursing Facilities5 5 Marshall Valuation Service, Section 97, Page 8
ALF Life Expectancy According to Marshall Valuation Service, the life expectancies for newly erected assisted living facilities are as follows. Economic Life Expectancy for Assisted Living Facilities6 6Marshall Valuation Service, Section 97, Page 5
Marshall Valuation Service suggests that the economic life will likely be extended based on good maintenance and the replacement of short-lived building components, which is proven to be true. • Many facilities that continue to operate, currently exceed the age of the respective property types in the Marshall Valuation Service table, and have reasonably good prospects for remaining in use as a nursing facility indefinitely.
Expected Economic Life Considers • Levels of physical deterioration – maintenance, replacements and renovations • Functional obsolescence • External obsolescence More buildings become obsolete before they are physically spent.
Qualitative Analysis -- Functional - Resident Room Bed Mix - SNF
Qualitative analysis Functional – Patient Room Toilets and Baths - SNF
Patient Room Toilet/Shower Room Which One Will The Market Select?
Therapy Areas Functional Obsolescence Impacting REL • Small areas for physical and occupational therapy prove to be clinical and marketing disadvantages • Functional deficiency may be curable or incurable. • Many nursing facilities have attempted to cure the deficiency by decommissioning several patient rooms or other functional space and renovated that area for therapy services. • Best to have purpose-designed and built therapy areas
Purpose-built vs. Adapted Therapy AreasWhich One Will The Market Select?
Eight-foot Corridor Standard • Corridors less than 8’0” are no longer allowed in new construction. Rooms along narrow corridor may eventually be delicensed.
Other Functional Issues • Absence of fire-protection sprinklers throughout the building is a functional deficiency that should be curable in most buildings. Federal law now requires that all nursing homes become fully sprinklered by 2013, or they lose their Medicare and Medicaid certification. • Other life-safety features – emergency electrical generation, fire alarms, secured doors • Lack of common areas and program space for patient, staff and visitors • Separated laundry and drying rooms • Well ventilated and cooled building
External Obsolescence And Economic Issues • Changes in supply and demand • Changing highest and best use – land value • Medicaid reimbursement limits • Life stage and future of the subject neighborhood
Changes In Supply And Demand • Changes in supply and demand • Baby boomers will cause demand surges, extended useful life • Certificate of need (CON) or other barriers may regulate and extend life, but only if state history is demonstrated • Absence of CON or loose CON practices encourages more competition, older facilities have less regulatory protection • Assisted living competition/alternatives – unsaturated assisted living markets could see further demand, siphoning off low-acuity SNF demand • Will other competition be replace or substantially renovated, and thus re-arranging market positioning? • How will the subject facility withstand these changes in relationship or in context to the competitive market long term?
Changing Highest And Best Use – Land Value • When will the building be worth more dead than alive? • Older SNF or ALF buildings on expensive land, where highest and best use has changed since the facility opened, may no longer represent highest and best use. • A 45-year-old , single-story SNF with a 3:1 land-to-building ratio on $75/SF land in Los Angeles or Orange County, California probably has a highest and best use issue. Collateral value may be excellent, but the remaining economic life is probably short lived.
Impact Of Medicaid Reimbursement On Remaining Economic Life Medicaid Capital Cliff • Capital reimbursement in many states is tied to original asset costs, and interest and depreciation are based on those costs. Once the interest and depreciation are amortized, those assets receive no further reimbursement. • Appraiser must address these risks in states with capital cliffs. • No national publications adequately address this issue – the appraiser will need to verify this issue with state experts or state reimbursement staff members.
An Argument For Extended Life • Economic life may be extended by bed shortages created by tight certificate of need policies • Economic life may be extended by inadequate reimbursements for new buildings that undermine the economic feasibility of new construction. • Baby Boomer demand surge, coupled with the prospects that the U.S. society may be unable to maintain the support currently afforded to long-term care may necessitate the extension of the usefulness of older nursing facilities.
Neighborhood Life Cycle And Stage • The life of any building rises and falls on the level of economic health of a neighborhood • A property developed a decade or two ahead of the arrival of most of the residential, commercial and institutional was developed in the market could experience an extended life. • Properties in deteriorating urban, inner-ring suburbs and declining rural communities have and/or will continue to experience declining census, quality mix and staff recruitment.
Ownership-specific Issues • Management and financial strength of the ownership can affect the useful life of similar nursing facilities differently. • Appraisers are unable to make owner-specific assessments regarding their management and financial conditions. • While HUD cap-ex reserve requirements might require higher maintenance, the financing might represent an obstacle and incentive for future, major renovations.
