LIHTC Nuts Bolts Budgets and Feasibility Budgets and

+ LIHTC Nuts & Bolts Budgets and Feasibility

+ Budgets and Feasibility Operating and Development n Two key components in determining financial feasibility: n Development Budget – includes all of the costs necessary to construct a project and all of the funding sources needed to pay for these costs. n Operating Budget – reflects the income a property is expected to earn less all of the ongoing operating costs and loan payments – what is left is cash flow.

+ The Development Budget

+ Budgets and Feasibility The Development Budget n Refer to the LIHTC application provided and check the following: n Pages 18, 19 A, and 20 – Development Uses n Pages 21 and 22 – Development Sources n. A Development Budget format, as with this one, should include all of the categories of expenses necessary to construct a project. n An electronic format allows quick changes as projected costs change – and costs will change.

+ Budgets and Feasibility The Development Budget n Cost n n n n n Categories include: Acquisition - land building Construction “hard costs” n Site Work n Rehabilitation / New Construction n General Conditions, Overhead, and Profit Contingency Architect and Engineer Fees Interim Costs – construction period costs like taxes / insurance Construction and permanent financing fees and expenses Professional reports and other soft costs Syndication costs Developers fees Reserves

+ Budgets and Feasibility The Development Budget n Construction Costs – also known as “hard” costs – categories include: n n n n Off-site work Site-work Demolition / Abatement New Construction Rehabilitation General Requirements, Overhead, and Profit Bonding / Letter of Credit Appliances / FFE n Costs should get more precise over time – initially based on estimates but eventually based on a contract. n Initially expressed as $/unit or $/SF.

+ Budgets and Feasibility The Development Budget n Architect and Engineering – includes fees paid to architects and engineers for building and site design, construction supervision, and testing. n Initially may be estimated, but eventually finalized in a contract. n Often estimated as percentage of construction costs: 4%-8%.

+ Budgets and Feasibility The Development Budget n Interim Costs are non-construction costs incurred during the construction period, and include: n n n Construction interest Construction loan fees Inspection fees Taxes Insurance n Calculating construction loan interest is important as this is not a fixed expense, but varies based on the length of time a loan is outstanding and the loan balance over the loan period.

+ Budgets and Feasibility The Development Budget n Soft costs are project-related but not directly related to construction like: n n n n Legal – only legal expenses related to construction financing are basis-eligible. Accounting – includes, at least, a cost audit at the end of the project – the cost certification Consultants Tax credit reservation / application fees Syndication fees – costs of forming the ownership entity Title, survey, and recordation fees Due diligence costs – market study, appraisal, and Phase I ESA

+ Budgets and Feasibility The Development Budget n Financing fees and expenses are the costs of obtaining permanent financing including: n n Points (on permanent financing) Closing costs (for permanent financing) Credit enhancement fees Developer’s Fee is intended to compensate the developer for staff time, entrepreneurial effort, and risk – amount is limited by project circumstances in the LIHTC application.

+ Budgets and Feasibility The Development Budget n Acquisition costs reflect the cost of purchasing land on which to build a project and/or the cost of a building or buildings to be rehabilitated. n Land building costs should be separated in a budget – for tax credit and, later, tax reasons. n Contingency is an allowance intended to covers the unknown – may be required by lenders / funders.

+ Budgets and Feasibility The Development Budget n Reserves are funds set-aside in the development budget to cover specific costs or risks: n n n Lease-up expenses. Operating losses. Replacement of capital assets. Debt service payments. Rent subsidies. n Reserves will required by lenders and investors.

+ Budgets and Feasibility The Development Budget n Financing falls into different categories depending on the stage of the development process and the need that the financing fills. n Some n n n of the different types of financing include: Predevelopment – for costs associated with the planning of a construction project Construction – short-term financing for construction-period expenses. Permanent (aka Take Out Loan) – long-term financing to cover period of indebtedness of note.

+ Budgets and Feasibility The Development Budget n Different n n n types of financing (continued): Bridge – temporary or interim loan made between a shortterm (construction) and permanent financing. Also used to bridge between extended equity pay-in Gap – additional funds necessary for completion of construction or purchase of property. Fills a“gap” between equity and debt. Mini Perm – a construction loan that rolls into a short-term (usually five years or less) permanent loan

+ Budgets and Feasibility The Development Budget n Financing consists primarily of grants and loans n Grant – normally funds given by a public entity for a particular project - funds may have conditions. n Loan – money lent with conditions: n n n Amortizing – payment of debt in regular installments of principal and interest Deferred – payment made at a future date Forgivable – after a period of time or condition is met, debt is wiped clean Interest – amount or percentage of money charged for use of a principal sum of money Term – maturity or period of time from beginning to end of a payment of a loan

+ Budgets and Feasibility The Development Budget n Equity is funding provided by the owner of a project. n Equity includes: n Owner’s cash down payment. n Equity from tax credits. n Loans are usually secured to ensure that the conditions of indebtedness are met. n Security is - real or personal property pledged to help guarantee an amount of indebtedness

+ Budgets and Feasibility The Development Budget n Types n n n of security and some security terms are: First or Primary Position: Interest in property whereby the security is guaranteed by the value of the property and no other rights to property exist Subordinate: Interest in property which may take a second or third position behind first Title: Legal evidence that one has right of ownership to property Lien: Legal instrument placing an encumbrance against property for money. All liens are encumbrances, but not all encumbrances are liens. Normally, a secured interest created by a mortgage Other terms: balloon, accrued interest, grant structured as a loan, principal and interest deferral.

+ Budgets and Feasibility The Development Budget n Loan underwriting ratios: Lenders look at a projects debt capacity in two ways: Debt coverage ratio Loan to value ratio n n Debt coverage ratio: Debt coverage ratio = NOI Annual Debt Service Loan to value ratio: Provides the lender with a measure of collateral coverage - value does not equal cost. Often will vary greatly for affordable housing – value usually much less than cost. LTV a factor for both the construction and the permanent lender. Loan to value ratio = Loan amount Value

+ Budgets and Feasibility The Development Budget n Conventional Financing n Tax-Exempt Bonds (VHDA) n Taxable Bonds (VHDA) n HOME or CDBG (VDHCD and localities) n USDA n FHLB of Atlanta n Local governments n PHAs n Private sources

+ Budgets and Feasibility The Development Budget n Historic n Provide a dollar for dollar reduction in taxes due to a taxing body. Federal credit of 20% of the improvement cost of certified historic buildings – used to offset federal taxes. n Virginia credit of 25% of improvement cost – used to offset VA taxes. Reduce LIHTC basis by an amount equal to the Federal Historic credit. Available for properties listed on the Federal / State registers of historic properties. Rehabilitation guided by Secretary of Interior’s Standards. n n Tax Credits

+ The Operating Budget

+ Budgets and Feasibility The Operating Budget n Income n Sources relating to rental of low-income units – each of these sources will require adjustment for utilities and number of bedrooms: n n Housing Choice Vouchers / HAP Tax Credit rents – 50% test and 60% test Other rental subsidy (USDA RD, ACC, and so on) Sources not directly related to the rental of low-income units: n n Market rate units Commercial space Laundry Surcharges

+ Budgets and Feasibility The Operating Budget n Two income constraints: regulatory and market n The Tax Credit rent calculations described are for the maximum allowable rents. n Market conditions may make these rents unattainable or unaffordable. n Rent n n types: Gross rent includes all utilities Net rent includes no or limited utilities Gross rent minus utility allowance equals net rent Utility allowance establishes figures for out-of-pocket utilities: n n n Heating & Cooling Cooking Lights Hot water Water / Sewer

+ Budgets and Feasibility The Operating Budget n Vacancy – adjustments to potential income – there are two types of vacancy: n Normal vacancy - a function of the area market and the types of units available: n n n sensitive to management. expressed as a percentage of gross income – 7%. Lease-up vacancy - occurs at the end of construction as occupancy goes from empty to full: n Lease-up reserve or equivalent reserve of cash from development can help offset costs incurred during lease-up period.

+ Budgets and Feasibility The Operating Budget n Operating n n n Expenses Costs that arise from operation of the project, rather than from its development/construction. Expenses that are recurring and necessary for the proper functioning of the project. Typical operating expenses include: n n n n Taxes Insurance Water/Sewer Utilities Maintenance Management Other Replacement Reserves

+ Budgets and Feasibility The Operating Budget n Projecting operating appropriately expenses accurately is critical as there is little margin for error. n n n Rents are often fixed and regulated Cash flow is thin The ability to raise rents in future years is limited

+ Budgets and Feasibility The Operating Budget n Real Estate Taxes n Tax paid to local government based on value of property n Initial valuation can be pulled from an assessment, if available, but an appraisal will provide market value. n Insurance n n n An insurance agent can provide an estimate for insurance – insurance may include property, liability, workmen’s compensation, fidelity bonding, health, and auto. May be able to estimate based on other projects. Ensure coverages are consistent with those required by your lenders and partners. s

+ Budgets and Feasibility The Operating Budget n Water n Can be estimated by the locality or a utility company engineer based on typical usage for comparable facilities. n Good design can reduce usage. n Rates vary greatly from community to community. n Other n n n / Sewer: utilities – may include the following: Electricity (not paid directly by residents – for common areas) Heat Cooking gas Electricity Trash

+ Budgets and Feasibility The Operating Budget n Maintenance – day-to-day items like: n Redecorating – cleaning and painting when tenants move out n Grounds maintenance and supplies Snow removal General repairs: n n Leaky faucets n Broken windows n Water heaters Clarify amounts for salaries and staffing, materials, and for outside contracts.

+ Budgets and Feasibility The Operating Budget n Management: n Management fee paid to firm responsible for overseeing property management: n n Generally paid as percentage of collections – 5% to 10% Varies based on project size, complexity, and unit rents Does not include cost of site manager or maintenance people – separate salary line items. Does not include cost of operating on-site office or manager’s unit. n Other operating expenses: n Accounting / legal n Inspections / Compliance n Ground rent

+ Budgets and Feasibility The Operating Budget n Replacement n Reserve: Funds set aside to replace major capital items: n n n Roofs Water heaters Appliances Lot paving Generally $300 per unit per year (different for USDA RD)

+ Budgets and Feasibility The Operating Budget n Net Operating Income - cash available to pay all stakeholders (lenders get paid first – investors and owners last) - Calculated as follows: = = n Cash n n Gross Income Vacancy Effective Gross Income Expenses Net Operating Income Flow: Cash flow = NOI less debt service payments to lenders. This is the owner’s return on their investment in real estate.

+ Budgets and Feasibility The Operating Budget n Proforma n n Tips Real estate is a long-term investment. The pro forma illustrates potential benefits five to ten years into the future. Increase income and expenses annually to account for inflation n Income 3% n Expenses 4%