Housing Development Finance Webinar Slides...• Using the LTV, the maximum loan amount is $941,176...

U.S. Department of Housing and Urban Development

Housing Development Finance Concepts

Developed and Conducted by The National Development Council

as part of a HUD Neighborhood Stabilization Program

Capacity Building Initiative

Community Planning and Development

Version: March 23, 2011

Goals of this Webinar •  Get ready for the National Development Council’s

classroom courses •  HD410-Home Ownership Finance (4 days) •  HD420-Rental Housing Development Finance (5 days)

•  Become familiar with housing finance terms •  Learn basic tools and techniques of housing

development finance •  Practice algebraic equations to become friendly

with numbers

2 Community Planning and Development

Why Develop Affordable Housing? •  To create decent, safe, sanitary housing that is

affordable to low and moderate-income people •  To improve communities by attracting private

investment to distressed and underdeveloped areas

•  To establish a market with a mix of incomes •  Two types of housing

•  Rental •  Ownership


Affordable Rental Housing: The Development Process •  Getting from an affordable rental housing project

concept to a completed and operating development requires many different players and a series of steps

•  Players •  Developer •  Lender •  Investor •  Appraiser •  Architect/engineer •  Building contractor •  Market analyst •  Property manager


Steps in the Development Process •  Creating the development concept •  Testing the market •  Evaluating site and design constraints and

estimating the cost of construction •  Developing the pro forma income and expense

schedule •  Preparing the initial sources and uses of funds


Steps in the Development Process (cont.)

•  Obtaining permanent financing •  Finding a construction lender •  Negotiating the tri-party agreement •  Constructing the project •  Managing the operating property •  Disposing of the property


The Development Budget •  How much will the project cost to build? •  Development budget or uses of funds: Itemizes

all construction and capital costs of completing a project •  Land •  Site improvements •  Construction •  Contingency •  Architect and engineering fees •  Construction interest •  Reserves •  Developer fee


The Development Budget (cont.)

•  Construction Cost Exercise •  The construction cost may be expressed as a per unit

cost or a per square foot cost •  Assume a rental housing project has the following

parameters •  40 units •  875 square feet per unit •  Construction cost of $60 per square foot

•  Calculate the construction cost


Sources of Funds •  Sources of funds must equal uses of funds •  How will we pay for the housing development?

•  Loans or debt: Fixed repayment schedule •  Equity: No fixed repayment schedule

•  Financing gap: The sources of funds are less than the uses of funds (typical in affordable projects)


Sources of Funds (cont.)

•  Loans and Debt Service (D/S) •  Debt service pays interest (i) due plus portion of

principal (p) of a loan •  Debt service includes p + i

•  Calculating Debt Service •  D/S = Loan Amount x Constant (“c”)



•  Constant •  A factor, that multiplied by the loan amount, yields the

annual debt service payment •  Example

•  Loan Amount = $750,000 •  Interest Rate = 9.0 percent •  Term = 30 years •  “c” = 9.66% or .0966

Then •  D/S = $750,000 x .0966 •  D/S = $72,450



•  D/S Exercise #1 •  Loan of $300,000 •  7.5%, 25-year term •  “c” = .0887 •  Calculate annual D/S (D/S = Loan x “c”)

•  D/S Exercise #2 •  Loan of $1,000,000 •  10%, 20-year term •  “c” = .1159 •  Calculate annual D/S


Developer Pro Forma •  How do you determine if an operating project

generates enough cash to pay the debt service on an annual basis?

•  Developer Pro Forma (or pro forma income and expense statement) •  Revenues: Rent (less vacancy) and other income •  Expenses: Costs of operating the development •  Debt Service: Payment to lender •  Net Operating Income (NOI): Revenues less vacancy and

expenses; dollars available to pay lender and owner/investor


Developer Pro Forma (cont.)

•  Developer Pro Forma (Income & Expenses)


CASH IN

GROSS RENT OTHER INCOME

- VACANCY FACTOR

Rent Collected Fully Occupied

Rent Not Collected Due to Vacancy

= EFFECTIVE GROSS RENT Expected Cash Rents Collected

CASH OUT FOR OPERATIONS

-  OPERATING EXPENSES Taxes Maintenance Insurance Utilities Management Fee Replacement Reserves

Cash Expenses

= NET OPERATING INCOME -  Debt Service = CASH FLOW

Cash Flow Generated by Property Return to Lender Return to Investor


•  Stabilized NOI •  Vacancy rates are often higher in the early years of a

project •  For example, consider a rental housing project with the

following vacancy rates •  Year 1 15 percent •  Year 2 10 percent •  Years 3 and beyond 7.0 percent

•  The stabilized vacancy rate is 7.0 percent •  Lenders make financing decisions based on several

factors, including the amount of NOI



•  In the above example, Year 1 NOI is low and would result in a low loan

•  Therefore, the stabilized NOI is used to calculate loan amount


Financing the Development •  Securing Financing

•  Obtain a permanent loan commitment •  Banks •  Mortgage companies

•  Find equity and gap (public) financing •  Public or private grant programs, or private equity

investors •  Obtain a construction loan commitment


Financing the Development (cont.)

•  Measures of Return on Investment •  Cash-on-Cash Rate of Return (“e”)

•  Definition: A property’s annual net cash flow divided by the cash equity, expressed as a percentage

Formula: “e” = Cash Flow Cash Equity

•  For example, if the net cash flow from a property is $10,000, and the cash invested in the property is $100,000, then the cash-on-cash rate of return is 10 percent ($10,000 / $100,000)



•  Capitalization Rate (Cap Rate or Ro) •  Definition: Expresses the overall cash return on real

estate, the Capitalization Rate is a ratio used to compare properties with different values, and to place a value on a property based on the income it generates

•  The Capitalization Rate represents the cash return on all invested capital (both debt and equity) in a project

•  Formula: Ro = NOI Sale Price

•  Market Ro is the number of cents of NOI demanded by a typical investor for $1.00 of investment

•  If Market Ro = .10, a typical investor will pay $1.00 for every $.10 of NOI



•  Fair Market Value (FMV) •  An estimate of the market value of a property, based on

what a knowledgeable, willing and unpressured buyer would pay to a knowledgeable, willing and unpressured seller in the real estate market

FMV = NOI Ro

•  Example •  If Market Ro = .10 and a property’s NOI is $100, the FMV

is determined as follows: FMV = NOI = $100 = $1,000

Ro .10



•  Lender Ratios •  Use lender ratios to determine how much debt can be

attracted to an affordable rental project •  Banks make loans based on the NOI of a project or its

collateral value •  Lenders typically use two ratios to determine the

amount of permanent financing •  Debt Coverage Ratio (DCR) •  Loan-to-Value Ratio (LTV)

•  Lenders will offer the loan amount that meets both ratios -- usually the lower loan amount



•  Debt Coverage Ratio •  This ratio is a measure of the cash flow available to service (pay)

debt •  It’s the lender’s first way out: Repayment from project revenue

Formula: DCR = NOI D/S

•  For example, a DCR of 1.15 means that for each $1.00 of debt service there is $1.15 of NOI (note that a DCR of 1.15 can also be expressed as 1.15 / 1.00 or as 1.15 : 1.00

•  Typically, lenders are looking for a DCR of 1.10 to 1.25



•  Using DCR to calculate a loan amount •  Assumptions

•  The bank’s DCR is 1.15 •  The project’s stabilized NOI is $111,200 •  Loan terms: 8.0 percent for 30 years (“c” = .0881)

•  Solution •  Solve for debt service

•  D/S = Stabilized NOI / DCR •  D/S = $111,200 / 1.15 •  D/S = $96,696

•  Solve for loan amount •  Loan = D/S / “c” •  Loan = $96,696 / .0881 •  Loan = $1,097,567



•  DCR Exercise •  Assumptions

•  The lender’s DCR is 1.20 •  The project’s stabilized NOI is $100,000 •  The financing terms are 7.0 percent and a 25-year term

(“c” = .0849) •  Solution

•  Solve for debt service •  D/S = Stabilized NOI / DCR

•  Solve for loan amount •  Loan = D/S / “c”



•  Loan-to-Value Ratio (LTV) •  Represents the lender’s second way out: Repayment

from sale of assets •  The goal: Resale value > Loan balance •  Typical LTV: 75 to 80 percent •  Remember, the lender’s loan amount must meet both

ratios, the DCR and the LTV

Formula: LTV = Loan Amount Fair Market Value



•  Lender Ratio Analysis Example •  Assumptions

•  A lender is offering a 7.0 percent, 25-year loan (“c” = .0849)

•  The lender’s DCR is 1.20; the lender’s LTV is 80 percent

•  The developer of an affordable rental project is requesting a $1.1 million loan based on the following pro forma with a stabilized NOI of $100,000


Financing the development (cont.)

•  Debt Coverage Ratio •  D/S = Loan x “c”

= $1,100,000 x .0849 = $93,390

•  DCR = NOI = $100,000 = 1.07 D/S $93,390

•  D/S = NOI = $100,000 = $83,333 DCR 1.20

•  Loan = D/S = $83,333 = $981,543 “c” .0849



•  Loan-to-Value Ratio •  The lender knows that the Market Ro = .085 •  FMV = NOI = $100,000 = $1,176,470

Ro .085 •  LTV = Loan Amount = $1,100,000 = 94%

FMV $1,176,470 •  Loan = FMV x LTV

= $1,176,470 x .80 = $941,176



•  Conclusion •  Using the DCR, the maximum loan amount is

$981,543 •  Using the LTV, the maximum loan amount is $941,176 •  The loan amount that meets both ratios is $941,176 •  The developer wants a loan of $1,100,000, but the

bank will lend only $941,176


Deal Structuring •  Project Costs (Uses)

•  Determined in the development budget •  Sources of Funds

•  Debt •  Equity

•  Financing Gap •  Project Costs > Debt + Equity •  Typical in affordable housing projects •  Another source of financing is needed to fill the

financing gap


Home Ownership Finance •  Two Problems

•  Affordability •  Neighborhood residents don’t have incomes high

enough to pay for the mortgage on a house plus insurance and taxes

•  Lack of investment •  The cost to build a house, pay for street improvements

and provide water and sewer services is high •  Families won’t pay what it costs to build new housing •  Costs are the same in a distressed neighborhood as

they are in a wealthy suburb


Home Ownership Finance (cont.)

•  Home ownership solutions •  Reduce development costs •  Reduce cost of capital •  Increase the availability of capital

•  Two financing approaches •  Financing the development (construction loan) •  Finance the purchase for the home buyer (mortgage

loan)



•  Construction loan •  A loan to a single family housing development for a

specific term and interest rate •  It is repaid when the project is completed •  Interest accrues during the loan term •  Principal is repaid when revenue is available

•  Key question: Does project have basic viability? •  Will revenue exceed and debt and equity invested •  Profit and loss statement provides a rough estimate of

viability



•  Sources of Construction Financing •  Banks •  Government financing programs •  Affordable Housing Program (AHP) of the Federal

Home Loan Bank (FHLB) •  Subordinated seller financing •  Equity •  Staged land purchase



•  Mortgage loan •  Financing for a buyer •  Permanent financing •  Provides cash to pay off construction loan •  Mortgage includes the following housing payments

(PITI) •  D/S on the mortgage (principal and interest) •  Payment for annual property taxes •  Cost of property insurance and, if applicable, mortgage

insurance



•  Debt capacity •  The maximum amount an individual or family can

borrow

Formula: Debt Capacity = (Monthly D/S x 12) / “c”

•  Exercise •  Monthly D/S = $450 •  “c” = .0966 •  Calculate debt capacity



•  Qualifying buyers •  How much can a buyer pay for a house?

•  Lender ratios •  Loan-to-Value (LTV) •  Housing expense to income-1st ratio •  Recurrent debt to income-2nd ratio (total debt / income)

•  Credit worthiness of buyer


Case Study: Golden Street •  Introduction

•  Boiling Springs Baptist Church, located in the Austinburg neighborhood of Macon, GA, has made neighborhood improvement a high priority

•  Church members are currently focusing their efforts on Austinburg’s main thoroughfare, Golden Street, and the development of affordable rental housing opportunities for local families

•  A rental housing development that would be affordable to families at 50 percent of AMI is proposed


Case Study: Golden Street (cont.)

•  The Project •  Far Better Place Apartments will provide homes for 50

families •  The development will consist of 20 one-bedroom and

30 two-bedroom apartments




Development Budget Land On-site improvements New Construction Contingency Survey Architecture and Engineering Real Estate Attorney Developer Fee Syndication Expense Construction Loan Interest Construction Loan Fee Appraisal Permanent Loan Fee Marketing Expense Operating Reserve Total Project Cost

$50,000 150,000

5,500,000 275,000

15,000 330,000

45,000 975,000

75,000 200,000

20,000 5,000

25,000 30,000

75,000 $7,770,000


•  Operating Budget •  Rents for the two unit types will be $525 and $675,

respectively •  Tenants will pay all utilities •  Rents will increase at a rate of 2.0 percent per year •  Operating expenses will increase 3.0 percent per year •  Replacement reserves will increase 3.0 percent per

year •  A market study indicates that the vacancy rate will be

10 percent in the first year and 7.0 percent in subsequent years



•  First Year Operating Budget


Advertising Management Fee Legal Administrative Utilities Maintenance Real Estate Taxes Insurance Replacement Reserves Total Operating Budget

$7,000 20,000

3,000 15,000 15,000 20,000 35,000 20,000

15,000 $150,000


•  Bank Financing •  First Babylonian Bank and Trust is willing to make a

30-year loan with a 15-year term at an interest rate of 6.0 percent as long as the DCR is at least 1.15

•  It is assumed that the Capitalization Rate will be 10 percent



•  Assignment •  Enter all pertinent project information into the rental

housing development finance spread sheet •  What is the total development cost of the Far Better

Place Apartments project? •  What is stabilized NOI? •  How much debt is attracted?


For More Information •  Contact

Chuck Depew, Director National Development Council 1218 Third Ave., Suite 1403 Seattle, WA 98101

Phone: (206) 441-5368 E-mail: [email protected]

Karen Garritson National Development Council 206 Willow Drive Mead, CO 80542 Phone: (303) 475-7986 Email: [email protected]


Housing Development Finance Webinar Slides...• Using the LTV, the maximum loan amount is $941,176...

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