Affordable Housing Finance

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AHF's How-To Guide

How to Survive Tough Times

AFFORDABLE HOUSING FINANCE • March 2009

Industry experts share tips for building new projects and protecting assets

BY DONNA KIMURA

The stakes are raised this year for affordable housing developers. The crumbling economy and struggling financial markets will test the ability of firms to build new projects and protect existing assets.

Owners and developers face extreme conditions. Low-income housing tax credit (LIHTC) equity is elusive. Cash-strapped states and local jurisdictions are slashing their budgets, threatening the availability of critical soft funds. And debt will come at a higher cost and tougher terms.

The sad irony is that the underlying fundamentals of affordable housing remain fairly healthy, and demand for affordable housing will likely grow as the numbers of foreclosed properties and people out of work mount.

Staying on track in these times will take a sure hand. To help, we’ve asked veteran affordable housing developers and experienced financiers for their best advice for surviving the tough times. Here are a few of their suggestions, which may provide some new ideas or at least a good checks-and-balances list in the days ahead.

Maximize existing properties

Developers will feel the pull to conduct new deals in this environment, but it’s also a time when they have to keep a watchful eye on their existing portfolios.

Pay attention to cash flow fundamentals at properties, says Todd Sears, vice president of finance at Herman & Kittle Properties, Inc. His Indianapolisbased firm is putting additional focus on how it manages bad debt collection, tenant retention, and implementation of a new property management software system. This will help ensure that the company has a smooth-performing portfolio and high occupancy rates this year.

Stick with your comfort zone

Several industry experts suggest that developers stay with what they know.

Instead of diving into a new market or building a new product type, developers might consider adjusting at the margins—sticking with what they are good at, but with some tweaks.

For example, Herman & Kittle plans to look at desirable Community Reinvestment Act areas within its existing footprint, as well as joint-venture opportunities with local nonprofit organizations that may be able to bring soft funds and other resources to a deal.

“You have to respond to market changes, but straying too far from your knitting will be more difficult than imagined, and it will be difficult to persuade investors that you will be successful,” says Sears.

Re-engineer your uses of funds

That’s a fancy way of saying that developers with a deal in the pipeline should scrutinize the project’s uses of funds line by line, says David Smith, CEO of Recap Advisors, LLC, the financial services arm of CAS Partners, a property and asset management services firm specializing in multifamily residential and affordable housing. “Satisfy yourself that the scope is essential and the amount listed is the best price,” he says.

A hard, detailed look at the budget is critical in today’s market. “Tax credit equity, which used to be roughly $0.85 per dollar of credit, now has a bid price of roughly $0.65 per dollar,” says Smith. That change is huge. For every $1 of basis—every dollar of total uses of funds— there is now a $0.20 hole.

Aside from eliminating or changing the project scope, you have to be hardheaded about testing the price, Smith adds. With a slowing economy, building materials may cost less; so may labor or contractor profit margins.

Developers who are just starting to put together their deals should be conservative in their LIHTC expectations. Put together your deal feasibility plans using a practical tax credit price, and project a relatively long equityplacement period. Then, if you have to settle for the low price, at least you will be prepared. If the price is higher, it will be a pleasant surprise.

Keep your friends close

Several developers stress that now is the time to meet face-to-face with strategic partners, including city leaders.

Jamboree Housing Corp. plans to break ground on three to five projects this year and knows that the turbulent financial markets will require good communication with its partners.

“My advice is to continue to communicate with all partners, letting them know what is going on in the market,” says President Laura Archuleta.

Developers may find themselves asking local jurisdictions for additional funding for their projects.

Cities want to see projects move forward, but they also want to make sure that they are protecting public funds, says Archuleta. That’s why they need to be at the table with the developer.

In one move, Jamboree recently created a community development manager position to meet with city leaders in its region. The manager will be an important conduit, developing new business for the nonprofit and helping the cities meet their housing and community development needs.

“The new position is timely for us,” says Archuleta. “We have done an excellent job in getting the brand out. Now’s the time to continue and get that face-toface time with strategic partners.”

Keep your lenders even closer

It’s also a critical time for owners and developers to meet with their existing lenders, especially if they have loans that are about to come due or have some wrinkles, says Steve Bram, principal and president of George Smith Partners, a Los Angeles-based real estate investment banking firm.

“In today’s market, the best new financing is really the existing lender and renewing or modifying the loan,” he says.

Bram stresses that relationships are key today whether reworking an existing loan or securing a new one.

Relationship lenders, those who know and have worked with a developer in the past, are going to be the ones who will work most aggressively to close another deal and maintain that connection, says Bram.

He points out that many lenders continue to do multifamily loans today, but they have cut their loan sizes, with 65 percent to 70 percent loan-to-value (LTV) ratios being common compared to 75 percent to 80 percent a year ago.

Bryan Friend, a vice president in community development finance at San Francisco-based Union Bank, also emphasizes the importance of long-term relationships in tough times.

He says that in some cases it may help for a firm to consolidate its banking needs with one institution. Again, this adds to the relationship. In another example, a bank may consider buying a project’s tax credits if it is also providing debt to the project. Give a bank multiple reasons to do a deal.

Know what funders want

Friend also points out the importance of understanding what lenders and funders look for in a project.

For example, many have responded well to projects with strong green features. This is because green building often fits into a bank’s own corporate mission or even a special initiative. Public funders may also be drawn to certain projects such as those that are serviceenriched, says Friend.

Developers will get a better response when their projects align with the goals and priorities of key funders.

Don’t assume pricing and terms

These days, market changes are happening quickly, so don’t assume that the pricing and term sheets from six weeks earlier are still good, says Paige Warren, managing director at Prudential Mortgage Capital Corp. Pricing, LTV ratios, reserves, and other financing terms are being adjusted frequently, and any changes may affect a deal.

In addition to keeping up with any changes on their own, developers should pick a financing partner that does a lot of business and knows what’s happening in the markets and with the agency lenders— Fannie Mae, Freddie Mac, and the Federal Housing Administration, according to Warren.

Owners and developers should also be aware of the stability of their partners. It’s critical that borrowers be scrupulous and work with lending partners that have strong financials, according to Warren.

Consider reorganizing

The reality is that some smaller sponsors will need to think about strategic mergers or partnerships. “It may be the case that your mission can be better served if you join with another entity that is compatible with you,” says Smith of Recap Advisors.

Determine your organization’s core competencies as well as those that could be outsourced or contracted if necessary. Management must carefully weigh where the company is losing cash, and where it can generate cash flow. While this strategy may challenge your assumptions, it’s necessary to realize an upside once the market rebounds, Smith says.

“There are always tough times,” says Bram of George Smith Partners. “We get this every 10 years. It too will pass. Things will improve. They always do.”