Developer reviews have become a vital part of the equity commitment process for low-income housing tax credit (LIHTC) deals, according to leading syndicators. These evaluations are crucial because developments often encounter delays and rising construction costs, which can pose significant challenges for project teams.
In general, breadth of experience, financial wherewithal, and REO (real estate owned) schedules are key elements of a sponsor review, cites Steve Kropf, president and CEO of Raymond James Affordable Housing Investments.
“With the increase in operating costs, investors and syndicators are very focused on working with experienced sponsors with high-performing portfolios,” he says. “Additional scrutiny is being place on any deals that are struggling to determine if the issue is symptomatic of a wider portfolio problem.”
Here are the key areas of review, according to LIHTC leaders:
1. Experience Matters:
A developer’s background and track record are critical when it comes to deals utilizing LIHTCs and other complex housing programs.
“When we are evaluating a new sponsor, we prioritize our questions around their experience and financial capacity,” says Tom Pereira, executive vice president at CREA. “We want to understand whether a partner has completed their previous properties on time and on budget, whether their portfolio is operating as expected and generating positive cash flow, and whether any deals that are experiencing issues are being rectified.”
If weaknesses are identified, CREA may require the developer to engage a second partner to provide an additional level or expertise or financial strength, he says.
“We undertake a thorough review and analysis of our developer partners, carefully looking at their prior LIHTC developments, their financial statements, and more,” adds Jason Gershwin, managing director at R4 Capital. “Approximately 80% of the LIHTC investments we make are with repeat developers. In many cases, we have closed dozens or more transactions with a given developer, and the ways in which a development company, its principals, and guarantors act during times of stress and when issues arise can be strong indicators for how they will behave should future deals encounter any type of challenge. We, of course, are looking for financially strong sponsors with a track record of success in the LIHTC industry, with an added focus on a sponsor’s experience in the states and local markets where they are showing us new equity and/or debt opportunities.”
When assessing a potential investment with a newer developer client, R4 Capital likes to see an experienced team put in place around the developer, such as a LIHTC consultant, general contractor, and property manager. “We seek to partner with sponsors who view their syndicator and investors as true partners and not just as a commoditized source of funds,” Gershwin says.
Julie Sharp, executive vice president at Merchants Capital, adds that her team looks at the LIHTC development experience of not only developers but also property managers and general contractors.
2. Portfolio Strength:
A developer’s portfolio will also come under scrutiny.
This review helps assess how well a firm’s properties are performing, properties operating below break-even, and cost overrun obligations, notes David Leopold, senior vice president and head of affordable housing at Berkadia.
Several syndicators cite the importance of an REO schedule, which is a list of a properties that a party owns and often includes information such as market values and debt obligations.
This analysis can help investors or syndicators determine if there are underperforming properties and why.
“Regardless of whether it’s a new or repeat developer, there is an in-depth review of REO schedule and financial statements,” says Ryan Robinson, president of Cinnaire Syndication.
If there are deals that are underperforming, investors want to understand how sponsors are funding deficits, what is causing deficits, and a detailed plan to turn the deals around, says Merchants Capital’s Sharp.
Sponsors who have spent time reviewing and understanding their schedules of real estate holdings are in the best position to address any questions about their existing pipeline, adds Paul Cummings, senior vice president, director of originations and capital markets, at National Affordable Housing Trust.
“The challenging reality is that almost every partner’s portfolio has challenges today that may not have been as present prior to COVID—and so it is important for partners to be able to speak to their portfolio from a position of strength, including a strategy for any/all properties that are not performing as well,” he says.
Hunt Capital Partners is also “spending a lot of time evaluating REO schedules given recent experience and operating issues as well as project delays that remain from COVID,” adds Amy Dickerson, chief operating officer.
3. Financial Strength:
A sponsor review can also include a deep dive into a developer’s overall business structure and financial strength.
This is important to see how sustainable an organization’s model is, according to Kari Downes, president of Enterprise Housing Credit Investments.
“First, we look at their liquidity and net worth,” she says. “We look at the performance of their portfolio in terms of their cash flows. We consider their contingent liabilities and the status of deals in development. We project their cash flows over the near term and evaluate the risk of them facing a liquidity challenge that proves insurmountable.”Other syndicators agree that financial capacity is a key area of review.
“With respect to a sponsor’s financial capacity, there is a trend analysis of at least three years of financial statements along with verifying the account balances of underlying liquid assets,” says Jen Erixon, senior managing director, head of equity originations, at Walker & Dunlop.
When it comes to business structure, syndicators may also inquire about the adequacy of staffing and succession plans.
4. Local History:
In addition to checking out a developer’s overall LIHTC experience, investors and syndicators like to see if a team has experience in their project’s market or if the company is entering a territory for the first time.
This is because real estate markets and development activity can be influenced by geographic conditions, policies, and trends. It also reveals if a developer has experience with the local and state agencies that will be involved.
5. Other Points:
The investment team may also check to see if a developer is involved in any legal action or has received negative press. This is another step that can help provide additional information about a developer or a project.
Catherine Cawthon, CEO of Ohio Capital Corporation for Housing sums up the overall review. “Investors seem to have three priorities when evaluating a sponsor—developer experience, cash and net worth positions (and how they have changed year over year), and operating statistics on the developer’s current portfolio,” she says. “As a syndicator, it is our job to evaluate these items, review the risks, but also help provide solutions where we can to help the investors make informed decisions.”
