Once unthinkable, nonprofit owners of affordable housing are seriously beginning to consider selling properties. Faced with revenue losses resulting from rising costs, COVID-driven collection problems, and loss of funding, owners are looking at either selling assets that are heavy losers or assets that have real value on the market. A sale could enable them to develop new properties or preserve other properties. It could support other development and social programs. It could even save an organization.
The question is how to make that decision. How do you evaluate risk and opportunity? Most owners are looking through their portfolios to pick out the losers and the potential golden eggs. They think about the mission value of each property considered for disposition. This is a rational approach. But it is also the same kind of opportunistic, transactional thinking that created inefficient portfolios to begin with. Most for-profit owners built their portfolio with an eye to consistency of product and efficiency of size and location. But nonprofit portfolios were built based on local needs, funding sources, political support/pressure, and opportunity.
Their focus, however, as industry veteran Helen Dunlap put it, is not disinvestment, but reinvestment. Now is the time for owners to ask which properties absorb disproportionate management resources and whether a property and its residents might be better served by a different owner. Could a different owner manage the property more efficiently or invest in energy-saving technology to drive down expenses? This is especially true of smaller organizations that have a far smaller range of opportunities and depth of resources.
The pressures on nonprofit owners are enormous. Competition for resources for new deals favor for-profits in many states. Resources for preservation are scarce—and getting scarcer. COVID funds are exhausted. Fundraising has many competing targets. Operating costs, led by insurance and payroll, are skyrocketing. And, due to housing shortages, the value of assets in some markets are increasing dramatically.
At this critical juncture, some nonprofit organizations think this is a chance to begin to rationalize their portfolios. Taking a longer view, their goal is to reduce risk in their portfolios while improving the longer-term cash flow possibilities across their entire portfolios.
In looking at underperforming properties, they are asking themselves the key question, as Rob Finlay of Thirty Capital noted, “Is it us? Or is it the market?” They are asking, “What are we preserving, and what can we preserve?” They are thinking about the asset value of their real estate as a whole and risk-rating their portfolio—not simply property by property.
So how does one evaluate a portfolio as a whole? Let’s begin at a very high level. When doing a bond rating, organizations like Standard & Poor’s focus on the health and strength of the parent so they look for very high-level indicators of portfolio health. They rate three categories: industry risk, market position, and management and governance. They focus on:
- Aggregate positive cash flow and the three-year trend;
- Percentage of revenue from operations—EBITDA (earnings before interest, taxes, depreciation, and amortization);
- Occupancy rates and the spread between physical and financial occupancy compared with market;
- Number of negatively performing properties;
- Owner loans to properties and unpaid developer fees by the properties; and
- Net asset trending and future funding needs.
Whether you are considering getting bond-rated or not, you must ask yourselves the same hard questions about the health and organizational impact of your portfolio. This requires:
1. At least a three-year cash flow for the portfolio as a whole—specifically cash to/from each property to the parent company. BRIDGE Housing, a large California-based nonprofit, is doing a five-year look back and look forward for each property;
2. A hard look at your rents. Obviously, nonprofits want to maximize affordability. But a potential purchaser will be thinking about the rents that the market and the regulatory structure permit. How much affordability can you afford, and how much room is there?;
3. Overlay the cash flow projection with potential investments that could improve performance (energy or marketability), potential dispositions, and, perhaps, a new rent policy;
4. Look at the properties that demand a disproportionate level of management and resources. Focus on properties that are not your core business or are geographic outliers, and estimate not only your savings by disposing of them but the benefit to the rest of your portfolio of better business and geographic focus;
5. Consider the mission and reputational risks associated with disposition. You will have to compare the mission impact that the properties now serve with the mission outcomes of what you do with substantial new resources. And that requires a hard look at your mission outcomes; and
6. Use cap rates to start to estimate values, but use market knowledge and broker opinions of value to flesh out your opportunities.
These variables are complex and interrelated. And disposition options depend on financing and regulatory restrictions. Dana Moore of Compass Advisors suggested creating a “score card” that you can use to evaluate individual deals. Having a clear evaluation methodology will be essential to making consistent decisions and protecting your mission and reputation. The score card provides a framework to bring together all the perspectives— development, asset management, finance, property management, resident services, and the board.
Thus far, we have focused on value and mission. Evaluating your portfolio, however, is both valuation and risk-rating. The “Stabilized Phase” risk-rating tool created by the Affordable Housing Investors Council (AHIC), which is available at ahic.org, provides a strong starting point in rating individual properties. There are clear benchmarks for 10 key indicators, including debt and expense coverage ratios, reporting and compliance, reserves, and condition. And, then it provides five different risk levels from “A—Excellent … performing according to original projections” to “F—Significant risk … recapture is imminent.” The risk rating is a key driver of disposition value and potential.
This analysis does not factor in planned improvements or changes, it does not assess portfolio inefficiencies, and it does not roll up the properties to frame the overall portfolio risks and opportunities. This is why Mercy Housing, the nation’s largest nonprofit owner of affordable housing, has begun to risk-rate its portfolio by using the AHIC preservation standards but adding a level of granularity to identify specific challenges and opportunities. Instead of having just a “watch list” of challenges, it has created a risk/opportunity map. All divisions of the organization share information and perspectives to draw up the plan.
Aggregating the portfolio risk is tricky. Yet this is the step between the property-by-property risk/opportunity analysis and the bond rater’s view of organizational strength. According to Dena Xifaras of Preservation of Affordable Housing, it is ultimately a subjective frame that an asset manager must build on how the portfolio is performing.
Now is the time for mission-driven housers to take a hard-nosed look at their real estate values and their organizational values to be able to maximize their strength and their ability to deliver precious housing and services.
