Why do we need to broaden affordable housing funding sources?

Because you get things like this 44-unit 1992 LIHTC property that loses $25,000 per year with no hard debt.

Housingpolicy.org, an initiative of the Center for Housing Policy is doing yeoman’s work in spurring ongoing conversations amongst professionals in affordable house. At their nascent forums, Ed Kaminski shares his frustration with the deal above, and its inability to make financial sense.

[Pennsylvania's] low rent levels do speed up the intersection of operating expense with operating income. We even avoid hard debt on tax credit deals whenever possible because at some point, costs will exceed income. This is certainly true in hindsite with taxes, utilities, insurance and maintenance all rising at a greater rent than rents.

We are being offered – free of charge – a 17 year old 44 unit tax credit property that losses $25,000 per year. It has no hard debt payments, but soft debt exceeds the appraised value. [We] have come to the conclusion that the only way to preserve this is to find a source that will subsidize operations. We are willing to enter into a 15 year restrictive use agreement in exchange for a 15 year commitment of $25,000 per year.

That is $568 per unit per year ($8520 per unit for 15 years) and a total of $375,000 of subsidy for 15 years. Producing 44 new units will cost $6-8,000,000 or more.

The ability of a State Housing Agency to exchange tax credits for cash does nothing if the money goes simply to the construction of affordable housing and not to its operations. Financial stability, much less sustainability, will not occur until states and more importantly, counties, become more serious about providing and supporting affordable housing.

LIHTC cannot solve this problem.

Direct HUD subsidies, HOPE VI, vouchers, all are powerless to solve the long term danger to affordable housing: incomes (and thereby rents) do not rise in concert with expenses.

Grand Unifying Theory of Sustainability (pt. 1)

Over the next few weeks, scattered amongst posts on GAO and HUD, the latest upheaval with LIHTC, and hopefully some more tales from the trenches, I’ll be attempting to outline my thoughts on what it will take for building sustainability and sustainable operations to become part of the vernacular. I’m starting with the aspect I’m actually least familiar with, insurance.

Insurance, by popular understanding, hedges against the risk of contingent loss. By varying pricing based on operations, materials, and design, insurance serves as a nudge to encourage lower risk profiles. In theory at least. We’ll leave unresolved questions about whether this risk reduction is always well reasoned or if you really get better pricing through these changes.

So it was unsurprising to read in Ceres’ new report “Risk to Opportunity” that insurers are moving from superficial PR “towards [thinking] more deeply and strategically institutionalized and embedded in the operations of companies.”

Climate change is becoming recognized as an issue of Enterprise Risk Management, spanning underwriting, asset management, and corporate governance.

One of the most constructive developments is more products and services focused on ensuring the quality of the customer’s energy or carbon savings efforts. These include performance insurance for renewable energy systems, coverage for green buildings that don’t deliver promised performance, and products that apply to carbon offset and trading activities. In all cases, loss-prevention takes the form of due-diligence, scrutiny of engineering assumptions, preventive maintenance, commissioning, measurement and verification, and other constructive interventions to help ensure project integrity and success.

Although released in April 2009, the report covers products existing or introduced in 2008. In many ways, the finding that some insurers were moving much faster than others led to the March 2009 action by state insurance commissioners to require that insurers reveal exposures and responses to climate change. How this will be enforced and what the ‘right’ answers are will be revealed when the responses are provided in March 2010.

[Note: The quote above was taken from an interview with study author Evan Mills with Climate and Insurance.org, an arm of industry advocate NAMIC, which does not like (really doesn't like) the new climate exposure mandate. Ceres retorts that "Insurance trade organizations remain relatively disengaged on climate change." Plus ça change, I suppose.]

Why does this matter? Because outside of government and its multiple layers, insurers and financial firms are best positioned to promote the systemic change in the built environment needed to achieve goals like Net Zero Energy, Architecture 2030, or multi-family specific programs like Greener Communities.

Insurers are perfectly placed to make the case for unifying “green” and “disaster-resilient”
practices across many domains (construction, energy, agriculture, land use), yet scant effort has
been exerted in this regard. It will become increasingly incumbent on insurers to demonstrate
the loss-reducing benefits of the green technologies and services that they reward. Loss-prone
infrastructure cannot be truly “sustainable”.

It’s worth recalling this recommendation from “Resilient Coasts”:

“Wise investing will involve asset managers understanding the impacts of climate change on their investments and managing that risk, especially in real estate, infrastructure and other financial instruments. Responsible banks will need to understand the levels of exposure within their investment and lending portfolios by incorporating climate risks into their due diligence.”

Change is coming in a thousand different ways from code changes, insurance, finance, builders, housing agencies, governments, and most importantly, residents. We’ll start addressing the financial world in short order.

Needs More Data

One of the reasons this blog started 99 posts ago was to encourage more data and greater awareness for sustainable methods and materials in multifamily housing.

Eighteen months makes a big difference as both data and awareness have increased as all participants recognize the necessity of accurate and actionable information. States like California require energy labeling, LEED now requires multi-year access to building performance, and the Federal government is getting into it, either through GSA’s Sustainable Design Program or through better use of existing resources such as HUD financial data.

Just as the brewmaster proclaims that Red Tick Beer “needs more dog“, I say that we need ever more data on building performance. We need building scientists, architects, builders, and engineers to better understand things like whole building design and sustainable construction (and waste) methods. In multifamily, we must understand not only the initial efforts of sustainability, but the ongoing need to consistently review the physical plant, operate sensibly, and dispose correctly.

Most importantly, however, we will need the financial world to come around. That means more information on operating expenses, projections for increased costs and an understanding that building sustainably means building differently. If underwriters and credit officers do not make the effort to understand how the regulation, construction, and operation of buildings have changed, then we cannot move forward with needed haste.

I’ll have more on the best bets to move forward in the next posts.

Foreclosures: Enterprise analysis of Neighborhood Stabilization Program

The folks at Enterprise Community Partners have released a thorough interim analysis of the proposals for HUD’s Neighborhood Stabilization Program (56-page PDF Report).

Eligibility for the NSP program is limited to CDBG recipients and 1st round funding must be disbursed within 18 months of April 2009. It’s not clear when 2nd round money must be disbursed by recipients. Given the very tight cycle of rule writing, allocation, and disbursement, this lengthy research document is both well done and a welcome discussion piece.

[Note: HUD has lots of resources including a 1.5hr kickoff video.]

Enterprise’s report reviews the proposed uses of 87 of the 306 NSP funding recipients (58% of total 1st round funding) and identified 7 “promising approaches”:

1. Acquisition and discount strategies
2. Disposition strategies
3. Geographic targeting
4. Green building and rehabilitation strategies
5. Income targeting and long-term affordability
6. Leveraging NSP funds
7. Partnerships and management

Cherry picked areas of interest:

Acquisition strategies reflect the diversity of local experiences and the dispersed nature of the foreclosed properties, and include both individual property purchases and bulk asset purchases. The likelihood of one strategy or another depends not only on the pattern of foreclosure but also on the preference of the funding recipient to focus on specific neighborhoods or to make select investments in relatively stable neighborhoods to prevent further deterioration. Funds from NSP can be used for acquisition and rehab, but not for operating expenses or maintenance. This limitation highlights the need to either dispose of these assets upon rehab completion or to use secondary financing (or rental proceeds) to meet ongoing financial obligations.

Disposition seems to reflect a traditional bias in favor of ownership, and provide for homeownership counseling and DPA. I’ll note my objection to DPA, but the full case is amply made at Calculated Risk. In short, DPA increases costs to borrowers (someone has to recover the DPA), and psychologically reduces the ‘at risk’ component of home equity. What looks more promising is a loan guarantee or reserve use, such as that pursued by Chicago and Atlanta. This allows NSP recipients to maximize the utility of their funding because they can provide a guarantee of a portion of the purchase price rather than devote the full amount to the purchase. There are some lease-purchase and rental programs that do acknowledge the likelihood of depressed pricing or inability of some people to afford the obligations of ownership.

Top 100 Foreclosure Markets by MSA, 2008

Geographic targeting is a mixed bag. Enterprise notes that the funds must be disbursed within 18 months, which is far faster than the HUD’s HOZ program, which has shown the importance of extended funding horizons. Furthermore, geographic targeting could be politically difficult if results are not quickly seen or if funding is concentrated in a limited number of areas. Nevertheless, a variety of data sources, including HUD census tract data, postal service vacant address records, and locally generated data have helped reduce the amount of study required for geographic targeting.

A variety of sustainable building strategies are identified. Reducing ongoing costs are essential for stabilizing these properties in the short and long term. Any efforts to meet third party criteria are welcomed.

I think the income targeting components are the most questionable and will be the hardest to implement. I would recommend additional (or substitute) qualifications that aid qualified government workers (teachers, emergency workers, e.g.), supportive housing/co-housing (which can call upon additional public and private funding), or use of an existing mechanism to identify potential renters or owners. The 18 month deadline just makes it too tight to invent a new process.

Leverage of NSP funds should produce the greatest amount of benefit and allow lenders to recoup some of their tarnished reputations. Again, the short time period in which to identify spending or property purchases will limit the spread of this technique, I believe that multiplying NSP funds through leverage is the best way to provide the greatest good. Through the use of credit enhancements, revolving loans, loss reserves, or additional HOME or CDBG funding, leverage will allow NSP recipients to achieve more for their efforts.

I’ll have to better understand the legislation and the guidance, but proper use of leverage could also support the creation of ongoing community oriented enterprises such as non-profit ESCOs or state-backed enterprises.

Crafted and implemented within a short period, the NSP represents a substantial source of funding and innovation for communities with foreclosure risks. The Enterprise report provides an excellent summation of the legislation and a welcome starting point for implementation.

[Update: Here’s HUD’s FAQ on expenditure timelines:
TIMELINESS OF USE & EXPENDITURE OF NSP FUNDS

How long do States and local communities have to spend this money?

Grantees have 18 months to obligate these funds, and four years to expend funds. Congress was very clear that this money be put to work quickly. In some areas, this level of federal funding will be unprecedented. Thus, HUD expects that grantees will have contracts signed or, at minimum, made written offers for properties within 18 months. Options or other non-binding instruments are not acceptable.

Congress was very clear that there is an urgency to deal with a national housing crisis.

How does HUD determine when NSP funds have been obligated?

As stated in the NSP Federal Register Notice page 58332, “Funds are obligated for an activity when orders are placed, contracts are awarded, services are received, and similar transactions have occurred that require payment by the state, unit of general local government, or subrecipient during the same or a future period.”

What will happen if grantees don’t obligate their funding within 18 months?

HUD will recapture the funds.

Finance and Investment: Can’t Someone Else Do It?

And we’re back.

As a longtime “Simpsons” watcher, I can find something from their 20+ years to apply in nearly every situation. In Trash of the Titans, Homer runs for Sanitation Commissioner by promising personalized trash handling, including in-house ‘cram downs’ by sanitation personnel. As you would expect, the whole enterprise ends in disaster with the town moving several miles away by the end of the episode.

But the lament that started Homer’s quest, “Can’t Someone Else Do It?” naturally contains a bit of truth.

[Note: Let's not pretend this is an original thought. Both "The Tao of Pooh" and "The Gospel According to Peanuts" applied children's characters or cartoons to weighty philosophical matters.]

Since the layoff I’ve been working on several ventures, consulting on others, and generally trying to promote sustainability in affordable housing. Many of these ideas include making use of stimulus funds for weatherization, community-based ESCOs, or enforcement of green building laws.

These conversations with people in DC and around the country have shown me that much of the work is repetitive. Everyone is so eager to solve foreclosures, propose stimulus funding, require sustainable building codes, that the work is inherently duplicative. As an antidote, I’ve pushed the belief that someone else can do this. Someone else can (or has) created a weatherization program, a foreclosure response protocol, or a useful residential green building code.

Thinking indirectly, there are already ways to verify or enforce programs. for weatherization, affordable housing, and green building by working with state and local housing agencies, utility companies, and tax assessors. Want to make sure that weatherization or modernization funds were spent correctly? Make it part of the annual filing to the state housing agency. Concerned about the energy efficiency of a new building (regardless of LEED status)? Use remote meter reading or create a review template as part of the annual assessment process.

Can’t someone else do it? Yes they can.

Green Underwriting Standards

Despite actively looking for these over the summer, I somehow missed the release of the National Green Building Investment Underwriting Standards.

The product of over 18 months’ work, and developed using ANSI-standards, the heavy lifting was done by (among others) Dan Winters at Evolution Partners, Mario Silvestri at Wachovia, and Steve Hoffman of Hoffman & Associates. Their work was backed by a blue ribbon collection of banks (if there is such a thing), NGOs, institutional investors, and governments. The project’s goal was to provide a financial context for various green and sustainable building initiatives. Designed to recognize increasing utility costs, tenant preference, and potential regulatory pitfalls, the Capital Markets Partnership “Green Score” should be used as an overlay within the existing underwriting framework.

More information is available in the actual standards and via Dan’s summary of the project, which appears in the 3Q 2008 Korpacz Real Estate Investor Report.

With college football taking a brief hiatus, I’ll try and read up on the standards and provide some additional feedback.

Renewing focus on the low hanging fruit

Green Building Law wrote a good post promoting pink over green (i.e. insulation over solar photovoltaic systems). Similarly, CSM ran an opinion piece entitled “Green homes: solar vs. energy efficiency” that came to a similar conclusion. GBL (and I) agree that CSM didn’t seem to try very hard in their search for solutions, writing that “Policymakers say energy efficiency doesn’t have out-of-the-box solutions that are easy to mandate or incentivize.”

Regular readers may recall that this site discussed weatherstripping just a few weeks ago as part of an ongoing discussion of complexity-free solutions.

The current incentive structure, while it has the added benefit of promoting R&D and other desirable benefits, typically sells short more reliable and well-known solutions that could be installed by soon to be displaced skilled but non-professional tradespeople. Single family home energy audits cost several hundred dollars ($400-700 seems to be the going rate in the DC area) but per unit costs would be significantly less and could actually be performed by on-site service teams. So long as there is a difference between interior and exterior temperatures, using an infra-red imager will allow you to see cold spots and intrusions without a blower door. I can do it and I’m about the most unskilled person allowed on sites.

My firm has investments in about 230,000 units nationwide in a little over 2,100 apartment communities. Because most of our projects participate in the LIHTC program, we are subject to the QAP process, in which states mandate certain minimums to receive tax credits for affordable housing. If these requirements (occasionally incentives) could be included in market-rate housing, the impact would be both immediate and widespread. To put that 230,000 unit number into perspective, there are 5 states with fewer than 260,000 households (2000 Census).

The way to improve efficiency is to educate owners and lenders, and use effective policy tools to promote the best comprise of timing, cost, and achievement. Eventually, home inspections will automatically include an energy audit. It is up to policy makers and lenders to speed that date.

Three points toward a trend

Galley Eco Capital fleshes out a recent NYT article on pension fund investments in sustainable buildings. Noting that the article said little about groups such as CERES or Business for Social Responsibility, GEC recommends that general partners have some information about their portfolio’s sustainability at the ready.

Without providing a timeframe, GEC says simply ’soon’. Given the hellacious market conditions, most GPs or LPs are probably just trying to keep above water (or no more than 3″ below the surface). Certainly I’ve become much more skeptical of GP claims about pending payments and improved performance. Until we finish triaging portfolios, I’m not sure we will see an increase in portfolio reporting requirements. Once that process is complete, probably by 2Q 2009, we’ll need to start working on financial stabilization or exit strategies for properties. At that point, I think there is a tremendous role for sustainable analysis to play.

In that vein, here are a couple of articles inspired by recent postings at Globest.com. Globe Street is terrible about their paywall, so I’ll link directly to the source material where possible. CalPERs announced on November 30th that its real estate partners reduced energy consumption in 2007 by 13%, partway toward their goal of a 20% reduction in energy use by 2009. The primary vehicle is the Hines Green Development fund, which currently has $725mm for promotion of sustainable real estate holdings. The methods identified by CalPERs are standard steps any responsible owner should be taking such as low-flow and sensor-operated fixtures, recycling programs, and preemptive, onsite water treatment.

The more important (and actually reported) article discusses a new CA law mandating utilities to maintain an Energy Star Portfolio Management Database for all non-residential properties in CA. Contained in Assembly Bill 1103:
1) Requires electric utilities, beginning January 1, 2009 and upon the written request of the owner or operator of a nonresidential building, to provide the owner or operator monthly energy consumption data for the building in a format that is compatible for uploading to the US Environmental Protection Agency’s (EPA) Energy Star Portfolio Manager.
2) Requires electric utilities, beginning January 1, 2009 and upon the written authorization of a nonresidential building owner or operator, to upload monthly energy consumption data for the building to ESPM.
3) Requires an owner or operator of a nonresidential building, on and after January 1, 2010, to disclose to a prospective buyer, lessee, or lender the ESPM benchmarking data and scores for the building.

Writes Globest’s Brian K. Miller:

One year from January, anyone looking to buy, finance or lease an entire building will be entitled to obtain the building’s Energy Star Portfolio Manager benchmarking data and ratings. The Energy Star program rates buildings on a scale from 1 to 100 against other buildings within its class. Buildings within the top quartile will be eligible to be recognized as an EPA Energy Star Building and can use the “Energy Star Label” to communicate its energy efficiency to tenants, lenders, and other stakeholders.

Obviously buyers and owners do this kind of comparison already, but with the addition of the Energy Star scoring, all parties will be in a position to both analyze and act upon energy efficiency opportunities rather than passively accept the consumption rates.

My East Coast bias won’t allow me to say that most initiatives begin in California, but by sheer market size, these requirements or requests for information are likely to start moving east in the next 18-36 months.

Confidence in Apartment Sales, Credit, Even Occupancies Declines, NMHC Reports

NMHC just posted their quarterly survey of apartment market conditions. Of the 70 respondents, 43 (61%) felt that conditions were looser (higher vacancy, lower rent growth) than three months ago. An additional 20 (29%) felt that conditions were unchanged. The number of respondents who felt conditions were worse (looser) jumped from 35% to 61% from the prior quarter and from 26% from the same period in 2007. Nearly 60% acknowledged that current credit conditions had a material impact on current and planned business activities.

Equity and debt availability (or its perception thereof) was at the lowest confidence in over 10 years. Unable to read this in table form, I threw together this quick graph for further analysis. Looking at the history of the survey (50 is neutral) sentiment for debt and market tightness moved inversely until October 2006 when everything fell of a cliff.

The survey measures investor sentiment so it imperfectly reflects debt and equity availability. The Q2 MBA survey of commercial and multifamily originations has more quantifiable data. In that survey, commercial and multifamily originations were down 63% over Q2 2007 and fell to their lowest level since Q1 2004.

Quarterly reports from Q3 2004 onward.

Echoing this falloff was an item I saw in MBA Newslink on October 30th providing this summary of an RBC report:

“Fannie Mae and Freddie Mac continue to finance 80 percent to 90 percent of multifamily transactions across different regions of the country, supplemented mostly by local and regional banks, RBC reported.”

I’ll guess that any non-conforming deals simply cannot be done at any reasonable LTV these days. I’m still looking or the RBC report but please send it along if you have a link.

HT: Multifamily Executive

Enterprise calls for low income energy efficiency

Essentially a position piece that encompasses an exceptional range of societal ills, Enterprise nevertheless identifies some reasonable solutions to promoting energy efficiency for LIHTC and other low income programs.

Enterprise describes one of the problems thusly: “In many areas, the utility allowance estimates for tax credit developments are based on older properties with much higher energy costs due to less efficient design and construction than is possible and increasingly common today. This results in higher than necessary utility allowances for many tax credit properties and reduces the incentive for developers to incorporate energy- and water-efficient features into their developments. Owners generally are not able to use alternative sources or methodologies.”

In bullet point form, Enterprise recommends:
• Building capacity to implement low-cost improvements
• Expanding and leveraging funding for weatherization
• Ensuring climate change legislation supports low-income home energy efficiency
• Funding the Energy Efficiency Block Grant and prioritizing very low-income homes
• Investing in green jobs and prioritizing homebuilding and rehabilitation
• Strengthening HUD’s commitment to energy efficiency
• Greening the revitalization of distressed public housing communities
• Improving and expanding federal tax credits for residential energy efficiency and solar power
• Incentivizing major financial institutions to finance energy efficient very low-income homes
• Supporting research and driving innovation

Qualified Application Plan and Sustainability

I need to finish reviewing the summary of state QAP’s, but the sustainability trend continues at the state level for affordable housing. Most of the language address a mix of location and material incentives. There is an uneven message on reuse and rehab and certainly some of the language seems cribbed from the USGBC. That’s not always a bad thing, but it certainly doesn’t do much for addressing the operational challenges of sustainability.

I’ll have more once I’ve finished reading the report.

“A Greener Plan for Affordable Housing”

For 2007, there’s an updated report “Greener Policies, Smarter Plans” by James Tassos and distributed by Enterprise Community Partners.

The bottom line is upfront:
“All states promote sustainable development in some fashion through their Housing Credit allocation plans. Forty-two states employ “threshold criteria” – mandatory design, construction, energy standards or other program requirements – that address sustainable development. Forty-eight states encourage green development using selection criteria incentives. State policies that address sustainable development generally fall into four broad categories: energy efficiency; sustainable site selection; resource conservation and indoor air quality.

Perhaps most significantly, 29 states (Alaska, Arizona, Arkansas, Colorado, Connecticut, Florida, Georgia, Indiana, Kansas, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, New Mexico, North Carolina, North Dakota, Ohio, South Carolina, Utah, West Virginia and Wisconsin) implemented notable new policies or substantially revised policies encouraging sustainable development since just last year. Thirty-nine states have made significant strides in this area during the past two years.”

The report does not offer substantial discussion of the various QAP allocations and preferences, but it does note some interesting trends. The one that jumped out at me was the Energy Star appliance requirement from 13 states. If you’re wondering, the states are California, Connecticut, Delaware, Georgia, Louisiana, Maine, Missouri, Nevada, New Hampshire, North Carolina, South Dakota, Vermont and Wisconsin.

Site selection continues to be a favorite area to add points, but given that almost all of my developments or properties are in urbanized areas, a project is right for LIHTC or not and a ’sustainable’ site shouldn’t be the determining factor. This is particularly true in states where there are already incentives for smart growth, TOD, or brownfield locations.

Financial Sustainability (series)

Greener Buildings has a good interview with Leanne Tobias at Malachite about the financing of sustainable projects. Tobias shares some useful information about the state of the commercial real estate market (CRE) in the fall/winter of 2007 and highlights some useful, if known, ways to improve energy efficiency. The nut graf, however is this section:

GreenBiz: OK. So after I’ve checked for incentives and when I go to my bank, what am I going to have to have on hand to show them?

Leanne Tobias: What you are going to probably have to have on hand is, first of all, a fairly detailed plan for what improvements you hope to undertake, the cost of the improvements, an energy audit which shows your existing energy use and your likely decrease in energy use after the installation of the improvements.

And then, most important, on the financial side, the lender is going to want to see that the cash flow from the building or some other form of cash flow is sufficient to repay the loan. So that part of it is analogous to what is asked for, for any commercial refinancing.

But in regard to some of the newer technologies that a developer might want to utilize, such as solar technologies or geothermal technologies, I think that the banking institution should be made comfortable with the improvements, the ease of installation and the likely effectiveness of the improvements after installation.

This is the challenge: no one really knows how much these initiatives can save. Municipalities and states are increasingly favoring projects with some sustainable effort, whether through faster plan review, extra points in the Qualified Application Process (QAP) for tax credit housing, or by mandating some type of LEED certification for buildings over ‘X’ square feet. The lenders I know still haven’t figured out exactly how to underwrite the benefits of operational savings, use of sustainable materials, or improved energy efficiency. To put it another way, Energy Star appliances cost more. On a 30 year, fixed rate mortgage, you have to offset that increased cost with savings on your utility bills.

Because these benefits are hard to quantify, there’s plenty of greenwashing in the financial industry. I’m looking at you Bank of America, and you, Enterprise. Which isn’t to disparage the efforts of these lending institutions, merely to point out that much of their contributions come in the form of investments previously committed or in the form of grants, which don’t directly help projects achieve financial sustainability. In the financial world, we know how to underwrite rents, we don’t know how to underwrite low-e windows.

More info to come as we explore the financing of sustainable projects.

Eco-Calculator

New green construction is not a typical focus here because its use for affordable housing is rarely feasible. Nevertheless, you may find yourself working on a greenfield construction project. In that case, take a look at the Eco-Calculator from the Athena Institute.

Eco-calculator

http://www.athenasmi.ca/tools/ecoCalculator/