CDBG/HOME Underwriting Washington, D.C. February 15, 2017

CDBG/HOME Underwriting Washington, D.C. February 15, 2017
Underwriting & Subsidy Layering CDBG/HOME Underwriting Washington, D.C. February 15, 2017 Key Points This presentation is based upon a presentation delivered by HUD at the NCDA 2014 Annual Conference and gives the latest guidance from HUD on how to conduct under writing and subsidy layering for homebuyer and rental development projects in the HOME program. It has been adapted to include CDBG underwriting requirements and compare and contrast them with HOME.

Underwriting & Subsidy Layering
Welcome Trainer Steve Gartrell, Survey of Underwriting Requirements for the CDBG and HOME Programs Key Points Introduce yourself to the conference participants. Cover your prior experience to working at ICF related to underwriting and subsidy layering. Be sure to mention your past and current technical assistance projects with HOME PJs, including past publication of HOME 2012 Appropriations Act and the HOME Final Rule requirements. Finally, either ask folks to shout out a few burning questions they have related to underwriting and subsidy layering.

Agenda What is “Underwriting” Comparison of CDBG & HOME Underwriting Requirements Determining Project Costs are Reasonable Subsidy layering Multi-family underwriting for rental housing development projects Exercise Underwriting for homeownership development projects Key Points Briefly review the agenda and expectations for the two hour session with conference attendees Note that the underwriting requirements do not eliminate the subsidy layering to be completed when triggered – importance of both to be stressed There will be plenty of time to take questions throughout the presentation.

What is “Underwriting?”
Underwriting & Subsidy Layering What is “Underwriting?” It’s doing Due Diligence to: Ensure a need/market for what’s being provided Ensure that costs (both development and long-term) can be covered, plus a little extra for: Profit, or Developer’s fee Ensure that enough but no more subsidy than necessary is provided Assessing the Risk of the project

Why Now? For CDBG – No underwriting standards for housing & advisory for Economic Development (except Public Benefit) Will likely change soon For HOME – Only Subsidy Layering required until Washington Post article Changed with 2013 Regs. Bullet 2 – High number of rental projects needing workouts. Backlog of unsold homeowner units (owner units are “easier”). Many projects committed (especially CHDO) but no action on too many.

Goal of Class Intro to Underwriting
Know what you should be looking at in a proposal Know when to get help

Current CDBG & HOME Underwriting requirements
Underwriting & Subsidy Layering Current CDBG & HOME Underwriting requirements Key Points This slide is simply a guide to the section that is coming up; however, please cover that this section is meant to be for both types of underwriting and subsidy layering: multi-family and homebuyer development projects. The presentation will not cover underwriting of homeowner-rehabilitation loan programs.

Underwriting Procedures
The following slides are based on HUD’s guidance for HOME Program underwriting Assume unless otherwise noted that these are requirements for the HOME Program They are for the most part also applicable to CDBG project underwriting (both housing and economic development) Will note CDBG/HOME differences HUD has indicated it will make underwriting mandatory for CDBG projects as well

CDBG Underwriting Guidelines (§570.209 & App. A to §570)
Underwriting & Subsidy Layering CDBG Underwriting Guidelines (§ & App. A to §570) Currently voluntary (except Public Benefit determination for Special Economic Development projects). Objectives of underwriting guidelines are to ensure: that project costs are reasonable; that all sources of project financing are committed; that to the extent practicable, CDBG funds are not substituted for non-Federal financial support; that the project is financially feasible; that to the extent practicable, the return on the owner’s equity investment will not be unreasonably high; and that to the extent practicable, CDBG funds are disbursed on a pro-rata basis with other finances provided to the project.

HOME Underwriting & Subsidy Layering Guidelines
Required by 24 CFR “A PJ is required to develop and use such guidelines to evaluate and ensure that the level of HOME investment does not exceed the amount that is necessary to provide quality affordable housing that is financially viable.” CPD Requirements for the Development and Implementation of HOME Underwriting and Subsidy Layering Guidelines Any HOME units in project – must look at entire project

HOME Definition – §92.2(2) Commitment to a Specific Local Project
Underwriting & Subsidy Layering HOME Definition – §92.2(2) Commitment to a Specific Local Project PJs may not commit HOME funds to a project consisting of new construction or rehabilitation until: All necessary financing is secured A budget and production schedule is established Underwriting and subsidy layering is completed Construction is expected to start within 12 months Key points: The new rule adds specific provisions that address what is required when committing HOME funds to a project. In some instances, PJs were committing funds to a project before the project was really “ready to go;” often leading to stalled projects or instances in which HOME funds needed to be repaid because affordable units were not produced. These requirements are included in the definition of “commitment” at 92.2. The new provisions are intended to ensure that the project is a real, viable project that can successfully be completed within the required 4 year completion timeframe BEFORE the commitment of HOME funds is made. This new definition of commitment will very likely create the need for PJs to change their program design, in the way they take in applications and announce awards of funds. For example, PJs may wish to make preliminary awards of funds before actual HOME commitments that meet the new definition of commitment. This is discussed in a later slide. Underwriting and subsidy review must be completed prior to committing funds and will be based on final numbers for project Context: Expected to start w/in 12 months was always there, the other elements are now explicit but “should have been” implicit parts of the determination that project could proceed all along.

HOME Underwriting & Subsidy Layering - General Requirements
PJs must ensure long-term sustainable projects by establishing guidelines for: Subsidy layering and underwriting Market assessment (all units, not just HA) Developer capacity and fiscal soundness Applies to rental projects and homebuyer development projects Must be done prior to funding commitment Certify compliance in IDIS at project set-up Key points: The new rule places a significant emphasis on improving performance – particularly project performance. PJs must ensure that HOME funds are invested in projects that are sustainable for the long term. Note that this section primarily about underwriting the project, but later we’ll discuss related requirement that PJs underwrite the individual homebuyer. In some projects, requirements overlap—underwrite the project before starting development and underwrite the buyer’s once they’re identified. The new requirements will help PJs better target HOME funds to neighborhoods in need of affordable housing, ensure market demand for such housing, and ensure that the HOME funds are invested in viable projects. PJs are ultimately responsible for underwriting, but they can coordinate with other funders or hire consultants to assist in underwriting. PJs must review the underwriting of each HOME-assisted project to ensure that it meets the PJs standard. These new requirements may require changes in PJs’ program designs. Adding the specific requirements in the rule establishes minimum analyses, which will help PJs reduce the risk of making bad investments. Note that this requirement is fundamentally the same as the FY 12/13 appropriations requirement for Project Evaluation.

HOME Subsidy Layering & Underwriting §92.250 (b)
Underwriting & Subsidy Layering HOME Subsidy Layering & Underwriting § (b) PJ must adopt Subsidy Layering & Underwriting guidelines, which must ensure that amount of HOME funds invested: Alone or in combination with other governmental assistance, are no more than necessary to provide quality, financially viable affordable housing, that is: Financially viable for a reasonable period Will not provide profit or ROI that exceeds PJs standards for size, type, & complexity of project Key points: Subsidy layering and underwriting are essential to both providing an appropriate HOME subsidy amount (i.e. not excessive) and long term project viability. The new rule strengthens and expands requirements to ensure that PJs make sound decisions. Previously, PJs were required to adopt subsidy layering guidelines and conduct subsidy layering review only for projects with other public subsidies. The 2013 Rule requires subsidy evaluation and underwriting of all HOME projects to ensure that HOME funds invested are reasonable and necessary to ensure project viability for at least the affordability period. Underwriting must include assessments of the project’s financial viability and sustainability over the affordability period, market demand in the project’s neighborhood, the developer’s experience and financial capacity, and whether all funding has been firmly committed to the project. In many respects, these items were implicit in existing requirements and have been promoted for years as best practices. Change to rule makes them explicit requirements. As public funders, we have to ensure that our assistance is not excessive, that we balance mitigating risk with not overfunding a project - that’s what subsidy layering and underwriting is all about. Tip: Reemphasize the benefits of doing underwriting and subsidy layering—better projects, less risk of repayment--rather than the perception of that this is going to be a lot of work, hard to do, etc. Tip: If pushed by a participant (does HUD think we’ve been making bad decisions?), may want to acknowledge that no PJ intentionally funded bad projects, and nearly all HOME staff considered the question of whether projects made sense—but rule change is intended to provide systemic framework for review intended to help PJs make better decisions.

HOME Subsidy Layering & Underwriting §92.250 (b)
Underwriting & Subsidy Layering HOME Subsidy Layering & Underwriting § (b) In order to determine appropriate subsidy, PJ’s guidelines must require PJ to: Examine Sources and Uses document and determine that the development costs are reasonable Do an assessment of: Market demand Experience & financial capacity of developer Determine reasonable level of profit/return to owner/developer for size, type, complexity of project Verify financial commitments are firm Key points: Subsidy layering and underwriting are essential to both providing an appropriate HOME subsidy amount (i.e. not excessive) and long term project viability. The new rule strengthens and expands requirements to ensure that PJs make sound decisions. Previously, PJs were required to adopt subsidy layering guidelines and conduct subsidy layering review only for projects with other public subsidies. The 2013 Rule requires subsidy evaluation and underwriting of all HOME projects to ensure that HOME funds invested are reasonable and necessary to ensure project viability for at least the affordability period. Underwriting must include assessments of the project’s financial viability and sustainability over the affordability period, market demand in the project’s neighborhood, the developer’s experience and financial capacity, and whether all funding has been firmly committed to the project. In many respects, these items were implicit in existing requirements and have been promoted for years as best practices. Change to rule makes them explicit requirements. As public funders, we have to ensure that our assistance is not excessive, that we balance mitigating risk with not overfunding a project - that’s what subsidy layering and underwriting is all about. Tip: Reemphasize the benefits of doing underwriting and subsidy layering—better projects, less risk of repayment--rather than the perception of that this is going to be a lot of work, hard to do, etc. Tip: If pushed by a participant (does HUD think we’ve been making bad decisions?), may want to acknowledge that no PJ intentionally funded bad projects, and nearly all HOME staff considered the question of whether projects made sense—but rule change is intended to provide systemic framework for review intended to help PJs make better decisions.

Comparison of CDBG & HOME Underwriting Requirements
Guidelines are (currently) voluntary Except evaluating Ec. Dev. Public Benefit If not used, “ expected to conduct basic financial underwriting” Guidelines apply to Ec. Dev. Projects But also useful for other kinds of projects, e.g. Housing HOME Requirements are mandatory PJs may not commit HOME funds to a project until: All necessary financing is secured A budget and production schedule is established Underwriting and subsidy layering is completed Construction is expected to start within 12 months

Comparison of CDBG/HOME Underwriting Requirements
CDBG Guidelines HOME Requirements Project costs are reasonable Examine Sources and Uses for cost reasonableness All sources of project financing are committed All necessary financing is secured To the extent practicable, CDBG funds are not substituted for non-Federal financial support No more HOME funds are invested than necessary The project is financially feasible; Look at project financing to: Ensure appropriate HOME subsidy Make sound investments over long term Accurately project income and expenses To the extent practicable, the return on the owner’s equity investment will not be unreasonably high; and Determine reasonable level of profit/return to owner/developer for size, type, complexity of project To the extent practicable, CDBG funds are disbursed on a pro-rata basis with other finances provided to the project. (Specific timing requirements: e.g., projects must be started in 12mo. , completed within 4 years of contract & complete project in IDIS w/in 120 days of final disbursement )

Determining Project Costs are Reasonable
Underwriting & Subsidy Layering Determining Project Costs are Reasonable Develop review guidelines for: Budgets Sources and Uses Pro forma for Operating Expenses, and How decisions will be made by Grantee Review guidelines include Underwriting criteria such as key ratios and dollar limits Guidance on reasonable costs Acceptable forms of documentation

Stages of Underwriting (HOME)
Preliminary Underwriting (UW) – Use UW & SL Guidelines to: Review project development budget for reasonable & necessary development costs Review operating budget & pro-forma for long-term viability Analyze the initial funding gap (need for HOME funds) Projected return to developer

Cost Allocation (HOME) – If <100% of units will be HA – PJ must either: Do cost allocation to determine minimum # of HA units required based on HOME $ requested; or Use proposed # of HA units to determine cost of HA units and max. permissible HOME investment See CPD Notice on HOME Cost Allocation requirements

Final Underwriting – After cost allocation, If PJ determines: Too few HA units; or Exceeds max. HOME subsidy limit Underwriting must be adjusted to meet HOME limits, by: Increasing # of HOME units; or Decreasing HOME investment

Stage of Underwriting (CDBG)
CDBG different from HOME: Project-based rather than unit-based: Project as a whole must meet CDBG National Objective [ NO] (for housing: majority of units – low/mod) No cost allocation required: If project meets NO up to 100% of costs can be funded by CDBG (but pro-rata subsidy highly recommended) No affordability period required (but highly recommended)

Stage of Underwriting (CDBG)
Preliminary Underwriting (UW) – Use UW Guidelines to: Review project development budget for reasonable & necessary development costs Review operating budget & pro-forma for long-term viability Analyze the funding gap (need for CDBG funds) Projected return to developer For Special Economic Development projects – must do Public Benefit Analysis

Reviewing Development Costs
Underwriting & Subsidy Layering Reviewing Development Costs

Reviewing Development Costs
Underwriting & Subsidy Layering Reviewing Development Costs PJ must determine all costs are eligible, customary and reasonable How CDBG/HOME funds will be used must be described Compare costs to similar projects, use cost estimation tools, or use a procurement process To document, obtain copies of: Detailed development budget – Sources & Uses Statement All sources of funds Total funds needed to complete project Supporting documentation PJ would need to review a detailed scope of work and budget for the project including defining how the HOME funds will be used in the scope of work. All HOME uses of funding must be eligible HOME costs. The project budget will document the total funds needed to complete the project and identify all sources of funding. This review cannot be completed until all funds have been committed. PJs may need to provide a tentative or conditional project approval as the await the final numbers to complete their subsidy review and final underwriting prior to commitment. Part of a cost reasonableness review would be a comparison of the project costs to determine if all costs are reasonable. Costs may be evaluated based on comparisons to similar project costs, use of cost estimation tools, or based on a procurement process. PJ may review similar projects within their portfolio and may need to define a comparable project. A permanent supportive housing project may have different costs based on the target population served versus a senior project. The scale of the project may also impact the per unit costs.

Sources & Uses Sources Uses Equity $163,920 Acquisition $250,000 Private Loan Design Services $50,000 Public Loan $100,000 Legal Fees $25,000 CDBG $324,000 Other Soft Costs HOME $800,000 Demolition Site Improvements $24,000 Construction $1,000,000 Developer’s Fee $113,920 Total Sources $1,537,920 Total Uses TDC/Unit $192,240 Example of simple Sources & Uses

Determination of Subsidy
Underwriting & Subsidy Layering Determination of Subsidy Development Costs (all) vs. Operating Costs (for rental projects) Based primarily on capacity of project to earn revenue in excess of expenses and thus carry debt To analyze rental project PJ must evaluate long term operating budget and assumptions such as escalation of rents, expenses along with vacancy rate as well as the development budget To analyze homebuyer subsidy PJ must use affordability standards for each household For projects – Development Budget For buyers – each household Subsidy levels will be set based on the PJ’s standards and review criteria as laid out in the Subsidy Layering Guidelines. Rental projects include long term affordability requirements so the PJ must not only review the development budget but must also include a detailed review of the operating budget to determine if the project will be sustainable. Homebuyer subsidy layering may be simpler compared to a multi-unit development but will focus on the affordability for each buyer. Homebuyer projects may include a detailed development review along with the homebuyer subsidy review based on the model being proposed.

Rental Projects Operating Budgets & Pro-forma
Underwriting & Subsidy Layering Rental Projects Operating Budgets & Pro-forma Developer must provide operating budget and affordability period pro-forma (rental projects & CDBG projects w/ long-term payback) PJ should establish standard electronic format for underwriting projects See HUD website for examples (NSP Underwriting Template also City of Houston HOME Template) At minimum should cover: Projected income and vacancies Operating expenses Contributions to reserves Debt service Cash flow and payments of deferred fees Rental section of this presentation will further explore the review of the operating and development pro-forma PJ needs to establish standards for projects used within the operating budget. These include escalation of rents and operating expenses over time, vacancy rates, projected utility costs, and needed reserves for operating and replacements. Different types of projects may require different standards. Reserve calculations should be specific to the project, materials, and location. More discussion within the rental underwriting section Note that HOME Multi-Family template is “unavailable” but NSP template should be very similar.

Operating Budget & Pro-Forma
Step 1 – Review Year 1 Operating Budget to determine Cash Flow Step 2 – Review Year 1 Debt Service Coverage Ratio (DSCR) Step 3 – Review Operating Budget Pro-Forma over life of affordability period Step 4 – If Pro-Forma is unsustainable (negative cash flow at some point) – review & revise costs, especially debt service to provide sustainability

Step 1 – Review Year 1 Operating Budget to determine Cash Flow

Simplified Operating Budget Gross Potential Rent $180,000.00 Rent Loss (7%) -$12,600.00 Other Income $1,800.00 Effective Gross Income (EGI) $169,200.00 Marketing $3,000.00 Payroll $45,000.00 Property Admin. & Mgmt $10,152.00 Utilities $6,000.00 Security $4,500.00 Maintenance $9,750.00 Taxes $15,000.00 Insurance Reserves for Replacement $12,000.00 Operating Costs $111,402.00 Net Operating Income (NOI=EGI-Operating Costs) $57,798.00 Debt. Service -$50,259.00 Cash Flow $7,539.00

Operating Budget Expenses – Summary
Underwriting & Subsidy Layering Operating Budget Expenses – Summary All cash expenses should be shown Reflect: Type and location of project Number of units Physical characteristics of property Cost environment for this project Trend expenses realistically given history Always higher than income growth Look at comparable properties Some PJs keep database Operating budget needs to capture projected expenses for the project. These costs may vary based on the design, location, and target population served. PJs that track expenses within their portfolio will have more accurate information about projected costs. Standards need to be updated based on current cost information throughout the life of the project.

Operating Budget Reserves for Replacements
Underwriting & Subsidy Layering Operating Budget Reserves for Replacements Deposits for future capital expenditures PJs have often used standard rule of thumb (e.g., $250 per unit – A BAD IDEA!) Better to do property-specific capital needs assessment §92.251(b)(1): Capital Needs Assessment required when rehabbing projects with 26 or more total units Research shows wide range of capital needs with average of $650 per unit per year

Step 2 – Determine Year 1 Debt Service Coverage Ratio (DSCR) DSCR = Net Operating Income / Total Debt Service DSCR = $57,798/$50,259 = 1.15 DSCR should be: 1.11 for Affordable housing for Market housing Net Operating Income (NOI=EGI-Costs) $57,798.00 Debt. Service -$50,259.00 Cash Flow $7,539.00

Step 3 – Review Operating Budget Pro-Forma over life of affordability period

Review Pro-Forma over Aff. Period
Underwriting & Subsidy Layering Review Pro-Forma over Aff. Period To End of Aff. Period Year 1 Year 2 Year 3 Year 4 Effective Gross Income (EGI) = 1% Inc. $169,200 $170,892 $172,601 $174,327 Operating Costs - 3% Inc. -$111,402 -$114,744 -$118,186 -$121,732 Net Operating Income $57,798 $56,148 $54,415 $52,595 Debt. Service -$50,259 Cash Flow $7,539 $5,889 $4,156 $2,336 Debt. Service Coverage Ratio 1.15 1.12 1.08 1.05 Cash Flow as a % of Op. Costs & DS 4.66% 3.57% 2.47% 1.36%

Review Pro-Forma over Aff. Period
To End of Aff. Period Year 4 Year 5 Year 6 Year 7 Effective Gross Income (EGI) = 1% Inc. $174,327 $176,070 $177,831 $179,609 Operating Costs - 3% Inc. -$121,732 -$125,384 -$129,145 -$133,020 Net Operating Income $52,595 $50,686 $48,685 $46,589 Debt. Service -$50,259 Cash Flow $2,336 $427 -$1,574 -$3,670 Debt. Service Coverage Ratio 1.05 1.01 0.97 0.93 Cash Flow as a % of Op. Costs & DS 1.36% 0.24% -0.88% -2.00%

Evaluating the Operating Budget & Pro-forma
Underwriting & Subsidy Layering Evaluating the Operating Budget & Pro-forma PJ can evaluate developer’s budget and pro-forma or do own calculations If using developer’s, spot check the numbers Ensure: Income is sufficient to cover expenses and debt service for all years of affordability period Expense cushion does not drop below threshold during affordability period Adequate cash flow each year 37

Evaluating the Operating Budget & Pro-forma (cont)
Underwriting & Subsidy Layering Evaluating the Operating Budget & Pro-forma (cont) Are rent assumptions realistic? Most HOME rents only grow by 1-3% annually Market rents should be based on comparable history Vacancy estimated at no lower than 5% Are expense assumptions realistic? Base on comparable properties Controllable vs. Non-Controllable Expenses Expenses should always trend higher than income Recent HOME rent study found that PJs underestimate expense increases Some areas of the country have experienced stagnant income growth and HOME rents have remain steady or declined rather than rising at a steady rate. Utility rate increases may lower actual contract rents when HOME rents remain stable – PJs need to be conservative on how they project changes over time. A 7 % vacancy rate has been accepted in many areas as a standard rule of thumb – less than a 5% rate is generally not reasonable. These variable may be specific to the type of property and the area. In the past many PJs overestimated the increase of rents but underestimated the escalation of operating costs and utilities.

Developers Can and Should Make Money
Underwriting & Subsidy Layering Developers Can and Should Make Money Many sources of potential $$ Developer Fees Property Management Appreciation and other equity increases Net cash flow Compare returns to other similar investment Appropriate level of return depends on: Project risk Returns available elsewhere OK for non-profit developers to earn revenue Developers need to make a return on their investment and non-profits need to generate revenue to support ongoing operation of the agency. Proper underwriting ensures that the return on the investment is proportional to risk and effort. More details included in the rental section Recommend also that they review the materials listed at the end of the presentation for further analysis

Cash Flow Remaining cash (if distributable) after payment of debt service “Cash-on-cash” return to measure Annual Cash Flow  Equity = X% Example: ($10,000 Cash Flow  $100,000 Equity) = 10% cash-on-cash return Since cash flow changes over time, average over the affordability period This calculation is required by HUD Notice

Basics of Subsidy Subsidy is determined by measuring the gap in funds needed to undertake the project and for the project to meet the long term requirements. Market project must support itself – revenue must cover all expenses, reserves and debt coverage Affordable project has lower revenue, so it can’t cover same debt and will need a subsidy to get it built Projects unable to cover operating expenses will also need operating assistance not eligible under HOME (but can reduce debt upfront reducing debt burden) PJ is liable for HOME investment based on the project successfully completing the entire affordability period. Subsidy is determined by measuring the gap in funds needed to undertake the project and for the project to meet the long term requirements. Projects with lower rent targets will have a harder time covering the long term operating and maintenance expenses. Subsidy layering will ensure that adequate investment has been made on the front end to create a sustainable project Some projects will not have the cash flow to support any debt service and may require some other source of operating subsidy to make them sustainable. The PJ is liable for the HOME investment based on the project successfully completing the entire affordability period. Failure to properly underwrite a project could result in the required repayment of all HOME funds.

Determining Debt and Debt. Service
Positive Cash Flow (and appropriate Debt. Service Coverage Ratio) critical to sustainability of project Reducing the need for debt (and therefore debt coverage) is appropriate way to subsidize project

Determining Debt Proposed Debt. = $429,000 Int. Rate = 8.1% Term = 25 Years Debt. Service = $40,000 Revised Int. Rate = 4.5% Debt. Service = $28, Reduction of $11,380

How Much Debt? Determine - Debt Service Coverage Ratio (DSCR)
The measure of the cash flow available to pay current debt obligations. DSCR = Net Operating Income / Total Debt Service. DSCRs should range from a minimum of: All Affordable – 1.11 Market – 1.4 + Less than these amounts means they don’t have sufficient income to pay debts Much more than these means they should take on more debt (and get less subsidy)

To Determine Debt DSCR = Net Operating Income / Total Debt Service DSCR= $45,000/$40,000 = 1.125 To determine amount avail. for debt service NOI / desired DSCR = Amt. for DS $45,000/1.125=$40,000

Subsidy Process Evaluate proposal and adjust all components for realism and accuracy Don’t forget eligibility! Apply appropriate cushions and controls Apply HOME limits & do cost allocation Negotiate Apply the correct subsidy or reject Later changes in scope or budget may require Subsidy Layering update & approval Subsidy layering is one aspect of the review require of the PJ in making a funding decision. All HOME limits and requirement along with other federal requirements must be evaluated in making a funding decision. Subsidy layering and underwriting may raise issues that will require negotiation of the project budget, sources, and unit designation to resolve. Any change in the project details may require an update to the subsidy layering process prior to finalizing commitment. Amendments that change the scope or budget of projects may also require the subsidy layering review to be updated prior to approving an amendment.

Analyze Risk Market risk What is the environment in which this project will compete? Developer risk Is our partner credible, capable, and solvent? Project risk What are the specific assumptions about cost, value, buyer funds, etc? Broader perspective also includes: Portfolio risk—concentration by type, developer, etc. Public considerations—subsidy layering & program performance Once you’ve determined the range within which you believe projects should fit and developed a process that gives you the information and documentation needed, you need to actually review that information and assess the project before you. We use words like underwriting and due diligence, but at its core, what we’re talking about is assessing and mitigating risk. Every project has some level of risk, no matter how well you underwrite, how strong your market is, or how capable your developer… things can always happen, but what we’re trying to do is limit the places we can be surprised and plan around issues we know could cause trouble. We’re going to talk about it in terms of market risk, developer risk, and project risk. These are the areas the statute calls out explicitly and where our focus is today, but let’s not forget that there are other areas we also need to take into account. Lenders also consider portfolio risk, essentially asking if we have too many eggs in one basket—too many projects with one developer, too many projects of the same type, etc. If one thing goes wrong are we in position that all of our projects are in jeopardy. And as public funders, we have make sure our assistance is not excessive, that we balance mitigating risk with not overfunding a project, that’s what subsidy layering is about, and given the reality that most of our projects involved multiple sources of public support, it’s a requirement we have meet… Finally, as part of the broader context of these statutory changes and attention that has been paid to the HOME program, we all have interest in making sure that the program performs, that we stay on top of projects, and that actively manage the bumps in the road to move projects toward completion.

Decide & Certify Document review & record decision Balance risks & mitigating factors Identify and explain waivers/exceptions to local policies and procedures IDIS Certification: “{PJ} has conducted an underwriting review, assessed developer capacity and fiscal soundness, and examined neighborhood market conditions to ensure adequate need for the project.” Who certifies? So you’ve determined the parameters, asked for the information you need to analyze the project, and determined how it fits into your local program. You need to make your funding decisions. Those will often require that you balance an identified risk with some sort of mitigating action—for example, you might have a smaller developer who has a good track record but is taking on a larger project than they’ve done before, you might limit the number of homes under construction at any given time to make sure they don’t get in over their heads. At the same time, you may find there are compelling reasons to waive one of your local policies. Perhaps you have a total development cost limit, but the project before you is asking to exceed that because the home being rehabbed is historic and requires additional funding to meet SHPO’s requirements. Whether you’re funding a project that just plain fits within the local program, you’ve made adjustments to ensure success, or you’re flexing to accommodate special features, its important that you document your analysis, that your file explains to future staff or HUD monitors why you made the decision you did, and that it demonstrates that you’ve fulfilled your obligations… Because, when you go to enter the project in IDIS, among the other certifications, you’re now also being asked to electronically raise your right and say that you have “conducted an underwriting review, assessed developer capacity and fiscal soundness, and examined neighborhood market conditions.” On that point, it’s also important to talk about who actually certifies this in IDIS. In practice, we know that the person entering the project setup in IDIS is frequently not the one responsible for making the actual funding decision. When it comes time for monitoring, the key will be that the PJs files clearly have signoffs from people who have been given the authority at the PJ level to sign off on projects. There should be a clear paper trail showing that someone with authority and with knowledge of the project and the PJ’s review of it has signed off and indicated to the IDIS person that, yes, I’m accountable for this certification, and that it’s accurate. With that introduction and overview, we’re going to take a break for a few minutes and take some questions about the statutory and regulatory background, and then we’ll talk in more detail about looking at market, developer, and project risk.

Key Elements of Underwriting
Underwriting & Subsidy Layering Key Elements of Underwriting

Underwriting & Subsidy Layering Key Elements of Underwriting Program level considerations. Understand your… Community’s housing needs, including Rental vs. owner Seniors vs. Families Supportive housing Housing costs (depth of affordability) Developer community Market Tolerance for risk Key Points – cover each of the following in brief: Community’s housing needs Supported by a housing needs assessement (formally or informally) Seniors v. Families (unit size) Supportive housing needs Depth of affordability (deep affordability to moderate) Transportation issues Neighborhood renewal considerations

Underwriting & Subsidy Layering Key Elements of Underwriting Program level considerations. Understand your… Community’s housing needs Developer community Who are the for- and non-profits capable of sponsoring deals (locally or not) Strengths and weaknesses of these partners – tap the strengths, counterbalance the weaknesses Housing priorities have to dovetail with what the development community can get done Key Points – cover each of the following in brief: Developer community Who are the for- and non-profits capable of sponsoring deals (locally or not) Strengths and weaknesses of these partners – tap the strengths, counterbalance the weaknesses Housing priorities have to dovetail with what the development community can get done

Underwriting & Subsidy Layering Key Elements of Underwriting Program level considerations. Understand your… Community’s housing needs Developer community Market is there adequate supply but inadequate quality? Will the market support the types of housing you want to support? Is there inadequate supply in certain sectors? Tolerance for risk Key Points – cover each of the following in brief: Market Condition issues – is there adequate supply but inadequate quality? Is there inadequate supply in certain sectors? Will the market support the types of housing you want to support?

Underwriting & Subsidy Layering Key Elements of Underwriting Program level considerations. Understand your… Community’s housing needs Developer community Market Tolerance for risk Construction period risk; operating finance risk; and affordability loss risk – repayment to HUD Key Points – cover each of the following in brief: Market Condition issues – is there adequate supply but inadequate quality? Is there inadequate supply in certain sectors? Will the market support the types of housing you want to support? Tolerance for risk - Construction period risk; operating finance risk; and affordability loss risk – repayment to HUD

Market Assessment Develop policies and procedures to assess and document current neighborhood market need for projects Conduct assessment to determine need for each project, including reviewing neighborhood market data before entering into legally binding agreement Resource for market analysis: Key points: The purpose of these requirements is to ensure that PJs consider whether there is adequate market demand for new (or rehabilitated) rental or homebuyer units, before committing HOME funds to a project. The nature of the market assessment is determined by the scale of the project under consideration. The market assessment for 5 in-fill rental units will be very different than that conducted for a new 200-unit rental complex. In this way, a multi-tiered approach is appropriate; not every project needs a “market study” like a large MF deal might have. Market studies and other materials may be submitted by the developer but the PJ must evaluate and determine if the justification of need for the units is valid. PJs may chose to commission market studies for their service area prior to setting their targets for funding such as prioritizing underserved areas or focusing on underserved sectors such as family units. Include in your evaluation projects in your pipeline that may not be included in a current market assessment of available unit. Accurate assessments are more critical under the new rule, because PJs are required to repay HOME funds invested in rental units that do not achieve initial occupancy within 18 months and convert or repay homebuyer units that are not sold to an eligible homebuyer within 9 months of construction completion. This is not covered in detail in this presentation; however, the webinar link above may be useful to participants until further HUD guidance is released.

Market Analysis Questions
Underwriting & Subsidy Layering Market Analysis Questions If buyers or renters haven’t been identified, is there adequate demand for the proposed units to be “absorbed” within program deadlines? In CDBG Ec. Dev., market need for project? Has the developer/administrator prepared an appropriate marketing plan? Does the unit, location, and affordability match the market demand? HOME Deadlines – Rental 18 months; homebuyer 9 months (6 months for 2012 projects) HOME program had a substantial number of units that were built across this country that are unsold or have taken an unusually long time to sell. You may have funded the projects at a time when units were selling, but by the time it was ready for the market, the market had turned. Prices were dropping, foreclosures were flooding the market, mortgages were more difficult to obtain. Some of you remain in saturated markets where it may be unwise to produce additional units. Since we don’t accomplish the goal of the HOME Program if we don’t get units into the hands of low income households, the Congress and HUD are putting the responsibility on PJs to make a judgment about the demand for the units. To certify that the PJ has “…examined neighborhood market conditions to ensure adequate need for each project”, the PJ really needs to be answer two questions: Have specific buyers been identified, and in such a case, broader analysis is not needed, but, if buyers haven’t been identified, is there adequate demand for the proposed units to be absorbed within the program deadlines – 6 months from completion for the 2012 projects? And, if buyers haven’t been identified, has the developer or program operator prepared an appropriate marketing plan to ensure that target buyers are made aware of the opportunities?

Key Points This slide is simply a guide to the section that is coming up. This section is on multi-family (rental) housing development projects.

Subsidy Layering Requirements
Underwriting & Subsidy Layering Subsidy Layering Requirements HOME Final Rule at (b) Always been required (including having SL Policy) CPD Notice provides guidance PJ must establish written guidelines Carry out prior to committing $$$ to project Certify in Consolidated Plan and now in IDIS (together with Underwriting) Subsidy layering requirements have been in place prior to the new HOME final rule and PJs are already required to have a subsidy layering policy in place. CPD Notice provides further guidance One CPD website includes the Subsidy Layering training materials from January 2011 which provide additional details. Subsidy layering along with underwriting must be carried out prior to making a commitment of HOME funds and evidenced in project file when triggered.

What is Subsidy Layering?
Underwriting & Subsidy Layering What is Subsidy Layering? Looking at project financing to: Ensure appropriate HOME and/or CDBG subsidy Make sound investments over long term Accurately project income and expenses Essentially is basic underwriting Subsidy layering is a basic underwriting to ensure that adequate HOME funds have been provided to ensure the project is sustainable but will not over subsidize the project. Subsidy layering ensures that the level of subsidy is based on need and is reasonable to the project Analysis protects the PJ from the underinvestment of HOME which can result in debt service carried by the project being too large to sustain. Under invested projects do not have the flexibility to sustain unexpected costs and may be at higher risk for failure Overinvestment of HOME funds use more public funds than are needed and reduce the ability of the PJ to address local needs. Overfunding may mean that the project is not utilizing the level of private financing that the project can support. These projects may provide a windfall for the developer with excessive cash flow. The PJ may not be able to support that their investment was cost reasonable. Operating pro-forma are projections of factors experienced by the project during the extended affordability period. Inaccurate or un-realistic projections will project unrealistic outcomes – the factors need to be reviewed and tested for validity. Subsidy layering also protects against the duplication of effort from multiple public funding sources.

When To Do Subsidy Layering
Underwriting & Subsidy Layering When To Do Subsidy Layering Required for all projects using HOME funds with other governmental assistance Not replaced by new underwriting requirements – document both All projects: Includes multifamily AND single-family projects Other governmental assistance defined broadly: Any direct or indirect assistance Federal, State or local (can sometimes use their SL analysis) Includes  Loan  Grant  Guarantee  Insurance  Payment  Rebate  Subsidy  Credit  Tax benefit Subsidy layering is not limited to multi-family projects. Any project with more than one source of public funding will require a subsidy layering analysis. Single family projects might be triggered when there are two sources of government assistance such as multiple sources of DPA or a mix of sources for development subsidy and affordability assistance Government assistance is defined as including all federal , state, and local assistance so the PJ will need to review all sources of project funding to determine if the project triggers this requirement. Subsidy layering is not replaced by the new HOME underwriting requirements – both the PJ’s underwriting process and the subsidy layering policy will need to be implemented and documented in the project file PJ can rely on layering evaluations from other agencies in some cases: LIHTC projects reviewed by State allocating agency HUD projects such as FHA Multifamily Insurance, Section 202, public housing PJ should obtain copy of that layering review

multi family Key Points This slide is simply a guide to the section that is coming up. This section is on multi-family (rental) housing development projects.

Sustainable Rental Housing
Underwriting & Subsidy Layering Sustainable Rental Housing §92.250(b): Underwriting & subsidy layering review required for ALL HOME-assisted projects. Must review each project to assess: HOME funds required Reasonable profit or return on owner investment Financial viability for entire affordability period Sources and uses Market demand for project §92.251(b)(1): Capital Needs Assessment Required when rehabbing projects with 26 or more total units (Effective January 24, 2015) Key points: Many of the changes effecting rental projects are intended to ensure that rental projects are sustainable over the entire period of affordability. Remind PJs that they need to fulfill the underwriting and subsidy layering requirements, which provides the front-end assessment of project viability and sustainability. This requirement was already covered in the “Project Evaluation” session. Note there is a new requirement for Capital Needs Assessments (CNA) when rehabilitating rental projects with 26 or more total units. The purpose of this requirement is to help ensure that HOME funds are appropriately spent on rehabilitation and that the HOME investment results in physically viable properties. If angst comes up here, may want to note that CNA requirement doesn’t apply until January 24, It will be discussed in more detail in the “Property Standards” session, and HUD will provide more training on this before implementation.

Multi-Family Underwriting & Subsidy Layering
This section: Rental developer capacity & fiscal soundness Key elements of underwriting Underwriting risk areas Key Points Briefly review the agenda for this section of the presentation.

Rental Developer Capacity & Fiscal Soundness
Underwriting & Subsidy Layering Rental Developer Capacity & Fiscal Soundness PJ must establish guidelines for examining developer’s capacity and fiscal soundness including: Experience, current staff capacity Capacity assessment varies by project size, scope, complexity and type of development entity Sufficient financial resources- develop metrics for: Liquidity Net worth Key points: As with market assessment, PJs should consider their policies in light of the size, scope, and complexity of project being funded. Staffing levels and financial resources will vary for small for-sale projects as compared to larger projects or those involving rental—skills sets are different too, sales ability vs. ongoing property management. What is level of staffing you expect to see available for projects of a given size? It may be ok for a small nonprofit to get by with a part time development manager when they’re only producing two homes a year, but what will you expect for a developer that proposes to build a dozen? Priority is on determination that the developer has the know how to do the project and the financial resources to carry it to completion if there are bumps in the road. HUD’s requirement is that PJs develop policies and procedures that make sense for your community and that you apply professional judgment. There is no specific HUD requirement that any developer seeking HOME funds has to have a minimum specified net worth, but you need to figure out the specific criteria that makes sense in your community. This criteria will need to consistently applied to projects. Consider having specific financial metrics about things like net worth and liquidity. For example, you may want a developer to have liquid assets equal to at least 10% of the total development costs, or in particularly complex situations—say a mixed-income, mixed-use master planned downtown development—you may want to see a much higher level of both net worth and liquidity.

Rental Developer Capacity
Underwriting & Subsidy Layering Rental Developer Capacity Key questions in assessing developers Assessment varies by project size, scope, complexity Type of development entity (CHDO, nonprofit, for-profit) New entities v. established developers Current workload Areas to assess: Recent, relevant experience & skills Strength: financial and organizational Key Points Types of information PJ needs to collect from rental developer applicants: When assessing developer capacity, PJ’s application kit / RFP needs to gather basic information about: PROJECT – (i.e. developer capacity in relation to project risk factors) Number of sources, complexity in getting them to work together (developmentally and operationally) Cost and size of development (all else equal, the dollar amount of the risk rises as the project size and cost increases) Market risk – deep affordability in great location is different than marginal affordability in second-rate location. DEVELOPER – Capacity in relation to the planned project Years in business, recent experience with similar deals Volume, location and type of past projects If not in-house recent, similar experience, then: Partner organizations and nature of relationship Projects currently underway by developer – not just in your PJ but anywhere: look for capacity issues and staff versus workload and skills needed. Financial backing/capacity

Development Team Fiscal Soundness
Underwriting & Subsidy Layering Development Team Fiscal Soundness Must assess team’s financial ability to complete project (development) and support project (operations) Available capital Request current financial statements with current valuation Need sufficient reserves/LOC to complete project Depends upon other obligations Depends upon size / risk factors of project Ensure stability for this project through pro-forma Key Points What to get from developers at application regarding financial status: Request financial statements from the developer to get a perspective on their current status However, developers don’t often have $ on-hand, their $ are working, they need the capacity to go get additional (e.g., where would you go if you had a $250k cost overrun? “We’ve got this line of credit at XYZ bank, we’ve never used it but it is available to us”) Depends upon other obligations Look at the developer’s existing portfolio and existing guarantees to help verify their capacity 10 properties, 8 struggling; developer is feeding them. Ask for projection of unrestricted positive or negative cash flow for all properties. Policy limiting funding to developers who cannot financially service shortfalls. Payment & Performance Bond – contractor goes bankrupt, insurer will put up the $$ to have another contractor finish the job. Completion guaranty – if development cost overruns, developer will fund them (usually you establish that they have the capacity to ‘service the gap’

Underwriting to Risk Areas
Underwriting & Subsidy Layering Underwriting to Risk Areas Sponsor Risk Market Risk HOME/CDBG Compliance Risk Design Risk Environmental Risk Revenue Risk Operating Expense Risk Capital Needs Risk Key Points The PJ’s underwriting policies will help the PJ to identify risks, evaluate risks, and mitigate (minimize the impact of) risks. Key risk areas include the following (organized roughly in the sequence in which the PJ will encounter them in the course of funding a proposed project): Sponsor Risk. Recent successful experience with similar projects in this local market? Experienced management? Sponsor financial strength? Sponsor organizational strength? Covered in discussion of Dev Capacity. Market Risk. Feasible location? Level of demand for these types of units at these rents in this location? Job growth? Population growth? Transportation-efficient site? Make sure not to confuse “need” (households with affordability problems) with “demand” (income-eligible households who can afford the rent and would want to live here). HOME Compliance Risk. For example: eligible activity, at least the minimum required number of HOME assisted units, pro forma uses the correct HOME rents (after subtracting the correct utility allowance), compliance with lead paint / Davis Bacon / other federal requirements, income-eligible tenants, lease that complies with HOME requirements. Relates to Dev Capacity: Are they capable of rental management in compliance with HOME Regs? Design Risk. Architecture fits into the neighborhood? Buildings can be constructed cost effectively? Materials will be long-lasting? Appropriate unit sizes? Appropriate number of baths / other features and amenities? Will the project meet accessibility requirements? The HOME rule requires that the PJs have written standards for rehabilitation – which the developer should be provided in advance of construction bids, to ensure that the quality of materials meet those standards. Environmental Risk. Has Environmental Review been completed? LBP? ACMs? PCBs? Fuel storage tanks (LUST)? Wetlands? Flood insurance?

Underwriting to Risk Areas (cont)
Underwriting & Subsidy Layering Underwriting to Risk Areas (cont) Cash Flow risk Risk of Inadequate Sources Subsidy Layering Risk of Additional Uses Construction Risk Developer capacity to manage process Risk of Source and Use Timing problems Lease-Up Risk Key Points Adequate Sources. Are the projected sources of funds, in total, reasonably sufficient to fund the estimated uses of funds, with appropriate cushion for contingencies? What level of cost overruns can be absorbed before there is a major problem? If there is a major problem, is it likely that the sponsor can contribute additional cash equity? The importance of the subsidy-layering analysis. The PJ must have a policy. Ensure that the project is not over-subsidized with public funds Not under-subsidized, unrealistic expectations about development costs or operating costs, inadequate cushions, high risk of failure. Adequate Uses. Are the projected uses of funds, in total, reasonably sufficient to develop and lease up a successful project, with this design, in this location? Is the proposed contingency reserve adequate? The PJ must review the construction costs for reasonableness. That might be having a 3rd party expert look over the costs, could be based on historic cost data accumulated, or maybe a rule of thumb that is proven by experience. Minimally, the PJ has to have some process.

Reviewing Others’ Underwriting
Underwriting & Subsidy Layering Reviewing Others’ Underwriting ‘Review’ does not mean ‘Substitute’ PJ must have its own standards and apply them consistently PJ must review others’ underwriting against its own standards PJ must document that it has done this review, what it has found, and what it has done about it Key Points You can look at someone else’s model. You don’t have to create your own financial analysis from scratch. You can accept other parties’ due diligence (appraisal, market study, rent comp study) You can accept other parties’ underwriting standards (required debt cover, reserves, cushions) – as long as you have explicity adopted those standards to serve as your own. What You Cannot Do: You cannot assume the modeling is correct. You should verify rents and other inputs are correct. You should verify the calculations are correct. Right amount of HOME assistance? Right number of HOME units, at the right rent limits? Development costs are reasonable, against the PJ’s standards? RISK FACTORS – You cannot assume someone else’s underwriting and funding decisions address your risk factors. f you cannot underwrite a deal, it follows that you cannot review the underwriting of others. If you cannot underwrite a deal, then relying on the underwriting of others is a substitute for your own underwriting, which is not OK. Cannot rely on others (state HFA) to ascertain that the HOME units are properly allocated in the deal. Cannot rely on the reputation of others, as a substitute for reviewing their underwriting.

Example: Rental Underwriting Standards
Underwriting & Subsidy Layering Example: Rental Underwriting Standards Sources committed and uses documented HOME affordability requirements met Pro forma shows positive cash flow thru end of affordability period Rent and Expense escalations meet standards Vacancy rate within standards Developer demonstrates financial and staff capacity Key Points Slide provides examples of rental underwriting standards a PJ might include in policy. These examples follow with earlier discussions of factors to include in project review. Additional examples and details are included in the Homebuyer and Rental materials included in the resources slide at the end of this presentation.

Exercise Review Watsonville CDBG Application #2 (Revised)
Fill out & review the: Sources & Uses Statement Simplified Annual Operating Budget Use the information provided to: Determine the Subsidy Answer the questions

HOMEOWNERSHIP Key Points This slide is simply a guide to the section that is coming up. This section is on single-family (homebuyer) housing development projects.

Sustainable Homeownership Program Design – §92.254(f)(1)
Underwriting & Subsidy Layering Sustainable Homeownership Program Design – §92.254(f)(1) Rule requires PJs to develop and follow written policies and procedures for: Underwriting homebuyer assistance Responsible lending, and Resubordination of HOME debt in the event of private debt refinancing Effective January 24, 2014 Key points: New requirements are imposed on PJs administering homebuyer assistance programs to strengthen program design and administration. The 2013 Rule adds a new paragraph §92.254(f) that requires PJs to have and follow written policies for: Underwriting Responsible lending Refinancing These requirements are discussed on the following slides. Note effective date for these policies is January 24, But PJs can implement these sooner if they are ready. HUD plans to provide guidance, training, and samples. Context if asked: final rule text uses “responsible lending” rather than “anti-predatory lending” in the text. Mostly a language change, but emphasizes that loan products should be “responsible” for the buyer’s individual circumstances. Some products that are not “predatory” per-se may not be “responsible” for a given buyer or for low income buyers in general.

Sustainable Homeownership Underwriting – §92.254(f)
Underwriting & Subsidy Layering Sustainable Homeownership Underwriting – §92.254(f) PJ must develop and follow written underwriting standards that evaluate the homebuyer regarding: Housing debt and overall debt Monthly expenses of the family Assets available to acquire housing Financial resources available to sustain housing Goal is appropriate amount of HOME assistance for each homebuyer Can’t provide flat amount of assistance to all Key points: PJs must now have written policies and procedures to evaluate a household’s ability to sustain homeownership for the long term. The PJ’s underwriting standards for homeownership assistance must address: housing debt and overall household debt, the appropriateness of the amount of assistance, recurring household expenses, assets available to acquire the housing, monthly expenses of the household, and financial resources available to the household to sustain homeownership Note that the requirements at § address underwriting a project. By contrast, these provisions are intended to underwrite the homebuyer – to ensure that the amount of assistance provided is appropriate given assets, expenses, etc., and the homeownership is sustainable. The most important point to make is that PJs can no longer run homebuyer assistance programs that provide a flat amount of assistance to all homebuyers regardless of need, or even staggered amounts based upon income bands. Each homebuyer must be underwritten individually to determine the appropriate amount of assistance.

Sustainable Homeownership Responsible Lending – §92.254(f)
Underwriting & Subsidy Layering Sustainable Homeownership Responsible Lending – §92.254(f) Rule requires written policies to ensure private mortgages obtained by homebuyers are sustainable (e.g., no predatory loans) PJ should develop standards based on loan characteristics and shouldn’t approve loans that don’t meet standards HUD will issue guidance to assist PJs in developing responsible lending guidelines Key points: The PJ must have a standards for private mortgages that protect HOME-assisted homebuyers from predatory lending. PJs must examine the terms and conditions of private mortgages obtained by HOME-assisted homebuyers and determine whether those terms are compatible with sustained homeownership. PJs should develop standards for the characteristics of loans they are willing to subordinate to.

Single-Family Underwriting & Subsidy Layering
Section covers: Market assessment Homebuyer developer capacity Underwriting – two step process Development Homebuyer Key Points Briefly review the agenda for this section of the presentation.

Market Assessment Up to the PJ if an independent market study is required, but at minimum developer must demonstrate understanding of the market: Market trends – What are the general housing and economic trends in the local market? Demand – Who do they seek to serve, where will buyers come from, and how many fit the profile? Supply – What products fit their needs and how do the proposed units compare? Key Points As noted, independent market studies aren’t always necessary, as long as the developer and PJ have a good enough understanding of market conditions – market trends, demand and supply. Note that the PJ could also contract out the market analysis, or underwriting in general, or review the market analysis of another funder. In either case, the PJ is ultimately responsible for the certification, and it needs to have a written agreement with any third parties that conduct these reviews on behalf of the PJ. Require developers to submit data that show that their proposed units will be competitive in the current market: Market trends – What are the general housing and economic trends in the local market? Demand – Who do they seek to serve, where will buyers come from, and how many fit the profile? Supply – What products fit their needs and how do the proposed units compare? Finally, while the focus today is on project underwriting, we should also point out that a solid understanding of your local market informs your overall program design. Thinking through what kind of market you’re in, for example, helps determine how you structure your homebuyer assistance—will projects be resale or recapture, will you forgive assistance over time or expect repayment. These policy decisions should be informed by your market and can have an impact on how marketable the product you’re funding will be when it comes time to sell.

Homebuyer Developer Capacity
Underwriting & Subsidy Layering Homebuyer Developer Capacity Two elements: Developer capacity – experience, current capability and team; AND Fiscal soundness – financial resources to pull it off Capacity assessment varies by: Project – size, scope, complexity Type of development entity: CHDO, for-profits, etc. Key Points There are two prongs to this test that you are going to need to think through. You’re asking if the developer has the experience and current capability and the team around them to successfully complete the proposed project. I think it’s worth emphasizing the “current” capacity. Additionally, you need to determine that the developer is fiscally sound… do they have the financial wherewithal to get the project done—the cash needed to complete predevelopment work, to buffer for delays in obtaining reimbursements or construction loan draws, and the resources to keep their staff in place if developer fees or other income are delayed. The point is that all the know-how in the world isn’t going to keep a project afloat if the developer goes bankrupt midway through construction. In all of this though, HUD recognizes—and expects your local policies and procedures to reflect—you are assessing the developer in the context of the project being proposed, not against a one-size fits all set of standards. The size, scope, and complexity of the project will drive your assessment about developer capacity—what you expect from a developer is going to be quite different if they’re proposing a 20 unit subdivision as compared to a local Habitat chapter that is seeking funding for two infill units. We also need to make decisions based on the type of developer such as CHDOs, forprofits, etc.

Homebuyer Developer Capacity (cont)
Underwriting & Subsidy Layering Homebuyer Developer Capacity (cont) Application should demonstrate full understanding of the work and challenges Resumes list experience, but not results – check references Review the current project load & status Look for projects in trouble Team should collectively have skills, and previous experience as team is preferred Key Points In that context, what are some the more specific things you want to look at during your review. Well, does the developer’s application or project proposal demonstrate a working knowledge of real estate development? Particularly in the context of HOME rules and cross-cutting federal requirements? Does everything hold together and make sense? Resumes list experience not results Consider what else in on the developer’s plate. Most of us have seen examples of developers who did a project and did it well and translated that success into taking on too many or too large a project the next time out and ended up going out of business or at least through a painful retrenchment. We want to avoid blowing up our partners, and looking at their whole portfolio of current work is part of that. It’s also instructive to look how they have handled trouble projects. Not just because we don’t want to have a current problem in the developer’s portfolio threaten their ability to do the project we’re about to fund, but how a developer has handled previous troubles can help show how they might handle unexpected bumps in the road on our project. You should be looking at the overall development team. Has the developer assembled a competent development team been? Does this supporting cast, on the whole, have the skills needed to complete the development, and do their individual strengths help mitigate areas where the developer may need some extra help? When it comes down to it, capacity is really about people more so than organizations. So it’s really important that within the organizational assessment, you understand who specifically is doing the work and assessing their track record and skill set. Finally, as Monte mentioned a few minutes ago, we need to note the 6 month deadline for sales here even though that’s not the primary topic of today’s session. You want to pay particular attention to the developer’s ability to move the homes within the 6 month (or 9 month) window, and it’s going to be necessary in some cases to simultaneously think about whether or not this developer has the wherewithal to manage the homes you’re funding as rentals if the sales don’t happen in the appropriate timeframe. As we’ll talk about in next week’s webinar that’s a tricky issue since developing for-sale housing and managing affordable rentals over time require some very different skills sets.

Developer Fiscal Soundness
Underwriting & Subsidy Layering Developer Fiscal Soundness Net worth – Developers should not owe more than they own Portfolio risks – Past developments should not be a current drain on the developer Pre-development funding – Developer needs to “front” cash for costs before closing Liquidity – Developer needs enough cash to pay the bills Key Points In terms of the fiscal soundness, there are a lot of fancy metrics that commercial lenders and financial professionals might use, but the key things you’re really looking for in the financial statements and audits include: Net worth—the developer shouldn’t owe more than they own. The current performance of the developer’s other projects, are they going to diminish the capacity to devote dollars to this project? And there’s the old maxim that it takes money to make money. You want to be sure the developer has enough cash on hand to cover predevelopment expenses—including their own operating costs—until the project can close and move forward. And once the project is underway, the developer still needs to have cash available to pay bills while waiting for reimbursement from HOME or other funding sources in the transaction or to deal with unexpected expenses that come up in the course of the project.

Underwriting: Development
Underwriting & Subsidy Layering Underwriting: Development Evaluate development budget for: Cost reasonableness, but Adequate to build competitive product, effectively market, and margin to cover unexpected costs Reasonable developer fees Adequate financing HOME/CDBG funds needed for development are reasonable Sales prices and projections are reasonable (and units can be sold within 9 months) Key Points Certainly budget review is a big part of the analysis: Are all costs and line items reasonable and necessary? Are improvements sufficient to make the product competitive? And does the budget include provisions for marketing and potential unanticipated costs? Are developer fees reasonable for the work and risks involved? Are the non-HOME financing sources committed? Are the HOME funds to assist the development necessary, reasonable and sufficient to ensure project completion? And are the sales projections reasonable in terms of pricing, timing and costs of sale? Please keep in mind that another requirement requires units to be sold within 6 months of completion, or the unit must be converted to affordable rental. We’ll address that in the next seminar.

Underwriting: Development (cont)
Underwriting & Subsidy Layering Underwriting: Development (cont) What property features balance marketability, sustainability, but still modest housing? Developer fees – amount & timing Soft costs – which are itemized, which paid from developer fee Key Points Some of the key policy decisions you’re going to need to make about the development end of transactions includes: What property standards and physical improvements ensure homes are marketable, but also sustainable or maintainable, while staying within the overall concept of “modest housing”; How much developer fee is appropriate, and when will you pay it out—recognizing that many of developers need income during the project to keep the doors open yet wanting to create both an incentive for performance and an additional contingency if things don’t work out; and Which soft costs are acceptable, reasonable, and allowed locally vs. which you might want to make the developer’s responsibility so that they have to manage the risk

Underwriting: Homebuyer
Underwriting & Subsidy Layering Underwriting: Homebuyer Four “C’s” of Buyer Underwriting Lender Metrics Credit Credit score Capacity Front/back ratios Capital Downpayment & after closing Collateral LTV Key Points While good homebuyer counseling helps buyers to avoid unattractive loans, the PJ must exercise due diligence in making certain that bad or risky first mortgages do not get ahead of the HOME debt. Most lenders underwrite loans considering a range of factors that the industry tends to refer to as “the 4 C’s” – credit, capacity, capital and collateral. Credit is reflected in the credit score. Capacity to carry the loan is determined by the front ratio – the ratio of housing cost, or PITI, to income – and the back ratio – the ratio of housing cost and other debt to income. While lenders have been more conservative in recent years, some lending still occurs on ratios that are too high and risky for our low income buyers. Capital refers primarily to downpayment, and most HOME programs recognize that it is important for the buyer to be able to provide some downpayment, mostly as an expression of commitment to homeownership and the ability to save for future ownership costs such as maintenance. But PJs might also want to make certain that buyers have some post-closing cash to deal with moving, furnishing and maintenance costs. Collateral refers to the house and how its value protects the loan, reflected in the loan-to-value calculation. Again, lenders have become more conservative of late, but PJs need to avoid excessive LTV first mortgages. PJs either need to plan to review every first mortgage, or develop written standards for its partners – subrecipients, CHDOs, etc. – to review the mortgages and make certain that risky or excessive first mortgages do not threaten the buyer’s home and the program’s junior lien.

Underwriting: Homebuyer (cont)
Underwriting & Subsidy Layering Underwriting: Homebuyer (cont) PJs need to determine assistance amount is reasonable Vary assistance by price and income levels Apply minimum front ratios Key Points Ultimately, the amount of buyer assistance is an important determination. Recent monitoring of the HOME program has raised questions about how PJs and their partners determine the amount of assistance to each buyer. It must reflect what is necessary and appropriate for the family and their purchase, and should not be a “one size fits all” assistance amount. Most PJs are using the recapture method, which permits sale of the home at fair market value, and allows separation of development subsidy, or excess development costs over fair market value, from the buyer subsidy, which is the amount of funds which help the buyer to purchase, whether the funds are second mortgages, mortgage buydowns, price reductions or downpayment assistance. PJs want to make certain that the home is fairly priced for the buyer but supportive of the market, so selling at fair market value with larger buyer subsidy amounts is preferable to price reductions, which hurt overall neighborhood values. Review of the lender appraisal helps to verify that. But PJs also need to make certain that the buyer assistance amount is reasonable given the price, the buyer’s income and the ability to secure a mortgage. Providing your partners with a “scale” of assistance amounts and the application of minimum front ratios help to make that determination. Note that how buyer assistance and development subsidy are treated later varies between resale and recapture.

Underwriting: Homebuyer (cont)
Underwriting & Subsidy Layering Underwriting: Homebuyer (cont) What are acceptable (and unacceptable) 1st mortgage terms? How should buyer subsidy amount be determined? Front/back ratios—floor and ceiling Buyer cash investment—min. & post-closing cash Range of buyer assistance amounts Key Points Ultimately, good buyer underwriting is built on PJ policies help to define what is reasonable in terms of: What first mortgages and terms are acceptable as loans that get in front of your HOME investment; and What levels of assistance are reasonable given varying prices, incomes and the ability of homebuyers to secure a mortgage, and using such things as minimum front ratios, downpayment and post-closing cash requirements and ranges of permitted assistance amounts.

Homeownership Value Limits – §92.254(a)(2)(iii)
Underwriting & Subsidy Layering Homeownership Value Limits – §92.254(a)(2)(iii) HOME statute requires initial purchase price/after rehab value not to exceed 95% of area median purchase price Continued use of 203(b) FHA Single Family Mortgage Limit would violate statute; new rule eliminates use of 203(b) in HOME Key points: PJs are no longer permitted to use the FHA 203(b) limit as a surrogate for 95 percent of area median purchase price. Statutory changes to the 203(b) statute over time increased the FHA Section 203(b) floor rendering the Section 203(b) limits an inappropriate surrogate for 95 percent of area median purchase price required by the HOME statute. HUD issued interim guidance in 2008 that permitted PJs to use the pre-Economic Stimulus single family mortgage limits as a measure of 95% of median purchase price until the regulatory changes issued by this new rule could be promulgated.

Conversion of Unsold Homebuyer Units – §92.254(a)(3) (cont.)
Underwriting & Subsidy Layering Conversion of Unsold Homebuyer Units – §92.254(a)(3) (cont.) Unsold HOME units must be converted to HOME rental units for the rental affordability period, or HOME funds must be repaid Units can become lease-purchase only if: PJ has an established lease-purchase program, AND Agreement with homebuyer executed before deadline Key points: HUD is requiring PJs to carefully consider projected demand for homebuyer housing (i.e., market assessment) and the availability of private mortgage financing for low-income homebuyers. Consequently, the rule requires a PJ that does not have a ratified sales contract with an eligible homebuyer within 9 months of a project’s construction completion, to convert the unit to rental housing in accordance with § It must remain rental for the duration of the applicable period of affordability. Note: when a unit is converted from homebuyer to rental, it must marked as “complete” in IDIS (as required by the Definition of Completion). PJs have 18 months from this point to meet the 18 month rental occupancy deadline (since the clock on the 18-month occupancy deadline starts at project completion. If an unsold homebuyer unit is not converted to rental housing, the PJ must repay the HOME funds expended on it. Well designed lease-purchase programs that include strong management, tenant support, and housing counseling can help PJs identify qualified lease-purchase tenants to rent/acquire unsold homebuyer units. However, only PJ’s with existing lease-purchase programs (must be in Action Plan) can place unsold units in a lease-purchase program. An executed lease-purchase agreement must be executed before the 9 month deadline.

Example Homebuyer Underwriting Standards
Underwriting & Subsidy Layering Example Homebuyer Underwriting Standards Front end ratio capped 35% Back end ratio capped at 42% Liquid assets not committed to purchase capped at $5,000 Purchase price at or below 95% value Minimum cash contribution Fixed rate, 30 year mortgage Key Points Review a sample SF underwriting for a project and demonstrate how subsidy layering works. Review both the development and homebuyer phases.

resources Key Points This slide is simply a guide to the section that is coming up. This section is on resources that are currently available, the HUDExchange website, and upcoming HOME guidance.

Resources HUD Exchange - HOME & CDBG sites Single Family Webinar HOME 2012 Requirements Multi-Family Webinar HOME 2012 Requirements Key Points Review the HOME mini site on the hudexchange website. Please let them know the presentation leaned two prior webinars on this topic, but updated for 2013 HOME Final Rule requirements; however, the recording/transcript might be helpful to them.

Resources Recent guidance: HOME Requirements for Developing HOME Underwriting Guidelines: CDBG, when developed, likely to be similar Key Points Review the HOME mini site on the hudexchange website. Please let them know the presentation leaned two prior webinars on this topic, but updated for 2013 HOME Final Rule requirements; however, the recording/transcript might be helpful to them.

Resources (cont) Recent guidance HOME Multi-unit Cost allocation notice Revises the former notice 98-02 Key Points A series of HUD notices will be published on this topic over the next several months. To be sure you receive the latest guidance, please make sure you are registered on the “mailing list” on

Resources (cont) Other training and TA products related to underwriting Sign up for HUDExchange mailing list, e.g., indicate both CDBG and HOME as an interest area: Key Points A series of HUD notices will be published on this topic over the next several months. To be sure you receive the latest guidance, please make sure you are registered on the “mailing list” on

CDBG/HOME Underwriting Washington, D.C. February 15, 2017

Similar presentations

Presentation on theme: "CDBG/HOME Underwriting Washington, D.C. February 15, 2017"— Presentation transcript:

Similar presentations

About project

Feedback

Log in

Auth with social network:

CDBG/HOME Underwriting Washington, D.C. February 15, 2017

Similar presentations

Presentation on theme: "CDBG/HOME Underwriting Washington, D.C. February 15, 2017"— Presentation transcript:

Similar presentations

About project

Feedback