Case Study: Disposition of a Year 15 Property

2012 North Carolina Affordable Housing Conference

Presented by:Jeff Carroll, PresidentAllen & Associates Consulting, Inc.3116 Glen Summit DriveCharlotte, North Carolina 28270Phone: 704-905-2276 | Fax: 704-220-0470E-Mail: jcarroll@allenadvisors.com

Introduction

Allen & Associates Consulting is a multi-disciplinary consulting firm specializing in affordable housing. Our practice areas include development consulting, property dispositions, valuation & market feasibility work, and engineering assignments (including capital needs assessments & utility studies).

The purpose of this presentation is to demonstrate how Allen & Associates might assist you in the disposition of your Year 15 property.

This presentation is based on an actual disposition we were recently engaged to handle.

The Problem

The owner of a HUD-subsidized Year 15 tax credit property located in Portsmouth, Virginia was thinking about selling.

He received an offer for $1 million, but felt the property could be sold for $2 million.

He asked Allen & Associates to assist him in the disposition of his property.

Our efforts brought him $5.2 million.

The Property

The property included 134 HUD-subsidized units which were originally constructed in 1978.

It was renovated in 1990 with tax credits and had completed its initial 15-year compliance period.

The property included 2, 3 and 4 bedroom units.

Type Units Rent

2BR/1.0BA 68 $582

3BR/1.5BA 50 $760

4BR/2.0BA 16 $813

Total/Average 134 $676

The HAP contract for the property was up for renewal. Here’s where the contract rents stood at the time:

Minimum Sales Price

The owner needed at least $3.1 million for this property:

◦ The property included $2.6 million in assumable debt which could not be prepaid.

◦ The property included $0.2 million due to the general partners.

◦ The partnership needed to yield approximately $0.3 million on the sale to cover exit taxes.

Clearly, the $1 million offer would not do. And the $2 million the owner was willing to accept would not be enough, either.

Traditional Methodology

The traditional method for valuing Year 15 properties is to apply an “as is” capitalization rate to the “as is” net operating income.

This approach, which has some significant shortcomings, is presented below:

Historic $/Unit Pro Forma

2005 2006 2007 $/Unit $

Effective Gross Income $7,621 $7,701 $7,780 $7,850 $1,051,900

Total Operating Expenses $4,951 $5,325 $5,069 $5,250 $703,500

Net Operating Income $2,670 $2,376 $2,711 $2,600 $348,400

Capitalization Rate 9.75% 9.75%

“As Is” Value $26,667 $3,573,000

Flaws in The Traditional Methodology

The traditional methodology does not evaluate how much a property could be sold for, assuming tax credits are used for renovation. The traditional methodology does not consider the following:

◦ Income capitalization assumes that a property is operated in its current “as is” condition indefinitely. If sold for renovation, this is not so.

◦ The traditional methodology fails to recognize upward rent potential by virtue of renovation. This can be significant for many properties.

◦ The traditional methodology fails to recognize potential reductions in operating expenses by virtue of renovation:

Reconfiguring Utilities: Passing electric, water & sewer through to residents. Energy Efficiency: Installing new appliances, doors, windows, and HVAC systems. Replacement Reserves: Major renovation typically results in reduced reserve requirements.

◦ The traditional methodology fails to account for the availability of tax credits associated with properties located in QCTs or DDAs.

◦ The traditional methodology fails to account for the availability of tax credits associated with properties found on the historic register.

Our Approach

Here’s what we did instead:

◦ Step 1: Establish a Scope of Renovation◦ Step 2: Derive a Renovation Cost Estimate◦ Step 3: Evaluate the Utility Configuration ◦ Step 4: Establish Post-Renovation Rents ◦ Step 5: Establish Post-Renovation Operating Expenses◦ Step 6: Estimate Post-Renovation Debt Capacity◦ Step 7: Estimate Available Renovation Tax Credit Equity◦ Step 8: Estimate the Value of the Property◦ Step 9: Identify a Developer to Purchase the Project◦ Step 10: Work with Developer to Close the Transaction

Note: Because our goal is to maximize sales proceeds to the Seller, we are paid by the Buyer at closing. If the transaction does not close, we do not get paid.

Step 1: Establish a Scope of Renovation

In the course of establishing a scope of work for this project, we conducted a unit-by-unit inspection of the property to evaluate the following site improvements & building systems:

Site ImprovementsTopography

Storm Water DrainageIngress & EgressPaving, Curbing & ParkingSidewalks & PatiosLandscapingRecreational FacilitiesUtilities

EnvironmentalOffsite

Improvements

Building SystemsFoundationStructural FrameExterior WallsRoofPlumbingHVACElectricalVertical

TransportationLife SafetyInterior FinishesADA Requirements

Step 2: Derive a Renovation Cost Estimate

Next, we developed a renovation cost budget for the subject property based on our scope of work:

$ $/Unit

Site Improvements $416,000 $3,104

Building Systems $4,476,592 $33,407

General Requirements $293,555 $2,191

Builder Overhead $97,851 $730

Builder Profit $293,555 $2,191

Bonding Fee $50,198 $375

Renovation Cost $5,627,751 $41,998

Step 3: Evaluate the Utility Configuration

Next, we evaluated the configuration of tenant-paid utilities for the subject property and established post-renovation utility allowances.

Establishing post-renovation utility allowances is an essential step in evaluating achievable rents for (and, consequently, the value of) tax credit properties:

Utility / SourcePre-

RehabPost-Rehab

Heat/Gas No No

Heat/Electric Yes Yes

Cooking/Gas No No

Cooking/Electric Yes Yes

Other Electric Yes Yes

AC/Electric Yes Yes

Hot Water/Gas No No

Hot Water/Electric Yes Yes

Water No Yes

Sewer No Yes

Trash No No

Utility Allowance / Unit Type

Pre-Rehab

Post-Rehab

2-Bedroom $82 $100

3-Bedroom $98 $128

4-Bedroom $108 $143

Step 4: Establish Post-Renovation Rents

Next, we established post-renovation achievable rents for the subject property.

Achievable rents are defined as the lesser of market or program rents (net of utility allowances). Market rents reflect the pricing for similar properties in the marketplace.

Our concluded rents reflected the post-renovation condition and utility configuration (water & sewer passed through to the residents) for the subject.

Establishing post-renovation achievable rents is an essential step in evaluating the “as is” value of a property being sold subject to renovation with tax credits:

Unit Type Units $/Unit $

2BR/1.0BA 68 $650 $530,400

3BR/1.5BA 50 $825 $495,000

4BR/2.0BA 16 $925 $177,600

Total/Average 134 $748 $1,203,000

Step 5: Establish Post-Renovation Operating Expenses

Next, we established post-renovation operating expenses for the subject property.

Our analysis, which included the compilation of operating expenses for comparable properties in the area, accounted for the new utility configuration (water & sewer passed through to the residents) for the subject property:

Comparable $/Unit Pro Forma

#1 #2 #3 $/Unit $

Maintenance & Operating $1,369 $1,794 $968 $1,751 $234,610

Utilities $586 $637 $457 $441 $59,129

Administrative $1,449 $1,416 $1,270 $1,268 $169,895

Taxes & Insurance $724 $691 $702 $862 $115,452

Replacement Reserves $300 $300 $300 $300 $40,200

Total Operating Expenses $4,427 $4,499 $3,697 $4,622 $619,286

Step 6: Estimate Post-Renovation Debt Capacity

Debt Capacity

Gross Potential Rent $1,203,000

Other Income $17,472

Vacancy & Collection Loss $48,819

Total Operating Expenses $619,286

Net Operating Income $552,367

Debt Coverage Ratio 1.15

Debt Service, Total $480,319

Debt Service, Assumed Debt $337,540

Debt Service, Additional Debt $142,779

Next, we determined the amount of debt which could be placed on the subject property after renovation. Our estimates, which reflect the terms of the assumed debt and market interest rates at the time of this transaction, are found below:

Assumed Debt

Debt Service, Assumed Debt $337,540

Loan Constant, Assumed Debt 0.1263

Loan Amount, Assumed Debt $2,672,820

Additional Debt

Debt Service, Additional Debt $142,779

Loan Constant, Additional Debt 0.0816

Loan Amount, Additional Debt $1,749,742

Step 7: Estimate Available Renovation Tax Credit Equity

$ $/Unit

Renovation Cost $5,627,751 $41,998

Soft Costs $1,848,057 $13,791

Developer Fee $1,569,000 $11,709

Subtotal $9,044,808 $67,499

Ineligible Costs $924,029 $6,896

Eligible Basis $8,120,780 $60,603

Basis Boost (30% for QCT) $2,436,234 $18,181

Qualified Basis $10,557,013 $78,784

Applicable Percentage Rate 9.00% 9.00%

Annual Tax Credit $950,131 $7,091

Tax Credit Recovery Period 10 10

Total Tax Credit $9,501,312 $70,905

Equity Pricing $0.90 $0.90

Equity, Renovation Tax Credit $8,551,181 $63,815

Next, we estimated the available renovation tax credit equity associated with this transaction.

Our estimate included a detailed soft cost budget, estimated developer fees, and an estimate of ineligible costs.

Our estimate also accounted for a 30% basis boost because the subject property is located in a Qualified Census Tract.

Finally, our estimate reflected the published APR and tax credit equity pricing at the time of this transaction.

Step 8: Estimate the Value of the Property

Value Estimate $ $/Unit

Loan Amount, Assumed Debt $2,672,820 $19,946

Loan Amount, Additional Debt $1,749,742 $13,058

Equity, Renovation Tax Credit $8,551,181 $63,815

Equity, Acquisition Tax Credit $1,376,819 $10,275

Sources of Funds $14,350,562 $107,094

Renovation Cost $5,627,751 $41,998

Soft Costs $1,848,057 $13,791

Developer Fee $1,569,000 $11,709

Value, Subject to TC Renovation $5,305,754 $39,595

Acquisition Equity Estimate $ $/Unit

Value, Subject to TC Renovation $5,305,754 $39,595

Value, Land $670,000 $5,000

Qualified Basis $4,635,754 $34,595

Applicable Percentage Rate 3.30% 3.30%

Annual Tax Credit $152,980 $1,142

Tax Credit Recovery Period 10 10

Total Tax Credit $1,529,799 $11,416

Equity Pricing $0.90 $0.90

Equity, Acquisition Tax Credit $1,376,819 $10,275

Next, we estimated the value of the property, subject to renovation with tax credits. We began by estimating the sources of funds available for this project. This included the assumed debt, the additional debt, and the renovation tax credit equity discussed previously. From total sources we deducted renovation costs, soft costs, and developer fees to arrive at a value estimate for the property.

It is important to note that the total sources of funds also included an estimate of the acquisition tax credit available for this project. The acquisition tax credit is a function of the value of the property, however, and vice versa. Consequently, we set up an iterative routine and converged on the final concluded acquisition tax credit and property values found below:

Step 9: Identify a Developer to Purchase the Project

Next, we identified a qualified developer to purchase and renovate the subject property with tax credits.

Because our practice is national in scope, we have earned the trust of developers throughout the country. Since 2000, we have worked on over 2500 transactions with over 200 developers in 41 states.

We ended up recommending a successful regional for-profit developer with in-house management who specializes in tax credit renovation projects.

We provided our underwriting to the developer, who immediately expressed an interest in the property. Within one week, the developer provided a $5.2 million offer to the owner, pending receipt of tax credits for renovation.

Step 10: Work with Developerto Close the Transaction

Finally, we worked with the developer to close the transaction. In the course of doing so, we assisted with the following:

Putting together the tax credit application Compiling third-party reports including:

◦ Scope of Work◦ Capital Needs Assessment◦ Energy Study◦ Market Study◦ Rent Comparability Study◦ Appraisal

Reviewing third-party reports including:◦ Survey◦ Title Work◦ Phase I Environmental Assessment◦ Accessibility Study

Identification of debt and equity sources

The project was awarded tax credits and sold for $5.2 million later that year, and we were paid by the buyer/developer for our work.

We valued the property at $5.3 million for the owner, who was initially willing to sell the property for $2.0 million. Clearly, this was an excellent outcome for everyone.

Qualifications

Jeff Carroll, President of Allen & Associates Consulting, is a certified general appraiser, licensed to appraise real estate in the states of Alabama, Delaware, Florida, Georgia, Kentucky, North Carolina, South Carolina, Tennessee, Texas, Virginia and West Virginia. Mr. Carroll, an associate member of the Appraisal Institute, is currently completing the requirements necessary to obtain the MAI designation.

Mr. Carroll is a member of the National Council of Affordable Housing Market Analysts, where he previously served on the Executive Committee and chaired the Data and Ethics Committees. Mr. Carroll has successfully completed the NCAHMA peer review process. Mr. Carroll has also served as a market study reviewer for the Georgia and Michigan housing finance agencies.

Mr. Carroll has written articles on affordable housing, development, property management, market feasibility, and financial analysis for Urban Land magazine, The Journal of Property Management, Community Management magazine, Merchandiser magazine, HousingThink, and a publication of the Texas A&M Real Estate Research Center known as Terra Grande.

Mr. Carroll has conducted seminars on affordable housing, development, property management, market feasibility, and financial analysis for the American Planning Association, Community Management magazine, the Georgia Department of Community Affairs, the Manufactured Housing Institute, the National Association of State and Local Equity Funds, the Virginia Community Development Corporation, and the National Council of Affordable Housing Market Analysts.

Mr. Carroll is also an experienced developer and property manager. His experience includes the development of tax credit and bond financed apartment communities, conventional market rate apartments, manufactured home communities, and single family subdivisions. He has also managed a portfolio of apartment complexes and manufactured home communities.

Mr. Carroll received his Bachelor’s Degree in Engineering from Clemson University and his Master’s Degree in Business Administration from Harvard University.