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How Does Your Development “Measure Up”?
Using AHIC Risk Rating Guidelines to Grade LIHTC Projectspresented by:
Vinnie Viola, MPA, HCCP, Principal
Birch Island Real Estate Consulting, LLC
Wednesday, May 17, 2017
Birch Island Real Estate Consulting, LLC www.birchislandrec.com
25 Collamore Street (617) 905-6340
Milton, MA 02186
PRINT THIS HANDOUT IN COLOR LANDSCAPE ORIENTATION
About the Real ‘Birch Island’
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Agenda•Overview of Affordable Housing Investors Council
•Development Phase Risk Rating Criteria
• Stabilized Phase Risk Rating Criteria
• Risk Rating Exercise – Island View Apartments, LP
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AHIC issued modified risk rating guidelines in April 2017.
Modifications are indicated throughout this presentation in red text.
About Affordable Housing Investors Council
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www.AHIC.org
AHIC Background
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• Non-profit group formed in 1995
• 25 founding corporations include USAA, Chrysler Capital and FNMA
• Members invest in affordable housing by purchasing federal tax credits
• Standardized formats for reporting, watch list issues and risk ratings
• Influenced multifamily underwriting and asset management best practices
Today’s Member’s Include…
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• AEGON USA
• Bank of America
• BMO Harris Bank B.A.
• Capital One
• Citi Community Capital
• Comerica Bank
• Discover
• Fifth Third CDC
• HSBC Bank
• JP Morgan CC
• MetLife
• Mutual of Omaha
• Nationwide
• New York Life
• RBS Citizens
• Regions Bank
• Silicon Valley Bank
• State Street Bank & Trust
• SunTrust CC
• TD Bank, N.A.
• U.S. Bank CDC
• Wells Fargo Bank
AHIC as a Risk Monitoring Tool
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• Industry stakeholders use AHIC guidelines to RISK RATE projects
• OVERALL grade: A, B, C, D or F
• Projects rated ‘C’ or less should likely be added to ‘watch list’ status
• Ratings typically reported to investors quarterly, but no less than annually
(SHOW OF HANDS)
• AFFORDABLE HOUSING PROPERTY DATABASE REPORTING FORMAT
(issued 04/2017)
What Are We Risk Rating with AHIC?
8
Tax Credit Fund
Investor Limited Partner
Limited Partnership* that
owns LIHTC Project
Capital inGeneral Partner
DeveloperManagement
Agent
Tax
benefits out
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Overall Risk Rating
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A - Excellent Performing as projected
B - Average Stable, slightly underperforming vs original projection
C - Weak
a) Unlikely to meet original projections; with two or more risk rate
issues... b) Any one issue, DSC, Occupancy, Compliance, Recapture or
Construction/Lease-Up a e suffi ie t to a a t C , watch list
D - Moderate RiskC edits a e at isk ith sig ifi a t isk of e aptu e;…e hi its th ee o
o e isk issues… e ui es i te se o e sight
F - Significant Risk Recapture is imminent
AHIC Life Cycle Phases
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Standardized reporting for two distinct lifecycle phases
Development 8 Risk Rating Categories
Stabilized 10 Risk Rating Categories
Transition from Development to Stabilized Phase
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• Development phase monitoring starts with partnership closing
• When construction loan is paid off or paid down at Permanent Mortgage Commencement, AHIC transitions to Stabilized phase
• Stabilized guidelines continue for year-15 federal Compliance Period
Development Phase
LP Closing
Transition Period Stabilized Phase
PMC
Year 15+
Construction
Completion /
100% QO
Transition from Development to Stabilized Phase
Development Phase Risk Rating Criteria
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Development Phase
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1.Construction / Lease-Up
2.Financial
3.Construction Loan
4.Permanent Loan
5.Program Compliance
6.General Contractor
7.GP/Sponsor/Developer/Management
8.Recapture
1. Construction and Lease-Up (C/LU)
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Delays can result in….• Variance in first-year tax credit dollar amount
• Reduction in investor capital contribution amount with timing and/or basis adjusters
• Potential reduction in cash developer fee
• Failure to meet the statutory place in service deadline
• Failure to meet statutory minimum set-aside deadline
=$
Critical Deadlines for Typical 9% LIHTC Project
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2016 2017 2018 2019
1. Construction and Lease-Up (C/LU)
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A
B
C
D
F
C/LU on or ahead of schedule
C/LU delayed > 30 days (was 60 days)
Estimated C/LU completion delayed > 90 days
a) Construction stopped. b) LU stopped prior to 100% Qualified Occupancy. For a
and/or b, GP/Guarantor unable to remediate. c) Mechanics liens filed and not
satisfied within 30 days
Estimated C/LU completion delayed > 180 days
Construction Schedule Examples
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AHEAD OF SCHEDULE BEHIND SCHEDULE
Calculate Actual from AIA G702/G703
2. Financial (health of the project)
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A
B
C
D
F
a) Sources / Uses (S/U) in balance. b) Cost overruns / change orders (C/CO) < 5% of
original contract, with funds to cover the gap
a) S/U out of balance 5-10%, with funds to cover gap. b) C/CO between 5-10% of
original contract, with sufficient funds to cover gap.
a) S/U out of balance 10-15%, with funds to cover gap. b) C/CO between 10-15% of
original contract, with sufficient funds to cover gap.
a) S/U out of balance 15-20%, with no funds to cover gap. b) C/CO between 15-20%
of original contract, with no funds to cover gap.
a) S/U out of balance > 20%, with no funds to cover gap. b) C/CO > 20% of original
contract, with no funds to cover gap.
3 Construction Loan
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A
B
C
D
F
Anticipated to be paid down according to original projections (underwriting)
Not expected to convert by original maturity date, but extension secured.
Not expected to convert by 1st extension; 2nd extension is being pursued.
a) Not expected to be paid down by any agreed upon extension. b) Debt restructure
needed or in process
a) Risk of foreclosure. b) Expired letter of credit
4. Permanent Loan
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A
B
C
D
F
Conversion on track with original projections.
Conversion delayed no more than 3 months from original projection.
a) Conversion delayed 6 months or more from original projection; conversion may
be in jeopardy. b) Notice of default has been issued.
a) Conversion delayed in excess of one years from original projection. b) Original loan
terms have unfavorable modifications.
a) Source of loan is lost and other source has been identified. b) Conversion gap
with no funds to cover shortfall.
5. Program Compliance
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A
B
C
D
F
a) Property projected to be complete by Place in Service Deadline or has a Carryover
Extension from the Housing Credit Agency (HCA). b) No material compliance issues.
Co e ta le o plia e issues ith o fi a ial i pa t.
a) Form(s) 8609 delayed. b) Meeting Minimum Set-Aside a concern. c) Material non-
compliance w/issuance of Forms 8823. d) Annual compliance certification not
submitted to HCA. e) Potential 2/3rds credits for 10% or more of units.
a) Property not expected to meet PIS deadline; delivery of credits is at risk. b)
Unresolved 8823s.
a) Property will not meet PIS deadline. b) Loss or recapture of ALL tax credits. c)
Property will not meet Minimum Set-Aside deadline. c) Expected lost of credits due
to uncorrectable 8823s
6. General Contractor
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A
B
C
D
F
GC in place and construction is on schedule with original projections.
GC has been removed, but a replacement GC is in place; construction remains on
schedule with original projections.
a) General Contractor is not performing and has not been removed. GC has been
removed for 30+ days and replacement GC has not been identified.
GC has been removed for 60+ days and a replacement GC has not been identified.
a) Significant misappropriation of funds. b) Construction defects due to GC
mismanagement.
7. General Partner / Sponsor / Developer/ Management
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A
B
C
D
F
GP/S/D is financially secure and able to meet all partnership obligations
a) GP/S/D has modest financial capacity, but liquidity is an issue. b) Partnership or
investor named in a lawsuit.
a) GP/S/D lacks ability or willingness to meet Guarantee Obligations. b) Bankruptcy is a
potential risk. c) Default has been issued.
a) GP/S/D bankruptcy. b) Material damages/litigation and costs incurred. c)
Foreclosure.
GP/S/D is financially secure and able to meet all obligations.
8. Recapture
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A
B
C
D
F
No recapture risk
Nominal actual or expected loss or recapture of tax credits
No recapture risk
a) Material Actual or expected loss or recapture of credits. b) 2/3rds credits
a) Total investment loss expected. b) Foreclosure imminent with loss of
affordability requirements
Calculating Tax Credit Recapture and Interest, Kyle Zochert, Journal of Tax Credits, Sept 1, 2014
Summary of Development Phase Criteria
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1. Construction / Lease-Up
2. Financial
3. Construction Loan
4. Permanent Loan
5. Program Compliance
6. General Contractor
7. GP /Sponsor / Developer/
Management
8. Recapture
Stabilized Phase Risk Rating Criteria
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Stabilized Phase Criteria
1. Debt Coverage Ratio
2. Expense Coverage Ratio
3. Occupancy
4. Reserves
5. Physical Condition
6. GP / Sponsor / Developer / Management
7. Program Compliance
8. Insurance / Taxes
9. Reporting
10.Recapture Foreclosure
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1. Debt Coverage Ratio (DCR)
• DCR applies to HARD (must-pay) debt service payments
• Exclude interest expensed but accrued / not paid on soft mortgages financing
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DCR =(Net Operating Income - Required Replacement Reserve Deposits)
(Hard Principal and Interest Payments)
DCR > 1.00 indicates above breakeven operations
DCR = 1.00 indicates breakeven operations
DCR < 1.00 indicates below breakeven, i.e., insufficient income to meet operating
expenses and required mortgage payments and replacement reserve deposits
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1. Debt Coverage Ratio
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A
B
C
D
F
DCR > = 1.20 or project performs as underwritten
1.20 > DCR > = 1.00
1.00 > DCR > = 0.85 and project current on must-pay debt
a) 0.85 > DCR > 0.50 or significant cash deficits*. b) Delinquent on must-pay debt
a) Project is in default on must-pay debt. b) Default notice issued
DCR Example
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Debt Coverage Ratio Calculation:
Net Operating Income:(i.e., Total Income less Total Operating Expenses)
Required Replacement Reserve Deposits:
($100,000 - $9,500) / $82,500 = 1.10
Must-Pay Debt Service:(i.e. Hard Principal plus Interest)
$100,000
$9,500
$82,500
‘B’ rating
2. Expense Coverage Ratio (ECR)
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A
B
C
D
F
ECR > = 1.10 or performs as underwritten
1.10 > ECR > = 1.00
1.00 > ECR > = 0.85
a) 0.85 > DCR > 0.50 or significant cash deficits.
ECR < .50
New metric for projects with no must-pay debt
ECR > 1.00 = above breakeven after payment of all operating expenses and
reserve funding
ECR = 1.00 = breakeven operations
ECR < 1.00 = below breakeven operations, i.e., insufficient income to cover operating expenses and required reserve funding
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ECR = Total Income
(Total Operating Expenses + Replacement Reserves)
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Example - Budgeted vs Actual ECR
Budget Actual Variance
1.09
Total Income(Total Operating Expenses + Replacement Reserves)
ECR =
1.06
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ECR =
36
‘B’ rating
3. Economic Occupancy
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Economic Occupancy Physical Occupancy =
Calculated with property s accrual basis income
statement
Property rent roll
3. Economic Occupancy (EO)
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A
B
C
D
EO > = 95%
95% > EO >= 90%
90% > EO >= 80%
EO < 80%
F EO < 70%
Economic Occupancy Example
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Economic Occupancy:
(Gross Potential Rent less Vacancy Lossless Concessionsless Bad Debtplus Recovery of Bad Debt)
Gross Potential Rent
($100,000less $4,000less $1,000less $2,000
plus $1,000)
$100,000 = 94%
Current Rent Roll says 97% Physical Occupancy but…
$94,000 / $100,000 = .94
B rating
4. Reserves and Escrows
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A
B
C
D
F
Fully funded as originally underwritten
Are being funded and are sufficient to meet obligations
a) Underfunded by 25% from original projection but deposits are being
made. b) Bala es a e i suffi ie t to eet p oje t s lo g-term needs.
a) Underfunded by 50% from projection but deposits are being made. b)
Balances are insufficient to meet immediate and long-term needs.
Reserves and/or escrows are depleted and no deposits are being made
Project Reserves and Escrows
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Review partnership agreement and loan documents• Lease-up reserve, operating deficit reserve and replacement reserves
• Lender-required tax and Insurance escrows
• Does investor have approval or consent rights for withdrawals?
Evaluate reserve and escrow accounts:• Audited balance sheet and year over year change in assets
• Unaudited financials may not have current balances
• Copies of bank statements
5. Physical Condition of the Asset
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A
B
C
D
F
No physical condition issues
Correctable deferred maintenance
a) Deferred maintenance, structural or environmental issues with inadequate
funding sources. b) Building code violations.
Significant deferred maintenance causing life / health /safety issues, structural and or
environmental issues with no identified sources to remedy issues
a) Off-line units with no funding sources to remedy. b) Major issues or buildings
condemned
5. Physical Condition
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Grade property s Physical Condition with:• Asset a age s a ual p ope t i spe tio epo t
• 3rd party physical condition assessment
• REAC score or State HFA report
• Local inspection authority and standards
44
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Uniform Physical Condition Standards Framework
* Image credit:
Inspector Guide for
UPCS Inspection
Protocol, USDHUD,
March 31, 2005,
page 1-8
Sidebar - Deferred Maintenance in Focus
1. Unfocused GP and or property management company
(no planning)
2. Needs are well-documented but no funding sources
(no resources)
3. Costly item(s) that require a project recapitalization
(a formal plan)
• Refinancing with proceeds for CAPX
• LIHTC (re)syndication (acq/rehab)
• Sale or transfer of partnership interest
• RAD conversion45
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6. General Partner/Sponsor/Developer/ Management
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A
B
C
D
F
GP/sponsor is financially secure and able to meet all partnership obligations
a) GP/sponsor has modest financial capacity, but liquidity is an issue. b) Weak property
management company with potential replacement necessary. c) Partnership or investor
named in lawsuit.
a) GP/sponsor lacks ability or willingness to meet guarantee obligations. b) GP / Guarantor
bankruptcy is a potential risk. c) Management company is ineffective; replacement is required
GP, projector partnership bankruptcy or foreclosure actions
a) GP/sponsor is financially secure and able to meet all partnership agreement obligations. b)
Minor property management issues
7. Program Compliance (LIHTC and HTC)
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A
B
C
D
F
a) No material compliance issues; b) Part III is on track*
a) Correctable compliance issues with financial impact. b) Forms 8609 delayed. c)
Failing REAC / MOR score with no corrective plan. d) s issued a d ot o e ted within 90 days. e) Part III is delayed greater than 3 months
a) Correctable compliance issues with no financial impact; b) Part III is on track
* Part III is the Certification of Completed Work i the De elope s Historic Preservation Certification Application
a) 8609s are delayed more than 2 years. b) Uncorrectable compliance issues. c)
8823s issued and uncorrected at year-end. d) Part III is in jeopardy with no remedy.
a) 8609s delayed more than 3 years. b) Part III denied. c) Recapture
8. Real Estate Taxes and Property Insurance
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A
B
C
D
F
a) No insurance or tax issues; b) adequate coverage in place.
a) Unpaid real estate taxes, but funds are available. b) Insurance requirements are
not being met. c) Expired insurance coverages.
a) No insurance or tax issues; b) adequate coverage in place.
a) Unpaid real estate taxes for two or more years. b) Tax certificates sold and
ownership rights can be asserted. c) Insurance requirements are not being met
and no funds are available to remedy issue.
Unpaid real estate taxes or unpaid insurance and no sources available.
8. Real Estate Taxes and Insurance
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Insurance• Do insurance policies meet LPA requirements?
• Are coverages current based on insurance certificates on file?
Real Estate Taxes
• Look for evidence of expensed real estate taxes and changes in tax escrow and accrued taxes on balance sheet.
• Search online or contact GP or local tax authority to obtain copy of tax bills (incorporate into quarterly / year-end reporting)
9. Reporting
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A
B
C
D
F
No reporting issues
a) Audit issues ith Goi g Co e . b) Reporting is consistently delayed.
Minor reporting deficiencies
a) Tax Return and/or Audit not received prior to April 15. b) Inadequate or
incomplete reporting. b) Accuracy of reporting in question.
Tax Returns are delinquent leading to incurable default.
9. Reporting
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Consider timeliness, accuracy and consistency of reporting by GP and/or property management agent, as required in LPA, et cetera:
• Quarterly (or monthly) property financial statements (unaudited)
• Occupancy reports
• Partnership audited financials and tax returns
• Annual certificate of continued compliance
Reporting Sidebar – What is a ‘Going Concern’?
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Accounting industry recognizes four types of audit opinions:
• Unqualified o lea opi io states that the o pa s [pa t e ship s] fi a ial statements present a fair and accurate picture of the company and comply GAAP.
• Qualified opinion contains exceptions, which may include the scope of the audit.
• Adverse Opinion contains a major exception or warning, such as a "going- o er “, i whi h the a ou ta t e presses dou t a out auditee’s a ilit to re ai i usi ess.
• Disclaimer of Opinion is issued when an auditor is unable to complete an accurate audit report. This may occur for a variety of reasons, such as an absence of appropriate financial records.
10. Recapture or Foreclosure
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A
B
C
D
F
No recapture
a) NOMINAL actual or expected loss or recapture of tax credits. b) Notice of default
issued.
No recapture
a) MATERIAL actual or expected loss of recapture of credits. b) Receiver has been
appointed.
a) Total investment loss expected. b) Foreclosure imminent with loss of
affordability requirements
Summary of Stabilized Phase Criteria
1. Debt Coverage Ratio2. Expense Coverage Ratio3. Occupancy4. Reserves5. Physical Condition6. GP/Sponsor/Management
7. Program Compliance8. Insurance / Taxes9. Reporting10.Recapture Foreclosure
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Stabilized Phase Risk Rating Exercise Island View Apartments, LP
Copyright 2015 Birch Island Real Estate Consulting, LLC
About Island View Apartments, LP
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Facts• 40 units in 3 three-story garden-style buildings
• 100% LIHTC project with a 40-60 Minimum Set Aside
• In Year-5 of 15-Year Federal Compliance Period
• Former Asset Manager rated the project an ‘A’, which you find inexplicable.
Let’s see why.
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Lender DCR Covenant: 1.10 or greater
About Island View Apartments, LP
58Copyright 2017 Birch Island Real Estate Consulting, LLC
As the new Asset Manager at Coastal Capital Partners, your task today is to risk rate
Island View Apartments for year-end 2016. Thus far you know:
1. Partnership Reserves and Escrows are fully funded as projected.
2. RE Taxes and Insurance are current and adequate, respectively.
3. Quarterly and annual reporting are accurate and timely. Audited financial statements
e p ess u ualified opi io s si e p oje t i eptio .
4. No compliance concerns at this time. Project scored well on the housing edit age s tenant file audit and physical inspection in November 2016.
5. GP is actively engaged in oversight of project and has raised some concerns about
unsatisfactory property operations and unfocused property manager.
AHIC Ratings for Island View Apartments, LP
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A B C D FOverall
DCR
Economic Occupancy
Reserves and Escrows
Physical Condition
GP / Sponsor / Management
Program Compliance
Insurance and Taxes
Reporting
Recapture
Update Your Grading Sheet
with what we know so far….
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Review of the unaudited Year-End 2016 Income Statement shows:
Debt Coverage Ratio
1.05x 1.23x
Revenue
Net Rental Income 224,500 237,750 (13,250)
Other Income 500 1,000 (500)
Total Revenue 225,000 238,750 (13,750)
Operating Expenses 200,000 212,250 (12,250)
Net Operating Income 25,000 26,500 (1,500)
Debt Service & Reserves
Principal Payments (5,000) (5,000) -
Interest Expense (3,100) (3,100) -
Total (must-pay debt service) (8,100) (8,100) -
Replacement Reserve Deposits (16,500) (16,500) -
Net Cash Flow (Deficit) 400 1,900 (1,500)
1
2
3
(1 - 3) =
2
AHIC rating? ______
Actual Budget $ Variance
DCR
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2016 Actual 2016 Budget $ Variance
Revenue
Gross Potential Rent 250,000 250,000 -
Vacacny Loss (18,500) (12,000) (6,500)
Concessions (2,500) - (2,500)
Bad Debt Expense (4,500) (250) (4,250)
Net Rental Income 224,500 237,750 (13,250)
Economic Occupancy 89.9% 95.1%
AHIC rating? _____
Actual Budget $ VarianceA
B
C
D
Economic Occupancy = (A – B – C – D) / A
Review of 12/31/2016 2016 Income Statement shows:
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Given operating trend concerns and perceived management company
issues, you conduct a site visit with the GP in January 2017 and determine:
• Island View Apartments has some minor deferred maintenance issues. GP plans to
add ess these ite s i the p ope t s app o ed ope ati g / apital udget.
• Management company is weak and reactive to most issues at the property. GP
intends to replace the management company in early FY 2017.
AHIC rating? _____
AHIC rating? _____
Using your findings in slides 58 to 61, what is your Overall AHIC rating for Island
View Apartments (continue to next slide)?
Overall AHIC Rating - Island View Apartments, LP
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A B C D FOverall
DCR
Economic Occupancy
Reserves and Escrows
Physical Condition
GP / Sponsor / Management
Program Compliance
Insurance and Taxes
Reporting
Recapture
Final Thoughts…
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1. Understand stabilized phase underwriting assumptions and expectations
2. C o elo o a o e DCR, E o o i O upa , Re aptu e, Co plia e or Construction / Lease-Up may be sufficient to warrant watch list status.
3. Watch list assets require a detailed Asset Management Action Plan and
more intense oversight / interaction among stakeholders
VINNIE VIOLA, MPA, HCCPPrincipal25 Collamore StreetMilton, MA 02186O 617-905-6340F [email protected]
Copyright 2015 Birch Island Real Estate Consulting, LLC
LIHTC Asset Management and Compliance Expertise
Questions?