national housing & rehabilitation association -...

NATIONAL HOUSING & REHABILITATION ASSOCIATION - NATIONAL COUNCIL OF AFFORDABLE HOUSING MARKET ANALYSTS

2011 SPRING AFFORDABLE HOUSING POLICY & UNDERWRITING FORUM Underwriting & Due DiligenceApril 29, 2011

Introductions

Anthony J. Alfieri, Chief Operating Officer and Managing Director, Royal Bank of Canada Capital Markets – Tax Credit Equity Group

Richard A. Floreani, Partner, Carlisle Tax Credit Advisors

Gregory B. Judge, Chief Operating Officer, Boston Financial Investment Management

Kristen M. Walsh, Senior Manager, Ernst & Young – Tax Credit Investment

Advisory Services Douglas P. Koch, Director,

RSM McGladrey, Inc.April 29, 2011

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Key Question

April 29, 2011

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What is changing in how investors and syndicators underwrite transactions?

Market Conditions

April 29, 2011

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Multi-investor Fund Equity Volume (in $ millions)

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Multi-investor Fund Yield vs. Lower Tier Equity Price

Yield Price

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Operating Deficit Guarantee Months of OERDS

Unlimited

>= 12 Months

9 - 12 Months

6 - 9 Months

< 6 Months

Market Conditions

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Hard Tax Credit Recapture Guarantee Term

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0.0%

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Average of % Equity Held to Constr. Compl. Average of % Equity Held to StabilizAverage of % Equity Held to 8609 Average of % Paid Dev Fee Held to 8609

Equity Withheld Until Benchmark Achievement

Market Conditions

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TCAP/Exchange more than offset reduced equity, allowed lower leverage, deferred pay-in, lowering investor risk

Higher-demand markets, larger rent spreads and more NOI cushion deals circled first, leaving more difficult transactions for later (pre current allocation rounds)

Deals again increasing from inexperienced developers

As a result, transactions are more challenging for investors/syndicators than 12 months ago, heightening the importance of underwriting

Investor Concerns

April 29, 2011

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Scope/breadth of underwriting – seems the same, but not standardized Varies by syndicator and investor (AHIC attempt at

standardization) Varies by type of fund Issues and conflicts:

Errors: Experience and competency of staff Management controls

Knowledge: Resource / data availability may differ Experiences will differ Scope depth may differ

Motivations: Syndicators business and return expectations differ from that of the investor Timing of syndicators’ benefits differs from that of the investors

Investor Due Diligence of Syndicators

Syndicator Due Diligence –Underwriting Policies Tax Credit Investment Advisory Services

Our Housing Credit Credentials

► Ernst & Young is the only major professional service firm with an entire practice (the Tax Credit Investment Advisory Services group) specializing in tax credit investments.

► Since 1993, we have completed due diligence reports on more than 400 housing credit funds.

► Our due diligence clients include banks, insurance companies, Wall Street investment banking firms and a wide variety of other Fortune 1000 companies.

► We have provided due diligence services for eleven of the 15 syndicators that offered multi-investor funds during the prior 12 months

Recent Engagements (Prior 12 Months)

► Primary Fund Due Diligence ► Capital Partners Series G, L.P.► Centerline Fund XXXVIII L.P.► CREA National Fund 2010-3► PNC Multifamily Capital Institutional Fund XLV, Limited Partnership► PNC Multifamily Capital Institutional Fund XLVI, Limited Partnership► RBC Tax Credit Equity National Fund – 13, L.P.► RBC Tax Credit Equity National Fund – 14, L.P.► Red Stone 2011 National Fund► U.S.A. Institutional Tax Credit Fund LXXXIV, L.P.► WNC Institutional Tax Credit Fund 32, L.P.► WNC Institutional Tax Credit Fund 34, L.P.

► Syndicator (Sponsor ) Assessments► Affordable Equity Partners, Inc.► Boston Capital► Boston Financial Investment Management► Centerline Capital Group► City Real Estate Advisors, Inc.► Enterprise Community Investment, Inc.► PNC Multifamily Capital► Raymond James Tax Credit Funds, Inc.► RBC Capital Markets Tax Credit Equity Group► Red Stone Equity Partners, LLC► The Richman Group ► WNC & Associates, Inc.

As Part Of Our Due Diligence We Look At:

► Fund► Treatment of upper-tier fees and expenses, fund composition, working capital

reserve, asset management fees, operating agreement provisions (transfer and removal rights), investment return profile

► Fund properties► Real estate, tax, and developer risk assessment

► Sponsor► Experience, tenure and succession plan of key professionals► Strategic direction and revenue diversification► Relationship with parent company (if applicable)► Financial strength► Sustainability and 15-year asset management stand-alone profitability

analysis► Warehouse line management► Acquisition, Underwriting, and Asset Management Policies and Procedures► Risk rating practices► Prior funds performance track record

Underwriting Policies - Overview

►Different Approaches► Minimal written documentation; experienced people► Moderate written documentation though subjective► Formal written documentation; many exceptions► Formal written documentation with targets and minimum

thresholds; formalized approval for exceptions

Market Studies

►Baseline► Third-party, commissioned by syndicator ► Dated within six months of lower-tier closing ► NCAHMA standards

Developer and Management Company

►Baseline► Successful experience with similar projects (construction type,

location, tenancy type, subsidies, etc.) ► Favorable portfolio track record► Financial strength► Background checks

Operating Expenses and Replacement Reserve Contributions

►Operating Expense Baseline► Line by line assessment► Documented support / cost verification ► Comparable operating expense analysis

►Replacement Reserve Contribution -AHIC Guidelines► Family - $250 per unit► Senior - $300 per unit► Rehabilitation - $400 per unit► 3% annual inflation

Syndicator A

Expertise you remember. Experience you need.April 29, 2011 | 20

Boston Financial Investment StrategyCritical Success Factors of a LIHTC Investment

Sponsor Quality and Track Record

Underwriting

Cash Support

Guarantees

Competitive Position

Importance

Market Study

Expertise you remember. Experience you need.April 29, 2011 | 21

Investment Track Record – ITC Series

29%27%

12%

7% 7%3%

0%

5%

10%

15%

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25%

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35%

<2000 2000-2004 >2005

Percent on

Watch List

Year

Watch List

High Risk

< 2000 2000 - 2004 > 2005 Total

Capital (b) 1.0 1.3 2.1 4.4

Properties 284 298 264 846

Overall

Watch List and High Risk

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Talking Points: NHRA Underwriting Session

Basically, it is RBC's view that LIHTC needs to be underwritten as 15 yr. real estate, and our underwriting focuses on this.

Similar to grading and pricing real estate loan exposure, we have developed a matrix specific to the asset class, called Equity Risk Grading (ERG).

Five component factors are weighted for each transaction: Market Risk, Financial Risk, Structural Risk, Sponsor Risk, and Construction Risk.

Within each category there are ~ 5-6 sub-categories, with a total of 30 different factors. This provides the necessary "granularity" which is key to ERG integrity.

Additionally, we incorporate the LT yield into the grading matrix to derive a risk-adjusted yield (RAIRR).

To understand the macro level portfolio risks of this product, RBC purchased 3 years of portfolio data from E&Y. The data was segregated into an “Acute Deficit”population, those funds where original projected yield was not met, in addition to “Operating Deficit Funding Sources” where lower-tier properties were performing at break-even or below.

Data was obtained on 550 funds and over 5600 properties encompassing over 700,000 units and $32B in net equity. The property-level data included the BE funding sources (deferral of management fee, GP loans, reserves, etc.)

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Talking Points: NHRA Underwriting Session

A key tool in that regard is our Underwriting Guideline Exception (UGE) tracking. Whereas the ERG is done at closing by Risk Management, the UGE is filled out and monitored by the deal team, and is also a part of the LOI approval process.

This helps "frame-up" potential risk points in a transaction, and gives us guidance on where the ERG will fall out once all diligence is received and reviewed. It is similar to AHIC standards, but more detailed.

The risk formulation process derived from both the UGE and ERG provides two distinct advantages:

− Utilizing this framework, we are able to commit and buy deals without specific investors lined up: Consistency & Transparency to Investors

− We developed the criteria and we have shared it with investors.

− Ability to monitor long-term deal success and adjust underwriting standards: Our Underwriting Report Card looks at a full-year stabilized operations as depicted in an audit and Tax Return, and compares it to that year in the original underwritten model. This is a powerful tool.

The results also allow RBC to better understand Economic and Regulatory Capital needed in support of the business initiatives of TCEG.

Market Analysis & Due Diligence Roundtable : Challenges in Investor Due Diligence

Presenter: Douglas P. Koch, MAI, AICP McGladrey Boston, MA [email protected] 617-241-1173

NH&RA Spring Affordable Housing Policy & Underwriting Forum (2011) 10:45 AM to 12:00 PM April 27-28, 2011 Washington, DC

mailto:[email protected]�

Challenges in LIHTC Investor Due Diligence

What is Tax Credit Housing Investor Diligence?Clients: Investors, Syndicators and the LIHTC Fund

under review. Also, a responsibility to the entire industry. Three primary Due Diligence Reports:Property Investment review for the 5 to 50

properties in a Typical FundFund Investment Review (Portfolio/Upper Tier)Sponsor, or syndicator, review

I will discuss the Property & Fund Investment Review & Kristen Walsh is discussing the Sponsor Review


Investor, syndicator and industry perspective.AHIC Industry Leaders on our panel.Difficulty of standardizing the analysis of a non-

standard investmentDavid Smith: “A cottage industry is not an

industry. ” “Harmonize with REIT reporting”Where to find consistent Guidelines/Benchmarks.Deal structure is too complicated, not repetitive Portfolio theory? Connecting the individual

investments with the Fund: Portfolio review and investment strategy, .Typical Report


Conventional Real Estate Fund/Securitized approachREITS: (www.reit.com)CMBS: www.mismo.orgDoes LIHTC have similar required elements? (AHIC,

NCSHA, NCAHMA, 19 years, Highly evolved IC Reports)

RBC’s Equity Risk Grading Property Template: “Consistency & Transparency to Investors”Greg’s review of BFIM’s comprehensive approach:

“Critical Success Factors of an LIHTC Investment”

http://www.reit.com/�

http://www.mismo.org/�


Original Purpose and continued development The Four C’s 50 Input pages including references to External

Guidelines (imbedded 133 cross-references to AHIC guidelines) and multiple worksheets covering debt and LIHTC analysis, development team underwriting, rent, expense and market analysis as well as third party professional reviews. Three Summary Pages with an Investor

Dashboard and a single summary narrative page set aside for unique or extraordinary descriptive disclosures.


Original Purpose and continued developmentDashboardColored highlights providing

quick indicator of degree of conformity to pre-defined criteria. 78 reporting items covering Project, Development

Team, Operations and Development financial structuring analysisKey parameters reviewed, sensitivity analyses

displayed and commentary on typically included or missing mitigation elements.

Red/ Green/ Yellow

Challenges in LIHTC Investor Due DiligenceWorksheet Analyses: Sample Page Identified & Corresponding AHIC Guideline

Development Budget Underwriting Title of Worksheet AHIC References (1-133)DevBudget Review of Development Budget 30, 31, 32, 33, 34, 35, 36Debt Debt Analysis 75, 76, 77, 78, 79, 80, 81, 82Deve Fee Development Fee Analysis 86, 87, 88, 89, 90, 91, 92

Other Other Development Period Considerations 107, 108, 109, 110, 111, 112, 113

Operating Budget Underwriting Title of Worksheet AHIC References (1-133)

RentCalc Initial Gross Potential Rent Calculation Input Rents

Revenues Rental Revenue Analysis 37, 38, 42, 43, 48, 49

RentAdv Calculation of Rental Advantage, Achievable Rent & FMR 38

Inflation Inflation Trending and Sensitivity 39, 40, 41Subsidy Project Based Subsidy Contract 44, 45, 46, 47Market 106 Exp-line Line Item Expense Analysis 51, 52, 53, 54, 55, 56Exp-comps 50LIHTC -Analysis Tax Credit Analysis AHIC References (1-133)

LIHTC-Questionaire 114, 115, 116, 117, 118, 119, 120, 121, 122, 123, 124

Other tax 124

(Sample: Page 3 of 5)

Challenges in LIHTC Investor Due DiligenceDashboard Disclosures 35-78 (Operations/Revenue Underwriting)

OperationsOperating Revenues48) Overall rent advantage vs. market49) Revenues constrained by max LIHTC limit 50) Achievable rent in excess of pro forma51) Subsidy overhang as % of revenue52) Cash flow/(deficit) as % of rev with overhang53) Commercial income as % of revenue54) Overall vacancy rate in market55) Market study concerns, qualified opinions56) 10-year Median Family Income growth trend57) Overall capture rate

Operating Expenses58) Average/best comparable property scores59) Evidence of due diligence60) Property tax underwriting conforms to AHIC61) Utility expense (documented and current)Key sensitivity measures62) Break even occupancy %63) Break even expense increase supported64) Deficits as % of reserves - as underwritten65) Deficits % of reserves - 10% market decline66) Deficits % of reserves - 20% market decline67) Deficits % of reserves - 1% annual rent trend

Partnership mitigation features meet AHIC guidelines68) Affiliate subordinating management fee69) Reserves - months of coverage70) Reserve release provisions71) Subsidy transition reserve72) Subsidy overhang reserve -yrs deficit covered73) Operating deficit guarantee - mths of coverageGuarantee provisions meet AHIC requirements74) Operating deficit guarantee - duration in years75) Operating deficit guarantee - other terms76) Tax credit compliance guarantee77) LP approval rights78) LP rights to remove GP

Mitigation features in the partnership (% of hard costs)35) Development fee holdback36) Contingency (Hard & Soft)37) Cash reserves38) Total construction contingency39) Mitigation exceeds costs in sensitivity analysesGuarantee provisions meet AHIC requirements40) Completion guarantee41) Repurchase obligation42) Adjuster provisionsTax credit issues43) Capital account projected to remain positive44) Bona fide debt (Inc.) test (% of debt - yr 15)45) Placed in service timing issues46) Excess eligible basis supported47) Other LIHTC issues meet criteria

(Dashboard Disclosures 1-34 not shown)


Portfolio & Fund Review Single Page summarizes key Fund elements: Investor Capital Contributions Use of Investor Proceeds -Cash Method Fund Load Annual Asset Management FeeWorking Capital Reserve Investor Transfer Provisions General Partner Removal Provisions Dash Board summary from Lower Tier Reviews (The 17 most significant items out of 78) Distributions of Properties by State Developers with more than 10% Fund Equity Distributions of Properties by Rehab/NC/Finance Type

Four Pages covering typical property/portfolio performance measures and the 78 due diligence dashboard highlights for each property. (Allows for categorical comparisons)

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Challenges in LIHTC Investor Due DiligenceSample Upper Tier/Portfolio page (Page 3 of 4)

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Drill Down: Sample small part of Rent & Revenue Worksheets (Sample Only)

AHIC Requirement 37B - underwritten (or reversion) rents should be compared to derived market rents

Rent Advantage Units Revenue % of RevenueGreater than 30% 10 $64,836 49% Strong advantage, should withstand all but collapse of marketBetween 20% and 30% 0 $0 0% Good advantage, should withstand moderate decreases in markeBetween 10% and 20% 7 $68,220 51% Adequate advantage, should withstand minor decreases in markLess than 10% 0 $0 0% Negligible advantage, at risk to any adverse changeTotal 17 $133,056 29%

AHIC/ Dashboard Highlights: Market Advantage

The chart on the left represents a calculation check on one underwriting input; rental revenue. Required Data checks specified.

AHIC Underwriting Guidelines as applied to the revenue analysis.

Challenges in LIHTC Investor Due DiligenceDrill Down: Sample small part of Rent & Revenue Worksheets (Sample Only*)

Samples chosen from different property reviews to maintain confidentiality


Assessment of Model: Discussion & CritiqueHow does it score on Four C’s:Usefulness?Relevancy to panelist’s comments/concerns?Transparency?What’s missing?Interested in receiving a copy of a sample Dashboard and Summary Page? Please give me a business card or Call or Email Doug at 617-241-1173 or [email protected]

mailto:[email protected]�

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