Recommended Practices in Housing Credit Allocation and Underwriting

Background on Recommended Practices Tailored to respond to specific state needs, Agency allocation and underwriting practices go well beyond the minimum IRS requirements and vary considerably from state to state. In 1992, NCSHA first adopted Recommended Practices in Housing Credit allocation and underwriting with input from the allocating agencies and industry representatives. These recommendations were designed to strengthen and continue to merit congressional confidence in state Housing Credit administration.

Background on Recommended Practices (continued) The Recommended Practices have been enhanced several times since 1992, most recently in Recommended Practices help states meet their program administration responsibilities, but also preserve individual state flexibility at the heart of the Housing Credit program. NCSHA’s Recommended Practices and their implementation by states have been favorably cited numerous times by the General Accountability Office in its reviews of the program. There are currently Recommended Practices in 24 areas related to allocation and underwriting.

1. Per Unit Cost Limits Agencies should develop a per unit cost limit standard based on total development costs, and publish the standard and the justification for it in the Agency’s QAP or other Housing Credit allocation guidelines. In developing a per unit cost standard, Agencies should examine 1) certified cost data on existing Housing Credit developments; and 2) building construction and land costs in the state, including variations in such costs within the state.

1. Per Unit Cost Limits (continued) If an Agency receives an application with costs in excess of its established limit, the agency should subject the development to further scrutiny and review. Credits should be awarded to such development only if the additional costs are justifiable, reasonable, and attributable to unique project characteristics. Agencies should carefully limit and justify the total number of developments with per unit cost in excess of the state’s established standard, as well as the total amount of Credit allocated to such developments. Agencies should document the justification in each case.

1. Per Unit Cost Limits (continued) Agencies should recognize that some markets, property characteristics, and circumstances individually or together may be cost‐prohibitive for Housing Credit development. Agencies should apply the same cost standards and rigorous evaluation to Housing Credit developments financed with tax‐exempt bonds. Agencies should regularly review the QAP and related allocation guidelines with a goal of reducing costs.

2. Developer Fee and Builder Fee Limits Agencies should limit developer fees to 15 percent of total development cost. Higher fees may be allowed on smaller and/or difficult to develop projects. Agencies should encourage lower developer fees for the acquisition portion of acquisition/rehab developments. Agencies should limit builder profit to 6 percent of construction costs, builder overhead to 2 percent of construction costs, and general requirements to 6 percent of construction costs.

2. Developer Fee and Builder Fee Limits (continued) Agencies should require developers to identify the existence of any identity of interest with any other party to the development, and take such identity of interest into consideration in determining maximum fees. 3. Consultant Fee Limits Agencies should permit consultant fees (other than fees for architectural, engineering, environmental, accounting, and legal services) only within the developer fee limit.

4. Verification of Expenditures and Issuance of IRS Form 8609 Agencies should require and analyze cost certifications for all developments prior to issuing IRS Form Agencies should analyze the reasonableness of costs. Agencies should issue Form 8609 in a timely manner after receiving all required documentation. For developments of 11+ units, Agencies must require the sponsor to submit an independent third-party CPA audit report as a part of the final feasibility evaluation. Agencies should adopt the model 10 Percent Test and final cost certification letters developed by NCSHA.

5. Operating and Replacement Reserves Agencies should establish operating and replacement reserve standards that consider development location, construction type and design, population served, and projected vacancies. Minimum operating reserves should generally equal 4-6 months of projected operating expenses plus: i) debt service payments; and ii) annual replacement reserve payments. Minimum replacement reserves should generally equal $250 per unit per year for senior new construction developments and $300 per unit per year for family new construction developments and for rehabilitation.

6. Operating Expense and Vacancy Rate Projections Agencies should establish and maintain an operating cost database based on historic and current Housing Credit property experience and use this data in underwriting. Agencies should assume a 7 percent vacancy rate projection. 7. Debt Coverage Agencies should require a minimum debt service coverage ratio of 1.15 (1.10 in RHS properties) until initial stabilized occupancy for debt financing that would foreseeably result in foreclosure if not repaid.

8. Market Analysis Agencies should review the market study for each proposed development to determine its implications for the financial viability of the property and whether it justifies the need for the number, size, and type of rental housing proposed. Agencies should specify in the QAP the time at which the market study must be provided to the agency and the components and analysis required in the study.

9. Development and Management Experience Agencies should consider the capabilities of the development team, including the project sponsor, developer, general contractor, architect, property manager, and key consultants. Agencies should take into account the team's track record, financial capacity, and experience in multifamily housing finance, development, management, and resident services. Agencies should require development team members to report past experience with affordable housing programs, including any removals as general partner, defaults, failures to receive IRS Form 8609, or project foreclosures.

10. Capital Needs Assessment Agencies should require any award of Housing Credits for rehabilitation to be preceded by and take into account a capital needs assessment. Issues identified by the capital needs assessment should be addressed in the rehabilitation proposal and considered in establishing project reserves.

11. Minimum Rehabilitation Threshold Agencies should establish a minimum rehabilitation threshold to assure meaningful, rather than simply cosmetic, rehabilitation of properties. Agencies should reference this threshold, and any exceptions to it, in the QAP.

12. Extended Use Agreements Agencies should require extended use agreements to: — Specify whether a project was allocated Credit under the nonprofit set-aside; — Identify all requirements imposed on the development material to the award of Credit—including income and rent restrictions, affordability period, reserve levels, amenities and services, and accessibility; and — Require mortgage liens on the property to be subordinate to low-income use restrictions, except in the event of foreclosure.

13. QAP Application to Bond Deals In evaluating and underwriting bond-financed properties, Agencies should apply standards substantially similar to those they apply to non bond-financed developments. 14. Application Procedures Agencies should streamline the application process for developments involving multiple subsidies by taking into account the different application and allocation schedules. Agencies should visit proposed development sites at the application stage to assess the viability of the site.

15. Appraisals in Acquisition/Rehabilitation Properties For acquisition/rehabilitation properties, Agencies should limit the acquisition price on which Credits are allocated to the lesser of the sale price or appraised value of the property. Agencies should require appraisals to specify an allocation of value between land and buildings. 16. Consistency Among Allocating Agencies Agencies should develop and adopt standardized procedures and requirements – i.e., standardized 10 Percent and cost certification reports, compliance reporting forms, etc.

17. Agency Staff Training Agencies should provide Housing Credit program staff opportunities for continuing education and training. 18. State-Designated Basis Boost Agencies should set standards in the QAP for determining which areas and/or developments are eligible for the state designated 30 percent basis boost and should make the reasons for such determinations available to the public.

19. Housing Credit Asset Management Agencies should establish Housing Credit asset management procedures detailing typical asset management functions associated with the development, lease-up, and operations phases of a project. 20. Facilitating Rural Development with the Housing Credit Agencies should analyze recent state experience in using the Housing Credit in rural rental housing development and consider QAP incentives or other policy initiatives to ensure rural housing needs are adequately addressed.

21. Use of the Housing Credit for Supportive Housing Agencies should analyze recent state experience in using the Housing Credit for supportive housing and consider QAP incentives or other policy initiatives to ensure such housing needs are adequately addressed. 22. Green Building and Sustainable Development Agencies should evaluate current Housing Credit QAP incentives or other policy initiatives designed to encourage green building and sustainable development and consider ways to continue fostering innovation in this area.

23. Housing Credit Developments at Year 15 Agencies should evaluate current QAP incentives and other policy initiatives to determine any impact on developments reaching the end of their initial 15-year compliance period. While agencies should approach Year 15 projects with a goal of preserving the housing stock, the best course of action for each development is a project-specific determination that considers the project’s current financial viability, its physical condition, and its relative competitiveness in the local market. Agencies should consider whether additional Credits and/or recapitalization are necessary for each deal.

24. Sponsor Certification of Project Sources and Uses of Funds Agencies should require sponsors to certify that they have disclosed all of a development’s funding sources and uses, as well as its total financing, and will disclose any future changes in funding to the agency.

2016 Recommended Practices NCSHA’s Board of Directors will consider the creation of a new Housing Credit Task Force today. If approved, this Task Force would review the existing 24 Recommended Practices and suggest enhancements where appropriate. It would also consider aspects of Housing Credit allocation and underwriting that may benefit from additional recommended practices.

Potential Revision of Existing Recommendations Refine cost standard to reflect recent development cost trends and Agency cost control experience. Review adequacy of developer and builder fee limits. Refine cost certification standard and sponsor certification of sources and uses of funds standard. Update model 10 percent and final cost certification letters to incorporate recent accounting industry guidance.

Potential New Areas of Focus Development siting – balancing investment in distressed neighborhoods with development in high-opportunity areas. Concerted community revitalization plans. Development issues in RAD deals. Preservation challenges and strategies at Year 30. Identifying and preventing foreclosures. Monitoring construction progress/fair housing accessibility. Encouraging Native American housing development. Encouraging mixed income housing development.

Potential New Areas of Focus (continued) GAO finding: including all statutory selection criteria and preferences and clearly referencing all allocation requirements and related documents in QAP. GAO finding: requiring local letters of support. GAO finding: documenting justification for use of state designated basis boost.