Managing Capital Expenses

10 min read

Asset managers make evidence-based choices  

Managing capital expenses in the tax credit-driven housing industry is a primary responsibility of asset managers. As this industry has matured, there has been a growing recognition of the need for a structured, thoughtful approach to maintaining the physical assets in order for properties to provide steadier, more long-term benefits. As with so many of the asset manager’s tasks, though the goals are often shared among companies, the methods of achieving them vary. NH&RA’s Asset Management (AM) Conference in June included a panel of owners of large, multi-regional portfolios discussing their practices in managing capital expenses (CapEx) moderated by Allen Feliz of TCAM.

Identifying and Authorizing Capital Projects
Capital Needs Assessments (CNAs), which identify physical items that a project needs and estimates their costs, are used widely in CapEx planning. Yet the value in CNAs comes from being able to translate the findings into a meaningful plan. Who reads the CNA? Do executives have the time, expertise or process to synthesize the findings? What is the role of the asset manager in this? How are current needs balanced against a future recapitalization (e.g. deciding what to “save” for future basis)?

Volunteers of America, one of the largest national non-profit owners, based in Alexandria, VA with nearly 20,000 units in 40 states, does CNAs on every property every five years, according to Peter DesJardins, vice president of asset management. CNAs include five-year projections, which are then used as a basis for capital budgeting and reserve planning. Asset managers help move the CNA from an informative to an actionable document by looking at findings for each property, speaking to maintenance supervisors and then identifying individual items to bring to management for authorization.

LDG Development, a developer-owner out of Louisville, KY with over 5,000 units and operations in eight states, has a generally younger portfolio, according to Co-Principal Chris Dischinger. Major capital needs so far have been rare, so the process is more informal, with executives more involved in case-by-case decision-making. As is common throughout the industry, much of LDG’s capital planning is done within the budgeting process, but Dischinger is involved in decisions on specific projects brought forward by asset managers. For these and other AM decisions, LDG convenes an “AM Committee” made up of the CFO, Dischinger, and representatives from AM. Dischinger emphasized the importance of taking time throughout the year to analyze the portfolio with AM staff, both for CapEx concerns and for broader operating insights.

Vesta Housing, a for-profit owner with over 7,500 units and headquartered in Weatogue, CT, has an organizational structure that provides a central locus for CNA and CapEx questions called the Physical Plant Department, according to Executive Vice President Chuck Moran. These staff don’t handle routine site maintenance, though they often come from construction or maintenance backgrounds and have a deep understanding of day-to-day maintenance. Instead, this department collects CNAs centrally for use in annual budgeting. Vesta created this department as an early, strategic investment (when its portfolio was under 4,000 units) with the expectation that this group lead a portfolio- and organizational-level (rather than property-by-property) approach to physical plant condition. Moran acknowledged that it’s a costly investment, but one that Vesta rolls into corporate costs, in part as recognition that for site managers, overseeing daily operations often crowds out the ability to focus on CapEx.

In-House versus Contracted CapEx Work
Owners of all sizes struggle to decide which CapEx projects to tackle using staff time and which to contract out.  Both options have pros and cons: vendors may be more specialized and have more flexible capacity, but may be expensive and must be selected after (potentially) time-consuming scope negotiations, then managed and overseen by staff. Meanwhile, using staff increases ongoing payroll cost regardless of utilization, and the logistics of working at far-flung sites can lead to high travel costs and down time, or even a need for local teams.

Vesta, which does not have an internal construction group, has generally found that using external contractors works better. According to Moran, staffing up for large CapEx projects rarely makes sense for Vesta, because the time between projects means that people end up idle too often. At the same time, some of the communication, mistrust and oversight challenges associated with outsourcing have been alleviated by cultivating a relationship with a single GC that does the vast majority of Vesta’s capital work. Moran remarked, “we have such a strong relationship [with that GC] that they kind of feel like they’re part of us sometimes.” While both companies have considered merging, it actually seems to work best as is, offering many of the benefits of an in-house group without the overhead of additional staff.

LDG, whose affiliated construction company focuses on new construction, has also found that timing considerations make it hard to keep an internal crew consistently busy. LDG does smaller, non-critical projects in-house, but has generally found that the specialized expertise and flexible capacity of vendors is more cost-effective otherwise.

Funding and Using the Reserve for Replacement (R4R)
In TCAM’s experience, stabilized properties with sufficient R4R balances are unfortunately rare, whether due to overly optimistic underwriting or some combination of rising costs, a desire to improve cash flow, and perhaps some under-appreciation for the true extent of ‘wear-and-tear.’ This is an area where reliable, searchable asset management data can support an owner’s bottom line: records of the actual usable lives of various items can improve underwriting and inform maintenance budgeting going forward. LDG periodically evaluates materials they’ve used (e.g. how long did a paint job last? how soon before fencing needed to be replaced?) to feed those insights back into future purchase decisions.

VOA ensures that annual R4R deposits include a three percent escalation provision, to reflect the inevitable rise in costs over time. Particularly for projects past Year 8 (Y8), where the time horizon for a recapitalization is shorter, it’s critical to recognize that $300 set aside in 2002 won’t yield $300 worth of work in 2017.

Vesta goes a step further by doing an internal analysis of R4R needs. Moran explains, “Even if the lender requires $350 [PUPY] but we see it’ll need $400, we’ll just put that extra $50 into a separate account that we hold.” Physical Plant Department staff coordinate the analyses to determine the amount of “extra” R4R deposit, while asset managers monitor balances and think about where the money for the next recapitalization may come from.

Preparing for Year 15 (Y15)
Most of VOA’s properties are slated for re-syndication shortly after Y15, which affects the organization’s scheduling and selection of CapEx projects. As asset managers consider which projects to put forward for approval, they – with an eye on how to pay for it rather than a deep scrutiny of the CNA’s recommendations – consider what would meaningfully affect basis if deferred until a LIHTC recapitalization. Some CapEx projects can be done well via annual CapEx spending, but some large or costly projects would be more comprehensively addressed with the resources of a new transaction. For owners thinking strategically about reserve balances at the LP’s exit, it may make sense to spend R4R dollars on property improvements rather than have them be distributed at Y15 only to be funded again at re-syndication.

What matters most is an organization’s ability to connect whoever is strategizing for a recapitalization with timely and easy-to-understand information about the physical plant, so decisions about what to defer can be made responsibly, not jeopardizing current life-and-safety or marketability at the property. For instance, at Vesta, asset managers look at what an anticipated capital event is likely to entail, and essentially reunderwrite the deal to estimate what funds (with what restrictions) are likely to be available then. VOA and Vesta agreed that an owner is well-served to think about Y15 throughout the project’s life, including when making annual CapEx decisions. Desjardins noted, “Even if you start thinking about Y15 around Y12, you may already be too late, and there may be some opportunities that are no longer available.” TCAM sees this often, for instance where an LP would prefer to exit as early as Y10 but the owner wasn’t ready with an analysis and buyout offer, or where costly capital account imbalances could have been prevented with earlier, strategic re-allocations or different CapEx decisions.

LDG’s young portfolio means they haven’t been through many Y15s yet, but Dischinger also described taking a long-term view, saying, “I’m careful not to get into a situation where we’re relying on a resyndication to actually keep up the property.” Given the spread between interest rates when some of the portfolio was originated and today, LDG also considers a refinance-and-hold plan for many of its assets. Looking at its (typically) 30-year affordability restrictions, LDG also considers the broader set of options that may become available at the end of the extended period.

Other Best Practices and Insights
Conferences and panels like these provide an opportunity to hear and learn from peers. The panelists offered specific examples from their organizations that have created long- or short-term cost savings.

  • VOA has an energy & sustainability manager on staff, who looks for local or federal sustainability incentives, including free labor or materials, purchase rebates and tax exemptions. In one recent example of a quick win of both cost and energy savings, VOA saved over $500 on the purchase of new energy-efficient boilers thanks to a state program.
  • Vesta looks for economies of scale by doing multiple similar projects at once (e.g. roof replacements) in a similar geography, even if it means some properties are improved slightly ahead of schedule. Similarly, LDG recently negotiated some savings on a painting job done by the same contractors working on a nearby construction project for them.
  • Said Moran, “A lesson we learned over time was to do things right the first time, use quality materials, and it pays off.” He acknowledged that the company has lost acquisition bids over this, as Vesta’s underwriting and anticipated cost of rehab can’t support a purchase price as high as what someone making a shorter-term investment may offer. Nevertheless, the company believes in the long-term payoff of this approach. One suggestion from both Vesta and LDG for a higher upfront cost that’s worthwhile in the end: use vinyl flooring instead of carpet, since it’s more durable and can be replaced in patches.
  • LDG is currently analyzing the payoff for investing in things like more expensive Hardie-plank (likely to eventually need repainting) as opposed to cheaper but shorter-lived vinyl siding. Such analyses are time-consuming and often fall to Dischinger himself to do, but LDG sees these decisions as potentially worth the effort, particularly if a long-term hold is expected. Development costs are partially subsidized as part of LIHTC basis whereas replacements in subsequent years are paid 100 percent by the project, so when better materials aren’t cost-prohibitive, they often turn out to be a good financial decision.

Asset managers in our industry continue to learn how best to attend not only to the investor’s financial exposure and the regulator’s compliance requirements, but also to the owner’s physical plant. Panelists at this session take a long-term view of their ownership. They are strategic and attentive in CapEx planning, and have seen their organizations’ investments of time and resources pay off.

Story Contacts:
Allen Feliz, Managing Director, TCAM
[email protected]

Peter DesJardins, Vice President of Asset Management
Volunteers of America, Inc.
[email protected]

Chris Dischinger, Co-Principal, LDG Development, LLC
[email protected]

Chuck Moran, Executive Vice President, Vesta Corporation
[email protected]