Partnering with PHAs

11 min read

Benefits and liabilities come with RAD deals

The problem is clear, pervasive, and all but overwhelming: According to U.S. Department of Housing and Urban Development estimates, there is a backlog of more than $26 billion in needed renovations, repairs and upgrades to the nation’s inventory of public housing properties, and 10,000 affordable units are leaving housing programs each year. A challenge of this enormity will not be susceptible to any single or comprehensive solution, so HUD is trying to address it on several fronts, and in so doing, has indicated its willingness to experiment.

One such experiment is RAD, the Rental Assistance Demonstration program, announced in 2013 by former HUD Secretary Shaun Donovan. The aim is to test new methods of placing public housing projects and certain assisted multifamily rental properties on a solid economic footing and make it easier for public housing agencies to attract private debt and Low Income Housing Tax Credit equity for the renovations. According to A. J. Johnson, a full service real estate consultant in Williamsburg, Virginia, the best candidates for RAD conversion are buildings with a per-unit rehab cost between $30,000 and $40,000. In at least half the deals, nine or four percent credits are being used to make the deals feasible.

From a public policy standpoint in an era in which Congress has not provided sufficient funding for Public Housing Authorities (PHAs) to keep up with capital needs, RAD makes a lot of sense. The question for private operators in various phases of the affordable housing industry is: Does it make sense to get involved?

The answer, like the problem RAD was designed to address, is: There is no single answer.

RAD provides stable funding by offering long-term Section 8 contracts – 15 or 20 years – either as project-based vouchers (PBV) or project-based rental assistance (PBRA). Local public housing authorities select properties they own that they’d like to preserve or upgrade, and designate them for mortgaging to private capital. If the building’s condition is considered unredeemable, it can be torn down and a new residential structure built on the site. As far as HUD’s own budget is concerned, RAD is supposed to be cost-neutral, simply shifting units from public housing to Section 8.

In September 2014, current HUD Secretary Julian Castro lauded the program: “Back in July, the residents of Magnolia Crossing Development [in Yazoo, Mississippi] wiped away tears as they broke ground on their renovation project. In the past, conditions were so bad that they’d coordinate when to do laundry because their units would flood when too many machines were running at the same time. Thanks to RAD, they are shaping a brighter tomorrow, and communities across the nation want to do the same.”

The Times They Are A’Changin’
So how do the plusses and minuses balance out for developers and other industry professionals considering RAD participation? That was the topic of an in-depth panel discussion at the 2016 NH&RA Annual Meeting and Public Housing Joint Venture Symposium at The Breakers in Palm Beach in February. Moderating was Patrick Costigan, one of the founders of CF Housing Group of Washington, D.C., and a former senior advisor to Shaun Donovan, with more than 30 years of affordable housing and community development experience. During his time at HUD, he led the effort to establish RAD.

“Why do you want to do this with a public housing authority?” Costigan posed to the panel and audience. “It’s like the Willie Sutton line about ‘Why do you rob banks?’ It’s where the inventory is. There are 2,000,000 units of public housing and a lot is not in good shape.”

Amy Glassman, an attorney with Ballard Spahr in Washington, D.C., has an overview of the entire RAD process, representing public housing authorities, developers, nonprofits and other recipients of HUD funds. She notes, “The housing authorities are in an interesting position. The only way to redevelop their properties is with private capital through partnerships. Even if they’re self-developing, they need partnerships with investors and lenders and others, which is not necessarily the way they were operating ten or 15 years ago, or for some, even two years ago. So some are getting good at acting like private developers.”

The Wherefore and the Why
While there are many considerations for developers and investors, the prime factor appears to be the local housing authority itself. They are not, it seems, all created equal. And some bring more to the table than others.

Milton Pratt, Jr. is Senior Vice President with Michaels Development Company in Marlton, New Jersey. Since 2005, Mr. Pratt and his team have developed more than 2,500 affordable units, valued in excess of $375 million. “We look at a lot of RFPs,” he comments. “And we’ve come to the realization that every deal may not be right for us. We’re looking for housing authorities with capacity and financial advisors; and are they listening to their advisors?”

He looks for housing authorities that are already working on master plans, because, “It is a challenge to bundle an entire package together.

“Next we’ll look at the buildings themselves that they’re talking about converting over to the RAD program. If there are poor conditions – not enough RAD rents or capital dollars to make these deals work – we have to say to the housing authority, ‘You might want to develop this yourself.’”

The real prize: “Communities with high land values where we go in for four percent credits.” He notes, “In many states, RAD is not eligible for nine percent credits.”

Costigan points out that a significant number of housing authority projects are in neighborhoods ripe for transformation, such as those near MIT in Boston and John Hopkins Hospital in Baltimore.

Cassandra Silvernail is a Senior Vice President of Bank of America in Houston and a Senior Equity Originator on the BofA Merrill Lynch Direct LIHTC platform. “As an investor, what we look for first from the housing authority or development team is experience with new construction or rehab,” she states. “And second: that they are financially capable of providing guarantees.” Since PHAs are often limited financially, she likes to see a package involving a private or nonprofit developer who can fill the gap between Section 8 subsidies and the LIHTC guarantees. A third-party management consultant with experience in tax credits is a definite plus.

Silvernail evaluates each deal based on a 15-year pro forma and summarizes her minimum requirements as a bonded guaranteed maximum contract (G-Max), completion guarantee, and reserves or capital demand note to backstop long-term risk.

By their very nature, RAD deals involve partnerships. Zoe Weinrobe’s first questions to a housing authority are, “What is your goal? Is it long-term ownership and stability for the residents? Do you want to diversify? Do you want to preserve existing housing or demo the site and start over?” And finally, “What are your RAD incomes and expenses? If you can’t make your cash flow, you can’t do the deal.” Weinrobe is Vice President of Recap Real Estate Advisors in Boston, with more than a decade managing development transactions in both the public and nonprofit sectors. Her work has included all aspects of the development, redevelopment and recapitalization of tax credit, federally assisted and public housing properties.

She divides RAD transactions into three “buckets”:

  • Straight conversions with low capital needs and limited soft costs.
  • Debt-only FHA or conventional mortgage financing with limited rehab.
  • Big projects with four or nine percent tax credit backing.

And for these, the considerations lead to more specific questions, similar to those voiced by Pratt: Does the housing authority have the necessary experience? Can it meet guarantees and tax credit compliance rules? Can it procure the necessary third-party vendors, such as architects and engineers? “It’s a nightmare, and a full-time position to do these deals,” she declares. “So those are the initial tough questions we have.”

Glassman also stresses to her clients the need to be sure there will be enough revenue to cover expenses plus debt. “If a property has deep capital needs, it might not work for RAD.”

A number of developers have considered applying to the program, but after completing their pro formas, determined they were looking at costs in the $60,000+ per unit range, so other types of funding packages would better meet their goals.

It’s Still the Same Old Story
Even though RAD conversions are somewhat specialized deals, the traditional considerations for affordable sector developers don’t go away. Just as for a new project or a traditional conversion, potential partners look for opportunities in which the local residents, governmental agencies and neighborhood stakeholders are in favor of the facility and will work to have it realized.

There is a perception in some quarters that RAD is privatizing public housing, and so it is a threat. Unless handled effectively, this can become a local hot button.

“Make sure you have the right political climate,” warns Pratt. “Otherwise, it can be a real quagmire.” The other issues for a potential developer to check out are the ease of zoning, permitting and regulatory relief – some jurisdictions are notorious in this respect – and whether there will be any help with infrastructure, such as water and sewer investments – “Things the city should do normally,” he says.

“And I sometimes don’t think [the local housing authorities] are spending enough time convincing their own boards that RAD is a good program and makes sense.”

From the housing authority’s perspective, Amy Glassman adds, “Do you need a developer partner? That really depends on the individual authority. There needs to be a frank discussion with the board to understand what they’re signing onto.”

The administrative structure of the partnership with the housing authority is important to some developers and investors. But that can be defined in different ways. Most want to know in advance who will be making the management decisions.

Says Pratt, “We have to start out with control – absolute, total control of the partnership. From our perspective, it doesn’t matter if the housing authority is the managing general partner or the administrative limited partner. We’re comfortable with giving the housing authority the right to take over property management if they can do it for less than us, but it’s not common. I do want to know how much of the developer’s fee do they want, and what are they going to do for it, and what percentage of risk are they accepting.”

Representing lenders and investors, Silvernail says, “I want the person standing behind the guarantee to be compensated fairly so they have a vested interest.”

Reviewing the Situation
“Public housing authorities are the gateways to subsidies,” Pat Costigan summarizes. And they can bring a lot to the table for developers and investors, including, most importantly, land; but also project-based vouchers; various kinds of reserves; in-place resident services and benefits; facilities and community spaces; and established resident support of a prospective development program.

On the other hand, there are Central Office Cost Center expenses, otherwise known as overhead; not always useful balance sheets; annually prorated operating and capital funds; HUD regulations; civil rights, relocation and other reviews; boards, intra-office politics and committees, among other baggage.

Another issue that will go into the decision-making process is the multitude of compliance requirements of all subsidy programs used in the RAD transaction, including, as mentioned, LIHTC and Section 8, HOME Investment Partnerships, and local rules. Additionally, each subsidy program has its own set of tenant eligibility requirements, so a developer will have to get them to overlap – not always (or usually) a simple task. For example, some current residents may be above the LIHTC income limit. And unless the local authority has made provision for tenant relocation during construction or made certain that it can move forward with residents in place, this can be both an added expense (as well as working out which partner is going to bear it) and a major headache.

So, developers or investors will have to take all of the benefits and liabilities of a partnership with a public housing authority into account: evaluating the organization, master plan, experience and personnel capabilities of that agency; scoping out the local support, political climate and regulatory cooperation of a particular area; weighing the upward transitional potential of the neighborhood; the physical condition of the property itself and that individual or organization’s own tolerance for uncertainty.

With this many variables, there is no simple answer. Each deal will rise or fall on its own potential risks and rewards.