Wednesday, February 17, 2016

A primer on permanent affordability

by Charlie Wilkins, The Compass Group

NHC invites guest blog authors from our membership to write on important housing topics. The views expressed by guest authors do not necessarily reflect those of NHC or its members.

Permanent affordability for affordable rental housing requires two things: a permanent commitment to affordability and permanent viability at affordable rents. Commitment without viability leads either to the eventual failure of the property or to the sacrifice of affordability. Viability without commitment runs the risk that affordability may be sacrificed in the future, when different decision-makers are in charge.

I’ll talk about the permanent commitment first. But I think that permanent viability is even more important.

Permanent commitment to affordability
Some think that ownership by a nonprofit constitutes a permanent commitment to affordability, but I’ve seen that approach fail when the nonprofit runs into financial trouble (and sells the property or raises the rents to provide more cash flow). Some think that a project-based Section 8 contract constitutes a permanent commitment to affordability, but clearly that commitment is only for the life of the Section 8 contract. And surely none of us thinks that a 30-year Low Income Housing Tax Credit is a permanent commitment to affordability.

Don’t get me wrong. Any commitment to affordability is a good thing, and it’s an even better thing when the commitment is long-term or when it takes a particularly strong form.

I think the best answer, for a permanent commitment to affordability, is a foreclosure-proof use agreement and that runs for a very long period of time.

“Foreclosure-proof” means that the use agreement is binding on all future owners, including on a lender that takes title as a result of a foreclosure. The usual approach is to record the use agreement in the local land records before recording any mortgages or deeds of trust, and to require that all lenders acknowledge the superiority of the use agreement. I also recommend telling all potential lenders about this requirement from the very beginning, so that there are no misunderstandings later.
The “very long period of time” part is important. “Permanent” is not an absolutely precise term, but I think we can all agree that it means some very long time, say, fifty years or more. So I don’t think we can use the word “permanent,” in good conscience, in the context of a twenty-, thirty- or forty-year commitment.

Two reasons why I like use agreements: (1) We have to be precise about the level of affordability because we’re creating a written document that’s going to last a long time and that’s going to have to be understood by lots of people; and (2) The use agreement doesn’t allow future decision-makers, such as a lender that takes title to the property via foreclosure, to trade away affordability.

(PS: if a lender tells you they won’t lend if there is a foreclosure-proof use agreement, they haven’t thought it through. All of the big lenders have accepted this approach.)

Should the use agreement be absolutely permanent? Fifty or sixty years from now, perhaps the best thing may be to tear down the buildings and reconstruct, or to serve a different resident population. If a permanent use agreement is too rigid, it could later become a mission problem instead of a mission asset. On the other hand, if the use agreement completely expires after fifty or sixty years, that may not be the right approach either. This is a good area for thoughtful innovation.

Permanent viability at affordable rents
Most of today’s affordable rental housing will fail unless it receives more public subsidies after ten, fifteen or twenty years. This is unfortunate. It’s also 100 percent preventable.

There are two big obstacles to long-term viability.

The largest one is long-term capital needs (expensive but very predictable replacements of long-life building systems such as appliances, flooring, heating, air conditioning, roofs, parking lots, windows and siding). The solution is to obtain a relatively inexpensive and quite reliable study called a capital needs assessment, and to use the study’s findings to structure the property’s financing so that the long-term capital needs can be funded without the need for new public subsidies later on.

The second obstacle is that, over a long period of time, bad things can (and often do) happen. Markets may change, tenant incomes may grow slower than expected, expenses may increase faster than expected and new, unanticipated expenses may become necessary. The solution is to build in margins of safety (basically, higher cash flow, higher reserves or both) so that the property can survive most adverse surprises without needing new public subsidies.

Structuring properties financially for long-term viability is called lifecycle underwriting; you can learn more here.

When the goal is permanent affordability, we need two things: a permanent commitment to affordability and the long-term ability to provide affordability without relying on future public subsidies. Both components are essential.

After a long career operating affordable rental housing, Charlie Wilkins became a consultant in 1997, founding The Compass Group, LLC with business partner Anker Heegaard. Compass has helped HUD implement the Mark-to-Market, Green Retrofit, Neighborhood Stabilization and RAD programs; has helped USDA implement the Multifamily Portfolio Revitalization initiative; and has helped the state of Louisiana finance mixed-income apartment communities to replace housing lost to Hurricanes Katrina, Rita, Gustav and Ike.

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