COSCDA | COSCDA Publication Using HOME For Rural Housing Development

PREFACE

The Council of State Community Development Agencies (COSCDA) is a membership organization for cabinet-level state agencies which administer federal and state resources for housing, homelessness, and community and economic development. These programs include the Community Development Block Grant (CDBG) and (in about half of the states) HOME Investment Partnerships (HOME)and the Emergency Shelter Grant. COSCDA members work extensively with local governments, nonprofit organizations and the private business community. COSCDA provides technical assistance, training, and advocacy for members in the areas of policy development and program practice.

This report is one of eleven reports COSCDA is preparing under a cooperative technical assistance grant funded by the U.S. Department of Housing and Urban Development. The grant is administered through the National Affordable Housing Training Institute (NAHTI), a nonprofit organization composed of eight public interest groups, including COSCDA. NAHTI provides technical assistance and training support to city, county and state governments in the areas of affordable housing and community development.

Under its cooperative agreement through NAHTI, COSCDA conducts various training and technical assistance acitivites to help state agencies administer the HOME program in an effective, innovative, accountable manner. These activities include HOME workshops, a quarterly newsletter called HOMEnotes, on-site consultations, and demand/response technical assitance and referral. The four Technical Assistance Reports produced under this grant profile selected state programs to offer models of best practices in the development, implementation and management of effective HOME programs and viable housing development. Other Technical Assistance Reports in this series are entitled Using HOME for Rural Housing; Managing & Monitoring HOME-funded Rental Housing, and HOME's Role in Community Revitalization & Welfare Reform (tentative title).

HOME is a federally-funded housing program that allocates funds directly to states and local governments on a formula basis (40 percent to states; 60 percent to local governments) for the development of affordable housing. Created in 1990 through the National Affordable Housing Act, the HOME program has generated more than 200,000 units of affordable housing and provided over 28,000 low-income families with tenant-based assistance.

HOME is currently the most flexible form of housing assistance provided directly to states and local governments. The program was developed, in part, due to recognition of the increasing state role in affordable housing development and to prompt additional and continuing housing development by states and local governments. The program also strongly emphasizes the role of community-based nonprofit organizations (formally designated as community housing development organizations, or CHDOs) in the housing delivery system. HOME funds may be used to support a range of activities necessary to produce decent, affordable rental and homeowner housing. It can also be used for transitional or permanent housing for people who are homeless. Program activities may include new construction, rehabilitation and acquisition of affordable housing, as well as tenant-based rental assistance (for an initial period of 24 months, which may be renewed) and security deposits. Funds also may be used to support project pre-development or organizational operating support for CHDOs.

Acknowledgements

Ellen Bowyer thanks Marty Evanson and Maire-Frances Fay, Wisconsin Department of Administration, for their assistance and information during the April site visit, and for their frequent comments and questions regarding use of HOME in rural areas. Great thanks also to all of the nonprofit providers in Wisconsin who met with Ellen, especially the staff of West Cap, who provided such an excellent tour of HOME-assisted housing.

NOTE

For the purposes of this report, "rural" is defined as units of local government which do not receive HOME funds directly from the federal government.

" The work that provided the basis for this publication was supported by funding under a cooperative agreement between the National Affordable Housing Training Institute (NAHTI) and the U.S. Department of Housing and Urban Development (HUD). The substance and findings of the work are dedicated to the public. The author and publisher are solely responsible for the accuracy of the statements and interpretations contained in this publication. Such interpretations do not necessarily reflect the views of the United States Government."

The HOME Investment Partnerships (HOME) program was authorized in 1990, receiving an initial appropriation of $1.5 billion for federal fiscal year 1991. States, who receive 40 percent of the national allocation of HOME funds, may use those funds in nonentitlement areas or in local governments which receive HOME funds on an entitlement basis. While it is difficult to generalize about state HOME programs, many states clearly their HOME funds extensively in rural (non-entitlement) areas.

A number of new programs and initiatives for rural housing development have been announced recently. Congress, for example, included a $300 million Fund for Rural America as a part of the Farm Bill enacted in April 1996 (up to 20 percent of Fund monies would be available through Rural Housing Services programs). In November 1995, the Local Initiatives Support Corporation (LISC), the Federal Housing Finance Board, and the 12 Federal Home Loan Banks announced the commitment of $200 million in Community Investment Program funds to help support rural community development corporations. LISC also independently initiated the Rural LISC program, a four-year, $302 million effort to support capacity building among rural CDCs. Such increased opportunities for rural housing development and support of rural housing organizations increase the need for states to be use their rural HOME funds effectively..

The HOME program represents one of the most significant sources of flexible housing financing assistance for development of affordable rental housing in rural areas. Development in rural areas, however, poses challenges not found in urban areas, where housing development assistance historically has been focused. This report provides guidance to state HOME program administrators in developing a program and financing structure that facilitates use of HOME funds for successful affordable housing development in rural areas.

Use of State Home Funds in Rural Areas

COSCDA surveyed states in mid-1995 regarding allocations of state HOME funds to local HOME participating jurisdictions (PJs). Of the 26 states responding, 17 have allocated HOME funds to PJs, with five indicating that they do not plan to do so in the future. Nine states indicated that they had not allocated funds to local entitlement communities in the past, and did not intend to allocate funds in the future.

Examination of the consolidated plans in six states with extensive rural areas indicates that three states (Oklahoma, North Dakota, and Nebraska) do not use any state resources in local HOME participating jurisdictions. Three other states (Alabama, South Carolina, and North Carolina) allocate funds statewide, without set asides or restrictions for local HOME entitlements. South Carolina does restrict its set aside for councils of governments to those located in nonentitlement areas to build rural capacity.

COSCDA surveyed State HOME program administrators in late 1995 on their use of HOME funds in general (42 states responded), finding that a majority of states indicated that "most of the projects developed under [their HOME] program" are in "rural areas" (as defined by the respondent). In addition, "working in rural areas" was identified as the third highest priority (among 14 issues) for training and technical assistance.

Report Purpose

This report clarifies some issues concerning affordable housing in rural areas from a state's perspective. It then provide guidance to states to concerning the difficult choices and decisions associated with using HOME funds to develop rental housing in rural areas. Issues addressed include: methods of encouraging rural housing development; decisions regarding allocations of HOME funds to projects; and strategies for supporting deals towards successful completion and operation.

For the purposes of this report, "rural" is defined as units of local government which do not receive HOME funds directly from the federal government. The definition of rural areas is less important, however, than the issues this report addresses: doing smaller-scale development in areas with fewer affordable housing resources and a relatively weaker delivery system for affordable housing than might be found in denser, older urban areas.

This report does not advocate for a greater or lesser state role in rural areas. Instead, it attempts to help states which use their HOME funds in rural areas . This report does not list sources of financing for housing in rural areas, nor does it act as a guidebook for putting together specific rural housing deals. A number of other reports currently provide such information and guidance.

Difficulties of Using Home in Rural Areas

Due to statutory and regulatory requirements associated with HOME, many states experience difficulty using HOME funds in rural areas. For example, the focus on "neighborhoods" in the statutory definition of CHDOs often was inapplicable to nonprofits which served large, low-density rural areas.

Since the inception of the HOME program, the regulatory definition of "project" was a development within a "four-block" area. This definition was not often to rural housing development, which is usually less concentrated than urban housing. Effective October 16, 1996, the Final Rule for the HOME program deletes this "four area block" provision from the definition of a "HOME project."

The statutory requirement that states conduct annual on-site monitoring visits to HOME projects also imposed strains on many states which have used HOME to fund scattered site, low-density rural development. Again, the Final HOME Rule relaxes these requirements by altering the requirement for on-site inspections of smaller projects: For one to four units, every three years; for five to 25 units, every two years; for 26 or more units, every year. All tenant-based rental assistance units, no matter the size of the project, still require an on-site visit every year.

Other issues associated with rural housing development complicate matters regardless of the funding source. While some development costs (such as for land ) may be lower in rural areas, the lower incomes of rural residents (relative to urban residents) translates to a higher relative cost of housing developments for the purposes of affordability. In short, lower average income make affordable rents more difficult to set, since the project must also generate sufficient operating income.

Additionally, rural areas often cannot access the numerous funding streams that may be found in urban areas. Players in rural delivery systems often may have less knowledge about affordable housing development, so they may provide less coverage for populations and areas in need. They also may not have the funds or other resources to pursue affordable housing development aggressively.

While nonprofits can play a strong role in affordable housing, nonprofits in rural areas may be too few in number or insufficiently experienced to take on complex affordable housing deals in a consistent and comprehensive way. Creating affordable housing in today's economic environment requires the ability to assess complex ownership, financing and operational system alternatives. Ongoing expertise in all those arenas requires a continuing exposure to each of their specific attributes. Such expertise cannot be maintained without constant practice, and rural areas may offer fewer opportunities for such practice than urban areas.

In summary, rural development can be difficult to structure and finance due to challenging economic realities, and can be difficult to execute due to weak delivery systems and geographic distance. States must continually balance the implicit need for deep subsidies in rural housing development with the desire to maximize leveraging of multiple funding sources. They must also establish effective project monitoring and tracking systems which work for developments throughout a large geographic area. This report is intended to help states work through some of these issues to help ensure that their programs effectively support the projects most needed within a given community.

Report Structure

Chapter Two describes rural housing development issues in the areas of housing needs, project types, project financing and delivery systems. Issues identified generally are illustrated with data and information from state consolidated plans. This chapter identifies and explores the difficulties of rural development from a state agency perspective. Chapter Three uses a case study to examine issues associated with financing rental housing, focusing on specific areas where states may need to assess rural project financing differently from those for urban projects. Chapter Four concludes the report by highlighting issues around capacity building for rural CHDOs.

To ensure that the technical assistance provided in this report is applicable to the needs of states, the author made a two-day site visit to Wisconsin, meeting with staff in the Department of Administration, as well as several community action agencies which use State HOME funds to do moderate and substantial rehabilitation and new construction. In addition, Consolidated plans and HOME programs in Alabama, Nebraska, North Carolina, North Dakota, Oklahoma and South Carolina were examined to identify rural housing issues and strategies. In most cases, HOME staff in those states were not consulted for this report; the information provided is drawn almost entirely from written documents.

Chapter 2. Issues in Rural Housing Development

Rural housing development differs from that in urban areas in four key ways: the needs being addressed, the projects being proposed, the specifics of project financing, and the capacity of sponsors involved in the deals. This chapter briefly identifies issues within each of these areas in order to lay the groundwork for the financing and capacity building discussions in Chapters Three and Four.

Rural Housing Needs

This section does not attempt to provide a comprehensive analysis of rural housing issues. Instead, it reviews some basic data on rural housing issues, buttressed by some of the key observations of states working in rural areas.

There are distinct characteristics to rural housing needs. A recent study prepared by the National Rural Housing Coalition indicates that the rural stock is declining compared to growth in metro areas, and while the ownership rate in rural areas is higher than in metro areas, much of that owner-occupied stock is lower-cost, lower-quality housing, such as mobile homes. While housing costs are lower in rural areas, cost burden still is an issue, and rural units generally have a higher rate of moderate or severe housing problems than metro units. The rural population is declining and aging, family incomes are growing more slowly than metro incomes, and the growth rate in the labor force is dropping at rates faster than those in metro areas. This relatively broad brush overview is borne out in specific state needs analyses as well.

Nebraska's Consolidated plan identifies as issues facing rural communities a poor quality and aging housing stock, a lack of available rental housing, and little opportunity for homeownership. Oklahoma's Consolidated plan observes that while "metro areas have a relatively high number of vacant housing units, the supply of housing may not be sufficient in specific rural areas" (page 24), especially those affected by sudden population increases due to the location of new or expanded business or industry. In South Carolina, "Census data indicate that the rural portions of South Carolina's counties are disproportionately low income and have a substantial inventory of substandard housing" (page III-17).

Alabama's consolidated plan identifies the lowest vacancy rates for both owner and renter units as being in rural areas. Rural Alabama renters and owners generally pay a larger proportion of their income for housing costs than their counterparts in more urbanized areas, and homeownership is proportionately higher in the rural areas (pages 7-14). One clear point made throughout Alabama's analysis is that while the incidence of housing problems may be higher in urbanized areas given the larger number of units, generally housing problems are proportionately greater in rural areas (that is, a higher percentage of the housing stock is affected than in more urbanized areas).

All of the State consolidated plans noted issues with special needs populations, including frail elderly and homeless people, and people with mental and physical disabilities. In South Carolina, "Housing that is both suitable and affordable to [low-income elderly and single parent families] is scarce statewide, especially in rural communities" (page III-18). One specific difficulty with assisting special needs populations in rural areas is the absence or inadequacy of needed support services.

In addition, many states note the need for infrastructure (such as sewer, water, and roads) associated with affordable housing provision. Rural housing projects often must include water, sewer and other infrastructure as a part of the total development cost. Additional delays often occur because of the needed permitting and funding for such infrastructure. The local community may find it difficult to support infrastructure; its utility systems may be old or over capacity, or may use outdated technology. Needed additions may require major redevelopment, beyond the ability of the community to finance. A need for a strong tie-in with infrastructure funding if often needed, which is available through the State Community Development Block Grant (CDBG) program in many states.

Another specific issue of concern to states economic development in communities that occurs in the absence of adequate affordable housing for employees. This is clearly an issue in Oklahoma and Nebraska. Nebraska's consolidated plan notes that "Selected communities along the I-80 corridor have had tremendous economic activity, but have been unable to meet the additional housing demand. The result is many individuals and families are living in substandard housing and/or overcrowded conditions" (page 23).

South Carolina's consolidated plan emphasizes the "interdependence between community economic development and housing supply in rural communities" (page VII-19). The particular issue in rural areas is that communities may have no housing and insufficient infrastructure for new construction -- they are essentially starting from ground zero with regard to available housing.

Rural Housing Projects

A hallmark of HOME is flexibility: a range of housing projects may be supported with program funds . Nationally, 49 percent of all of the units which have received funding commitments under HOME are rental units (new construction, rehabilitation or acquisition; this figure excludes tenant-based rental assistance), while 27.1 percent are homebuyer units, and nearly 24 percent are homeowner rehabilitation units. While it is difficult to generalize about the kinds of rural housing deals which come in under State HOME programs, the physical distance between projects, the lack of economies of scale in doing deals, the lack of infrastructure and the relatively higher emphasis on homeownership result in deals that are different from those being proposed in more urbanized areas. Many of the projects are single-family rehabilitation, small, scattered-site rental housing developments, and first-time homebuyer assistance.

For example, much of the activity under Wisconsin's program tends to be oriented towards homeowners: since program inception, homeowner rehabilitation accounted for 38 percent of all units receiving commitments and first-time home buyers accounted for nearly 22 percent of all units receiving commitments, while rental units (including 482 units of tenant-based rental assistance) accounted for about 40 percent of all units receiving commitments. A total of 703 units utilized HOME funds for new construction, rehabilitation or acquisition, resulting in a direct contribution to the rural housing stock. More importantly, those 703 units were grouped into 267 projects, meaning that each project contained an average of just under three units.

As organizations gain capacity, however, these trends may be changing somewhat. In Wisconsin, several community action agencies noted that recently they are beginning to pursue more multifamily rental housing projects. One agency recently completed development of a project containing three rental duplexes, and another is mid-way through construction on two buildings, each containing two rental housing units. In North Dakota and North Carolina, staff note that they are seeing more multifamily housing development in rural areas proposed for HOME funding. Oklahoma instituted a housing strategy (allocating HOME and state funds for rental housing to CHDOs) specifically to encourage the development of multifamily projects in rural areas of the state.

Rural Housing Finance

Housing finance addresses the costs of financing and operating a housing development, and the source of funding available to support those costs. While the hard costs of housing development in rural areas generally are lower than those in urban areas -- land costs and construction wages may be lower, and raw materials may be available at lower costs -- some soft costs -- such as financing and legal fees -- may be higher. Further, in some cases, rural housing development may not benefit from the economies of scale enjoyed by urban projects and there may be greater expenses associated with transporting materials and work crews longer distances than in urban areas. Land regulations also may have a strong negative impact on rural housing costs. For example, Alabama's 1995 consolidated plan notes that with regard to local zoning ordinances and subdivision requirements, "The application of suburban standards for some areas often results in a situation in which affordable housing is not economically feasible...a combination of these factors often causes development costs to be unreasonably high in Alabama's rural areas" (page 73).

Another key issue is fair market rents (FMRs), which are used to help structure the HOME rents. In the last four to five years, states have noted difficulties with what they see as unrealistically low FMRS, especially in rural areas. The lower the FMR, the lower the HOME rents on projects, which in turn lessens project cash flow needed to support fixed costs (operating, maintenance, debt service) that are only slightly lower than those for urban developments. Further complicating matters are the lower incomes in rural areas. Rural employment is primarily in low-skill, minimum wage jobs in agriculture and agriculture service businesses. Work is often seasonal or part-time, and the job market may be characterized by instability and little economic diversification. This means that even if rents could be increased, many tenants would be unable to afford the units.

Low FMRs and tenant incomes in rural areas mean that projects must be supported by creative financing to ensure their affordability. This includes combining grants with low-interest or forgivable loans to ease the debt side of the project proforma. In general, rural communities often have less access than urban communities to private contributions and corporate grants to reduce debt service or provide operating support to nonprofits. Further, rural banks may be less able to access secondary market finances, and have less knowledge and experience in combining grants, tax credit syndication proceeds, low-interest and forgivable loans to make projects work.

Financing Sources

A number of financing sources exist which are specifically targeted to rural areas; accessing these resources is critical. The Rural Housing Service (RHS) under USDA Rural Development is a key source of federal financing for rural housing. One of the strengths of RHS has been its extensive network of county supervisors with a track record of local responsiveness to community needs. Local representatives are given a high level of authority to make projects work and to tailor programs to meet local needs. For example, local authorities are given freedom to interpret appraisals, counsel buyers and structure "work-outs" on problem loans.

HUD and RHS have attempted to make the guidelines and requirements for their respective programs compatible, and for the most part they have been successful. The different underwriting procedures of each agency, however, have created occasional differences. For example, HUD and RHS have different definitions of project cost. Of greater concern is the lack of information available to program staff regarding the various governmental programs available to rural communities. The outreach activities of RHS and HUD generally have not been extensively coordinated.

While local lender participation is crucial to an effective housing delivery system, many lenders in rural community find it difficult to play a significant role in financing affordable housing development, despite incentives provided under the Community Reinvestment Act. Lenders are often too small to provide total project financing and may not have access to secondary markets or private capital sources like insurance companies or pension funds. Often one major obstacle is lack of knowledge about many government financing programs, such as HOME and LIHTC. States and rural CDCs have a stake in educating private lenders about ways in which alternative resources enhance project feasibility and protect the private investment.

Indirect Funding Sources

Secondary market access has always been problematic in rural areas. While Fannie Mae, Freddie Mac and other secondary mortgage sources have been expressing interest in serving rural areas, rural communities still are relatively unfamiliar territory. Rural projects do not fit standard underwriting and appraisal policies and the stability of many rural communities does not fit their guidelines which have been built around an active, often volatile, marketplace. For example, FNMA's appraisal policy requires a frequency of sales proximate to a subject property that doesn't exist in most rural communities.

Private industry is another important potential source of support. Increasingly, especially in rural communities where there is an obvious connection between new job creation and a critical need for affordable worker housing, industries are being brought into the equation for the expansion of the affordable housing stock. Expanding and new industries can bring their own economic clout to the table. They can provide guarantees to banks that make mortgages available and provide direct assistance to planning and infrastructure expansion. Private industry also often purchases federal housing tax credits used to expand local rental housing supply.

Rural Housing Development Capacity

Capacity incorporates a broad range of issues around the successful initiation, completion and maintenance of affordable housing development, which play out among a broad range of housing actors. A wide variety of organizations pursue housing development in rural areas, including nonprofits (especially, under HOME, community housing development organizations (CHDOs)), local governments, housing authorities, community action agencies and for-profit developers.

For example, Oklahoma works with nonentitlement local governments, CHDOs, and community action agencies (specifically ones experienced in weatherization) while Nebraska works with local governments, CHDOs, and eligible entities which have received funding under the Section 515 Rural Housing Loan Program. Community action agencies play a large role in Wisconsin's HOME program, being the principal administrators for the HOME Weatherization program (which provides funds for moderate rehabilitation of owner-occupied units also receiving assistance under the Weatherization program) and also sponsoring projects under other State HOME program set asides.

Extensive weaknesses in the rural housing delivery system often exist. Local governments may not have the knowledge or capacity to support affordable housing development., whether in terms financial support or general development expertise. Rural lenders often are less versed in the intricacies and difficulties of financing rural housing, and may not be knowledgeable about the sources available to finance affordable housing. These issues have been touched on in preceding sections.

Nonprofit Capacity in Rural Housing Areas

Strengthening nonprofit organizations' ability for affordable housing development is especially key given that states must allocate at least 15 percent of their HOME funds to CHDOs, and may use HOME funds to support operating and redevelopment funds for CHDOs. While it is difficult to generalize about rural nonprofit capacity, there appear to be a few common characteristics that are related to their work and location in rural areas.

One is that few rural nonprofits are used to doing large, complicated affordable housing developments or to doing several even moderately-sized deals concurrently or consecutively. Instead, much of their work in the past has been confined to minor rehabilitation or fragmented homeownership (repair or first-time buyer) housing activities. While this is due in part to the fact that this is the type of development in demand in rural areas, and that prior to HOME there was less state-administered money for housing going into rural areas, the result is a lower administrative capacity for extensive or sustained housing development.

Second, these organizations rarely are able to focus on one or two communities, but instead must generally take a regional approach to housing development. Wisconsin notes that of the 14 organizations now being supported under its CHDO Resource Fund, only three or four of those are serving one community; the balance are serving several communities or entire regions. One region served by a single CHDO, for example, is geographically the size of the state of Connecticut. Taking a regional approach means that the nonprofit developer almost necessarily will be less familiar and rooted in any one community, which in turn has implications for the project's ability to effectively utilize all forms of community support, from resident interest to local private financing sources.

Third, nonprofits may find it difficult to establish strong, fair partnerships with local for-profit developers and other entities which provide access to development expertise and financing. Rural nonprofits with less exposure to extensive financing and deal structuring may be more at risk of entering into deals which are not structured to protect their financial interests, and which may not take fully into account their potentially limited abilities.

Long-term management and monitoring of HOME-funded projects are essential, which means the property manager is, from the beginning, a key component of the development team. Rural developers often may not have access to highly experienced property management firms. In many cases, the developments being proposed are too small to attract the attention of more experienced firms. North Carolina staff note that 60 units constitutes the minimum feasible number for a successful management strategy, while the maximum HOME project size in Alabama is 56 units, again since that is the minimum to support on-site management staff. It is often economically and programmatically infeasible to manage small, scattered-site rural housing developments. This means that nonprofit developers in rural areas face a double problem with regard to property manage-ment: greater expenses and greater reliance on their own expertise.

Summary

The preceding suggests that while rural communities may have extensive housing needs -- high levels of substandard housing or an outright lack of housing, and residents who are less able to afford housing -- they lack the financing and development expertise often found in urban communities. The following two chapters suggest how states can use their HOME funds to greatest effect to alleviate both of these problems, in terms of structuring financing (Chapter Three) and building community capacity (Chapter Four).

Chapter 3. Financing Rural Housing with the Home Program

The most effective program is flexible and permits a wide range of activities. Wisconsin notes, for example, that it makes HOME funds available as set asides within the whole range of eligible activities, looking to communities to identify the types of programs for which they need to apply. Montana does not identify any program set asides, but allocates HOME resources on the basis of applicant demand. Financing and capacity building, conversely, require more detailed, focused consideration by the state. In short, the use of HOME funds in rural areas -- the extent to which it is demanded and can be accessed for rural development -- depends more on the commitment of the state to dealing with financing and capacity building issues than it does with specific program requirements. This chapter examines these two areas with reference back to the discussion in the preceding chapter, and makes recommendations for actions and strategies that reflect an emphasis on approaches that effectively support difficult housing deals while retaining protections for the public finance.

Financing affordable housing through public resources demands that states balance two concerns. The first concern is to ensure that the project meets the needs of the community in which it is to be located. On a programmatic basis, this concern means that states must have application and project review procedures that reflect a concern for local needs assessments. Applications and project review procedures must be sufficiently flexible to permit development of deals which, while non-traditional and possibly difficult to finance, meet a critical community need. A concern revolves around accountability and appropriate use of public resources. Given the scarcity of public resources, and the need to ensure that HOME-funded projects are able to meet long-term affordability and housing quality requirements, states need to ensure that the financial structure of every funded project is sound, and that the funding awarded to individual deals are sufficient to support a strong development, without being excessive.

These issues are very difficult to balance due to the unique characteristics of rural housing development identified in the preceding chapter. Financing gaps are greater, for example, since tenant incomes are lower and sources of financing more difficult to access. While projects are generally smaller (in terms of units), the transaction costs are relatively constant. A six- to twelve-unit project may require the same attention to zoning changes, permitting, securing financing and legal costs as a 50-unit project. The need for direct services provision and provision of infrastructure may raise project costs. This suggests that states may need to assess the proformas for rural housing development differently from those for urban or suburban projects.

The following case study highlights issues in four areas: project costs, project financing, operating costs, and project income. The case study compares two similar hypothetical projects. The case selected is a typical small multifamily project, appropriate for HOME funding in either a rural or an urban setting. This simplifies the comparison of programmatic and development issues, and clarifies the mix and layering of conventional and public financing required in each setting, in that way high ghting the need for different levels of technical support to local agencies. This comparison therefore serves to illustrate the differences in project make-up, and the issues and concerns that arise from using similar evaluation criteria for rural and urban projects.

	Urban Project	Rural Project
Raw Land	$160,000	$80,000
Utility Extensions	---	50,000
Tap Fees	40,000	20,000

Total Site Costs	$200,000	$150,000

Architect/Engineer	60,000	60,000
Contruction (Structures)	620,000	640,000
Sitework	40,000	40,000
Paving/Landscaping	60,000	45,000
Legal Organizational	10,000	10,000
Financing Costs	30,000	30,000
Leasing/Operting Reserves	35,000	35,000

Total Improvements	$855,000	$860,000

Developer Fees	125,000	125,000

TOTAL Project Costs	$1,180,000	$1,135,000
TOTAL Cost Per Unit	$59,000	$56,750

Project Costs

The total development cost projected for the urban project of $1,180,000, or $59,000/unit, is only
slightly higher than the $1,135,000 or $56,750/unit cost, for the rural project. In the case study, project costs have been assumed to be similar for both the rural and urban project but there are a few important differences. All costs used in this example are based on land and development costs in typical urban and rural settings in a western state using Marshall Valuation Service as a guide. The cost of land with access to public utilities is $50,000 ($2,500/ unit) less in the rural setting despite the fact that sewer and water main extensions are assumed to be needed in the rural project. Labor costs are assumed to be higher on the urban project, although material costs are assumed to be lower.

The net result of these effects is that total construction costs are $20,000 ($1,000/ unit) higher on the rural project. Paving requirements are assumed to be more extensive in the urban setting and existing indigenous landscaping is assumed to be available to the rural setting, reducing costs. All other line items are assumed to be comparable between the two projects. Total development costs are $45,000 higher in the urban setting ($2,250/ unit or about 4.0 percent).

Operating Costs

The operating costs are assumed to be about six percent higher on the urban project. Most operating line items are the same between the two projects. However, payroll costs are assumed to be about 10 percent higher on the urban project reflecting a general trend of higher wage and salary rates in metropolitan areas; taxes are assumed to be 50 percent higher in the urban project due to generally higher tax rates and higher property values, and insurance is assumed to be slightly higher in the rural project due to its greater distance to fire protection services.

Although each sponsor plans to provide enrichment programs for tenants, the costs of those services are not reflected in the operating budgets. The sources of funds to cover the costs of those services should be identified and evaluated separately during loan underwriting if those services are deemed by the state to be essential to the success of the community. If plans for such services are vague or unrealistic during project planning, the project may suffer during its operational phase.

Incomes and Rents

Project rental income is limited by both market constraints and the program constraints of various federal funding sources. In this case study rural household incomes are about 70 percent of those in the urban community. This is consistent with national trends-- nationwide, household incomes in non-metropolitan areas are about 68 percent of those in metropolitan areas. Market rents are also lower in the rural project of this study. This reflects the fact that market conditions are affected by the supply of money within a community (as measured by area median incomes) to pay for goods and services (in this case, housing).

Low-HOME rents are the maximum rents allowed to be charged on those units designated as very low-income (VLI) units serving households at or below 50 percent of area median income (AMI). The federal HOME program requires that at least 20 percent of HOME-assisted units be designated as VLI units. Note that this project initially proposes to designate a higher percentage of units as VLI.

High HOME rents are the maximum rents allowed on low-income (LI) units serving households with incomes up to 80 percent of AMI. The federal HOME program allows incomes on all HOME-assisted units on a particular project to be up to 80 percent AMI, although at least 90 percent of all HOME tenants served by the program must be below 60 percent AMI. Most states require that all LI tenants' incomes be at or below 60 percent AMI at initial occupancy to ensure that this program requirement is met and to coordinate better with the Low Income Housing Tax Credit Program (LIHTC).

HOME rents are periodically published by HUD for every locality in the country. The gross rents published by HUD must be adjusted by the applicable utility allowance which estimates the cost of utilities paid by the tenant given the particular characteristics of each unit. The adjusted rent is the maximum rent allowed for that unit type. Note that owners often set actual rents at levels below the maximum to reflect market realities or to ensure greater tenant affordability.

The market rents reflect the going rate for comparable rental units within the market area. Market rents are generally estimated by surveying other properties and applying reasonable adjustments to account for differences in size, condition or amenities. Market comparables are usually much easier to measure in urban areas than rural areas since urban areas have larger pools of potential comparables. Rural sponsors therefore have a much greater responsibility to use their knowledge of the community to measure local market conditions. They may also have a harder job of demonstrating to lenders and investors that the project can achieve the projected rents.

In initial project planning, the sponsors have established proposed rents with these parameters in mind. In each project four 2-bedroom and four 3-bedroom units have rents below the Low-HOME rents. The remaining units are all limited by market rents since those rents are actually lower than the High-HOME rents (i.e. the maximum High-HOME rent could probably not be achieved in the marketplace if comparable units are available elsewhere for lower market rents).

Note that no obvious advantage exists for either project in designating four units as market rate since the rents for the market rate units are no higher than those for the LI units. One or both of the sponsors may wish to keep these units as market rate in hopes that they will be able to achieve higher rents on these units in the future, or to retain the flexibility to rent to a non-LI household. As will be demonstrated later, however, other considerations may cause them to compromise on their original goal of developing a mixed-income community.

Identifying the Financing Gap

The projections of rental income and operating expenses are used to determine the amount of private financing which would be available to the project. A mortgage from a private lender is assumed to be available at an 8 percent interest rate with a 30-year amortization. The private loan requires a minimum debt coverage ratio (DCR) of 1.25 to 1 and a maximum loan to value ratio (LTV) of 80 percent. The maximum private loan for each project will therefore be the lesser of the two amounts as determined by these two limitations.

The rental income from the urban project could support a loan of up to $640,000 from the private lender with debt service payments of $56,398/ year. However, a loan of this size would be about 85% of the $756,000 appraised value, thus exceeding the lender's underwriting guideline (maximum loan-to-value = 80%). The maximum loan at 80% loan-to-value would therefore be $605,000 ($605,000/ 756,000= 80%). the other hand, the income from the rural project could support a private loan of only $370,000 with payments of $32,781. A $370,000 loan is only 69% of the rural project's appraised value of $533,000, which is well within the lender's 80% limit. these two projects had to rely solely on private debt financing, neither would ever be built. Given the maximum loans available from the private sector, each project has significant funding gaps which will have to be closed if they are to be developed as affordable housing.

Closing The Financing Gap

The following details how to close the financing gap, looking to the LIHTC and to the HOME program, structured in a couple of different ways.

Using the LIHTC

The first strategy employed by each sponsor to close their initial financing gap is to look to the Low Income Housing Tax Credit Program (LIHTC). Equity provided through Low Income Housing Tax Credits would close a significant portion of the funding gap for each project. However, the urban project still needs to raise $70,000 and the rural project still needs $245,000. The following explores the implications of filling that remaining gap in one of three ways: HOME as a zero interest, deferred loan; HOME as an interest-only loan; and HOME as an amortizing loan.

The most important point to emphasize here is that one way of structuring HOME is not inherently better than another. Instead, it is critical that the state be sufficiently flexiblee in structuring HOME assistance so that a given project is successful.

Using HOME as Zero Interest, Deferred Loan to Close the Remaining Gap

The simplest way to close the remaining gap would be a zero interest deferred payment loan (with no payments required during the affordability period and all principal due upon sale or refinancing). Structuring a HOME investment as a deferred loan rather than a grant allows it to be counted in the basis on which LIHTC are calculated. If the HOME money were provided as an outright grant, the LIHTC basis would be reduced and less equity would be available to the project.

When a HOME loan is used in conjunction with LIHTC, in order to maximize the LIHTC equity, a minimum of 40 percent of units must be offered at the 50 percent LIHTC rents (which is usually equivalent to the Low-HOME rents). When layering multiple funding programs such as HOME and LIHTC, the most restrictive applicable program requirements generally are used. For example, LIHTC are only available to units which are restricted to occupancy by households at or below 60 percent AMI. To maximize LIHTC equity, all units within the project must be income- and rent-restricted to households at or below 60 percent of AMI. In the case study, the sponsors have already proposed to limit 40 percent of units to occupants at or below 50 percent AMI at Low-HOME rents. They originally had planned for some of the remaining units to be available to households with incomes up to 80 percent of AMI and the remaining units to be unrestricted. Unless they choose to restrict all units to tenants at or below 60 percent of AMI, they will not be eligible for the full amount of tax credits.

Since market rents are well below the maximum 60 percent tax credit rents, the urban project could restrict all units to tenants at-or-below 60 percent of area median income at 60 percent LIHTC rents without losing any rental income Since the 60 percent LIHTC rents are slightly below market rents in the rural community (which actually widens the funding gap somewhat), however, income would decrease slightly for the rural project.

The rental income in the rural project would be adjusted as follows if LIHTC are used on all 20 units:

While the effect of this reduction in rental income is to decrease Net Operating Income by $3,013 and increase the funding gap by $25,000, that decrease is more than offset by the additional equity available from claiming credits on all units. The rural sponsor may decide that the additional equity is an acceptable tradeoff for having lower rents and may change their original goal of developing a mixed income community. This is just one example of numerous choices which must be made by project developers during the process of "massaging the numbers".

Using Interest-Only HOME Loans to Close the Remaining Gap

Although providing the HOME loan as a zero interest deferred loan is a simple way of closing the gap, and one which potentially provides the non-profit sponsors with greater income which could be used to finance the enrichment programs which are planned in conjunction with the projects, some state PJs may prefer to structure the HOME investment in a way which would provide at least a modest amount of program income during the term of the loan, particularly if the project can afford to make payments. Both of the projects can afford to make some loan payments, although the Urban Project can afford a much higher interest rate. Given that the first mortgage required a DCR of 1.25 to 1, a significant amount of cashflow is available to make interest payments on the HOME loan with a DCR of at least 1.10 to 1. The example below illustrates the effects of charging interest while continuing to defer principal repayment. The Urban Project can support a rate of 8 percent and still maintain a healthy DCR over 1.20 to 1, while the Rural Project cannot support a rate higher that 1.5 percent without falling below a 1.10 to 1 DCR.

Note that the interest-only loans in these scenarios are made without regard to a specific loan-to-value ratio (LTV). Total combined debt on the rural project property is $615,000 ($345,000 + $270,000), but the assumed appraised value is only $533,000, resulting in a LTV of 115 percent (615,000/ 533,000). If the HOME loan were limited to 100 percent LTV, the maximum HOME loan would be $188,000 and the project would have a remaining gap of $82,000. Given that appraised value is usually based on a project's net operating income assuming market rents, and given that market rents are often depressed in areas where affordable housing is developed, appraised values are often also depressed in those areas. For this reason it is not unusual for development costs to be significantly higher than appraised values on affordable housing projects. A rigid loan-to-value underwriting standard could pose an obstacle to developers of affordable housing projects. This is often most evident in rural communities since market rents tend to be much lower in rural versus urban or suburban settings. States may wish to consider waiving LTV requirements or allowing LTVs over 100 percent in rural areas in order to remove this common obstacle to rural housing development.

In the above example, the Urban Project was able to easily support an interest-only loan with a rate of 8 percent per year. Given the relatively small size of the funding gap on the Urban Project, it can even support payments on a loan which fully amortizes within 20 years while maintaining a DCR of 1.17 to 1. The Rural Project, on the other hand, could not support any type of amortized loan for the full amount of the funding gap. Note that in this example, the funding gap on the Urban Project was not directly created by the cost of the private financing, it was created by the lender's terms. That is, the private lender could have provided 100 percent of the debt financing needed on this project if it were willing to accept a lower DCR and a higher LTV ratio:

Debt Service on $675,000 (8 percent, 30 yrs.): $59,435

Debt Coverage Ratio ($70,498 NOI): 1.19 to 1 (min. 1.25 to 1 required)

Loan to Value Ratio ($756,000 Appraisal) 89 percent (max. 80 percent allowed).

If the lender had allowed a DCR of 1.20 or more and LTV of up to 90 percent, virtually all of the urban project's debt financing needs could have been met by the private lender. This example helps to illustrate the benefit to states of proactively courting private lenders and persuading them to provide financing on the most flexible terms possible. As private lenders' requirements get more flexible, the need for HOME investment on individual projects decreases, making more HOME money available for other projects. The cost of the private financing was one of several factors contributing to the Rural Project's funding gap. A slight loosening of underwriting standards on the market rate private loan would not have come close to eliminating the funding gap on the Rural Project.

Deciding on the Form of Home Investment

The alternative scenarios above indicate the importance of careful consideration in decisions as to whether the state HOME investment should be made as a grant, zero-interest deferred loan, interest-only loan, amortized loan or some combination of the above. States must also establish appropriate terms and interest rates and must decide whether any portion of a HOME loan will be forgiven.

Most states are guided by certain principles in making decisions on the structure of the HOME investment. This decision process is often a balancing act between a state's desire, on one hand to maximize private financing, and on the other hand to maximize program income. States may seek to achieve both goals by structuring the HOME investment in ways which best complement the available private resources. That is, once the funding gap is identified, the HOME administrator can determine which method provides the project with the minimum resources needed for reasonable feasibility.

In the case study, the Urban Project was easily able to afford a relatively small, fully amortizing loan at a market interest rate, whereas the Rural Project required a much larger investment at 1.5 percent interest with principal deferred for at least twenty years. This does not suggest that rural projects are always more difficult to develop than urban projects. It does suggest that different market conditions within a state may require different solutions. States should be guided by their overall goals as described in their consolidated plan in determining the form of HOME assistance and the specific terms of that assistance. If states wish to serve a broad range of needs, they may need to establish maximum flexibility in determining the proper form of assistance to meet the particular needs of projects serving those goals.

Lessons from the Case Study

Since the projects presented were hypothetical, and because different market forces are present in different states, there are limits to the conclusions which can be drawn from the preceding analysis. A few broad and general themes have emerged which highlight some of the unique problems facing developers of rural rental housing.

First, incomes and market rents in rural communities are generally much lower than those in metropolitan areas, whereas development and operating costs are usually only slightly lower in rural areas. As the case study illustrated, the end result often is larger financing gaps in rural projects, which in turn creates a need for larger subsidies on "softer" terms than might be offered to rural or suburban projects.

Second and related to the above, appraisals tend to be lower in rural areas, due to generally lower market rents, despite the fact that development costs in both project types tend to be very similar. States wanting to target HOME funds to rural rental housing development may need to be more flexible in establishing minimum loan to value requirements on those investments.

Third, as discussed in Chapter Two, rural housing delivery systems tend to be less developed than those in urban areas, and rural financial institutions tend to be less familiar with the financing needs of affordable housing projects. This is complicated further by the fact that underlying economic forces affecting rural housing development are arguably more challenging than those affecting development in metropolitan areas. It may be difficult enough to convince a "less sophisticated" rural lender to make a loan to an emerging nonprofit sponsor using multiple layers of federal funding. It may be even more difficult to explain to that lender why development costs are more than double appraised value, or why a professional market study prepared by a firm located 150 miles away cannot identify good rent comparables. States can educate rural housing providers and their potential financial partners about the mutual benefits of working together on such projects. Lenders are likely to be more willing to participate in such projects as they develop more confidence in the capacity of emerging local developers and become more familiar with the process of financing affordable rental housing in general. Positive experiences will create greater willingness to be more flexible on loan terms, allowing states to leverage HOME funds at greater levels.

Conclusion

To best support rural housing development, HOME funding programs should be structured to facilitate coordination with other funding sources. For example, in areas with weak or non-existent delivery systems, it may be necessary to invest significant resources in technical assistance, training, and capacity building long before any development project is undertaken. In such cases, states may need to provide HOME-funded CHDO operating support and redevelopment loans years in advance of the development project.

As the case study illustrates, LIHTC equity can have a dramatic impact on project feasibility. While LIHTC is a complicated program, which makes demands on the structure of the ownership entity and often requires the involvement of private investors who may not share the sponsor's commitment to the long-term affordability of the project, syndication proceeds can be crucial to the feasibility of rural affordable housing projects which tend to have large financing gaps. HOME programs which are structured with guidelines and application schedules coordinated with their state's LIHTC program will be better able to accommodate joint LIHTC/HOME projects. Also, some states have given preference in their LIHTC Qualified Allocation Plan to rural development and/or to developments which target the lowest income populations.

Another area of coordination is with private lenders, both with regard to financing and to project oversight. States may encourage local lenders to provide all of a project's construction financing needs by offering strong take-out commitments with few conditions, thus minimizing the local lender's risk. Alternatively, states may arrange to loan a portion of its HOME investment during construction in participation with the local lender, who would be responsible for making inspections and monitoring construction progress. Local lenders also may be encouraged to provide as much of the permanent loan as their underwriting criteria will allow. Usually LIHTC syndication proceeds or a subordinate HOME loan allow local lenders to provide partial financing with minimal risk. One key strength of local banks is their knowledge of local markets and their ability to provide local project oversight, functions which centrally managed state programs may be least well-suited to manage. The most obvious role for a local lender, particularly in remote rural communities, is that of construction loan administrator or construction lender.

Chapter 4. Capacity Building and Conclusion

The previous chapter focused on state considerations in assessing the financing of rural affordable housing. One key implications of that discussion is the need for support for the sponsors of rural housing. This chapter discusses issues around states' use of HOME funds to support the capacity of the rural nonprofit delivery system. COSCDA will be preparing a more detailed report on capacity building in the near future. For this reason, this chapter is fairly summary in nature and focuses on specific issues around capacity building that are relevant to developers operating in rural areas.

Structure of the Delivery System

Delivery System structure refers to the network of housing providers in a state and their role in the delivery of affordable housing. This discussion does not assume that states can directly build a delivery system, since in most cases delivery systems usually develop in a more or less ad hoc fashion, depending on the needs and energy of the local communities. Instead, this discussion focuses on how the state can most effectively target the capacity building resources at its disposal. Many of these issues have been implied in the discussion of the structure of capacity building resources provided above. This highlights considerations with regard to the types of organizations eligible for capacity building assistance and the overall geographic structure of the delivery system.

Organizations to be Assisted

Capacity-building implies that a CHDO has a need for some level of assistance; it leaves entirely unanswered the existing level of capacity of the CHDOs selected for assistance. The decision as to whether to support newer, start-up organizations as opposed to more established and experienced groups will depend on nature of the delivery system in place, and the types of goals the state is trying to achieve. Beyond this, however, there are two issues relevant for rural CHDOs.
One is that rural CHDOs as a whole may have lower levels of capacity and experience than their urban counterparts. For that reason, one set of eligibility criteria may result in a greater number of urban CHDOs receiving assistance. This issue will be addressed later in this chapter with regard to expectations established as a part of any CHDO support fund program. Second, rural CHDOs, again given the area they cover, are less tied to specific "neighborhoods" -- to the extent that those exist at all in rural areas -- than urban CHDOs.

This means that if the state is seeking to support grassroots organizations, it needs to redefine the term to encompass issues relevant to rural groups. For example, the definitions associated with "community" and service areas may need to be expanded, and ways of demonstrating local support may need to be revised. It is not within the purpose of this report to highlight those issues; again, a future report in this series will be devoted to capacity building issues. Instead, for both of these issues, it is important for the state to be aware of the need for different criteria if it is concerned to ensure capacity development among rural CHDOs.

Geography of a Network

As was discussed in Chapter Two, CHDOs operating in rural areas often must cover a geographically larger area than those operating in urban areas. This complicates states' decisions around supporting CHDOs in a couple of different ways. Decisions have to be made around whether operating and pre-development funds will be provided to several smaller organizations or to fewer, more regionally-based organizations. One effective approach to rural capacity building may be supporting development of regional organizations with an explicit expectation that they would in turn further the development of smaller organizations within their region, either through partnering with them on specific projects, or providing more general assistance in project identification and development.

Supporting the Delivery System

Regardless of the apparent financial strength of a deal, loans made to weak or poorly qualified developers or borrowers may result in poorly managed properties and loan defaults. In all cases, the State agency will want to clearly assess the ability of the developer/borrower to undertake and complete the deal. Further, once that assessment has been made, the state will need to determine how best to support identified areas of weakness. This discussion highlights issues in three different areas: linking less experienced nonprofits with more experienced for-profits, providing general operating support to the developer, and providing predevelopment support for the project.

Developing Effective Partnerships

It often may be useful to have a less-experienced nonprofit developer partner with a for-profit developer either on a specific housing project or on a regular basis within a general program of housing development. The state agency can take three actions to encourage partnerships. First, it can help structure guidelines for fair, effective partnerships. This is the most important, and most complex, component of the state role. There are three key areas in which states can establish partnership guidelines: the ownership structure, the developer's fee, and the specific roles and responsibilities of each partner.

Second, the state agency can provide information and support to nonprofits in linking up with more experienced organizations. Third, it can encourage such partnerships via additional points within application rating and ranking systems. This section suggests two basic sets of reasons states might want to encourage partnerships, then makes recommendations within each of the three areas identified above.

There are a couple of caveats to all of the following information. First, the state agency needs to be very clear as to the parameters of the relationships it is encouraging. It needs to be relatively specific as to why it is furthering relationships, and its expectations as to the long-term ramifications of those relationships. If, for example, the state is expecting a given nonprofit sponsor to gain experience, but not to have long-term control of a project, it needs to ensure that the nonprofit's involvement is heavily weighted towards the front end, development side of a deal. In short, at the outset, the state agency needs to clearly define the term "effective management control" and ensure that the provisions put in place to implement and govern that control work.

Second, in all cases, the state will need to provide a relatively high level of contact with the deal to ensure that both partners are adhering in good faith to the guidelines and agreements which have been established. Developing affordable housing through a partnership arrangement offers enormous benefits, but also holds a number of risks. The state agency must play a fairly aggressive role to minimize the risks, so as to ensure the long-term viability of the project.

In general, the discussion below assumes a partnership structure comprised of two primary players: a general partner (which may include both non-profit and for-profit developers) who owns one percent of the project ; and a limited partner (the investors) owning a 99 percent share of the project. This maximizes the use of any federal housing credits that may be involved in the deal.

Provide Relatively Inexperienced Nonprofits with Development Experience

In many cases, states will want to encourage partnerships in order to give inexperienced nonprofits the opportunity to gain some development experience. In these cases, significant, continuous, and continuing, nonprofit control of a project may be less important than the benefit the nonprofit gains from having some level of involvement in the construction and management decisions around an affordable housing development. In this case, "effective management control" may mean that the for-profit entity in the general partner has a relatively strong veto power over decisions relating both to project development and management.

In this case the ownership structure may be one in which the non-profit owns a minority interest (<= 49 percent) in the general partner entity with the for-profit owning the controlling interest (>/= 51 percent). States may wish to require some minimum level of non-profit participation in order to recognize the deal as a nonprofit project (e.g. 10 percent, 25 percent, 33 percent, etc.).

Developer fees paid to the general partner should be distributed in proportion to the percentage of ownership interest. For instance, if the nonprofit owns a 25 percent interest in the general partner corporation, it should receive 25 percent of the developer fees. Project financial realities will often require the non-profit to defer payment of a portion of the developer fees which it has earned until the project begins to operate profitably.

As a co-general partner the non-profit would share general liability with the for-profit and will probably be required to put up some form of financial guarantees. The guarantee requirements can often be met by pledging the deferred portion of the nonprofit's developer fee to the partnership until the guarantees are satisfied.

Nonprofits with a minority-interest in the general partner entity may be lulled into a passive role, thinking that they have no ability to influence the business decisions made by the majority partner. Such nonprofits should be aware that the role of general partner involves certain liabilities. They should be encouraged to actively participating in management decisions to help the project avoid legal liabilities and to learn more about the business of housing development and management. Nonprofits may also be able to protect their organization's assets from liabilities arising from the partnership by creating a wholly-owned subsidiary corporation to serve as the co-general partner.

Appropriate roles for nonprofits with a minority interest in the project could include community relations, marketing of rental units, tenant selection, and participation in decisions regarding project planning and management. The majority-interest for-profit general partner's role in this scenario probably includes establishing and maintaining bank accounts, paying and receiving partnership funds, overseeing the property manage-ment entity, reporting to partners, preparing tax returns, and providing financial guarantees to limited partners.

Provide Experienced Nonprofits with Financial Guarantees

In cases where the nonprofit sponsor is more experienced, states may want to encourage partnerships in order to give the sponsor a stronger financial backing, which will in turn facilitate project financing, both construction and permanent. In these cases, significant, continuous, and continuing, nonprofit control of a project is an absolute must, while the for-profit should have a relatively more constricted role which consists principally of its gaining some well-defined financial benefit from the project. In this case, "effective management control" could mean that the nonprofit sponsor has lead control over all decisions relating both to project development and management, and the for-profit partner plays a far more advisory role with virtually no veto power, other than in areas where the decisions might affect his guarantees.

For example, limited partner equity investors typically will require the general partner to guarantee that a certain minimum amount of tax credits will be available over the life of the partnership. If, for example, any of the units fall out of compliance and are no longer eligible for tax credits, the guarantor may be required to pay the investors an amount which compensates for the loss of credits on that unit. Therefore, it may be appropriate for all guarantors to maintain some control over the management company which documents tenant eligibility to ensure that all units remain eligible for credits, even if that guarantor is a minority-interest general partner.

When states wish to promote long-term non-profit control of a project through partnerships with for-profit developers, they may wish to promote ownership structures in which the non-profit owns a majority-interest (>= 51 percent) of the general partner entity and in which the partnership agreement clearly defines a role for the non-profit which places it in control of most management decisions. Note that this second point is extremely important; the details of the agreement must be examined closely to ensure that the state's intentions to promote non-profit control are not being subverted by the assignment of roles and responsibilities within the agreement. For example, a non-profit managing general partner should generally have the right to hire and fire the management agent for cause, provided that all general partners are consulted and all guarantors are satisfied that any agent hired is competent to document tenant eligibility and perform all other functions necessary to protect their guarantees. An agreement which gave the minority general partner exclusive rights to hire and fire management agents may be viewed as unacceptable to states with the goal of promoting non-profit control of projects.

As in the scenario described above, the developer fees paid to the general partner should be distributed in proportion to each entity's ownership interest. One or both general partners may defer receipt of a portion of its (their) fee until particular milestones are reached (e.g. initial flow of tax credits, break-even lease up, 12 months of positive cashflow, etc.). A non-profit may be asked to defer a portion of its fee until all of its financial guarantees to the project are fulfilled.

Under this scenario, the non-profit's role could include having an equal say in the selection and management of the development team, actively participating in project financial structuring, preparing (or assisting in the preparation of) financing applications, primary oversight of the property management entity, management of partnership fiscal affairs and reporting to all partners as to the activities of the partnership. The for-profit minority general partner will undoubtedly wish to actively participate in management decisions, but would generally only have veto power over those matters which would directly affect their financial guarantees.

Providing Information and Support

Especially in rural communities, where there may generally be a lower level of capacity for housing development, it will be extremely important for the state to help nonprofits identify competent, reliable for-profits which are interested in partnering on affordable housing developments.

It is important to note, however, that this is a difficult component of the state's role that will require care in execution. For example, the state will need to assess carefully the quality of the organizations they identify as potential partners, and will want to ensure that in identifying partners, they are not at the same time making legal representations on behalf of any given organization. Further, states must ensure that any references provided are made in a fair manner, with full representation of the eligible and interested organizations within a given area. One way to help ensure the integrity and viability of this type of activity is to develop and publish for comments procedures proposed for references.

Encouraging Partnerships

If encouraging partnerships is seen as important and effective, states can further their likelihood by establishing bonus points for applications which include partnerships. Any action in terms of establishing guidelines and forming a pool of references can be published for public review and comment as part of the state's application process, which will help strengthen and further future partnerships.

One of the clear distinctions that needs to be made here relates back to the question raised at the outset of this discussion: why is the state encouraging partnerships? Partnerships encouraged to give nonprofit sponsors some development experience most usefully can be placed within HOME-only funding pools. Partnerships being encouraged to obtain the financial backing offered by for-profits most usefully can be placed within the "nonprofit" pool for federal housing credits. In this case, the state must ensure substantial nonprofit participation and can best do this by requiring a partnership structure that gives the nonprofit more than a 51 percent ownership stake in the one percent general partner. This higher level of nonprofit control -- structured by the guidelines the state has established -- will help ensure conformance with the IRS guidelines around nonprofit participation. It also will help ensure that the deals which result are strong and will continue as viable affordable housing developments which continue to generate tax benefits for the limited partnership (the investors).

General Operating Funds

As noted earlier, one of the key ways to develop organizational ability is to develop housing on a regular basis, and there may be fewer opportunities for this type of regular and sustained housing development activity in rural areas. In part for this reason, general operating funds may be especially critical to encourage and support ongoing housing capacity among rural nonprofits.

General operating funds may by used to pay salaries, building rent, supplies, communications costs, and other expenses associated with operating a business. States may use up to 5 percent of their annual HOME allocation to provide general operating funds to CHDOs. Several states are using HOME funds for this purpose, in some cases establishing a new program and in others using HOME to expand an existing state commitment. There are a couple of key considerations around establishing and maintaining this type of program for rural CHDOs.

Expectations for Financial Self-Sufficiency

With a few exceptions, most programs for general operating support contain explicit expectations that the CHDO ultimately will become self-supporting financially. While this is, for a number of reasons, a difficult goal for many nonprofits, it is complicated in rural areas for two reasons. First, operating resources -- also provided by foundations or by local governments, sometimes with their own HOME resources -- may be less available in rural than in urban areas. Second, in many cases operating resources are gained via the developer's fee on affordable housing projects. Rural CHDOs tend to do fewer, smaller deals -- again, in part due to the nature of rural housing development -- than urban CHDOs, and consequently operating resources are decreased.

These facts do not suggest that states should eliminate requirements for ultimate financial self-sufficiency. Instead, it suggests that states should be sensitive to the differences between rural and urban CHDOs, and may want to establish different types of requirements. This may require a more detailed and careful assessment of the resources available in the CHDO's community and more aggressive and targeted technical assistance by state staff in helping the CHDO identify and access alternative forms of financial support.

Expectations for Development Activity

A second area for greater attention is in expectations for development activity. Federal requirements for CHDO operating support require that there be an expectation that within 24 months of receiving operating support, the CHDO receive an allocation of HOME development funds from the 15 percent CHDO set aside within the state's HOME allocation. This in turn implies that the development activity expected to be undertaken is a substantive one in which the CHDO acts as developer, sponsor or owner. In order to comply with federal requirements, then, the state must establish this development expectation formally within the contract awarding the operating funds.

Given some of the issues identified throughout this report, states need to give explicit attention to this expectation in providing support funds to rural CHDOs. The state may need to provide additional training and technical assistance to ensure that the CHDO will be capable within 24 months of undertaking substantive housing development. Further, state staff should be willing to play a more active role in helping the CHDO identify and formulate a development project eligible for HOME funds. In short, there may be a greater commitment of state staff resources needed to ensure that the expectation established within the contract is real, and can be used as part of a formal assessment of both the CHDO's performance under the grant, as well as the state's overall CHDO operating fund program.

Assessment of Performance

Both of the issues identified above are joined in considerations around performance standards within an operating fund program to support rural CHDOs. Performance standards are essential to program integrity, and should be established and clearly identified at the outset of a program to ensure that responsibilities are clearly understood. As the discussion above suggests, in structuring performance operating standards for a CHDO operating support program, states will want to consider differences between rural and urban CHDOs and the environments in which they are operating. Development of a single set of standards, applied in an identical way for organizations operating in very different settings, may lead to inaccurate assessments of performance, and may result in premature terminations of assistance to rural CHDOs which may have required more time or assistance to reach the levels of performance and activity of CHDOs in more urban areas.

Predevelopment Loan Funds

States may use up to 10 percent of their 15 percent CHDO set aside for loans to support predevelopment expenses. Eligible expenses include costs associated with project feasibility; consulting fees; costs of preliminary financial applications; legal, architectural or engineering fees; engagement of a development team; soft costs of site control; and title clearance. Some states are using HOME funds for predevelopment loans. Similar to the discussion for operating fund support, above, there are a couple of key considerations for states which plan to use predevelopment funds in rural areas.

Importance of the Resources

Predevelopment loans may be critical to ensuring the viability of a rural project. As has been referenced throughout this report, financing resources may generally be less available in rural areas, and predevelopment loans, given their risk, may be especially difficult to obtain. While there are always complications to developing affordable housing, rural projects often have greater need for up-front support given that developers are frequently starting from ground zero on a given project.

For example, there may be extensive site considerations, especially with regard to infrastructure and transportation, there may be less information generally available on the affordable housing needs and market in smaller communities, and there may be less pro bono assistance -- from architects, engineers and attorneys -- than in urban areas, where there is a greater concentration of professionals in those areas. For these reasons, predevelopment financing may be especially important for gaining an initial idea of project feasibility and for getting the project from the conception stage to a point at which lenders are motivated to finance development.

Use of the Resources

In many cases, states are structuring predevelopment loan awards as a part of project financing. For some of the reasons suggested above, this may not be an effective way to structure predevelopment loans for rural projects. Instead, the state may want to consider using the resources more as risk capital: as a way to encourage needed housing directly, rather than supporting proposed projects. The issue for state administrators is that this is a highly staff-intensive process. Use of predevelopment loan funds as risk capital entails greater marketing by the state, greater technical assistance to prospective CHDO applicants, and more rigorous and knowledgeable assessment of the projects proposed. In short, while use of predevelopment funds as risk capital may be a powerful catalyst for rural development, it demands a commitment from the state to close oversight and attention to the use of small amounts of funding, for relatively uncertain ends.

Conclusion

Decisions concerning the structure and use of HOME funds will be driven extensively by specific circumstances and issues within a given state. This report has tried to provide guidance to states to help them negotiate decisions successfully within the context of needs and strategies identified within the State consolidated plan. While this report has tried to clarify those issues, one of the underlying themes throughout has been the need for state activism and commitment to ensure that rural initiatives are successful.

Rural project financing is complicated and resources may be less available than in urban areas. Capacity may be lower, and development of that capacity will require a substantive commitment of state staff time and expertise. While HOME can be used to further rural housing effectively, it clearly may require greater work and directed commitment from the state administering agency, and may, in many areas, conflict with activities in urban or suburban parts of the state.

This report has not attempted to touch on those more political issues. In closing, however, it suggests that one way to resolve those political issues is to use the priorities, strategies and actions identified in the state consolidated plan. Development of the Plan provides a public forum for clarifying relative need and relevant issues, and for structuring the tailored, directed strategies which may be needed for success.

COSCDA is the premier national association advocating and enhancing the leadership role of states in holistic community development through innovative policy development and implementation, customer-driven technical assistance, education and collaborative efforts.

Zoning: 10 units/acre	2 acre site

(10) 2 BR units @ 850 sf	8,5000 sf
(10) 3 BR units @ 1000 sf	10,000sf
(1) Community room @ 800 sf	800 sf

Total Structures	19, 300 sf
(8) units to very low-income families	(Low-HOME Rents)
(8) units to low-income families	(HIgh-HOME Rents)
(4) units unrestricted	(Market Rents)

	Urban (per unit/year)	Rural (per unit/year)
Management Fees	360	360
Administrative	300	300
Payroll	420	380
Advertising	60	60
Repair/Maintenance	300	300
Real Estate Taxes	480	320
Insurance	150	180
Legal/Audit	120	120
Utilities	240	240
Replacement Reserves	250	250
Other	240	240

Total Per Unit/Yeat	$2,920	$2,750

TOTAL per Project/Year	$58,400	$55,000

Household Incomes:	3 person	4 person	5 person
Urban Project Very Low-income	$23,900	$26,000	$28,650
Low-income	$37,450	$41,600	$44,950
Rural Project Very Low-income	$16,000	$18,150	$19,600
Low-income	$26,150	$29,050	$31,350

Urban Rents	2 bedroom	3 bedroom
Utility Allowance	$65	$85
Gross Low-HOME Rents	$597	$690
Adjusted Low-HOME Rents	$532	$605
Gross High-HOME Rents	$644 (FMR)	$864 (FMR)
Adjusted High-HOME Rents	$579 (FMR)	$779 (FMR)
Market Rents (adjusted)	$550	$625
Rural Rents	2 bedroom	3 bedroom
Utility Allowance	$65	$85
Gross Low-HOME Rents	$408	$471
Adjusted Low-HOME Rents	$343	$386
Gross-High-HOME Rents	$519 (FMR)	$625
Adjusted High-HOME Rents	$454 (FMR)	$540
Market Rents (Adjusted)	$450	$500

Urban Project
	per month/unit	per year/project
(4) 2 BR (VLI)	$525	$25,200
(4) 3 BR (VLI)	$600	$28,800
(4) 2 BR (LI)	$550	$26,400
(4) 3 BR (LI)	$625	$30,000
(2) 2 BR (mkt)	$550	$13,200
(2) 3 BR (mkt)	$625	$15,000
Gross Potential Rental Income $138,600

Rural Project
	per month/unit	per year/project
(4) 2 BR (VLI)	$340	$16,320
(4) 3 BR (VLI)	$385	$18,480
(4) 2 BR (LI)	$450	$21,600
(4) 3 BR (LI)	$500	$24,000
(2) 2 BR (mkt)	$450	$10,800
(2) 3 BR (mkt)	$500	$12,000
Gross Potential Rental Income $103,200

	Urban Project	Rural Project
Gross Potential Income/Yr	$138,600	$103,200
Less: Vacancy @ 7 %	(9,702)	(7,224)
Effective Gross Income/Yr	128,898	95,976
Less: Operating Expenses	(58,400)	(55,000)
Net Operating Income	70,498	40,976
Max. Debt Svc @ 1.25 DC	56,398	32,781
Max Mortgage (8 %, 30 yrs.)	$640,000	$370,000
Assumed Appraised Value	$756,000	$533,000
Max. Mortgage at 80 % LTV	$605,000	$425,000
Total Development Costs	$1,180,000	$1,135,00

	Urban Project	Rural Project
Initial Project Gap	$575,000	$765,000
Less: Equity from LIHTC	(505,000)	(520,000)
Remaining Gap	$70,000	$245,000

(4) 2 BR (VLI)	$340 /month/unit	$16,320/yr.
(4) 3 BR (VLI)	$385 /month/unit	$18,480/yr.
(6) 2 BR (60 % LIHTC)	$425 /month/unit	$30,600/yr.
(6) 3 BR (60 % LIHTC)	$480 /month/unit	$34,560/yr.

	Urban Project	Rural Project
Maximum Bank Loan	$605,000	$345,000
LIHTC Equity	505,000	520,000
HOME Loan (int. only)	70,000*	270,000*
Remaining Gap	--0--	--0--
Total Development Costs	$1,180,000	$1,135,000

Payments on $605,000 mortgage (8%, 30 yrs)	$53,271
Payments on $70,000 HOME loan (8% int.only)	$4,050
Total Debt Service Payments	$34,428
Combined Debt Coverage Ratio	1.20 to 1

Payments on $345,000 mortgage (8 %, 30 yrs.)	$30,378
Payments on $270,000 HOME loan (1.5 % int.only)	$4,050
Total Debt Service Payments	$34,428
Net Operating Income	$37,963
Combined Debt Coverage Ratio	1.10 to 1