Partners (Spring 1999)
Partners (Spring 1999)
Making the Transition from Supporting to Building Communities
This article was excerpted from "Breaking Ground: A Beginner's Guide for Nonprofit Developers" published by the Federal Reserve Bank of Dallas. To receive a copy of the publication, contact Mia Worlds of the Federal Reserve Bank of Dallas at (214) 922-5377 or e-mail email@example.com.Communities-both urban and rural-have found that the need for affordable housing increasingly surpasses the supply. Throughout the country, community-based nonprofit organizations have emerged as effective producers of affordable housing-often in partnership with local government, financial institutions, foundations or others.
The information in this article is specifically geared toward community-based nonprofit organizations interested in learning more about becoming affordable housing developers, establishing public-private partnerships, and helping to meet the housing needs of low- and moderate-income families. Its purpose is to provide basic information that prospective nonprofit developers need to know about planning, financing and developing affordable housing.
Self-Assessment: Looking at the Organizational RealitiesBefore the first brick for new housing is laid, the leadership of your nonprofit organization will want to make sure the organization will be around to see the project completed, welcome new neighbors, host the mortgage burning, and continue the good works that you've started. To accomplish this, your board of directors must take a close look at the nonprofit's capacity and financial soundness.
Your Mission Statement, Bylaws and Strategic Plan ReviewAlthough developing affordable housing is a good idea, your board of directors may find that it does not fit with the organization's goals. Your board of directors (or a committee) must draw up bylaws and a mission statement or review existing ones to ensure that becoming a housing developer furthers the purpose of your organization.
Becoming involved in housing development will significantly impact your organization's future. Developing a strategic plan that reflects the development goals will help keep your organization on track while the project is under way and after its completion.
Assess the Efficiency of Your Board of DirectorsBecoming an affordable housing developer will require your board of directors to assume additional responsibilities, such as increased fund-raising, closer community scrutiny, a larger staff and potentially greater fiscal liability.
Internal OperationsUndertaking a development project requires good planning, accounting and reporting systems to ensure that the development is carried out in a proper and efficient manner and that your organization is complying with the requirements set by funding sources. The three basic systems all nonprofits need are project planning, financial and reporting systems.
Staffing ConsiderationsUsing personnel resources wisely is important to the success of any development project. An important question your nonprofit's board of directors must answer is whether the skills of your current staff match the skills and experience your organization needs to become an affordable housing developer. If the answer is no, your board of directors must hire or contract for the needed expertise. Some organizations hire a director and contract for other services and expertise on an as-needed basis. Other organizations hire a staff that might typically include an executive director, construction/rehab manager, receptionist/secretary and bookkeeper. Each organization must develop a staffing pattern that best meets the goals set by the board of directors.
Essential Components of a Successful DevelopmentA successful development does not just happen — it must be skillfully managed. There are five essential components that require planning, research, decisions and action: team, community, market, product and resources. Your development team should be diverse, committed, and able to provide expertise and access to the community and resources. Team members should be involved from the beginning of the project, kept informed and called on to provide input and resources.
Community involvement and support is critical to the success of your development. Community input is essential for you to understand local housing needs, and it will be needed throughout your project. The community should be involved in planning the development as much as possible. You should seek their feedback and ask for their commitment to the development's goals. Your market study must match realistic market wants and needs with the need to maintain housing affordability. When choices must be made, the best choices will increase long-term durability and marketability of the housing.
Once your market research is finished, you should know who your customers will be and what their housing needs are. Depending on customers' needs, you will have a number of development options to choose from-single-family rehabilitation, new single-family construction, multifamily rehabilitation and new multifamily construction.
Developing Resources to Fund Affordable Housing DevelopmentThe goal of developing affordable housing is to build or rehabilitate quality housing that will be affordable for low- and moderate-income families. To accomplish this, your development funding must be compatible with this goal. To keep a housing development affordable, it is often necessary for you to use many different types of funding.
Your funding sources for subsidies and debt and equity investments require information about the costs and future income of the proposed development to determine the amount and types of funding resources your development will need. Your organization must develop at least three comprehensive budgets for the development-predevelopment, development, and operating income and expense (pro forma) budgets- which will be presented to your funding sources and used throughout the development phase and the operation of the project.
Acquisition, Construction and Permanent FinancingObtaining debt financing, attracting equity investments and securing subsidies or grants are the components of development funding. Every project you do will need three stages of funding: acquisition, construction and permanent.
Acquisition funding may be in the form of an equity investment or a short-term loan that is paid off when the permanent financing is closed. Banks and other private lenders are often reluctant to finance property acquisition because vacant land and buildings are not income producing and may not provide adequate collateral for a loan. Your alternative sources for acquisition financing include state and local governments, housing finance authorities, foundations, and bank community development corporations.
Banks are often willing to make a construction loan because it is short-term, usually 12 to 18 months. Because the lender wants to make sure the loan will be paid off when construction is finished, permanent financing commitments must be secured before the loan is made. The amount of the construction loan will be limited by the amount of permanent funding. State and local governments can also provide construction financing.
Permanent funding may be in the form of equity investment or debt financing. Permanent debt financing should be at a fixed rate of interest for a long term-at least 10 years and, more ideally, 15 to 30 years. Both single- and multifamily housing developments require permanent financing.
Ratio Analysis-Determining the Debt, Equity and Subsidy MixWhen assessing how much debt your development project can prudently repay, your lenders will be interested in two ratios-the loan-to-value ratio and the debt-coverage ratio. The maximum amount of debt financing will usually not exceed the maximum of either ratio. Once the maximum amount of debt financing is determined, the balance of the project costs will have to be covered by either equity investments or grants and subsidies.
The loan-to-value ratio (LTV) compares the amount borrowed with the appraised value of the project. Most lenders will not lend more than 80 percent of the value. As the developer, your organization will have to seek equity investments or grants and subsidies totaling at least 20 percent of the project's value.
The debt-coverage ratio is the amount of monthly net operating income (income minus expenses), divided by the amount of monthly debt service (principal and interest payments on the loan). When underwriting a loan, the bank must make sure that after all operating expenses are paid, there is enough cash to make the principal and interest payment, as well as a cushion for unforeseen circumstances. A commonly used debt-coverage ratio is 120 percent -paying 100 percent of the monthly debt service and an additional 20 percent.
The Funding GapThe funding gap is the difference between your total development budget and the amount of debt financing available. Filling the funding gap requires you to identify and leverage many resources that can either help lower the cost of your project or increase the amount of equity investment and grants and subsidies.
Putting It All Together-Funding Sources and Uses StatementOnce you have developed the project's budget and identified potential funding sources, you will need to prepare a statement of sources and uses of funds. The statement will serve as a guide for seeking sources of funding to match your development budget. The mix of your funding sources will determine the monthly principal and interest payment your organization has to make on the development project loans. The more equity funding the project has, the lower the monthly debt payment will be.
Information Needed by Funding SourcesIn addition to budget information, your funding sources will want information about your organization and your development project.
Funding sources, including financial institutions, will need to assess your organization's stability, resources and experience, as well as its ability to complete the development and, if necessary, provide long-term management.
Your funding sources will need information on the development project itself, including information about the market the project will serve, other funding sources and data on the property.
The funding source will also order an appraisal, survey, environmental report and property inspection, all of which will generally be an expense to the nonprofit developer.
A strong community-based nonprofit organization, solid community support, committed partners, good planning and a sound financial plan are the ingredients for successful affordable housing development. Many nonprofit organizations have put these ingredients together to rehabilitate single-family homes, create new single-family developments, rebuild multifamily housing and even build new multifamily complexes. This important work provides affordable housing for individuals and families, whose lives will be made better by your organization's efforts and those of other nonprofit community-based organizations taking on the challenge of developing affordable housing.
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