California Community

1
California Community Economic Development
Association

• California Community
• Reinvestment Initiative
• Federal Reserve Bank of San Francisco
• Office of the Comptroller of Currency
• January, 2006

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CCEDACalifornia Community Economic Development
Association
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Underwriting and Financial Structuring for Real
  Estate
• Glenn Sanada, Director of Training and Technical
  Assistance
• Mitch Thompson, CCEDA Development Consultant
• Carol Gallant, Director of Program Development

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Agenda
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• 800 AM - 830 AM Registration
• 830 AM - 845 AM Introductions
• 845 AM - 1015 AM Underwriting Real Estate
  Overall Review Glenn Sanada
• 1015 AM - 1030 AM BREAK
• 1030 AM - NOON Underwriting Real Estate
  Review Case Studies
• NOON - 100 PM LUNCH
• 100 PM - 230 PM Equity Resources / Soft
  Debt and Gap Resources
• San Bernardino Community Development
• Clearinghouse CDFI
• Enterprise Foundation
• Low Income Investment Fund
• 230 PM - 245 PM BREAK
• 245 PM - 415 PM Debt Sources
• Washington Mutual
• Citibank
• Wells Fargo
• Bank of America
• 415 PM - 430 PM Summary Wrap Up

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Overview of Underwriting and Financial Structuring
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Goal To give you an understanding of how
  community development real estate transactions
  are structured.
• This session will take you through the historical
  context of how bank underwriting evolved in
  understanding lending risk.
• This session will teach you how to critically
  look at your deals and understand how you can
  address basic development and financing issues
  before they slow or kill your project.
• You will be ready to answer most of the questions
  investors and lenders will ask when you proceed
  thorough the financing process.

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Overview of Underwriting and Financial Structuring
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• The following are the types of transactions we
  will be discussing during this session. The
  overview will provide an historical perspective
  of community development lending.
• The session focuses on types of transactions in
  relationship to the previous transaction
  (generally speaking, the transactions become a
  bit more difficult at each step, and reflects the
  evolution of community development lending).
• Focus is on key credit and lending risks, how
  they are mitigated, and what types of financial
  structuring and conditions are typically imposed
  to mitigate risks

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Overview of Underwriting and Financial Structuring
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• For Profit Real Estate Transaction
• Multi Family Rental (Tax Credit Transaction)
• Affordable For Sale Housing
• Mixed Income For-Sale Housing
• Multi Family Rental with Small Retail/Office or
  Community Space (Income from Non Housing Use Not
  Needed for Mortgage)
• Multi Family Rental with Large Retail/Office or
  Community Space (Income from Non Housing Use
  Included in Mortgage)
• Stand Alone Retail/Office
• Stand Alone Community Facility

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Overview of Underwriting and Financial Structuring
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Exercise One
• Its Family, but.

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Overview of Underwriting and Financial Structuring
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Exercise One
• Its Family, but.
• Character of the Borrower
• Experience
• Location
• Market
• Real Estate (Type, Condition)
• Financial Capacity
• Ability to Complete the Development
• Repayment
• Deal and Finance Structure
• Secondary Sources of Repayment

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Overview of Underwriting and Financial Structuring
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Key to Underwriting Financial Structure and
  Project Pro Forma.

Cushion Cushion Cushion Cushion Cus
hion Cushion Cushion
Cushion And Cushion
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Overview of Underwriting and Financial
StructuringKey Terms
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Debt Service Coverage Net Operating Income /
  Debt Service Debt Service Coverage
• Monthly Gross Rents 100,000 50,000
  (Expenses/Operating) NOI of 50,000
• If NOI is 50,000 and DS is 40,000
  50,000/40,000 1.25
• 1.05 Aggressive (Market for Affordable)
• Loan to Value
• Loan to Value
• (Loan 8,000,000 and Value 10,000,000 LTV
  80)
• Restricted Rent Real Estate Value
• Subordinate Debt (Cash Value or Discounted
  Value)
• Other Equity (Tax Credit)
• Loan to Cost Cost of Development

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Overview of Underwriting and Financial
StructuringKey Terms
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Contingencies
• Hard (Generally 5, on Rehabs 20)
• Soft
• Developer Fees (Ugh!!!!)
• Interest Reserves
• Rate Cushion (1-2 ???)
• Average Outstanding Balance
• Term (Construction) Advised, Un-Advised
• Borrower/Customer
• Experience
• Financial Strength

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Overview of Underwriting and Financial Structuring
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• I. For Profit Real Estate Transaction
• This is the basic transaction that lenders
  understood prior to the advent of community
  development lending. They are relatively simple,
  with 2 sources of funds, borrowers equity and
  the loan. In these deals, the borrower has
  extensive experience and had a very strong net
  worth that they will use to guarantee the loan.

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Overview of Underwriting and Financial
StructuringI . For Profit Real Estate
Transaction
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Structure
• One source of equity
• One source of debt
• Highly experienced developer
• Loan secured by real estate and borrower
  liquidity
• Risk
• Borrower Risk minimal
• Location Typically in good market, risk minimal
• Financial Borrower with good liquidity
• Completion Very experienced, risk minimal
• Repayment Good real estate, good liquidity,
  risk minimal

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Overview of Underwriting and Financial
StructuringI. For Profit Real Estate
Transaction
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Risk Mitigation
• Borrower Requirements met
• Location Requirements met
• Financial Requirements met
• Completion Requirements met, guaranty by owner
• Repayment Requirements met, guaranty by owner,
  take out lender is a strong bank partner

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Overview of Underwriting and Financial
StructuringII. Multi Family Rental (Tax Credit
Deals)
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Structure
• Many sources of equity (near equity)
• Many sources of debt
• Un-experienced developer
• Loan secured by real estate only, no borrower
  liquidity

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Overview of Underwriting and Financial
StructuringII. Multi Family Rental (Tax Credit
Deals)
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Example A Tax Credit Deal (9)
• Project Development Costs 10,000,000
• Tax Credit Equity
• Hard Costs 7,000,000
• 9 of Value 6,000,000
• LP Purchase or TC Equity 5,500,000
• City or County 3 Deferred Loan 3,000,000
• Discounted Value or Full
• Other Sources 500,000
• Conventional Loan 1,000,000
• TOTAL SOURCES 10,000,000

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Overview of Underwriting and Financial
StructuringII. Multi Family Rental (Tax Credit
Deals)
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Risk
• Borrower Risk high
• Location Typically in transitional markets,
  risk questionable
• Financial Many sources of equity (investor
  and local grants). Many sources of debt
  (local and state deferred loans)
• Completion Experience of development team
  unknown
• Repayment Quality of real estate unknown, no
  borrower liquidity, risk questionable. Take
  out lender also new to community development
  lending.

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Overview of Underwriting and Financial
StructuringII. Multi Family Rental (Tax Credit
Deals)
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Exercise Two
• How Do We Mitigate These Risks.
• How Do I Get This Approved.

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Overview of Underwriting and Financial
StructuringII. Multi Family Rental (Tax Credit
Deals)
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Risk Mitigation
• Borrower
• Development Team Experience Require strong
  development team with experienced contactor,
  architect, and engineer. Borrower needs
  construction management representative.
• Organization Development staff dedicated to the
  project with experience, or with an experienced
  consultant. Board of Directors must reflect
  capacities to proceed. Organization must have
  both community and local government support for
  the proposed project. Financials must be in
  order.
• Location/Market Environmental issues must be
  addressed. Site suitable for residents
  (families, elderly, or special needs). Rents
  must be below market.
• Financial Bank will remain in first position.
  All equity must be used prior to disbursement of
  bank funds. Inter-creditor agreements during
  construction period required.
• Completion Guaranty by borrower. Risk
  mitigated by strength of development team and
  financing cushion (interest reserve, unadvised
  construction period extensions, contingencies,
  developer fees). Participating lenders
  subordinate and funding in earlier.
• Repayment Take out agreement and requirements
  meet bank standards. Lease up requirements.

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Overview of Underwriting and Financial
StructuringIII. Affordable For Sale
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Over view The market is your key risk
• Rental units are typically rented below market,
  so demand for units is always there.
• For-sale requires another level of expertise to
  understand the market for the proposed product.
• Even with subsidized units, the developer needs
  to understand the qualification process and time
  needed to pre-qualify buyers, a process
  multiplied in complexity by the number of sources
  of secondary mortgage support.
• It is also essential to have the right
  development team that can take developers through
  the department of real estate entitlement process
  

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Overview of Underwriting and Financial
StructuringIII. Affordable For Sale
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Structure
• Many sources of equity that may convert to soft
  secondary financing for buyers
• Many sources of debt during construction to may
  convert to soft secondary financing for buyers
• Un-experienced developer
• Loan secured by real estate only, no borrower
  liquidity

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Overview of Underwriting and Financial
Structuring III. Affordable For Sale
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Risk
• Borrower Risk high
• Location Typically in transitional markets,
  risk questionable
• Financial Many sources of equity (investor and
  local grants). Sources of take out financing
  somewhat more limited as compared to market
  rate projects. Many sources of secondary take out
  debt.
• Completion Experience of development team
  unknown
• Repayment Quality of real estate unknown

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Overview of Underwriting and Financial
StructuringIII. Affordable For Sale
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Risk Mitigation
• Borrower
• Development Team Experience Require strong
  development team with experienced contactor,
  architect, and engineer (experienced in the
  subdivision entitlement process). Borrower needs
  construction management representative.
• Organization Development staff dedicated to the
  project with experience, or with an experienced
  consultant. Board of Directors must reflect
  capacities to proceed. Organization must have
  both community and local government support for
  the proposed project. Financials must be in
  order.
• Location Market analysis required (noting
  absorption rate). Environmental issues must be
  addressed. Site suitable for residents
  (families, elderly, or special needs). Sales
  prices must be targeted to families and
  individuals below market.
• Financial All equity must be used prior to
  disbursement of bank funds. Inter-creditor
  agreements during construction period required.
• Completion Guaranty by borrower. Risk
  mitigated by strength of development team and
  financing cushion (interest reserve, unadvised
  construction period extensions, contingencies,
  developer fees).
• Repayment Prequalification or pre-sales may be
  required. Bank may require phased development.
  Release price requirements. Developer fees taken
  on final unit sales.

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Overview of Underwriting and Financial
Structuring IV. Mixed Income Affordable and
Market Rate For Sale
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• What Changed
• The underwriting issues remain the same as the
  previous section (affordable for-sale).
• The most significant risk is to understand the
  market for the for-sale units and the level of
  experience
• Close scrutiny will be applied to the market
  study
• To protect the bank from the risk of the market
  rate units not being sold, financial cushions
  will be incorporated.
• Additional Requirements
• Market analysis required (noting absorption rate
  of the market units)
• Greater pre-sales and accelerated repayment on
  sales

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Overview of Underwriting and Financial
Structuring V. Multi Family Rental with Small
Retail/Office or Community Space NOT Dependent
on Income from the Other Use
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• What Changed? Not Much
• Income from Non Housing Use Not Needed for
  Mortgage
• No change from multi-family rental underwriting.
• The lease-up or income generated from this space
  is not needed to debt service the loan.
• It is important to note how the track record for
  retail space under this development scenario has
  been mixed, at best.

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Overview of Underwriting and Financial
Structuring VI. Multi Family Rental with
Small Retail/Office or Community Dependent On
Income from Other Use
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• What Changed? Much
• The lease-up or income generated from this space
  is needed to debt service the loan
• Developers will need to understand affordable
  housing development and commercial/office
  development and lending.
• No change from multi-family rental underwriting.
• Team must reflect experience in developing and
  financing commercial (office/retail) real estate.
  
• Commercial market must be analyzed (vacancies,
  lease rates, lease terms, conditions and
  turnover).

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Overview of Underwriting and Financial
Structuring VI. Multi Family Rental with
Small Retail/Office or Community Dependent On
Income from Other Use
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Additional Requirements
• Commercial (retail/office) footprint may need to
  be legally separated from the housing and a
  separate loan made for the space.
• Space may be underwritten at a higher vacancy
  rate
• Master lease to the non profit may be required.
• If the space is significant, tenants (and leases
  agreements) must be identified, underwritten and
  approved by the bank.
• Rated tenants and agreements may be required (on
  large spaces).

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Overview of Underwriting and Financial
StructuringVII. Stand Alone Retail/Office
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Developers will need to understand
  commercial/office development and lending.
  Financing is very dependent on the credit
  worthiness of the tenant. The stronger known
  tenants (credit tenants) are needed as the anchor
  tenant.

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Overview of Underwriting and Financial
StructuringVII. Stand Alone Retail/Office
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• These deals will typically be underwritten by
  commercial lenders that are part of the
  commercial lending arm of financial institutions
  (versus the specialized community development
  lending units).
• Many of the larger banking institutions will
  rely on conduit lending where there is a set
  lending parameter that other institutions have
  approved. Loans are sold or participated.
• If the project becomes underwritten through the
  conduit or commercial lender, there is very
  little give on the lending requirements.
• If the community development lenders are
  involved there maybe a bit more flexibility, but
  the specific risks must be identified and
  mitigated through additional guarantees, funding
  (equity) or cushion (LTV, DSC or reserves).

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Overview of Underwriting and Financial
StructuringVII. Stand Alone Retail/Office
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Team must reflect experience in developing,
  financing and managing commercial (office/retail)
  real estate.
• Commercial market must be thoroughly analyzed
  (vacancies, lease rates, lease terms, conditions
  and turnover).
• Additional market drill-down analysis may be
  required.
• Space may be underwritten at a higher vacancy
  rate.
• Master lease to the non profit may be required
  for some of the space.
• If the project is of significant scale, rated
  tenants and lease agreements must be in place and
  underwritten and approved by the bank.
• Other tenants (and leases agreements) must be
  identified and approved by the bank.
• Significant private sector leverage will be
  required

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Overview of Underwriting and Financial
StructuringVIII. Community Facility
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Developers will need to understand the business
  aspects of the specific use.
• This applies to charter schools, child care or
  health care providers or other service related
  business.
• Youth and recreation centers are very different
  since their business structure is not easily
  identifiable.
• In most cases, the level of debt is minimal due
  to the lack of cash flow generated by the use.
• The ability to raise significant equity becomes
  the key to successful projects.
• Sources for debt are found by a few lenders that
  may specialize in the specific use (they
  understand the risks of the specific business
  use).
• For community development activities, the
  Community Development Financial Institutions
  (CDFIs) and other community based loan pools
  might be the best bet for debt.

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Overview of Underwriting and Financial
StructuringVIII. Community Facility
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Space may be underwritten at a higher vacancy
  rate.
• Master lease to the non profit may be required
  for some of the space.
• If the project is of significant scale, the
  major tenants will be underwritten (as it applies
  to charter school, health care and child care
  providers) and lease agreements must be in place
  and underwritten and approved by the bank.
• Other tenants (and leases agreements) must be
  identified and approved by the bank.

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Overview of Underwriting and Financial
StructuringSession 4 One on One Assistance
CALIFORNIA COMMUNITY ECONOMIC DEVELOPMENT
ASSOCIATION

• Based on the information provided in session 3,
  participants are encouraged to proceed with
  potential projects for their communities. CCEDA
  staff will schedule meetings with organizations
  to discuss specific projects, and to assist in
  structuring finance, reviewing project pro forma,
  or assisting in proceeding through the
  development steps.
• Cities and local government jurisdictions are
  encouraged to schedule meetings with CCEDA
  Community Development Services staff to discuss
  potential acquisition programs.
• This is also an ideal time to discuss potential
  targeted assistance efforts. CCEDA staff will be
  available to meet with potential teams to
  outline how services may be obtained, and what
  the outcomes would be.
• Glenn Sanada, Training Technical Assistance
  Director
• [phone] ? e-mail glenn_at_cceda.com
• Mitch Thompson, CCEDA Development Consultant
• [phone] ? e-mail mitchthompsonmitch_at_yahoo
  .com
• Carol Gallant, Director of Program Development
• [phone] ? e-mail carol_at_cceda.com