Before undertaking a preservation project, consider these development and management implications.
One of the emerging and most important types of affordable housing development is what is known generically as preservation. This type of project involves the acquisition and/or substantial rehabilitation of an affordable apartment community, usually one with a Section 8 or Rural Development subsidy.
Preservation of the existing affordable housing inventory is a critical step in maintaining a balance of local housing opportunities, but before undertaking a preservation project, there are several important development and management considerations.
Why pursue a preservation project?
Preserving an existing building makes sense for many reasons:
- It protects subsidies—many preserved projects have existing federal subsidies that help residents pay their rent, and if the buildings aren’t preserved, the subsidies disappear because they generally can’t be transferred.
- It recapitalizes a viable asset.
- It preserves a significant or “historic” building in a neighborhood.
- The cost of preservation is usually much less than new construction or complete replacement.
- Other cost-effective capital subsidies, such as U.S. Department of Housing and Urban Development (HUD) Section 236 decoupling and Rural Development Section 515 1 percent mortgages can be retained in the project.
What makes for a “good” preservation project?
Preservation projects are unique, given that the projects involve existing buildings, many different resources and programs, and often an existing resident population. A central factor in a preservation project is the existence of a rental subsidy program or other capital subsidy. Such programs usually result in a stable occupancy level, with lower rents designed to assist renters at a very low income. From a social-benefit perspective, rental subsidy allows the project to reach a much lower-income resident—occasionally as low as 10 percent to 15 percent of median income.
Even if no subsidy is funding rents, occupied units usually mean the community is attractive to potential renters, adding to the attractiveness of the preservation project.
The type of unit is also critical. Depending on market dynamics, there might be a pressing need for larger-size units or for accessible units. Preservation projects can be composed of townhomes or walk-up units, mid-rise or high-rise. They may contain larger three- and four-bedroom types that are not prevalent in the market, so market forces may dictate the importance of preserving the project.
Another important factor is the need in the market. Do not write off a project immediately because of low occupancy; the community’s trouble could mean that the project is in desperate need of preservation because it cannot rent units. A recapitalization that involves rehabilitation could be just the move that results in higher levels of occupancy.
Then again, not all preservation projects involve a significant turnaround. Preservation could simply consist of ensuring that valuable affordable housing continues to be available because the property remains restricted to low-income occupancy. This happens most often in very strong markets.
What analysis should an owner or manager conduct?
Making a decision regarding a preservation project will involve close scrutiny of several factors. First, the existing market must be considered. Will the market be able to continue to support the project? Second, what is the condition of the property? A capital needs assessment (CNA) will be necessary. The CNA will identify major and minor problems with the building and its site. This will help make the decision about the viability of rehabilitating the building. The CNA also will be required by many public and private investors. An environment review report, which identifies potential environmental hazards in and around the project being preserved may also be necessary, depending upon the possible funding sources involved in financing the project.
Early on in the process of considering a project, it is important to identify residents who may not be qualified for the programs that were used to preserve the project. This can be accomplished through individual meetings with residents or by a review of annual reports submitted for any federal or state programs currently financing the project. The earlier these residents are identified, the more time the owner and developer have to implement the appropriate relocation plan.
State and federal agencies should be consulted in the beginning stages of due diligence. Often these agencies will be required to approve preservation plans as ownership changes and approve the rehabilitation scope of work. Owing to program changes over the years, each project differs slightly. Early involvement by current or potential funders will help to ensure problems are avoided.
At the time discussions are occurring with state and federal agencies, owners should conduct due diligence on the property title to ensure there are no surprises such as liens or other covenants and to ensure the property will qualify for acquisition tax credits. Additionally, any regulatory agreements or land use restriction agreements should be carefully studied to identify potential roadblocks.
It is wise to consult local community groups as well as the most important group—the existing residents. These discussions can help uncover problems earlier in the project and lead to a more satisfactory project.
How are preservation projects usually financed?
Financing for preservation projects is as diverse as the projects. Several programs, such as multifamily bonds and Low Income Housing Tax Credits provide the majority of funding. HUD programs such as 236 decoupling, Section 202, 221 and the Mark to Market program are also prevalent in preservation deals. The Rural Development demo program, similar to HUD’s Mark to Market program, also provides funding for restructuring mortgages and financing projects.
Trends in preservation
As with all current real estate development, green buildings are attractive. Developers of preservation projects are increasingly being encouraged—and even required—to include as many energy efficiency measures as possible. This can benefit both the resident and the owner by lowering energy usage. HUD offers extensive green assistance to projects in Mark to Market restructuring. Achieving green or energy efficiency goals in preservation projects can be tricky, as the buildings are often older and funding is limited.
Changes to unit sizes and mixes also are growing trends. Many preservation projects involve rehabilitating senior living communities. Even if the number of bedrooms is not increased, projects are expanding the size of units. It is important to note that not all such changes can be part of subsidized projects. Any such changes should be cleared with the agency providing the project-based subsidy. For example, HUD has specific rules about conversion. A project not following HUD’s conversion rules will find that its subsidy for resident rents is at risk.
Construction and Funding Issues
Much of the construction and rehabilitation work in a preservation project usually must be completed “around” the residents. Thus there will be issues with accessing units during work hours. Not all work can be completed with residents in place. In these instances, residents must be relocated within the property, or to a unit outside of the property. If the move is for a short period of time, putting them up in a hotel may be appropriate. If the move is for a longer period, an apartment may be necessary. Projects using federal funds must follow very explicit relocation rules.
Since preservation projects already have residents in place, there are often reserves, deposits and other project resources that must be transitioned. Security deposits are the property of the residents, not the community. Reserves are a cash asset of the community. There is also all of the community’s “stuff” to consider, such as furniture, fixtures, mowers, tools, supplies and other items that help operate a community. Ensuring these resources are transitioned properly from the old owner will get a project off to the right start.
Management Considerations
The challenges of successfully completing a preservation project do not end with completing the construction phase. Eventually the owner has to pick a placed-in-service date and ensure that all of the residents are qualified to reside in the community if the owner wishes to maximize the tax credits or other financing used to facilitate the project.
One barrier to maximizing tax credits and other subsidies is over-income residents. Over-income residents do not qualify a unit for tax credits, limiting the amount of credits the new owner will receive, nor can over-income households receive rent subsidy. Nonetheless, most federal subsidy programs do not require over-income residents to move. Therefore, a project with a Section 8 contract may have residents with income higher than would be allowed at move-in. Unfortunately for owners, there are limited options to resolve this and similar issues. Such residents can be encouraged and incentivized to move, but such steps must be taken with care. Over-income residents who wish to stay will likely have to be allowed to remain.
Long term, preservation projects will present some other challenges. Even with a significant rehabilitation and much marketing work, there may still be some stigma associated with a property. There also are long-term maintenance issues to consider, as well as the additional administrative costs associated with combining two or more affordable housing resources.
Preservation projects can be challenging. The rewards for the developer and the residents are considerable. Given the large stock of existing housing, and the limited number of projects preserved to date, preservation opportunities will be available for years to come.
Brian Carnahan is Director of the Ohio Housing Finance Agency’s Office of Program Compliance, where he manages the compliance monitoring of tax credit, HOME and Section 8 communities. Carnahan can be reached at 614/728-5608 or bcarnahan@ohiohome.org. Doug Klingensmith is a Vice President of Development at the Ohio Capital Corporation. Klingensmith originates investment opportunities for Low Income Housing Tax Credit projects and can be reached at
dklingensmith@occh.org or at 614/224-8446.