Financing and Developing Rental Housing
Financing and Developing Rental Housing
This section provides an overview of how rental properties can be financed and developed using HOME and CDBG funds. It highlights:
- Development partners that jurisdictions may wish to work with;
- The methods of financing and assisting projects;
- Eligible rental projects;
- Determining assisted units;
- Eligible costs;
- Property standards; and
- Other Federal requirements that apply to the development process.
In developing rental housing, most jurisdictions work in partnership with other organizations. In many communities, rental housing is created by nonprofit and for-profit developers. While it is eligible for jurisdictions to develop and own rental housing themselves, it is not common practice because of the legal and operational complexities of managing such property.
There are many roles that partners can play in the rental housing development process, including:
- Developer. This is the entity that puts together the rental deal. It finds the financing, arranges for the property purchase (as applicable), and oversees the construction process. After project completion, the developer may or may not retain ownership of the property.
- Owner. This is the entity that owns the rental property once it has been built, acquired, or rehabilitated. This entity is responsible for the ongoing compliance of the property (as applicable).
- Sponsor. This is an organization (typically a nonprofit) that works with another organization to help this other entity to develop the rental housing. The sponsor typically owns the property during the development process and assists with assembling the financing. Upon project completion, the sponsor typically sells its ownership to the second entity that becomes or remains the owner.
- Property Manager. In some cases, owners will select another organization to assist with the property management once the project is complete. The property manager may or may not be legally related to the ownership entity. The role of the property manager is to oversee the maintenance and marketing of the units. Typically, the property manager is responsible for maintaining documentation to demonstrate compliance with income and affordability requirements.
- Consultant. There are many consulting roles that partners can play in the development of rental housing. For example, some rental projects require community input. A partner organization can act as a neighborhood liaison, organizing community meetings and providing outreach information. Consultants can also provide services such as market assessments, tax credit expertise, or construction management.
- Program Manager. In some jurisdictions, a nonprofit or other public entity might manage the rental development program on behalf of the local public agency. In this instance, it is acting as a subrecipient to the jurisdiction and its job is to select and fund projects.
- Lender. A wide range of lenders can act as partners in a HOME or CDBG-funded rental housing project. Sometimes lenders are for-profit companies—such as banks or credit unions. Other times lenders are nonprofit organizations that may be either lending their own resources to the project or acting as subrecipients and lending HOME or CDBG funds to the project. One special type of lender that may sometimes participate in HOME or CDBG programs are Community Development Financial Institutions (CDFIs). CDFIs are community-based lenders working to address housing and economic development needs. Note that under the CDBG Program, projects undertaken by CDFIs get special regulatory flexibility related to applying the national objective for jobs or housing.
Under the HOME Program, PJs are required to invest some funds in housing that is owned, developed, or sponsored by CHDOs. The development of rental housing is an eligible CHDO set-aside activity and these expenditures count toward the 15 percent threshold. In order to count as a CHDO set-aside activity, the CHDO must be acting in the role of owner, sponsor or developer. CHDOs can play other roles in the development process but it does not count toward the 15 percent minimum CHDO set-aside.
Under the CDBG program, grantees are not required to work with any one particular type of partner. Nonprofits and for-profits may play any of the roles outlined above. However, grantees sometimes find it beneficial to work with CBDOs. As noted in Section 1, CBDOs are a special type of organization whose purpose is community development. A CBDO may undertake activities related to neighborhood revitalization, energy conservation, or community economic development. Housing–-including rental housing–-can be a component of these efforts. Note that under the State CDBG Program, these entities are generally known as nonprofit development organizations working under Section 105(a)(15) of the Housing and Community Development Act, and individual states may or may not call these organizations “CBDOs”.
There are several reasons why grantees may wish to partner with CBDOs or nonprofit development organizations serving the needs of non-entitlement areas (referred to generally as CBDOs below):
- CBDOs are intended to be organizations with a relationship to the community. They offer the local resident perspective to the development.
- A CBDO is the only entity that is allowed to construct new housing with CDBG funds (other than units developed as last resort housing for relocation purposes). This new CBDO housing must be in the context of neighborhood revitalization, energy conservation, or community economic development.
- If the grantee adopts a Neighborhood Revitalization Strategy Area (NRSA), or for recipients of State CDBG funds, a Community Revitalization Strategy Area (CRSA), any services undertaken by the CBDO pursuant to the strategy within that area are not subject to the 15 percent public services cap. This means that the grantee could fund public services via the CBDO using CDBG funds without having to worry about needing to reduce its funding to other public services activities in order to fit all activities within the cap. This could be especially helpful to service-enriched rental projects located within the NRSA or CRSA area, such as elderly projects with meal, medical, or counseling services.
It is important to note that there are key distinctions between CHDOs and CBDOs. Table 2-1 compares these two types of development organizations.
As noted in Table 2-1, HOME CHDOs that have a geographic area of operation that does not exceed one neighborhood will automatically qualify as a CBDO, regardless of whether they meet other CBDO criteria. This organization must have received HOME funds or be expected to receive HOME funds. Note that in order to qualify as a CBDO activity, the CDBG-assisted activity must be part of a community economic development, neighborhood revitalization, or energy conservation project.
In choosing partners, jurisdictions need to ensure that they adhere to the Federal requirements related to conflict of interest. In general, no covered person or entity may obtain a financial benefit due to his or her working relationship to the HOME or CDBG programs. A covered person is a jurisdiction employee, agent, or officer and their immediate families and business partners. So, a jurisdiction employee could not form a development firm and then request HOME or CDBG assistance to build rental units.
In addition to these requirements, HOME also imposes requirements related to the occupancy of units. In general, no owner, developer, or sponsor of HOME-assisted housing, including their officers, employees, agents, consultants, or elected officials may occupy a HOME-assisted unit. Note that there are exceptions for owner-occupied rehabilitation and rental property managers or maintenance workers.
Table 2-1: CHDO and CBDO Comparison*
15% of the annual grant.
Provision of affordable housing for low- and very low-income persons.
Community development, including housing and economic development. Focus on meeting the needs of low- and moderate-income persons. Primary purpose is improving the physical, social and economic environment of its service area.
Must have a defined geographic service area, although need not be single neighborhood. May include multiple jurisdictions, but not the whole state.
Works within a defined geographic area within the jurisdiction—does not cover more than one jurisdiction. This requirement is not applicable to the State CDBG Program.
Organized under State and local law. Must have 501(c) nonprofit status from IRS. No profits may benefit any individual.
May be nonprofit or for-profit, as long as profits are incidental to operations.
Table 2-1: CHDO and CBDO Comparison*
Must be at least 1/3 low-income representatives. This can include low-income residents or residents of low-income neighborhoods or elected representatives of low-income neighborhood organizations. Must also have other means of input by low-income residents.
51% of governing body is low- and moderate-income residents of, or officers of institutions of, or representatives of low- or moderate-income neighborhood organizations in their service area. Board must be nominated and approved by membership or permanent governing body. The board requirements are not applicable in the State CDBG Program.
Public agency participation
Cannot be an instrumentality of the public agency. No more than 1/3 of the board may be representatives of the public sector.
Cannot be an instrumentality of the public agency. No more than 1/3 of the board may be representatives of the public sector. The board requirements are not applicable in the State CDBG Program.
Capacity & experience
Must demonstrate 1 year of experience in serving the community. Must demonstrate staff capacity.
No CDBG regulatory requirement. Jurisdictions may develop their own requirements.
No specific requirements.
At dissolution of the CBDO, its assets cannot revert to the jurisdiction.
No specific requirements.
Must be free to contract for goods/services of its own choosing. Not required to be a subrecipient, but if so designated by the grantee, is subject to 24 CFR Part 84.
CBDOs not meeting above criteria may qualify if they:
- Are organized under Section 301(d) of the Small Business Investment Act of 1958;
- Are an SBA approved Section 501 State Development Company or Section 502 Local Development Company or a Section 503 SBA Certified Company under the Small Business Investment Act;
- Are a single neighborhood CHDO (see text discussion); or
- Are approved by HUD as being sufficiently similar in purpose, function and scope.
In order to qualify for the 15% set-aside, must be acting as an owner, sponsor, or developer of rental or homebuyer housing. Can undertake other activities but does not count toward 15 percent set-aside.
Must be part of neighborhood revitalization, community economic development, or energy conservation activities within their geographic area.
Not a subrecipient unless running a program on behalf of the PJ. In this instance, the HOME funds to the CHDO would not count toward the 15% set-aside. When receiving administrative funds to operate the subrecipient program, it is administrative funds, and not CHDO operating funds.
Not a subrecipient unless the grantee elects to treat them as such. If so, additional administrative requirements apply.
Up to 5% of the PJ’s annual HOME allocation may be allocated for CHDO operating expenses. Each CHDO may receive up to the greater of $50,000 or 50 percent of its total operating expenses in a given fiscal year.
Income earned by CHDOs is project proceeds not program income. Project proceeds may be used for any low-income housing activity.
None unless the grantee elects to consider the CBDO a subrecipient. Assuming the CBDO is not a subrecipient, project proceeds kept by them may be used for any lawful purpose.
* Note that the State CDBG Program has a less stringent definition of which organizations qualify under Section 105(a)(15) of the statute. See U.S. Department of Housing and Urban Development Guide to National Objectives and Eligible Activities for State CDBG Programs, pages 2-70 to 2-80. Available online at https://www.hud.gov/offices/cpd/communitydevelopment/library/stateguide/index.cfm.
Forms of Assistance
HOME PJs and CDBG grantees can provide financial assistance for rental housing in a number of different ways. Some types of financing that the jurisdiction may wish to consider, and the risks involved in each, are shown in Table 2-2.
Table 2-2: Financing Types and Characteristics
Uses and Eligibility
Predevelopment loans or grants
- Pay for project planning and pre-construction activities.
- Predevelopment expenses include staff costs of the developer that are directly associated with the project, option to purchase land or a building, legal fees, architectural and engineering fees, appraisals, and possibly loan application fees.
- May not be used before completion of environmental review and approval of the request for release of funds and related certification, except as authorized by 24 CFR Part 58.
- Eligible under CDBG or HOME if related to an eligible project.
- Highest risk because money is spent before the developer can determine whether the project is feasible.
- If project is not completed, costs are ineligible except under HOME when predevelopment costs are loaned to CHDOs. In this instance, the predevelopment loan may be forgiven.
- A short-term or interim loan to cover the cost of constructing or rehabilitating a project, with one or more long-term, permanent loans taking out (paying off) the construction loan at project completion.
- Construction loans from traditional private lenders are typically at a higher interest rate than permanent loans due to the high risk involved.
- Pays for the costs of building the housing.
- Eligible under HOME.
- Eligible under CDBG if
related to rehabilitation and not new construction (unless the grantee is using a CBDO, since a CBDO may undertake new construction).
- Jurisdiction should verify that permanent financing is available before making such a loan (to make sure it will be repaid).
- Jurisdiction may inherit a partly finished building if anything happens during construction to create a significant budget shortfall, or if developer abandons building.
- In such an event, it is unlikely jurisdiction could sell building for what has been invested.
Permanent mortgage loans
- Proceeds used to repay the construction, bridge, and predevelopment loans.
- If the permanent financing replaces other loans, original loans must be used for eligible costs.
- Jurisdictions may choose to finance part or all of the total development costs.
- Provides long-term financing; repaid from the operating income from a rental or cooperative housing project
- HOME or CDBG assistance must have been part of the original financing package.
- Eligible under CDBG for rehabilitation or acquisition. New construction only eligible under limited circumstances (see above).
- If there is a high vacancy or unexpected increase in operating costs, or reserves are depleted, jurisdiction may not get repaid.
- If not combined with private financing, ties up large amounts of HOME or CDBG funds in a few projects and, therefore, risks are concentrated.
- A short-term loan, often provided by construction lender, if upon construction completion, project does not yet meet requirements of permanent financing.
- Used when the project will not be ready for permanent financing when construction is complete, such as with multi-stage projects.
- May be used when permanent mortgage lender wants project to establish a track record before making loan.
- Eligible under both CDBG and HOME if the project is eligible as previously discussed.
- Significant changes in the project’s projected income or expenses could affect the availability of permanent financing, even if a loan commitment is in place.
- Includes loan guarantees and mortgage insurance.
- Used to enhance the credit-worthiness of a project to attract private lenders who would not otherwise participate.
- Eligible under both CDBG and HOME if the project is eligible as previously discussed.
- Default requires cash pay-off of lender.
- Take out existing debt on the rental property.
- HOME or CDBG funds may be used to refinance existing debt if the funds are used to rehabilitate the property and the refinancing is necessary to permit or continue affordability. Certain restrictions apply.
- Refinancing can be an expensive use of program resources.
Both HOME and CDBG offer a wide range of options in the design and selection of rental projects. There is flexibility in:
- Property and unit types;
- Unit income mix; and
- Targeting for special needs populations.
Property and Unit Types. HOME and CDBG allow for significant flexibility in the types of properties that can be used to develop rental housing. Eligible properties may be:
- Publicly or privately owned; and
- Residential or mixed use. However, HOME can only pay for the residential portion of the building. CDBG can be used to pay for both residential and commercial development although additional requirements apply.
HOME funds may not be used for development, operations, or modernization of public housing projects financed under the Housing Act of 1937. HOME funds can be used in combination with HOPE VI funds. CDBG funds can be used to modernize public housing units but CDBG cannot be used to operate public housing or to construct new public housing.
For both programs, there are no preferences for project or unit size or style. Often when people think of rental housing they picture large, multifamily buildings. While these types of buildings are certainly allowed under both CDBG and HOME, other building styles and forms of ownership are possible. HOME and CDBG rental projects may be one or more buildings on a single site, or multiple sites that are under common ownership, management, and financing.
A key distinction in unit types between CDBG and HOME involves units that were previously funded. Properties previously financed with HOME during the affordability period cannot receive additional HOME assistance unless provided during the first year after project completion. CDBG funds, on the other hand, can be used subsequent to the initial CDBG investment and/or during the HOME affordability period as well, for a new eligible activity.
Mixed-Income Housing. Both HOME and CDBG funds allow jurisdictions to develop mixed-income housing. However, the requirements are handled very differently under each program. HOME funds may be used to assist mixed-income projects but HOME funds may only be used for HOME-eligible costs, and only HOME-eligible tenants may occupy HOME-assisted units. So, this flexibility allows jurisdictions to target resources to particular units within a project.
The amount of HOME money that may be invested in the mixed-income rental project will depend upon the maximum per unit subsidy cap, the total eligible costs for the project, and whether units are comparable. If units are comparable, the PJ can pay for a proportionate share of the eligible costs, up to the subsidy limit. If the units are not comparable, costs must actually be allocated to the units that will be HOME-assisted and costs must be capped at the subsidy limit.
CDBG may also be used to assist mixed-income projects so long as the national objective is met. That means that 51 percent of the units must be occupied by low- and moderate-income households, or the project must meet one of the slum/blight national objectives. This is very different than the approach taken by the HOME Program. Regardless of the amount of CDBG funding—be it $100 or $10,000,000—if the low- and moderate-income housing national objective will be used, 51percent of the units must be occupied by low-and moderate-income households.
There is one exception to this rule when a grantee is helping to write down the costs of new construction of multifamily, non-elderly housing. However, do not forget that unless a CBDO is involved, the grantee cannot actually pay for the construction itself but rather might help through eligible activities such as acquisition or site clearance. In this instance, CDBG can pay for a proportionate share of units and the costs (less than 51 percent) so long as at least 20 percent of the units are occupied by low-and moderate-income households.
Mixed-Income Housing Options
Newtown wants to develop mixed-income rental housing. It has available $200,000 in HOME funds and $50,000 in CDBG funds. A developer has a 10-unit rental acquisition
and rehabilitation project that it would like to undertake with a total development cost of $1,000,000. The City’s per unit HOME maximum subsidy limit is $150,000.
Q: If Newtown invested all $200,000 of HOME funds, how many units would need to be HOME-assisted?
A: Two units. Since 20 percent of the costs are paid by HOME, 20 percent of the units must be considered HOME-assisted (assuming units are comparable).
Q: If Newtown instead invested $50,000 of CDBG in the project, how many units would need to be occupied by low-income persons?
A: Assuming that this is not a blighted area or site, six of the units would need to be occupied by low- or moderate-income households. This project would need to be qualified under the housing national objective and that requires 51 percent occupancy by low- or moderate-income persons.
Special Needs Housing. There is also a significant difference between the HOME and CDBG programs when it comes to special needs facilities. Transitional and permanent housing for persons with special needs, including group homes and single room occupancy (SRO) units, are eligible under HOME and CDBG.
Properties that are “facilities” are not eligible under HOME, but are eligible under CDBG. This includes shelters that include a residential component, such as homeless shelters or orphanages. These buildings are not considered housing under CDBG but rather “public facilities”. This is important for three reasons:
- First, public facilities are not subject to the CDBG ban on new construction of housing, so grantees can build new facilities for persons with special needs.
- Since these units are not housing, they qualify under the limited clientele national objective rather than under the housing national objective. If the facility exclusively serves a clientele that is presumed to be low- and moderate-income (see Section 1 for this list), the grantee is not required to document household income.
- Public facilities must be owned by the grantee, a nonprofit, or another public agency. Therefore,
for-profit firms cannot develop and own a facility for persons with special needs under CDBG.
There is also an important difference in the way that HOME and CDBG approach assisted units. Under CDBG, the housing national objective is met at the time that the project is completed and the units are first occupied. At initial occupancy, 51 percent of the units need to be occupied by households who are low- or moderate-income, if the activity is based on the low-and moderate- income national objective. However, if those households move out and others move in, there is no requirement that the grantee evaluate or constrain the income of subsequent tenants. So, the program does not include the concept of a “CDBG-assisted unit” over the long-term, although a grantee can impose such a requirement.
HOME, on the other hand, establishes long-term affordability periods for HOME compliance based upon the activity type and amount of investment (See “Ongoing Compliance” in this section for more detailed information on this topic.) During this affordability period, certain units that are deemed as “HOME-assisted” must remain affordable and occupied by low-income households. There are two methods of determining HOME-assisted units:
- Fixed. When HOME-assisted units are “fixed,” the specific units that are HOME-assisted (and, therefore, subject to HOME rent and occupancy requirements) are designated and do not change during the affordability period.
- Floating. When HOME-assisted units are “floating,” the units that are designated HOME-assisted may change over time as long as the total number of HOME-assisted units in the project remains constant.
- The floating designation gives the owner some flexibility in assigning units and can help avoid stigmatizing the HOME-assisted units.
- If the floating designation is used, the owner must ensure that the HOME-assisted units remain comparable to the non-assisted units over the affordability period in terms of size, features, and number of bedrooms.
A wide variety of rental development costs can be paid for with HOME or CDBG funds provided that these costs are incurred in the context of an eligible project. This section highlights eligible direct rental project costs and discusses approaches to addressing activity delivery costs.
Direct Project Costs. Eligible rental project expenditures under HOME or CDBG may include:
- Site acquisition;
- Labor, materials, and other construction costs;
- Energy efficiency improvements;
- Utility connections;
- Inspection, testing, and abatement of lead-based paint;
- Reserves remaining at the end of 18 months may be retained for reserves at the PJ’s discretion.
- Relocation costs for assisted properties;
- Soft costs such as: financing fees; credit reports; title binders and insurance; surety fees; recordation fees; transaction taxes; legal and accounting fees, including cost certification; appraisals; architectural and engineering fees, including specifications and job progress inspections; environmental reviews; builders’ or developers’ fees; affirmative marketing; and
- Handicap accessibility improvements.
Remember that CDBG cannot pay for new construction of rental housing unless it is undertaken by a CBDO as part of a neighborhood revitalization, community economic development, or energy conservation project. However, grantees may provide support for the development of new rental housing as an eligible activity. “Support” refers to:
- Acquisition (if purchased by the grantee, or another public or nonprofit entity);
- Site clearance; and
- Site improvements (if in public ownership).
Note that HOME requires that all units be brought up to code and it has a minimum investment requirement of an average of $1,000 per HOME-assisted unit for the project. So, while handicapped accessibility and energy efficiency improvements are eligible as a part of construction, they are not typically able to be stand-alone activities because these work items alone typically do not bring a property up to code. CDBG does not have a minimum investment or code requirement, so single purpose rental rehabilitation programs are eligible.
HOME funds can also be used to cover the cost of funding an initial operating deficit reserve for new construction and rehabilitation projects. This is not an eligible cost under CDBG.
- This reserve is meant to meet any shortfall in project income during the project rent-up period.
- The reserve cannot exceed 18 months.
- The reserve can be used only for project operating expenses, scheduled payments to replacement reserves, and debt service.
- The disposition of any remaining funds at the end of the 18-month period should be determined in the agreement between the developer/owner and the PJ.
Activity Delivery Costs. HOME and CDBG treat the jurisdiction’s housing program or activity delivery costs differently. Activity delivery costs include specifications, inspections, underwriting, loan processing, and other staff and contracted costs needed to deliver and oversee the eligible project. Under CDBG, these types of costs are eligible when needed to deliver a rehabilitation program or project or if new construction is being undertaken by a CBDO. They are considered activity delivery costs and are not counted toward the administrative cap. Under HOME, these costs can be charged to a specific project (and therefore not against the administrative cap), if the PJ tracks costs unit-by-unit so that they can be included within the per unit maximum subsidy limit. Otherwise, the costs have to be charged as administrative costs, and are subject to the 10 percent program administration cap.
It is important to note that CDBG contains an eligibility category that is designed to enable grantees to use CDBG for housing services under the HOME program. Under 24 CFR 570.201(k) of the CDBG regulations and 105(a)(20) of the statute, grantees may elect to pay for costs related to housing services under HOME. As noted above, services may be provided to owners, tenants, contractors, or other entities participating or seeking to participate in HOME-funded activities. Grantees may pay for the following types of HOME costs with CDBG funds:
- Housing counseling;
- Energy auditing;
- Preparation of work specifications;
- Loan processing;
- Tenant selection; and
- TBRA management.
This is an important addition to the CDBG program because these costs are a separately eligible activity under CDBG and are not counted toward the grantee’s administrative cap. This new flexibility provides a good option for combining CDBG and HOME.
Property and Neighborhood Standards
There is a significant distinction between HOME and CDBG when it comes to property standards. Under CDBG, there are no established rules regarding property quality. Obviously the grantee should be prudent and use its funds wisely. CDBG grantees are free to design rental rehabilitation programs that focus on particular trouble areas—such as handicapped access or emergency repairs—without bringing the entire building up to standard.
However, as with all HOME-assisted properties, HOME rental properties must meet certain written standards.
- Acquisition. If no rehabilitation or construction is planned, the housing acquired must meet state and local housing quality standards and code requirements. If no such standards or codes exist, the property must meet Housing Choice Voucher Housing Quality Standards (HQS).
- Construction and rehabilitation. Housing that is constructed or rehabilitated with HOME funds must meet all applicable state and local codes, rehabilitation standards and ordinances. If no state and local codes apply, the property must meet one of the national standards.iv If new construction, the property must also meet the Model Energy code.
- New construction of rental housing. The site and neighborhood standards of 24 CFR 983.6(b) apply to new construction of rental housing. PJs are required to perform the review and maintain records that document the results.
Other Federal Requirements
In general, rental housing developed under CDBG and HOME is subject to similar other Federal requirements. Jurisdictions should carefully review all applicable regulations and HUD guidance on other Federal requirements.
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