Chapter 2: Review Financial Feasibility

This chapter continues the discussion on project review that commenced in Chapter 1. Chapter 2 provides guidance on how to review the financial factors that impact a HOME-LIHTC project’s success and feasibility and describes the issues the PJ must analyze in order to determine how to best structure HOME funding invested in a HOME- LIHTC deal.

Overview of the Financial Feasibility Review

The need for a thorough project feasibility and sustainability review is just as important for a project with HOME and LIHTC funding as it is for a project only funded with HOME. Even if the state allocating agency has already reviewed the project and allocated credits, the PJ should undertake its own review of the project application. The state allocating agency’s review assesses the project in relation to the state’s needs and standards. The PJ can never assume that the state’s standards accurately reflect current local construction costs and building standards, include all the costs that may be associated with compliance with HOME financing, and meet the PJ’s local housing and cost policies.

The review of the project’s feasibility and long-term sustainability is referred to as underwriting.

  • Project feasibility refers to the process of analyzing and evaluating the likelihood that a proposed project will be successfully completed. For the PJ, it involves analyzing a project’s eligibility, site, financing, and development team, in order to determine whether the project can be initiated, completed, and successfully opened for business.
  • Project sustainability refers to the project’s ability to generate affordable rental housing for the duration of the affordability period, without additional public subsidy. Projects are sustainable when the underwriting is based on realistic and conservative cost estimates, the market for the unit mix is strong, the financing structure of the deal is viable, construction is sound, and, once operational, the project is maintained and managed effectively.

Through the underwriting process, the PJ assesses the risks of the project, and decides whether or not to finance the project based on its assessment. Projects that are based on sound underwriting and realistic financial projections are far more likely to succeed in the long term than those that are based on poor underwriting or unrealistic financial projections.

The underwriting process is comprised of four key areas of review:

  • Preliminary screening of the project, sometimes referred to as a “threshold review” (see Introduction)
  • Market risk assessment
  • Borrower risk assessment (review of the project development team qualifications)
  • Project risk, feasibility, and sustainability analysis.

Projects that are funded with FY 2012 HOME funds and later 2 are subject to new underwriting requirements imposed by the Consolidated and Further Continuing Appropriations Act of 2012 (P.L 112-55). The Act requires PJs to underwrite each project, assess the developer capacity and fiscal soundness of the developer being funded, and examine the neighborhood market conditions to ensure that there is an adequate market for the project. When it makes a project commitment, the PJ must certify that it has taken these actions. The Act also requires that any ConPlan submitted after November 2012 must be based on an assessment of the local market that helps the PJ specify the types of housing, locations, and target populations that will be eligible for funding.

2 These requirements apply to any development project that receives FY 2012 HOME funds, including all 2012 CHDO set-aside funds. A FY 2012 HOME–funded project is defined as any HOME activity set up in Integrated Disbursement and Information System (IDIS) under a 2012 Consolidated Plan/Annual Action Plan Project.

Underwriting addresses elements of the project beyond regulatory compliance; however, complying with HOME and LIHTC requirements are integrally related to underwriting and the financial and operational viability of the project.

Attractive new affordable housing projects -- home to responsible tenants and recognized as major improvements to their neighborhoods – make all of the PJ’s efforts worthwhile. It is especially satisfying to see the same projects - ten, fifteen, and even twenty years later - continuing to meet the community’s affordable housing needs. Long-term success in HOME-LIHTC projects is rarely an accident. It is a function of good up-front planning and project review that emphasizes both feasibility and sustainability.

Assessing Developer Capacity

The purpose of the PJ’s review of the developer’s capacity is to assess whether the proposed development team has the right mix of skills, capacity, and experience to develop the proposed HOME-LIHTC project. The core questions in reviewing HOME- LIHTC developers are the same as for the PJ’s review of any HOME project.

Exhibit 2-1 summarizes the key questions that the PJ should answer when it assesses the development team of a proposed project. With an LIHTC ownership entity, the PJ’s review should assess the capabilities of the managing partner or general partner who will carry out the day-to-day responsibilities of the project.

Exhibit 2-1: Assessing Development Team Qualifications

Exhibit 2-1: Assessing Development Team Qualifications

In evaluating the development team’s skills, capacity, and experience, the PJ should consider how similar the proposed project is to the projects that the team has previously developed. For instance, in a HOME-LIHTC project, the ideal development team has experience building and operating affordable rental housing using HOME funds, LIHTC funds, and HOME and LIHTC combined. If the development team has experience in only one program, it is important for the PJ to determine how the team plans to gain expertise in the other program, in order to ensure that the team is competent to develop and manage the property in compliance with both sets of program requirements.

Likewise, the PJ should evaluate whether the developer has undertaken projects that are similar to the proposed project—in terms of the project size and scope, target population, and geographic location. A developer may succeed with a series of projects of one type, but then fail when it attempts a different type of project, a project in a different market, or a project of significantly greater size. For instance, a developer who has a wonderful track record with medium-sized new construction projects for low-income seniors in the suburbs may fail when it attempts a large rehabilitation project for low-income families in the inner city, or a market-rate project, or a project in another town.

CHDO Involvement in LIHTC Projects

When CHDO funding is involved in a HOME-LIHTC project, the PJ needs to evaluate the CHDO’s anticipated role in the project. This is especially true if the PJ wants to “count” the HOME funds invested in the project toward its CHDO set-aside requirement. This is the HOME requirement that a minimum of fifteen percent of each annual HOME allocation must be invested in housing that owned, developed, or sponsored by a CHDO.

In some HOME-LIHTC projects, the CHDO is the managing member of an LLC or general partner of a limited partnership. Often, however, the CHDO is a co-sponsor with a larger or more experienced developer. If the CHDO is not the sole managing partner of the LLC, the PJ must obtain a waiver to use CHDO set-aside funds. In these projects, the larger developer may be the managing member or general partner, and the CHDO may be a subordinate member with a more limited role. These roles and responsibilities are explicitly addressed in the project’s Partnership Agreement (discussed in Chapter 3). If the PJ wants to use CHDO set-aside funds in the project, it must determine that the CHDO serves in a capacity where it has effective project control. The PJ should review the Partnership Agreement carefully to make that determination.

For more information on what constitutes effective project control, see HUD Notice CPD 97-11, Guidance on Community Housing Development Organizations (CHDOs) Under the HOME Program , issued October 8, 1997. This HUD Notice is available on the HOME website at

To use CHDO set-aside funds in an LIHTC project, the CHDO must have effective project control. For tax credit projects, this generally means that the CHDO must serve in the capacity of managing member (in an LLC) or the general partner (in a limited partnership)."

Reviewing the Project’s Marketability

Before investing in an affordable rental housing project, the PJ should secure and/or review a market study of the specific project under consideration. The market study describes the demand for the housing (including an assessment of the proposed rent structure) and competition for the proposed housing, the capture rate needed to maintain an occupied property, and the absorption rate expected for the project. A market study is required of projects that are funded with HOME FY 2012 funds, or later.

The PJ must review the market study carefully to evaluate the validity of the developer’s assumptions about the marketability of the project. Exhibit 2-2 summarizes the key elements of the market study. This evaluation is extremely important because if the project is unable to attract tenants to keep the building occupied, it will not remain financially viable and will be unable to provide affordable housing to the community. Failure of the project to provide affordable housing throughout the affordability period may result in HUD requiring the PJ to repay HOME funds.

For HOME-LIHTC projects, market studies are required as part of the owner’s tax credit application. The state typically provides detailed instructions for preparing the market study in the QAP. This sometimes includes specific qualifications for those that prepare the market study. The PJ should become familiar with the state’s requirements. If the state’s requirements are satisfactory, the PJ may want to adopt them or it might impose additional requirements of its own. If the state’s market study is sufficiently detailed to meet the PJ’s criteria, the PJ may elect to simply request a copy and conduct its own review of that study. If the state’s market study criteria are not as stringent as those adopted by the PJ, the PJ may wish to request a more detailed study.

Demand for the Housing

  • How many potential renter households (target market) might want to live in the project?
  • What unit features/amenities are desired by the target market?
  • How much is the target market willing to pay?


  • What existing rental properties will the target market consider?
  • Are there other competing properties that are under construction, or proposed, that the target market would consider?
  • What features (such as, unit size, number of bathrooms, appliances) and amenities (such as, parking, swimming pool, or laundry facilities) do the competing properties have?

Exhibit 2-2: Key Elements of the Market Study

Exhibit 2-2: Key Elements of the Market Study

Capture Rate

  • What share of renter households seeking housing of this type, in this location, and at this price range, need to be “captured” (i.e., leased) by the proposed property in order for it to succeed? (This capture rate is usually stated as a percentage.)
  • Is the capture rate low enough to suggest that the property is likely to succeed and lease up quickly?

The PJ needs to understand its neighborhoods and housing markets to understand the capture rate. Generally, the capture rate may need to be higher for populations with a greater number of options than it would need to be for those who might have fewer options. For example, a property would need a low capture rate for a deeply subsidized apartment, whereas it might need a higher capture rate for a unit that will be rented at or near market.

Absorption Rate

  • What is the number of units per week or month that the property can be expected to “absorb” (i.e., lease) once the property begins accepting residents? For example, if the property is 60 units, and the expected absorption rate is ten units per month, it should take six months for the property to lease up.

To determine if the project’s absorption rate is sufficient, the PJ should compare the absorption rate with how quickly the property must lease up in order to be financially successful. To continue the example, if the property is 60 units, and in order to succeed, the property must lease up in four months, an absorption rate of 15 units per month is needed.


Financial Review of HOME-LIHTC Projects

The financial review process for a HOME-LIHTC project is substantially the same as it is for a project funded with HOME funds alone. The PJ’s financial feasibility analysis involves:

  • Evaluating the development-related expenses and the availability of funds to develop the project
  • Making predictions about the future operating expenses and revenues to anticipate the long- term viability of the project
  • Analyzing the financial data, the impact of HOME and LIHTC requirements, and economic and market trends, in order to make decisions about how much HOME funds to invest, and what terms and conditions of funding to impose.

For the PJ, it is important to make realistic, if not conservative financial judgments. This helps ensure that the development of the project will be completed and the project will yield the revenues it needs in order to be sustained throughout the affordability period, while complying with the HOME Program’s occupancy and rent restrictions.

This chapter assumes that the reader has a basic understanding of project underwriting for affordable housing. For more information on underwriting, see the Underwriting HOME Rental Housing Guide. This publication is available online at"

The PJ underwriter may save time and be more thorough in its financial analysis if it reviews and understands the state’s underwriting standards. These are typically available in the QAP. These standards explain the state’s financial requirements for tax credit projects, such as requirements for the maximum total development cost, replacement reserves, operating expense levels, and first mortgages. These QAP requirements may be inconsistent with PJ requirements, and the PJ needs to decide how to resolve the differences and how to respond to questions from developers about these differences. To the extent feasible, PJs should seek to minimize any conflicts between PJ underwriting requirements and underwriting requirements in the state’s QAP.

Coordinating the PJ’s and State’s Financial Feasibility Review

It is a best practice for the PJ and the state allocating agency to coordinate with each other regarding underwriting requirements and determinations. This practice is likely to improve the accuracy of both underwriting analyses, and is necessary to ensure the appropriate level of total assistance to projects.

Financial Analyses

The PJ typically begins to review the financial projections of a project by reviewing financial information that the developer provides. Typically, this financial information is presented in the form of Sources and Uses Statement and an operating pro forma:

  • Sources and uses of funds statement shows the uses of funds (i.e., the development budget) together with the sources of funds (i.e., the funds that will be used to pay for the costs in the development budget). The uses of funds are an estimate for all of the costs that the developer will incur to complete and lease-up a project.
  • Operating pro forma is an estimate of the revenue and expenses that the proposed project should produce upon completion.

Initially, the PJ reviews these documents to ensure that the costs are reasonable, necessary, and complete.

Reviewing the Development Budget

The PJ underwriter reviews the development budget (uses) to evaluate whether it contains reasonable estimates for all of the project development costs. In general, these development costs are the same for a project, regardless of the funding source. However, there are some differences in the development budget for a HOME-LIHTC project of which the PJ should be aware:

  • There may be some costs in an LIHTC project that a PJ might not normally see in a HOME- assisted project.
  • There may be some costs in a HOME project that might not otherwise be in an LIHTC- assisted project.
  • Presentation of the budget may differ because of LIHTC cost eligibility.
  • Certain costs may be higher in a tax credit project than in other HOME-assisted projects.

LIHTC Costs that Are Not Found in a HOME Project

Housing tax credit projects can be complex, and the owner needs to engage the services of a variety of experts in order to successfully execute a housing tax credit deal. The PJ should expect to see the following costs in a project that has LIHTC equity funds. These costs are not typically present in a project that is funded only with HOME:

  • Syndication Fees. Usually, the owner pays a syndicator to serve as a broker between the equity investor and the developer. This is referred to as the syndication fee. The syndicator might pool several projects into one equity fund, so that investors share the risk among several projects. Syndication is key to securing investor equity to the tax credit project.
  • Tax advisors. Owners and investors rely on the advice of tax advisors to ensure the project complies with the IRS rules, so as not to jeopardize the tax credit.
  • LIHTC application fees. Most states impose LIHTC application fees, to offset the costs of reviewing and processing LIHTC applications. In some states, there is a different fee structure for for-profit and nonprofit developers.
  • Organizational fees. This is the cost to create the new ownership entity (Limited Liability Corporation or Limited Partnership) for the project.

These costs are standard costs in LIHTC deals, and they should be reflected in the development budget. The PJ should consult with the state to assess the cost-reasonableness of these fees; the state’s QAP may also provide guidance on the expected cost of these fees.

HOME Costs that Are Not Found in an LIHTC Project

There are a number of HOME requirements that are not LIHTC requirements. When reviewing a development budget, particularly for a project that was initially conceived as a tax credit project or that has already received an allocation of tax credits, the PJ should be sure that the budget reflects these HOME-related costs, as applicable:

  • Davis-Bacon prevailing wage for projects with twelve or more HOME-assisted units
  • Lead-based paint treatment for projects that include a pre-1978 building
  • Environmental clearance requirements
  • Relocation costs for any project that includes a property that is currently occupied
  • Energy efficiency improvements required by the International Energy Conservation Code.

All of these costs are eligible HOME costs. Some of these costs may be eligible in the LIHTC basis, such as Davis-Bacon prevailing wages and lead-based paint treatment costs. These costs are related to the construction and building and can, therefore, be depreciated. Some of these other costs may or may not be eligible in the LIHTC basis, depending on the specific type of the cost and whether the cost(s) can be depreciated for income tax purposes. The project sponsor should consult with its tax attorney or tax credit advisor to make this determination. The following section of this chapter discusses eligible LIHTC costs in more detail.

Presentation of LIHTC-Eligible and Ineligible Costs

LIHTC cost eligibility is important for determining how many tax credits can be allocated to a project. The general principle underlying LIHTC cost eligibility is that a cost must be eligible to be depreciated for income tax purposes in order to count toward LIHTC basis. Therefore, eligible costs are referred to as “in LIHTC basis,” and ineligible costs are “outside LIHTC basis” (that is, the costs are not eligible to be included in LIHTC calculations which determine the amount of tax credits that can be issued). These items are driven by IRS rules about depreciation. There are no limits on how the equity in an LIHTC project can be spent once basis is established and tax credits are allocated (equity can pay for costs that are outside of the basis). This is significantly different than the HOME Program – HOME funds can be spent only on eligible costs for HOME-assisted units.

The development budget for an LIHTC project is often presented so that the costs are identified as “in basis” or “outside of basis.” For instance, when LIHTC funds are involved in a project, the development budget usually separates the land and building costs because construction costs are in basis (LIHTC-eligible), but land is outside of LIHTC basis (not LIHTC-eligible).

In general, the PJ does not need to review whether or not this delineation is accurate because the state reviews this component of the project. If the project has not yet secured a tax credit allocation, however, it is helpful for the PJ to have a basic understanding of what is inside and outside of basis because if the owner calculates the eligible basis incorrectly, it impacts its projection of how much tax credits the project can secure and this impacts how much HOME funding the project needs. Using the example of splitting the land and building cost, if the state has accepted the land/building split proposed by the developer, the PJ does not need to question this split and the inclusion in basis further. However, if the tax credits have not yet been requested, the PJ should understand the reasoning behind the split, so that it can assess if the tax credits anticipated by the developer are realistic.

Exhibit 2-3 identifies the standard line items in a development budget, and identifies if these are eligible costs under the HOME Program, and whether they are in or outside of LIHTC basis.

Exhibit 2-3: HOME Eligible Costs and LIHTC Eligible Basis

Exhibit 2-3: HOME Eligible Costs and LIHTC Eligible Basis

Additional Costs

Certain fees may be higher for a HOME-LIHTC project than they are for a HOME-only project, including developer fees and attorney fees. These higher costs may be reasonable, depending on the project and the market, and should be expected because an LIHTC project is more complex than a typical deal and requires a high level of expertise and more time to put the deal together. The PJ may want to consult with the state to determine the cost reasonableness of these higher costs.

Assessing Sources and Uses

The Sources and Uses Statement shows all the funding sources available and all the proposed costs, or uses of the funds (the development budget). Exhibit 2-4 provides a sample, simplified Sources and Uses Statement.

Exhibit 2-4: Sample Sources and Uses Statement

Exhibit 2-4: Sample Sources and Uses Statement

The PJ should review the Sources and Uses Statement to determine three things:

  • The availability of all the sources to ensure that the Sources and Uses are in balance before construction proceeds.
  • Whether uses are cost-eligible, considering the restrictions on the uses.
  • Whether the timing of the availability of sources is adequate to meet uses, throughout the development and construction period.

Availability of Sources

First the PJ should assess whether the owner has firm commitments for all sources listed on the Sources and Uses Statement. A firm commitment would be a legal agreement or legally binding commitment letter from the source.

In many instances, HOME funds are committed to projects early, before other sources are invested. In some cases, other funders, such as private lenders, want to know that the public sources are “locked in” before the funder will commit to the project. It is acceptable for HOME to be the first source committed to the deal, but, the PJ should be careful in how and when it allows draws of HOME funds for these types of projects. If the PJ allows HOME funds to be used to acquire the land or begin the construction prior to having all of the other sources firmly committed, it runs the risk that the developer will be unable to raise sufficient resources to complete the units. If this occurs and the affordable housing is not completed, the PJ must repay the HOME funds back to HUD.

Cost Eligibility

The PJ should examine the Sources and Uses Statement to determine that: (1) there are sufficient sources of funds to pay all of the costs of the project, and (2) all of the costs of the project can be borne by sources for which they are eligible.

As noted above, the notion of “eligible cost” is different in HOME and LIHTC. The HOME rules identify specific costs as eligible and ineligible (found in 24 CFR 92.206 and 92.214, respectively). HOME funds cannot be used to pay any cost that is not eligible.

Timing of Sources, Including Equity Pay-In

For any project, the PJ must consider the cash flow into a project throughout construction. Generally, most uses need to be paid during the construction period. Typically, the LIHTC equity is paid to the developer in stages over the development period. The investor usually prefers to delay payment until stabilization, when the project has been completed, has been leased-up, has achieved its projected Net Operating Income (NOI), and when the investor has less risk regarding project completion. The developer, on the other hand, prefers to receive payment as early in the construction process as possible, offsetting the need to borrow funds (and pay interest costs) during construction. The tension between these two points of view results in a wide variety of pay-in structures.

Typical events in the pay-in schedule include:

  • Initial closing
  • 25 percent, 50 percent, 75 percent, and 100 percent construction completion
  • 100 percent of the units have been placed in service
  • Stabilization

The PJ should be aware that there is often a tradeoff between the price of the tax credits and the pay-in schedule. Investors are willing to pay more for credits when their pay-in schedule is late in the construction process and their risk is minimized. While the PJ might desire an earlier equity pay-in schedule to limit its own risk, this will likely decrease the price of the credits, which in turn may increase the need for HOME financing.

Due to these timing issues, typical HOME-LIHTC transactions need temporary financing to be able to pay construction costs before all of the permanent sources of funds have been received. The two most common forms of temporary financing are:

  • Construction loans, which usually are for the same principal amount as the permanent first mortgage, from a lender who specializes in managing the risks during the construction period.
  • Bridge loans, which most commonly bridge the timing gap between when LIHTC equity funds are needed (in order to pay construction and other development costs) and when the LIHTC investor has agreed to provide the funds.

Exhibit 2-5 illustrates how to project the timing of Sources and Uses over the development period. In this example, a construction loan has been added to the Funding Sources Summary in order to make sure there are sufficient sources to meet uses at each point during the development period.

Exhibit 2-5: Sample Sources and Uses Timing Illustration – Requiring a Construction Loan

Exhibit 2-5: Sample Sources and Uses Timing Illustration – Requiring a Construction Loan

Exhibit 2-5: Sample Sources and Uses Timing Illustration – Requiring a Construction Loan

Exhibit 2-5: Sample Sources and Uses Timing Illustration – Requiring a Construction Loan

Exhibit 2-5: Sample Sources and Uses Timing Illustration – Requiring a Construction Loan

Exhibit 2-5: Sample Sources and Uses Timing Illustration – Requiring a Construction Loan

The PJ must also consider how the pay-in schedule might impact the project’s ability to pay the ineligible costs of the project during construction. If HOME funds provide the bridge or construction loan, the proceeds of the HOME loan can only pay for eligible costs, even if the tax credit equity will take out the HOME financing upon completion. There must be sufficient other funds during the construction process to pay the cost of any ineligible items. For instance, consider a project that requires sewer development. This is not a HOME-eligible cost. The PJ must determine that the full cost of the sewer development can be carried by another source of funds (such as the private financing) during construction and permanent financing.

Reviewing the Operating Pro Forma

Accurately and realistically projecting operating costs in HOME and LIHTC projects is important because the project’s long-term financial viability will be impacted if there are inaccuracies in the projected costs and revenues. The pro forma should encompass all stages of the project—from lease-up to stabilized operations, and throughout the affordability period.

Exhibit 2-6: Sample Multi-Year Operating Pro Forma

Exhibit 2-6: Sample Multi-Year Operating Pro Forma

In the example illustrated by Exhibit 2-6, the first year is not stabilized (meaning that the property has not yet achieved full occupancy) and it produces a loss of ($55,000). Typically, this “lease-up” expense would be paid through a reserve established specifically for this purpose, and it would be funded as a development expense of the project.

In addition to its standard review of the operating pro forma, the PJ should pay special attention to the following elements of the pro forma in a HOME-LIHTC project:

  • Unit mix
  • The reasonableness of the gross potential rent projections
  • The reasonableness of operating expenses, including whether they are sufficient to ensure the long-term success of the project
  • Trending assumptions about the inflation rate for revenues and expenses.

Unit Mix

The term unit mix refers to the range of unit types, sizes, and rents and occupancy restrictions that are proposed to be included in the HOME-LIHTC project.

The PJ determines the minimum number of units which must be designated HOME-assisted based on the amount of HOME investment in the project and the maximum per unit subsidy for the area. This process is known as cost allocation. Attachment 2-3, located at the end of this chapter, illustrates how to use cost allocation to determine the minimum number of HOME- assisted units in the project. The PJ may designate a greater number of HOME units than the minimum required. The PJ also determines how many units must be designated High HOME Rent and Low HOME Rent units in the project. In projects with five or more HOME-assisted units, at least 20 percent of the units are designated as Low HOME Rent units. Again, the PJ may designate more than 20 percent of the units as Low HOME Rent units if it so chooses. The remaining units are High HOME Rent units. See the section below for more information about rents.

The number of units that are designated as tax credit units is stated in the use agreement with the state allocating agency. This must either be a minimum of 40 percent of the units when the occupancy is restricted to households with incomes at or below 60 percent of area median income (AMI), or 20 percent of the units when occupancy is restricted to households with incomes at or below 50 percent of AMI. Many tax credit project owners designate all the units as LIHTC units, because the greater the percentage of tax credit units, the greater the amount of tax credits that can be allocated to the project.

The developer and PJ face the decision whether to add the HOME restrictions to units that are subject to LIHTC rent restrictions, or to apply the HOME restrictions to units that are not LIHTC-restricted (if any). This decision may be impacted by what the HOME and LIHTC rent limits are, the market rents, and the financing impact of overlaying rent and occupancy restrictions to achieve greater tax credit equity.

It is helpful to generate a unit mix table that summarizes key unit mix information:

  • Number of units of this type
  • Number of bedrooms
  • If there is more than one type of unit with this number of bedrooms, additional information identifying this particular unit type (for example, number of baths, whether there is a den, or affordability level)
  • Rental square feet
  • Gross potential rent
  • Whether the unit rent is subject to LIHTC rents, High HOME rents, Low HOME rents and/or other rent restrictions
  • Whether any utilities are tenant-paid, and what utility allowance applies (estimate for the monthly cost of tenant-paid utilities).

Exhibit 2-7 provides a sample of how this information can be presented.

Exhibit 2-7: Sample Unit Mix Table

Exhibit 2-7: Sample Unit Mix Table


Since both HOME and LIHTC units carry rent restrictions, it is critical that the PJ’s underwriters verify that the correct rents are being used in the rent projections. The rent projections that should be used will depend on:

  • The unit mix (i.e., how many units are designated High HOME Rent units, Low HOME Rent units, LIHTC units, and both HOME and LIHTC units)
  • The current High and Low HOME Rents and LIHTC rent limits for the jurisdiction, and whether or not the tenant pays for utilities
  • The estimated market rents for the project.

HOME and LIHTC Rent Limits

Both HOME and LIHTC require that the rents that are charged for assisted units are affordable to income-eligible households. Each program issues its own rent limits to define what is affordable. The rent limits represent the maximum rents that can be charged to income-eligible households. The cost of any tenant-paid utilities must be deducted from the published rent limit to determine maximum rents that can be charged. Each program issues utility allowances for this purpose— these represent the average utility cost for the area.

For each specific unit(s), the PJ’s underwriter uses the following guidelines to determine the rent limit that applies:

  • HOME rent limits apply to units that are designated as HOME-assisted units only.
  • Tax credit rent limits apply to units that are designated as tax credit units only.
  • The lower of the HOME or LIHTC rent limit applies to units that are designated as both HOME and tax credit.

If the estimated market rents for HOME or LIHTC units are below the program-restricted rent limits, the underwriter should use the lower, market rent in underwriting the project. Simply because a rent is restricted does not guarantee that it is below-market, and tenants will never pay above-market, restricted rents.

If the project has any market rate units (that is, units are neither HOME- nor LIHTC-assisted), the estimated market rate rents should be used.

In projects that serve persons with special needs, it may not be possible for a unit to carry a HOME- and LIHTC-assisted designation and still be in compliance with the program’s requirements related to serving the special needs group. See Chapter 4 for a more detailed discussion of this issue.

Basis of the Rent Limits

HUD issues HOME and LIHTC rent limits and adjusts them for different localities and for each bedroom-size unit from zero (efficiency) to six bedrooms. HUD updates the HOME and LIHTC rent limits every year.

High HOME rent limits are based on the lesser of one of the following:

  • The Section 8 Fair Market Rents (FMRs) for existing housing
  • 30 percent of the adjusted income of a family whose annual gross income equals 65 percent of AMI.

Low HOME rent limits are based on one of the following:

  • 30 percent of the tenant’s actual adjusted income
  • 30 percent of the annual gross income of a family whose income equals 50 percent of AMI (this is the HUD-issued Low HOME Rent)
  • If a property has a Federal or state project-based rental subsidy and the very low-income tenant pays no more than 30 percent of his or her adjusted income toward rent, the maximum rent allowable under the project-based rental subsidy program.

Note that Low HOME Rents are used in the units that must be occupied by very low-income occupants in properties with five or more HOME-assisted units. Low HOME Rent units must represent at least 20 percent of the units in projects with five or more HOME-assisted units. Most PJs use the HUD-issued Low HOME Rents, unless the project has a project-based rental subsidy.

LIHTC rent limits are based on one of the following:

  • 30 percent of 50 percent of AMI, when units are restricted to this population
  • 30 percent of 60 percent of AMI, when units are restricted to this population
  • 30 percent of a lower AMI, as required by the project-specific use agreement.

For a unit that serves to meet both the HOME and LIHTC requirements, the rent cannot exceed the FMR, because the FMR serves as a ceiling rent for the HOME Program. State allocating agencies update rent limits annually based on HUD-issued income limits.

Using Utility Allowances

In projects where the tenants pay for some or all of the utilities, the PJ’s underwriter must deduct the anticipated utility allowances from the rent limits to determine the maximum rent that can be charged for the unit. Failure to do this will result in an over-estimate of the potential gross rents of the property since utility costs can impact the rent figures significantly.

LIHTC and HOME may use different utility allowances. The LIHTC utility allowance must be deducted from the LIHTC rent limit to determine the maximum allowable LIHTC rent. The PJ’s utility allowance must be deducted from the HOME rent limits to determine the maximum allowable High HOME Rents and Low HOME Rents. The PJ can choose to adopt the LIHTC utility allowance for its tax credit projects, to simplify this process. For each unit that is designated as both a HOME and LIHTC unit, the lesser rent limit is used after utility allowances have been deducted.

Affordability and Market Rents

It is risky to assume that the property will achieve its “use-restricted” rent limits. The PJ should always compare the HOME and LIHTC rent limits to the market rents in the neighborhood. In some communities, the rent limits imposed by the LIHTC and HOME Programs will result in a higher rent for a unit than the market will actually bear. For example, a unit might have a maximum tax credit rent of $660 after utilities, a maximum HOME rent of $625 after utilities, and a maximum market rent of $500. Regardless of the program rent limits, the property cannot charge more than the market will pay, or $500. This lower market rent complies with the LIHTC and HOME rent restrictions, because it is always acceptable to set rents lower than the rent limits.

Expenses that Help Ensure Long-Term Success

Both HOME and LIHTC require compliance for some period of time after construction completion. Certain line items impact the longevity and long-term financial viability of the project. The PJ should be sure that these line items are sufficient to meet the project’s needs over the long term:

  • Maintenance budget
  • Property management
  • Reserve for replacements.

Maintenance Budget

Preventive maintenance helps ensure that major systems meet their useful life. Operating budgets should provide for adequate ongoing maintenance.

Property Management

Sufficient property management fees help attract and retain qualified and competent property managers. Managing a HOME-LIHTC project requires understanding and complying with requirements of two different programs, and includes annual income certifications, periodic property inspections, implementing rent restrictions, and organized recordkeeping systems. The PJ should expect to pay more for a property manager of this type of project than it might for smaller projects, or for projects that are HOME-assisted only. PJs should be careful not to underwrite to below-market property management fees, even if such fees will be charged to the project initially. Doing so may leave the property without enough breathing room in its operating expense budget to replace a failing management agent with a qualified agent, at prevailing prices.

Replacement Reserve Deposits

Replacement reserves are payments made in escrow to cover the costs of capital needs and major systems repairs and replacements that occur as the property ages. For example, this might include the need to replace appliances, air conditioners, water heaters, and roofs. The state allocating agency and/or the first mortgage lender may have guidelines about the level of Reserves for Replacements. The PJ should not adopt these guidelines without making its own assessment of whether the required replacement reserve is sufficient. Without sufficient reserves, as these properties age, they will need to supplement the replacement reserves with some combination of excess future cash flow, refinancing proceeds, or new government subsidy.

The Replacement Reserves estimate should be based on a capital needs assessment, whenever possible. Attachment 2-1, found at the end of this chapter, discusses how to prepare a capital needs assessment.

Assumptions about Inflation

In affordable rental housing underwriting, it is prudent to assume that revenues will grow at a slower rate than expenses. Depending on the relative growth assumptions for revenues and

expenses, NOI may actually decline as the property ages. This could be a serious problem for HOME-LIHTC properties that must comply with affordability restrictions for some period of time.

The following exhibits illustrate the impact of using the same income and expenses, but different assumptions for long-term inflation rates; they illustrate how these assumptions impact cash flow. Exhibit 2-8 shows inflation assumptions that are typical for market rate apartments, where the inflation rates assumed for revenues and expenses are the same. Exhibits 2-8 and 2-9 illustrate the effect of lowering the inflation rate assumption for revenues, while holding the inflation rate for expenses constant. In the third illustration, in which income is projected to rise at 2 percent per year while expenses increase at 3 percent per year, cash flow starts to decline after about Year 10.

Exhibit 2-8: Illustration with Equal Inflation Rate for Revenue and Expenses<br>(3% Inflation for Revenue, 3% Inflation for Expenses)

Exhibit 2-8: Illustration with Equal Inflation Rate for Revenue and Expenses
(3% Inflation for Revenue, 3% Inflation for Expenses)

Exhibit 2-9: Illustration with Lower Inflation Rate for Revenue than for Expenses<br>(Assuming 2.5% Inflation for Revenue, 3% Inflation for Expenses)

Exhibit 2-9: Illustration with Lower Inflation Rate for Revenue than for Expenses
(Assuming 2.5% Inflation for Revenue, 3% Inflation for Expenses)

Exhibit 2-10: Illustration with Lower Inflation Rate for Revenue than for Expenses<br>(Assuming 2.0% Inflation for Revenue, 3% Inflation for Expenses)

Exhibit 2-10: Illustration with Lower Inflation Rate for Revenue than for Expenses
(Assuming 2.0% Inflation for Revenue, 3% Inflation for Expenses)

These illustrations demonstrate how seemingly small differences in the trending assumptions can have a very significant impact on the outcome of NOI and cash flow over time. There are significant implications for HOME-LIHTC projects. In many HOME-LIHTC projects, conservative underwriting indicates that expenses will increase at a faster rate than income (rents), because of the market, the proposed project’s regulatory structure, and the restrictions on rents that can be charged. In these projects:

  • The project will probably need a larger debt service coverage ratio (DSCR) at the beginning, so that if NOI growth becomes negative at some point in the future, there will still be an adequate operating margin.
  • The monthly deposits to the Reserve for Replacements will probably need to be increased, because there is much less likelihood that there will be available future cash flow to pay for some long-term capital needs.
  • The first mortgage loan should probably have a shorter rather than longer period of amortization, so that principal will be paid down quickly, ensuring that the project will be able to refinance if necessary.

Determining the Amount of HOME Subsidy

Once the PJ has evaluated the developer’s financial information and has determined that the cost estimates are sound, the PJ must analyze this information to determine whether or not to fund the project, and if so, the amount of the HOME subsidy.

The maximum HOME subsidy that can be invested in a project is the lesser of these three amounts:

  • The financial needs of the project, based on a subsidy layering review
  • The portion of the total project cost that is HOME-eligible and can be allocated to HOME- assisted units
  • The 221(d)(3) maximum per unit subsidy limit.

The PJ can make changes to its assumptions about the HOME funding, in order to increase the amount of funding it invests in the project. For instance, by increasing the number of units that are designated HOME-assisted, the amount of HOME funds that can be allocated to the project increases.

In a HOME-LIHTC project, there are a number of specific issues that the PJ must analyze to make these final determinations, such as:

  • What is the appropriate level of subsidy for the project, given the tax credit equity?
    • Is the project’s financing gap closed?
    • Are the PJ’s requirements met?
    • Is the proposed subsidy at or below the HOME maximum per unit subsidy limit?
  • How does the form of the HOME subsidy (grant vs. loan, and interest rate terms) impact the potential tax credit contribution?
  • Will the tax credits be marketable to investors for the proposed project, and at what price?

With a thorough analysis, the PJ can make the best possible choices about how to invest HOME funds in the project to ensure that the HOME investment is protected, and potentially yields a return to the PJ.

The Financing Gap

Typically, the role of HOME funding in a HOME-LIHTC project is to fill the financing gap between the development budget, on the one hand, and the available sources of funds, on the other hand. Exhibit 2-11 illustrates a project with a financing gap.

Exhibit 2-11: Illustration of the Financing Gap

Exhibit 2-11: Illustration of the Financing Gap

The financing gap is not static. It changes every time the owner or the PJ alters its key economic assumptions (e.g., rents and the unit mix that affects rents, rent loss, expenses, and development costs). Exhibits 2-12 and 2-13 illustrate how the financing gap changes for a proposed 50-unit HOME-LIHTC project with gross potential rents at $650 per unit per month (Exhibit 2-12) versus $600 per unit per month (Exhibit 2-13). In some jurisdictions, this might be the rent differential between the High HOME Rent and the LIHTC rent.

In each illustration, the arrow indicates the direct relationship between the amount of first mortgage debt service that the NOI can support, and the first mortgage amount.

Exhibit 2-12: Illustration When Gross Potential Rent is $650 Per Unit Per Month

Exhibit 2-12: Illustration When Gross Potential Rent is $650 Per Unit Per Month

Without having changed any other assumptions, the $50 (7.7%) reduction in rents results in a $294,000 (43%) increase in gap financing requirements for this sample project.

Most economic assumptions are interrelated, and every time one key assumption changes, the underwriter needs to re-evaluate how the change impacts the other assumptions. For example, in the illustrations above, if the rents are lowered, there may also be a reduction in rent loss, because the proposed rents are more of a bargain.

Or, the underwriter may need to consider how a reduction in unit size might impact rents and operating expenses. For instance, the cost to repaint or replace carpet might be lower for a smaller unit.

The financing gap can only be determined after generating a relatively realistic development budget and operating pro forma. The PJ must evaluate its funding estimates by asking:

  • Is the development budget aggressive? Conservative? Adequate without being excessive?
  • Is the operating budget aggressive? Conservative? Adequate without being excessive?
    • Are the proposed reserves adequate without being excessive?
    • Are the proposed rents achievable?
    • Are the underwritten rent loss (vacancy and bad debt) assumptions realistic?
    • Is the proposed income from other sources (laundry, parking, or commercial space) realistic?
    • Could the owner get a real estate tax abatement or payment in lieu of taxes?
  • Might the owner secure better loan terms from another lender?
    • Could the owner secure a lower interest rate than that proposed?
    • Could the owner get a loan with longer amortization, later maturity, lower origination or prepayment costs, or fewer restrictions?
  • Is the proposed LIHTC equity price competitive? Does the equity pay in early (resulting in lower bridge financing costs), or later?

Subsidy Layering Requirements

HOME and LIHTC each contain requirements to ensure that the total amount of government assistance is no more than is necessary to produce the project. The term subsidy layering analysis refers to the process that PJs (for HOME) and state LIHTC allocating agencies use in order to make this determination. The subsidy layering review ensures that the PJ identifies the amount of the financing gap and invests no more funds than the amount that is sufficient to fill the gap, neither more nor less. Funding more than the gap means the project is over-subsidized. Funding less than the gap means that the owner may have inadequate funds to complete the project successfully.

HOME Subsidy Layering Requirements

The PJ is required to conduct a Subsidy Layering Review (SLR) whenever HOME funding is combined with other public funding, including LIHTC funding. HOME requires the PJ to develop and use standardized procedures to conduct this subsidy layering review. The PJ’s SLR must be in writing and must remain in the PJ’s project file.

For HOME-LIHTC projects, PJs are permitted to accept the subsidy determination of the state allocating agency for subsidy layering purposes, as described in the following section. The PJ must still conduct its own review to determine compliance with all other HOME requirements.

Tax Credit Subsidy Layering Requirements

The LIHTC regulations contain a requirement similar to the HOME subsidy layering requirement. These regulations require that the state allocating agency have procedures for making the tax credit allocation determination, including standards for acceptable developer and builder fees.

For tax credit projects, if the PJ chooses to adopt the subsidy determination of the state allocating agency, it must request a copy of the state’s subsidy layering review. The PJ should thoroughly review and analyze it to ensure there is agreement with its determinations. If the PJ determines it is satisfactory, it can adopt the review for the HOME-LIHTC project and retain a copy of this review in the project file.

Rate of Return on Equity

When conducting a subsidy layering review, the PJ should carefully assess the rate of return on the owner’s equity. All else equal, the more cash flow and residual profit the owner can expect, the less HOME funding should be provided, because the owner should be expected to make more of an initial investment itself.

Post-Construction Subsidy Layering Reviews

Both the PJ and the state allocating agency are required to conduct a SLR at the time the HOME award is made. LIHTC projects are also required to include a post-construction cost certification audit by an independent accountant. This type of audit details the actual development costs that are incurred by a project. Because often there are material changes between the projected and actual sources and uses, it can be extremely helpful for the PJ to also conduct a final SLR based on the actual sources and uses. A post-construction (actual cost) subsidy layering analysis determines whether actual uses were lower than estimated in the underwriting. For tax credit projects, this is done to verify that there was enough actual basis for the tax credits.

If the PJ intends to carry out a post-construction SLR based on actual costs, the written agreement between the PJ and the owner should make the owner aware of this requirement and should provide that the amount of the HOME award may be decreased (but not increased) based on the result of eligible costs within the post construction SLR.

For more information on subsidy layering requirements and evaluating the owner’s rate of return, see Layering Guidance for HOME Participating Jurisdictions When Combining HOME Funds with Other Government Subsidies, HUD Notice CPD 98-01, issued January 22, 1998. This Notice is available online at

Allocation of Costs to HOME-Assisted Units

All HOME funds that the PJ invests in a project must be allocable to the HOME-assisted units plus a proportionate share of costs for the common areas. This is sometimes called HOME’s fair share. The PJ can never invest more HOME funds in a project than its fair share.

The approach to determining the cost allocation depends on whether or not the units in the project are comparable units, meaning similar in size, quality, and amenities. When the units that are HOME-assisted are not comparable to the non-HOME-assisted units, the PJ must determine cost allocation based on actual unit costs plus a fair share of common costs. When the units are comparable, a pro-rata method of cost allocation can be used, or the actual cost method can be used. Attachment 2-3, found at the end of this chapter, illustrates both methods of cost allocation.

HOME Maximum per Unit Subsidy Limit

HOME imposes a maximum per unit subsidy limit. This is a fixed dollar amount that is based on the current Section 221(d)(3) cost limits for the city or county where the proposed project is located, based on number of bedrooms. These 221(d)(3) limits are available from the HUD Field Office or online on the HOME Program website at

The total amount of HOME funds invested in a project can never exceed the per unit subsidy multiplied by the total number of HOME-assisted units in the project.

Impact of Lender Requirements on the Financing Gap

The first mortgage lender imposes a number of important requirements, typically including the following:

  • First mortgage loan amount. This affects the size of the financing gap.
  • First mortgage monthly payment (debt service). This is based on the term and interest rate. It affects the financial viability of the project on an ongoing basis.
  • Prepayment / refinancing requirements. Some loans may not be refinanced for some period of time (referred to as a prepayment lockout period). Other loans may be refinanced if the owner pays a fee (referred to as a prepayment penalty). Other loans must be refinanced at a particular point in time (these loans are referred to as balloon loans or bullet loans). Depending on these requirements, the underwriter can make different assumptions about changes to debt service over time.
  • Funding conditions. The first mortgage commitment specifies the requirements the developer must meet before the first mortgage loan funds will be made available to the project. Funding conditions for a HOME-LIHTC project typically include:
    • Completion of the project
    • Issuance of certificates of occupancy
    • Evidence that all buildings are placed in service within the required deadline
    • Satisfaction of the lease-up requirement, typically 90 percent physical occupancy for 90 consecutive days
    • An NOI requirement, typically achievement of the pro forma stabilized NOI for three consecutive months.

Determining the Form of HOME Assistance

HOME allows virtually any form of financial assistance, or subsidy, to be provided for eligible projects and to eligible beneficiaries. The PJ decides what forms of assistance it will provide. However, some forms of HOME assistance will affect the amount of tax credits the project may receive. In addition, some forms of assistance will require specific legal instruments to implement. The HOME regulations list the following forms of subsidy as eligible:

  • Interest bearing loans or advances. These loans are amortizing loans. Repayment is expected on a regular basis, usually monthly, so that over a fixed period of time, all of the principal and interest is repaid.
    • Such loans may have interest rates at or below the prevailing market rate. Often, very low interest rates (i.e., one to three percent) can make monthly payments more affordable to the borrower. Prior to 2008, the interest rate on the HOME loan determined whether the costs paid by that loan could be included in the LIHTC basis. However, with the Housing and Economic Recovery Act (HERA) programmatic changes in 2008, 3 any eligible amounts paid by a HOME loan may be included in basis, regardless of whether the interest rate on that loan was less or more than the applicable Federal rate (AFR).
    • The property or some other assets are used as collateral.
    • The term of the loan may vary.

Non-interest bearing loans or advances. The principal amount of such loans are paid back on a regular basis over time, but no interest is charged.

  • As with interest-bearing loans, these loans use the property or other assets as collateral and the term of the loan varies depending on the nature of the activity funded.
  • Such loans are made when the borrower is able to make regular payments but even a small amount of interest is not affordable.
  • Eligible costs covered by these types of loans are generally permitted in the LIHTC basis provided there is a reasonable expectation that the loan will be repaid (i.e., that it is actually a loan and not a grant).

Deferred loans (forgivable or repayable). These loans are not fully amortized. Instead, some, or even all, principal and interest payments are deferred to some point in the future. Deferred loans can be structured in many different ways.

  • Deferred payment loans can be forgivable or repayable.
    • If forgivable, the forgiveness might be structured to occur at one point in time (such as at the end of the affordability period), or forgiven incrementally (such as forgiving one-fifth of the loan each year over five years).
    • If repayable, repayment might be required at the sale or transfer of the property or at the end of a fixed period of time.
  • Like the amortizing loans discussed above, these loans can either accrue interest or be non-interest bearing.
  • Deferred payment loans require the property or some other form of collateral to be used as security for repayments.

3 Public Law 110-289, also known as the Housing and Economic Recovery Act of 2008 (HERA), became law on July 30, 2008. HERA made significant programmatic changes to the Low-income Housing Tax Credits (LIHTC).

  • Deferred payment loans may be used to help rental projects by allowing deferral of loan payments for the first few years until the project becomes stable.
  • Deferred payment loans may be problematic if the owner wishes to count the costs paid by these loans in the LIHTC basis. The state allocating agency needs to assess whether or not there is a reasonable expectation that this loan will be re-paid. If the state determines that the deferred loan functions like a grant, it will likely determine that the costs paid by this deferred loan are not eligible in the basis.

Grants. Grants are provided with no requirement or expectation of repayment.

  • Grants require no liens on the property or other assets.

HOME is sometimes used for acquisition of land and other costs that are ineligible to be included in the LIHTC basis and therefore can be granted without impact on that basis.

  • Interest subsidies. This is usually an up-front discounted payment to a private lender in exchange for a lower interest rate on a loan. An interest subsidy may also be a deposit into an interest-bearing account from which monthly subsidies are drawn and paid to a lender along with the homeowner’s monthly payment.
  • Equity investments. An equity investment is an investment made in return for a share of ownership. Under this form of subsidy, the PJ acquires a financial stake in the assisted property and is paid a monetary return on the investment if money is left after expenses and loans are paid.
  • Loan guarantees and loan guarantee accounts. HOME funds may be pledged to guarantee loans or to capitalize a loan guarantee account. A loan guarantee or a loan guarantee account ensures payment of a loan in case of default.
  • A loan guarantee is a written promise to pay the lender some percentage of the outstanding principal balance of a loan in the event the borrower defaults. It may be held for a specified period of time or reduced by a specific amount over time as the loan principal is repaid.
  • A loan guarantee account is a loan loss reserve held by the lender in an amount equal to some percentage of the outstanding principal.
    • The lender holding the loan guarantee account may require a minimum balance, as well as a percentage of the principal amount of the loan. The percentage of the loan amount held as guarantee may vary from loan to loan, or from program to program.
    • HOME rules require that the amount of money in a loan guarantee account must be based on a reasonable estimate of the default rate on the guaranteed loans, and may not exceed 20 percent of the total outstanding principal guaranteed, except that the account may include a reasonable minimum balance.

Negotiating the Best Position for the PJ

Due to project viability considerations, HOME funds will most often be provided in the form of a soft loan. This term refers to a loan that has one of the following repayment structures:

  • No required payments from operations
  • Required payments that are limited to a percentage of available excess cash
  • Payments that do not begin until late in the life of the project.

When structuring a soft loan, PJs need to consider the interest rate, loan term, repayment requirements, lien position, and sale /refinancing requirements. The LIHTC project sponsor may have certain needs and preferences about how the PJ structures these terms, because of the impact of these terms on the investors’ taxes (and their resulting impact on the price of the credits). These terms should be discussed and negotiated before the PJ finalizes its loan structure. This is because loans increase the amount of eligible basis in the project. IRS regulations require that loans are likely to be repaid; and therefore the HOME loan will need to be structured in a way that demonstrates it is likely to be repaid.

Factors Affecting the Strength of the PJ’s Negotiating Position

Factors Affecting the Strength of the PJ’s Negotiating Position

The PJ may be in either a strong or weak position to negotiate favorable loan terms, depending on a number of factors including:

  • The timing of the LIHTC application. If the owner has already negotiated a cash flow waterfall with other parties to the transaction, it is more difficult to accommodate the PJ’s requirements.
  • The size of the PJ’s investment. If the HOME funds are a relatively large source of funds to the project, the PJ is in a stronger position to negotiate favorable terms.
  • The level of expertise on the PJ’s team. If the PJ’s underwriter, attorney, and other advisors are experienced in LIHTC deals, and are aware of the factors that impact a HOME-LIHTC project’s success, then there is an increased likelihood that the PJ can negotiate favorable terms.

Loan Terms

LIHTC owners typically prefer HOME loans that have as long a term as possible. One reason is that it may be important for income tax purposes to demonstrate a reasonable expectation that the loan will be repaid from cash flow and sale proceeds. All else equal, extending the term of the HOME loan increases the likelihood that it will be repaid. It is a good practice for PJs to develop policies for the maximum loan term that the LIHTC owner finds acceptable.

Repayment Requirements

Typically, PJs are more interested in ensuring the long-term affordability of the project than maximizing repayment of HOME funded loans. Consequently, when lending HOME funds to projects, PJs often offer loans at the lowest rate of interest and the longest term that are acceptable to both the PJ and the LIHTC owner.

Other HOME loans are intended to provide future program income to the PJ. These loans are intended to be repaid, at least in part. For these loans, the PJ needs to consider:

  • Interest rate. A relatively high interest rate generates more program income for the PJ. However, a relatively low rate minimizes the risk that the property will have too much debt, and maximizes the likelihood that the project will be able to repay the loan in full. The LIHTC owner’s income tax concerns affect this decision as well.
  • Level of required payment. A best practice is to require the project to repay a percentage of available (surplus) cash. HUD’s Office of Multifamily Housing provides a good definition of surplus cash: cash that is not needed to meet operational requirements on a particular day (such as December 31). If the PJ requires a relatively low percentage of the surplus cash to be repaid (such as one-third), the owner may have more incentive to maximize cash flow. If the PJ requires a high percentage of surplus cash be repaid (such as three-fourths), it may minimize the owner’s incentive to operate the property efficiently and in so doing reduce the amount of surplus cash.
  • Deferral. It is a best practice for PJs to begin required payments after the project has stabilized for a few years. This practice limits the burden on cash flow in the early years of the project.
  • Priority position. LIHTC owners are likely to ask the PJ to subordinate payments on the soft HOME loan to a variety of non-operational payments. This means that these non- operational payments would be made before calculating available surplus cash, a percentage of which will be paid to the PJ. Project sponsors may refer to this process as deciding the position that the HOME loan will have in the cash flow waterfall.

In HOME-LIHTC projects, negotiations regarding priority are likely to arise in at least these areas:

  • Asset management / monitoring fees to the LIHTC investor. Investors commonly ask for an annual fee to be paid by the project, from excess cash, to cover the investor’s cost for monitoring compliance.
  • Deferred developer fee. If a portion of the developer fee cannot be paid from Sources of Funds, that portion of the fee is called a deferred developer fee and is paid from future cash flow, refinancing proceeds, and sale proceeds. In order to include a deferred developer fee within LIHTC basis, the project sponsor must be able to demonstrate a reasonable expectation that the deferred fee will be repaid, with interest, during the 15-year LIHTC compliance period. Obviously, if the deferred developer fee has a high position in the cash flow waterfall, the likelihood of repayment is greater than if it has a lower position in the waterfall. Sophisticated PJs will project how much of the deferred developer fee is likely to be repaid based on the long-term operating pro forma, and will negotiate a cash-flow sharing arrangement that balances the developer’s interest in collecting the deferred fee, with the PJ’s interest in repayment of its loan.
  • LIHTC adjusters. LIHTC investors typically negotiate guarantees from the LIHTC owner that the owner/manager will not rent to ineligible tenants, set rents above LIHTC maximums, commit fair housing violations, or take other actions that could cause the investor to lose LIHTCs. LIHTC owners often ask a PJ to subordinate HOME loans to these as “LIHTC adjusters.”

It is a good practice for the PJ to have clear requirements, stated in its Request for Proposals (RFP) or Notice of Funding Availability (NOFA), regarding repayment provisions, and for these requirements to strike a reasonable balance between meeting the PJ’s needs and providing the LIHTC owner with sufficient flexibility to achieve a successful project. Otherwise, the owner can (and likely will) claim that it was not aware of the PJ’s requirements, that the owner has already negotiated the cash flow waterfall, and that it is simply not possible to accommodate the PJ’s requirements.

Lien Position and Payment Priority

If there are multiple soft loans, there will be negotiations concerning lien position and payment priority. The lien position determines which soft lender will be paid first in the event of foreclosure. The payment priority identifies which soft lender will be paid first from available cash. Most typically, soft lenders demand lien position and payment priority according to loan amount. That is, the largest soft loan is most likely to demand and receive second lien position and second payment priority, after the first mortgage. PJs need to be aware of lien position because of the requirement to repay HOME funds in the event of loss of the affordable units during the minimum affordability period.

Sale / Refinancing Requirements

In structuring their HOME loans, many PJs require the HOME loan to be due on sale. Many LIHTC owners, however, want to be able to sell the property, and to refinance the first mortgage, without triggering repayment requirements for the HOME loan.

The PJ, however, will not want to grant these types of concessions routinely. It should consider the following issues regarding assumption of the HOME loan by a subsequent purchaser:

  • Acceptability of the purchaser. The PJ wants to ensure that the purchaser is qualified to own/manage the property in compliance with remaining HOME requirements. One approach is to require that the purchaser meet any requirements that were contained in the PJ’s NOFA or RFP and to require the purchaser to submit its qualifications to the PJ, and be subject to PJ approval.
  • Affordability. At a minimum, the PJ must require, as a condition of assumption, the continuation of the existing affordability requirements. The PJ may opt to impose longer and/or deeper affordability restrictions on the purchaser.
  • Paydown. The PJ may want to require that a portion of the loan be repaid, in a lump sum, as a condition of assumption. This is especially true if the sale involves equity pay-out to the seller and/or a new developer fee to the purchaser. This enables the PJ to capture some of the net proceeds from the sale and not allow all of it to go to the owner. At a minimum, the PJ may require the loan to be brought current to the date of the sale. For example, consider the case where a PJ provides a loan of $100,000 with the understanding that it would be repaid over 20 years, with principal payments of $5,000 if there is surplus cash flow. If there is no cash flow, the payment is deferred. In year 10 the property is sold. The PJ has been repaid $25,000 through year 10 and has deferred $25,000. A sale occurs and generates net proceeds of $100,000. The PJ may say that the first $25,000 must be paid to bring the HOME note current, and the remaining balance will be paid from future cash flows of the project. The original use agreement stays in force.
  • Lien position and payment priority. The PJ typically would not want to allow assumption if the result is that the HOME loan would have a lower lien position and/or a lower position in the cash flow waterfall.

Because assumption decisions typically require case by case judgment, it is difficult to state these sorts of requirements in advance, so it is a best practice for HOME loans to be due on sale, allowing the PJ to later negotiate transaction-specific terms.

Similar issues arise with respect to refinancing. LIHTC project owners often ask for the right to refinance the first mortgage without requiring any payment on the HOME loan. PJs typically are reluctant to agree to such a request in advance. However, if the proposed first mortgage term is shorter than the term of the proposed HOME loan, the PJ and owner should discuss what happens when the first mortgage either has to be refinanced or is paid off.

Issues that may come up regarding a potential future refinancing include:

  • First mortgage loan amount. Typically the PJ does not want the new first mortgage amount to be higher than the amount being refinanced, but the LIHTC owner will want the opposite result.
  • First mortgage loan payment. Similarly, the PJ generally does not want the new first mortgage payment to increase because it decreases the amount of cash flow available for repayments on the HOME loan, and the LIHTC owner is likely to have an opposite motivation.
  • Equity pay-out. Typically, the PJ wants a portion of any net refinancing proceeds to be paid toward the HOME loan. The LIHTC project sponsor wants any such payment to be as small as possible.
  • Affordability. The PJ may want a commitment to longer and/or deeper affordability as a condition of refinancing, especially if there will be an equity pay-out.

Attachment 2-1: Capital Needs: Saving for a Rainy Day

Capital planning for affordable rental housing can be summed up simply: stuff wears out. Importantly, however, the rate at which the various building systems wear out is well known and replacement costs also are well known. As a result, it is possible to estimate how much money will be needed to cover replacements, year by year, as the property ages. This analysis is called capital needs assessment or capital planning. Exhibit 2-14 provides a simple capital needs assessment in the form of a spreadsheet.

Exhibit 2-14: Sample Capital Needs Assessment Sample (only five years shown)

Exhibit 2-14: Sample Capital Needs Assessment Sample (only five years shown)

Actual capital needs assessments typically evaluate building systems over a 20-year period. Twenty years is used because most major systems require at least one replacement during that time frame. The column labeled “Now” may also be labeled “Rehab” or “Year 0” or “Required Repairs.” It indicates replacements that are needed because the inspector found (for example) a furnace that was not working and was old enough to require replacement.

The Refrigerators line indicates one replacement in the first year, then two replacements per year for years 2-5 (at $500 per refrigerator). The Furnaces line indicates one immediate replacement, then 5 per year for years 1-5 (at $2,500 each). The Parking Lot Resurfacing line indicates no needs until year 5.

The Total line tells the owner and PJ how much money will need to come from Replacement Reserve withdrawals, future cash flow, future refinancing, and possibly future subsidies, in order to maintain the proposed project. The cost of replacing capital items is not reflected in the operating expense underwriting or budget of the property.

Typical Timing of Capital Needs for New Construction Projects

Below, Exhibit 2-15 illustrates the annual capital needs, per unit, that a newly constructed property might expect to incur over its first sixty years.

The capital needs are virtually nonexistent in the first five years, small in years 6-10, and then increase steadily over the next 20 years, with a peak in years 21-30 when a number of major building systems (typically, roofs, siding, windows, and parking lots) require major repair or replacement.

Exhibit 2-15: Average Annual Capital Needs Per Unit (constant dollars)

Exhibit 2-15: Average Annual Capital Needs Per Unit (constant dollars)

Lessons on Replacement Reserves in Affordable Housing

Traditionally in the apartment business, Replacement Reserve deposit requirements have been created by lenders, specifically for market-rate apartments. Because most first mortgage loans for market-rate apartments must be refinanced every seven to twelve years, and because market-rate apartments are expected to generate annual increases in NOI, lenders typically have required relatively small Replacement Reserve deposits in combination with relatively large requirements for repairs at the time of financing or refinancing. Because of the relatively short period between refinancings, market-rate apartment lenders also typically did not require the Replacement Reserve deposits to increase for inflation.

Affordable housing underwriters adopted these Replacement Reserve practices from the lenders of market-rate apartments, only to find that these practices did not translate well into affordable apartments. In particular, these problems became apparent as the first wave of affordable apartments aged:

  • Rents did not rise as quickly in rent-restricted developments as they did in market-rate apartments. Therefore, NOI did not rise as quickly.
  • Many early affordable apartments had significantly greater operating expenses than owners and funding agencies expected. As a result, affordable apartments generally did not have the same financial ability to refinance as market-rate apartments.
  • First mortgage loans on affordable housing developments generally did not require refinancing, and were designed to be self-amortizing (that is, after the final payment during the mortgage term, the remaining balance would be zero).
  • Many first mortgage loans were designed not to be refinanced. In fact, many first mortgage loans for affordable apartments contained the key affordability provisions and accordingly contained prohibitions on prepayment.
    • As a result, many affordable apartments could not refinance even if doing so would be sensible from a purely financial standpoint.
  • Following market-rate apartment practice, first mortgage loans did not require inflation adjustments to the Replacement Reserve deposit.

The result is that affordable housing owners and funding agencies have found themselves invested in properties that face increasing capital needs as properties age, with small Replacement Reserve balances, small ongoing Replacement Reserve deposits, only modest cash flow, and often regulatory prohibitions on refinancing.

Funding agencies made two primary responses to this set of problems:

  • Second mortgage programs and grant programs, for needed repairs
  • Decisions to structure new properties so that this would not happen again. These decisions involved requirements and guidelines to ensure:
    • Larger initial Replacement Reserve deposits
    • Increased monthly deposits to cover inflation
    • More attention to the sustainable underwriting principles discussed in this publication.

Attachment 2-2: How to Determine the Minimum Number of Home-Assisted Units in a Project

The PJ must designate the number of HOME-assisted units at the time of project commitment. The minimum number of units that the PJ can designate is based on the amount of the HOME investment. The process for determining this number varies, depending on whether the units are comparable or not. Comparable units have the same number of bedrooms, amenities, and square footage.

  • When units are not comparable, the minimum number of HOME-assisted units is based on:
    • The actual units in which HOME funds are invested (i.e., the actual costs for the HOME-assisted units, plus a proportional share of the HOME-eligible common costs). These costs cannot exceed the maximum per unit subsidy limit.
    • For example, if the PJ rehabilitates six units that are not comparable, the PJ must track the development costs by unit. If the PJ invests $25,000 per unit for three 3- bedroom units, and invests only private funds in the remaining units, then only the units with HOME investments are HOME-assisted.
  • When units are comparable, the minimum number of HOME-assisted units is based on one of the following:
    • The proportional share of total HOME-eligible costs paid with HOME funds, in relation to the total eligible development cost
    • The maximum per unit subsidy limit, in relation to the total eligible development cost.

The HOME maximum per unit subsidy is based on the 221(d)(3) limits. These limits are available on the HOME Program website at homeprogram.

Exhibit 2-16 illustrates how to determine the minimum number of HOME-assisted units in a project with comparable units.

The PJ may designate more than the minimum number of HOME-assisted units, if it so chooses.

Exhibit 2-16: Example: Determining the Minimum Number of HOME-Assisted Units When the Units Are Comparable

Scenario: The Paradise PJ plans to develop a 10-unit rental property. It will invest $450,000 in HOME funds. The maximum per unit subsidy for the planned bedroom size in this locality is $80,000. The units are comparable, as they all have the same square footage, two bedrooms, and the same amenities.

Paradise PJ must perform two tests, to determine the minimum number of units that it must designate as HOME-assisted.

Test 1: Fair Share Test

Step 1: Determine the total eligible project costs. $900,000

Step 2: Determine the planned HOME investment. $450,000

Step 3: Divide the HOME investment by the total project cost and convert to a percentage.


= .5

= 50%

Step 4: Multiply the number of total units in the development by the cost percent (determined in Step 3), to get the pro-rata share.

Ten Total Units

x 50%

= 5 units

Step 5: If the result is not a whole number, round up.

Test 2: Per Unit Subsidy Test

Step 1: Determine the total eligible project costs.


Step 2: Identify the maximum per unit subsidy.

$ 80,000

Step 3: Divide the total eligible project costs by the maximum per unit subsidy.


= 5.6 units

Step 4: Note—if the result is not a whole number, round up:

6 units

Attachment 2-3: How to Determine the Home Cost Allocation

The approach to determining the cost allocation depends on whether or not the units in the project are comparable units, meaning similar in size, quality, and amenities. For example, if the HOME-assisted two bedroom units have the same square footage, features (e.g., refrigerators), and finishes (e.g., carpet) as the non-HOME-assisted two bedroom units, then these units are comparable. If the HOME-assisted units are smaller or have a lower quality of features or finishes than the non-HOME units, then the units are not comparable.

When the units that are HOME-assisted are not comparable to the non-HOME-assisted units, the PJ must determine cost allocation based on actual unit costs plus a fair share of common costs.

When the units are comparable, a pro-rata method of cost allocation can be used, or the actual cost method can be used.

  • Pro-Rata Method of Cost Allocation. If all the units in a multi-unit project are comparable, the PJ may determine its “fair share” of costs based on the portion of units that are to be HOME-assisted. The percentage of the total HOME-eligible costs that may be paid by HOME is equal to the percentage of units that are HOME-assisted. In general, the cost allocation equation may be described as:

HOME UNITS                     = TOTAL UNITS

It is important to note that this equation is based on total HOME-eligible costs, not all costs. If the project’s development budget includes ineligible items under HOME, such as swimming pools or luxury amenities, these costs must be subtracted before the percentage can be applied.

  • Actual Cost Method of Cost Allocation. If all the units in a rental project are not comparable, or if the developer/PJ chooses to use this method, then the cost allocation is determined by assessing actual unit construction costs. In other words, the PJ or the architect/engineer must determine the specific and actual costs for the HOME units. This can be determined based upon the work write-up for these units. Once these unit costs are known, HOME can then pay for its “fair share” of the common costs such as the acquisition, eligible soft costs, or common areas such as lobbies, elevators, or roof.

The PJ must always ensure that the HOME investment does not exceed the 221(d)(3) limit. (In rental housing, units that are not comparable must always be fixed rather than floating units.)

In general, the cost allocation equation for units that are not comparable may be described as:

Total Eligible Costs         +   HOME UNIT SQUARE FOOT    X         Eligible Common Costs
for HOME Units                    TOTAL UNIT SQUARE FOOT

Note, for both methods of cost allocation, the total amount of eligible costs directly relates to the number of HOME-assisted units in the project. If the financing gap in a project is greater than the amount of funds that can be allocated to the project, the PJ can increase the number of HOME- assisted units in order to increase the total amount of HOME funds that can be invested. PJs should be aware that adding additional HOME units may affect (lower) the property’s rental income. This, in turn, could reduce the amount of first mortgage debt and increase the size of the funding gap.

If the PJ knows the total amount of investment it wants/needs to make in a project, Exhibit 2-17 illustrates the corollary principle of how to determine the minimum number of units that must be designated HOME-assisted.

Exhibit 2-17: Illustrations of Cost Allocation

Exhibit 2-17: Illustrations of Cost Allocation

For more information on cost allocation, see Allocating Costs and Identifying HOME-Assisted Units in Multifamily Projects , HUD Notice CPD-98-02, issued March 18, 1998. This Notice is available on the HOME Program website at

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