Case Study: Disposition of a Year 15 Property

1. Case Study: Disposition of a Year 15 Property 2012 North Carolina Affordable Housing Conference Presented by: Jeff Carroll, President Allen & Associates Consulting, Inc. 3116 Glen Summit Drive Charlotte, North Carolina 28270 Phone: 704-905-2276 | Fax: 704-220-0470 E-Mail: jcarroll@allenadvisors.com

2. Allen & Associates Consulting is a multi-disciplinary consulting firm specializing in affordable housing. Our practice areas include development consulting, property dispositions, valuation & market feasibility work, and engineering assignments (including capital needs assessments & utility studies). The purpose of this presentation is to demonstrate how Allen & Associates might assist you in the disposition of your Year 15 property. This presentation is based on an actual disposition we were recently engaged to handle. Introduction

3. The owner of a HUD-subsidized Year 15 tax credit property located in Portsmouth, Virginia was thinking about selling. He received an offer for $1 million, but felt the property could be sold for $2 million. He asked Allen & Associates to assist him in the disposition of his property. Our efforts brought him $5.2 million. The Problem

4. The HAP contract for the property was up for renewal. Here’s where the contract rents stood at the time: The property included 134 HUD-subsidized units which were originally constructed in 1978. It was renovated in 1990 with tax credits and had completed its initial 15-year compliance period. The property included 2, 3 and 4 bedroom units. The Property

5. The owner needed at least $3.1 million for this property: • The property included $2.6 million in assumable debt which could not be prepaid. • The property included $0.2 million due to the general partners. • The partnership needed to yield approximately $0.3 million on the sale to cover exit taxes. Clearly, the $1 million offer would not do. And the $2 million the owner was willing to accept would not be enough, either. Minimum Sales Price

6. The traditional method for valuing Year 15 properties is to apply an “as is” capitalization rate to the “as is” net operating income. This approach, which has some significant shortcomings, is presented below: Traditional Methodology

7. The traditional methodology does not evaluate how much a property could be sold for, assuming tax credits are used for renovation. The traditional methodology does not consider the following: • Income capitalization assumes that a property is operated in its current “as is” condition indefinitely. If sold for renovation, this is not so. • The traditional methodology fails to recognize upward rent potential by virtue of renovation. This can be significant for many properties. • The traditional methodology fails to recognize potential reductions in operating expenses by virtue of renovation: • Reconfiguring Utilities: Passing electric, water & sewer through to residents. • Energy Efficiency: Installing new appliances, doors, windows, and HVAC systems. • Replacement Reserves: Major renovation typically results in reduced reserve requirements. • The traditional methodology fails to account for the availability of tax credits associated with properties located in QCTs or DDAs. • The traditional methodology fails to account for the availability of tax credits associated with properties found on the historic register. Flaws in The Traditional Methodology

8. Here’s what we did instead: • Step 1: Establish a Scope of Renovation • Step 2: Derive a Renovation Cost Estimate • Step 3: Evaluate the Utility Configuration • Step 4: Establish Post-Renovation Rents • Step 5: Establish Post-Renovation Operating Expenses • Step 6: Estimate Post-Renovation Debt Capacity • Step 7: Estimate Available Renovation Tax Credit Equity • Step 8: Estimate the Value of the Property • Step 9: Identify a Developer to Purchase the Project • Step 10: Work with Developer to Close the Transaction Note: Because our goal is to maximize sales proceeds to the Seller, we are paid by the Buyer at closing. If the transaction does not close, we do not get paid. Our Approach

9. In the course of establishing a scope of work for this project, we conducted a unit-by-unit inspection of the property to evaluate the following site improvements & building systems: • Site Improvements • Topography • Storm Water Drainage • Ingress & Egress • Paving, Curbing & Parking • Sidewalks & Patios • Landscaping • Recreational Facilities • Utilities • Environmental • Offsite Improvements • Building Systems • Foundation • Structural Frame • Exterior Walls • Roof • Plumbing • HVAC • Electrical • Vertical Transportation • Life Safety • Interior Finishes • ADA Requirements Step 1: Establish a Scope of Renovation

10. Next, we developed a renovation cost budget for the subject property based on our scope of work: Step 2: Derive a Renovation Cost Estimate

11. Next, we evaluated the configuration of tenant-paid utilities for the subject property and established post-renovation utility allowances. Establishing post-renovation utility allowances is an essential step in evaluating achievable rents for (and, consequently, the value of) tax credit properties: Step 3: Evaluate the Utility Configuration

12. Next, we established post-renovation achievable rents for the subject property. Achievable rents are defined as the lesser of market or program rents (net of utility allowances). Market rents reflect the pricing for similar properties in the marketplace. Our concluded rents reflected the post-renovation condition and utility configuration (water & sewer passed through to the residents) for the subject. Establishing post-renovation achievable rents is an essential step in evaluating the “as is” value of a property being sold subject to renovation with tax credits: Step 4: Establish Post-Renovation Rents

13. Next, we established post-renovation operating expenses for the subject property. Our analysis, which included the compilation of operating expenses for comparable properties in the area, accounted for the new utility configuration (water & sewer passed through to the residents) for the subject property: Step 5: Establish Post-Renovation Operating Expenses

14. Next, we determined the amount of debt which could be placed on the subject property after renovation. Our estimates, which reflect the terms of the assumed debt and market interest rates at the time of this transaction, are found below: Step 6: Estimate Post-Renovation Debt Capacity

15. Next, we estimated the available renovation tax credit equity associated with this transaction. Our estimate included a detailed soft cost budget, estimated developer fees, and an estimate of ineligible costs. Our estimate also accounted for a 30% basis boost because the subject property is located in a Qualified Census Tract. Finally, our estimate reflected the published APR and tax credit equity pricing at the time of this transaction. Step 7: Estimate Available Renovation Tax Credit Equity

16. Next, we estimated the value of the property, subject to renovation with tax credits. We began by estimating the sources of funds available for this project. This included the assumed debt, the additional debt, and the renovation tax credit equity discussed previously. From total sources we deducted renovation costs, soft costs, and developer fees to arrive at a value estimate for the property. It is important to note that the total sources of funds also included an estimate of the acquisition tax credit available for this project. The acquisition tax credit is a function of the value of the property, however, and vice versa. Consequently, we set up an iterative routine and converged on the final concluded acquisition tax credit and property values found below: Step 8: Estimate the Value of the Property

17. Next, we identified a qualified developer to purchase and renovate the subject property with tax credits. Because our practice is national in scope, we have earned the trust of developers throughout the country. Since 2000, we have worked on over 2500 transactions with over 200 developers in 41 states. We ended up recommending a successful regional for-profit developer with in-house management who specializes in tax credit renovation projects. We provided our underwriting to the developer, who immediately expressed an interest in the property. Within one week, the developer provided a $5.2 million offer to the owner, pending receipt of tax credits for renovation. Step 9: Identify a Developer to Purchase the Project

18. Finally, we worked with the developer to close the transaction. In the course of doing so, we assisted with the following: • Putting together the tax credit application • Compiling third-party reports including: • Scope of Work • Capital Needs Assessment • Energy Study • Market Study • Rent Comparability Study • Appraisal • Reviewing third-party reports including: • Survey • Title Work • Phase I Environmental Assessment • Accessibility Study • Identification of debt and equity sources The project was awarded tax credits and sold for $5.2 million later that year, and we were paid by the buyer/developer for our work. We valued the property at $5.3 million for the owner, who was initially willing to sell the property for $2.0 million. Clearly, this was an excellent outcome for everyone. Step 10: Work with Developerto Close the Transaction

19. Jeff Carroll, President of Allen & Associates Consulting, is a certified general appraiser, licensed to appraise real estate in the states of Alabama, Delaware, Florida, Georgia, Kentucky, North Carolina, South Carolina, Tennessee, Texas, Virginia and West Virginia. Mr. Carroll, an associate member of the Appraisal Institute, is currently completing the requirements necessary to obtain the MAI designation. Mr. Carroll is a member of the National Council of Affordable Housing Market Analysts, where he previously served on the Executive Committee and chaired the Data and Ethics Committees. Mr. Carroll has successfully completed the NCAHMA peer review process. Mr. Carroll has also served as a market study reviewer for the Georgia and Michigan housing finance agencies. Mr. Carroll has written articles on affordable housing, development, property management, market feasibility, and financial analysis for Urban Land magazine, The Journal of Property Management, Community Management magazine, Merchandiser magazine, HousingThink, and a publication of the Texas A&M Real Estate Research Center known as Terra Grande. Mr. Carroll has conducted seminars on affordable housing, development, property management, market feasibility, and financial analysis for the American Planning Association, Community Management magazine, the Georgia Department of Community Affairs, the Manufactured Housing Institute, the National Association of State and Local Equity Funds, the Virginia Community Development Corporation, and the National Council of Affordable Housing Market Analysts. Mr. Carroll is also an experienced developer and property manager. His experience includes the development of tax credit and bond financed apartment communities, conventional market rate apartments, manufactured home communities, and single family subdivisions. He has also managed a portfolio of apartment complexes and manufactured home communities. Mr. Carroll received his Bachelor’s Degree in Engineering from Clemson University and his Master’s Degree in Business Administration from Harvard University. Qualifications