California Community Economic Development Association

1. California Community Reinvestment Initiative Federal Reserve Bank of San Francisco Office of the Comptroller of Currency January, 2006 California Community Economic Development Association

2. CCEDACalifornia Community Economic Development Association  Underwriting and Financial Structuring for Real Estate Glenn Sanada, Director of Training and Technical Assistance Mitch Thompson, CCEDA Development Consultant Carol Gallant, Director of Program Development

3. Agenda 8:00 AM - 8:30 AM Registration 8:30 AM - 8:45 AM Introductions 8:45 AM - 10:15 AM Underwriting Real Estate � Overall Review: Glenn Sanada 10:15 AM - 10:30 AM BREAK 10:30 AM - NOON Underwriting Real Estate � Review � Case Studies NOON - 1:00 PM LUNCH 1:00 PM - 2:30 PM Equity Resources / Soft Debt and Gap Resources San Bernardino Community Development Clearinghouse CDFI Enterprise Foundation Low Income Investment Fund 2:30 PM - 2:45 PM BREAK 2:45 PM - 4:15 PM Debt Sources Washington Mutual Citibank Wells Fargo Bank of America 4:15 PM - 4:30 PM Summary Wrap Up

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

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

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

7. Overview of Underwriting and Financial Structuring Exercise One It�s Family, but�.

8. Overview of Underwriting and Financial Structuring Exercise One It�s Family, but�. Character of the Borrower Experience Location Market Real Estate (Type, Condition) Financial Capacity Ability to Complete the Development Repayment Deal and Finance Structure Secondary Sources of Repayment

9. Overview of Underwriting and Financial Structuring Key to Underwriting Financial Structure and Project Pro Forma�.

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

11. Overview of Underwriting and Financial StructuringKey Terms: Contingencies: Hard: (Generally 5%, on Rehabs 20%) Soft: Developer Fees: (Ugh!!!!) Interest Reserves: Rate + Cushion: (1-2 %???) Average Outstanding Balance Term (Construction): Advised, Un-Advised Borrower/Customer Experience Financial Strength

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

13. Overview of Underwriting and Financial StructuringI . For Profit Real Estate Transaction Structure: One source of equity One source of debt Highly experienced developer Loan secured by real estate and borrower liquidity Risk: Borrower: Risk minimal Location: Typically in good market, risk minimal Financial: Borrower with good liquidity Completion: Very experienced, risk minimal Repayment: Good real estate, good liquidity, risk minimal

14. Overview of Underwriting and Financial StructuringI. For Profit Real Estate Transaction Risk Mitigation: Borrower: Requirements met Location: Requirements met Financial: Requirements met Completion: Requirements met, guaranty by owner Repayment: Requirements met, guaranty by owner, take out lender is a strong bank partner

15. Overview of Underwriting and Financial StructuringII. Multi Family Rental (Tax Credit Deals) Structure: Many sources of equity (near equity) Many sources of debt Un-experienced developer Loan secured by real estate only, no borrower liquidity

16. Overview of Underwriting and Financial StructuringII. Multi Family Rental (Tax Credit Deals) Example: A Tax Credit Deal (9%) Project Development Costs: $10,000,000 Tax Credit Equity Hard Costs: $ 7,000,000 9% of Value $ 6,000,000 LP Purchase or TC Equity: $ 5,500,000 City or County 3% Deferred Loan: $ 3,000,000 Discounted Value or Full Other Sources: $ 500,000 Conventional Loan: $ 1,000,000 TOTAL SOURCES: $10,000,000

17. Overview of Underwriting and Financial StructuringII. Multi Family Rental (Tax Credit Deals) Risk: Borrower: Risk high Location: Typically in transitional markets, risk questionable Financial: Many sources of equity (investor and local grants). Many sources of debt (local and state deferred loans) Completion: Experience of development team unknown Repayment: Quality of real estate unknown, no borrower liquidity, risk questionable. Take out lender also new to community development lending.

18. Overview of Underwriting and Financial StructuringII. Multi Family Rental (Tax Credit Deals) Exercise Two How Do We Mitigate These Risks�. How Do I Get This Approved�.

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

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

21. Overview of Underwriting and Financial StructuringIII. Affordable For Sale Structure: Many sources of equity that may convert to soft secondary financing for buyers Many sources of debt during construction to may convert to soft secondary financing for buyers Un-experienced developer Loan secured by real estate only, no borrower liquidity

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

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

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

25. Overview of Underwriting and Financial Structuring V. Multi Family Rental with Small Retail/Office or Community Space: NOT Dependent on Income from the Other Use What Changed? Not Much Income from Non Housing Use Not Needed for Mortgage: No change from multi-family rental underwriting. The lease-up or income generated from this space is not needed to debt service the loan. It is important to note how the track record for retail space under this development scenario has been mixed, at best.

26. Overview of Underwriting and Financial Structuring VI. Multi Family Rental with Small Retail/Office or Community: Dependent On Income from Other Use What Changed? Much The lease-up or income generated from this space is needed to debt service the loan Developers will need to understand affordable housing development and commercial/office development and lending. No change from multi-family rental underwriting. Team must reflect experience in developing and financing commercial (office/retail) real estate. Commercial market must be analyzed (vacancies, lease rates, lease terms, conditions and turnover).

27. Overview of Underwriting and Financial Structuring VI. Multi Family Rental with Small Retail/Office or Community: Dependent On Income from Other Use Additional Requirements: Commercial (retail/office) footprint may need to be legally separated from the housing and a separate loan made for the space. Space may be underwritten at a higher vacancy rate Master lease to the non profit may be required. If the space is significant, tenants (and leases agreements) must be identified, underwritten and approved by the bank. Rated tenants and agreements may be required (on large spaces).

28. Overview of Underwriting and Financial StructuringVII. Stand Alone Retail/Office Developers will need to understand commercial/office development and lending. Financing is very dependent on the credit worthiness of the tenant. The stronger known tenants (credit tenants) are needed as the anchor tenant.

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

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

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

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

33. Overview of Underwriting and Financial StructuringSession 4: One on One Assistance Based on the information provided in session 3, participants are encouraged to proceed with potential projects for their communities. CCEDA staff will schedule meetings with organizations to discuss specific projects, and to assist in structuring finance, reviewing project pro forma, or assisting in proceeding through the development steps. Cities and local government jurisdictions are encouraged to schedule meetings with CCEDA Community Development Services staff to discuss potential acquisition programs. This is also an ideal time to discuss potential targeted assistance efforts. CCEDA staff will be available to meet with potential �teams� to outline how services may be obtained, and what the outcomes would be. Glenn Sanada, Training & Technical Assistance Director (213) 353-1382 ? e-mail glenn@cceda.com Mitch Thompson, CCEDA Development Consultant (619) 726-6405 ? e-mail mitchthompsonmitch@yahoo.com Carol Gallant, Director of Program Development (213) 989-3218 ? e-mail carol@cceda.com