Improving Communities Enhancing Lives

NDC is the nation’soldest non-profitprovider of communitydevelopment technicalassistance and training

A Powerful Mission

Increasing the flow of capital forinvestment, jobs and community development to distressed urban and rural communities throughout the U.S.

Partners in Community Development Since 1969

NDC works in partnership with local and state governments and non-profit organizations to help them build their communities and economies

The Pub Group in Portland, OR

Partners in Community Development

Technical AssistanceNDC defines, designs and executes development and business finance strategies, programs and projects

NDC identifies, secures and structures public and private financing and develops project from concept to completion

Bijou Theatre in Bridgeport, CT

Partners in Community Development

NDC Training & Professional Certification

NDC offers courses designed to give participants the skills and knowledge they need to successfully facilitate housing and economic development in the communities where they live and work

NDC’s Chuck Depew teaching Mixed-Use Real Estate Finance

Partners in Community Development

NDC Corporate Equity Fund

As an equity investor, NDC finances affordable housing and historic preservation

Dublin Road Townhomes in Mankato, MN

Partners in Community Development

NDC Grow America Fund

NDC creates jobs and economic development with direct small business lending with a focus on women and minority-owned businesses

Red Barn Pet Products in Long Beach, CA

Partners in Community Development

NDC Housing and Economic Development Corporation

NDC finances and builds community and public facilities on behalf of our client communities

Redmond City Hall in Redmond, WA

Partners in Community Development

HEDC New MarketsAs one of the leading non-profit participants in the New Markets Tax Credits program, NDC provides technical assistance and NMTC financing for economic and community development projects

YMCA in Albany, NY

Evaluating A Project’s Need for Public Gap Financing

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• A project’s financing gap is defined as the difference between projected costs (uses) and the debt and equity (sources) it can reasonably attract as follows:

Project Costs- Bank Loan- Equity= Gap

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Evaluating A Project’s Need for Public Gap Financing

Project Costs – are they reasonable & adequate?- Bank Loan – maximized?- Equity – fair return without undue enrichment? = Gap – are there public sources available to close?

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Defining the Financing Gap

• Project Costs Often Greater Than Completed Value • But...debt and equity are a function of value, not

cost• Where project costs exceed fair market value,

there will likely be a need for federal, state and/or local economic development resources to get the project done

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A Fundamental Problem in Real Estate Finance

Cost-Value Differential Example

Residential Units 60 Commercial Retail Space 40,000

Project Costs Fair Market Value$20,000,000 $10,000,000

Project Costs $20,000,000Debt (75% of FMV) $7,500,000Other Sources Needed $12,500,000

Mixed-Use Development: Planned Improvements

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Why Do Economic Development Projects Require Public Sector Assistance?

• Project Costs > FMV• Investors see inadequate Return on Investment

(ROI)• Lenders see unacceptable Level of Risk

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• Investors are seeking to maximize economic benefits and minimize equity investment• Looking to invest in projects yielding the highest

Return On Investment (ROI)• Concerned about the liquidity of the investment

(can it be sold to free up equity for next opportunity)

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Investor’s Perspective

• Lenders are risk limiters, not profit maximizers• Lending is a low-margin, high-volume business• No “upside" for lenders

• Marginal return on investment (interest)• Expected return of investment (principal)

• Fixed returns• Will participate but want to mitigate all risks

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Lender’s Perspective

Project Sources and Uses• Structuring the Project

• Sources of funds must be equal to uses of fund• Identify all project costs (uses)

• Acquisition• Construction• Soft costs and Reserves

• Identify all project sources• Debt• Equity• Public Gap Financing

• If uses are greater than sources, find additional sources

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Sources and Uses

SourcesBank $ 6,000,000

Equity 2,335,000$ 8,335,000

Uses (Project Cost Summary)Land $ 100,000

Site Improvements 200,000Construction – Shell 5,000,000

Parking 50,000 Architect and Engineering 200,000 Tenant Improvements 1,000,000 Legal and Accounting 50,000Permanent Loan Fees 90,000Construction Loan Fees 120,000Organizational Expenses 40,000Construction Interest 300,000Marketing 60,000Property Taxes 25,000Lease-up Reserves 600,000Developer Fee 200,000Contingency 300,000

Total Project Cost $ 8,335,000

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Lender Underwriting / Debt Capacity

• The maximum loan amount will be determined by the lender’s primary underwriting criteria:• Debt Coverage Ratio (DCR)• Loan to Value Ratio (LTV)

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Permanent Lender Underwriting (cont.)

• Debt Coverage Ratio (DCR)

DCR = NOI D/S

• Measures project's ability to repay loan from revenues (lender's "first way out“)

• Higher the DCR, lower the risk• Typical DCRs: 1.10 to 1.35

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• Loan-to-Value Ratio (LTV)

LTV = Loan Amount FMV (Fair Market Value)

• Measures project's ability to repay loan from sale of the asset (lender's "second way out")

• Lower the LTV, lower the risk• Typical historical LTV: 75%

Permanent Lender Underwriting (cont.)

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Sizing Equity: Three Benefits of Investing in Real Estate• Investors/developers seek three benefits when

investing in real estate:• Cash Flow• Tax Benefits• Appreciation

• Investors want all three benefits, but cash flow requirement is first because it is the most immediate and tangible benefit

National Development Council

• Cash Flow

Income

- Operating Costs

- Debt Service

= Cash Flow

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Benefits of Owning Real Estate (cont.)

• Tax Benefits – two main benefits• Income tax deferral from depreciation• Income Tax Reduction from Tax Credits

• (Historic) Rehabilitation Tax Credits• Low-Income Housing Tax Credits• New Markets Tax Credits• (Renewable Energy) Investment Tax Credit

National Development Council26

Benefits of Owning Real Estate (cont.)

• Appreciation

Selling Price- Purchase Price= Appreciation in Value

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Benefits of Owning Real Estate (cont.)

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Time Value of Money• Investors demand a return on their money given their

perception of:• Risk• Inflation• Opportunity Costs

• These three factors determine the discount rate. The discount rate converts a future value to a present value

• The discount rate is the same as the investor's desired rate of return

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Valuing Investor Benefit 15% Discount Factor

Year RTC LIHTCsAfter-TaxCash Flow

Total Benefits After Taxes

Discount Factor PV

1 400 144 30 574 .870 495

2 144 28 172 .756 130

3 144 26 170 .658 112

4 144 24 168 .572 96

5 144 22 166 .497 82

6 144 20 164 .432 71

7 144 18 162 .376 61

8 144 16 160 .327 52

9 144 14 158 .284 45

10 144 12 156 .247 39

400 1,440 210 2,050 1,187

PV is what an investor who demands a 15 percent return would be willing to invest in equity to receive the prospective benefits stream outlined above.

• Reduce Development Costs• Discounted or donated properties• Fund infrastructure and site work through general obligation

bonds• Reduce Cost of Capital

• Lower price and longer term• Make Capital more Readily Available

• Subordinated (junior) financing • Stretch debt • Reduce equity

• Loan guarantees

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Filling the Gap: The Public Toolbox

• Decrease Operating Costs to Expand Borrowing Capacity and Equity Attraction• Tax abatements or Payments in Lieu of Taxes (PILOTs)• Utility savings

• Attract outside Equity• State and federal tax credits in exchange for equity• Types of federal credits

• Low-Income Housing Tax Credits• Historic Rehabilitation Tax Credits• New Market Tax Credits• Investment (Renewable Energy) Tax Credits

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Filling the Gap: The Public Toolbox (cont.)

• Attract Grants• Less commonly available these days• Always tied to public benefit standards

• Monetize Tax Increment• Tax Increment Financing (TIF)

• Using future tax increment to finance up-front capital costs, especially infrastructure

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Filling the Gap: The Public Toolbox (cont.)

For More InformationTom Jackson, Director

tjackson@nationaldevelopmentcouncil.org

New York Office Training Division708 Third Avenue, Suite 710 927 Dudley RoadNew York, NY 10017 Edgewood, KY 41017212-682-1106 0ffice 859-578-4850 Office

www.nationaldevelopmentcouncil.org