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Special Case of Cost Polices (post 7 of 10)

Published by Mark Shelburne on Monday, September 20, 2021 - 12:00AM

This post is part of a series on QAPs:

  1. Introduction
  2. Set-Asides
  3. Thresholds
  4. Selection Criteria
  5. Underwriting
  6. Creating a Competition
  7. Special Case of Cost Policies
  8. 114 Different Criteria
  9. Drafting Considerations
  10. Providing Effective Input

A perennial hot topic is how to regulate the cost of development. The subject is one of the most important and difficult in low-income housing tax credit (LIHTC) policy.

Reality of Policies

The first key is understanding numbers in a qualified allocation plan (QAP) do not set the actual, final total. The vast majority is determined by third parties outside a developer’s control (even with a related-party general contractor). Complicating matters, application submission can be a year or longer before construction starts. Accurately predicting changes in labor or materials is impossible.

Instead, QAP limitations indirectly control debt and equity investment (LIHTCs awarded), since sources must equal uses.

Setting the Budget

What determines the figures in an application? The next key is realizing developers will make rational choices based on the incentives.

  • Maximums: Listing the entire amount allows for the most possible hedge against future increases, reduces the chance of a shortfall.
  • Scoring: Show whatever earns the most points; applicants very rarely opt to be less competitive.
  • Lowest Relative to Others: Aggressively estimate the least amount (known as a “race to the bottom” described in the preceding post).

Note a missing consideration: predicting the eventual costs themselves.

Stated differently, the following describes an entirely logical approach for how to budget:

  1. What proposal gives the best chance of an award? Having perfect numbers is small consolation when not awarded.
  2. If the answer to the preceding question is a range, pick the maximum (provides the most cushion).
  3. Will the resulting sources be close to enough to develop the property? This analysis takes into account all of the QAP design standards.
  4. If the answer to the preceding is yes, apply and hope for the best.

The above is not a critique, rather a description of entirely understandable choices.

Allocating Agency Role

The next key is for agencies to accept their role in developers’ decisions. Specifically, the effect of incentives and how requirements relate to construction. While there are many options, certain policies and practices stand out as particularly helpful.

In setting standards, separating new construction and preservation is crucial. The cost for rehabilitation depends on the scope of work, which is a function of the structures’ physical circumstance. Often a higher amount is better since it shows more work being done and/or addressing housing in greater need of improvement. The same concepts apply much less when building from the ground up.

Where new construction can vary greatly is the amount spent on land and site work. Therefore, an all-inclusive per unit, bedroom, or square foot metric is imprecise at best. Limiting the entire budget together means expanding or constricting what’s available for everything else based on whether the real estate or earth moving is cheap or expensive.

Instead, policies can separate out line-item(s) for vertical construction since they are more uniform. However even these are different between types of structures, such as single family and steel frame construction.

Agencies also should consider the effect of QAP priorities such as amenities, design features, green certifications, minimum sizes and others. Another step to consider is adopting the NCSHA recommended practice of setting the developer fee on a per-unit basis. Doing so avoids rewarding inefficient production, which is an unintentional aspect of the traditional percent of costs calculation.

With regard to implementation activities, agencies can undertake some or all of the following:

  • use data from third party sources and/or developments recently placed in service (recognizing labor and materials increased since then);
  • compare similar applications to look for outliers, especially among non-construction line-items;
  • staff (or a contractor) reviewing plans and visiting sites during construction;
  • engaging third-party estimators; and/or
  • requiring general contractor cost certification (another NCSHA recommended practice).

Conclusion

Although difficult, agencies have a responsibility to establish policies regarding development costs.

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