RAD Program Leaves Room for Innovation in Financing

Published by Brad Stanhope on Tuesday, March 5, 2019
Journal cover thumb March 2019

There’s far more than one way to complete a transaction under the U.S. Department of Housing and Urban Development’s (HUD’s) Rental Assistance Demonstration (RAD) program.

Since the RAD program launched, about half of the public housing units that participated in the RAD program to rehabilitate the public housing stock used low-income housing tax credit (LIHTC) equity as the primary source of funding. However, creative developers and public housing agencies continue to find new ways to finance the conversion to Section 8 funding.

“People will look at individual business circumstances and come up with solutions,” said Charlie Rhuda, a Novogradac partner in the firm’s Boston office. “I think that’s a good takeaway.”

Part of that is necessity.

“Public housing authorities (PHAs) are repositioning a bit,” said Matthew Rooney, chief executive officer of MDG Design + Construction in New York City. “In certain areas, they’re more like a developer than a management agent.”

Richelle (Shelly) Patton, president of developer and consulting group Collaborative Housing Solutions, says there is room for creativity.

“Every year, I see more creative ways [to finance RAD developments], although unfortunately, it’s a fairly limited toolbox,” Patton said.

To understand some options, consider two RAD developments in the New York City metro area.

Conventional Financing, Bonds

In Madison, N.J., the Madison Housing Authority (MHA) wanted to complete a RAD transition, but tax credits were a non-starter.

“We have wealthy poor people. … A lot of our residents have grown income-wise and now are no longer eligible [under the LIHTC regulations],” said Louis Riccio, MHA’s executive director. “Since there’s no continued occupancy requirement and we can’t force them out, we needed a different way.”

MHA financed its 134-apartment RAD conversion with conventional financing and tax-exempt bonds.

“We knew we had to find other means,” Riccio said. “We contacted several banks and explained tax-exempt financing, but we had to go through an education process, both for them and for us. We explained how you can finance through tax-exempt bonds.”

MHA worked with Lakeland Bank in New Jersey, which contacted HUD and funded the transaction.

“We didn’t borrow a lot,” Riccio said. “Our [study] showed that there was about $3.5 million needed for it to be done, which isn’t a lot.”

MHA’s financing includes a 2.5 percent interest rate with a balloon payment that can increase every five years, but has a maximum increase of 2 percent. Riccio said MHA can pay off up to 10 percent of the outstanding mortgage every year and has a chance to pay extra every five years. MHA’s plan has been to pay off the mortgage in 15 years to enable another loan.

Riccio, through Execu-Tech Inc., consults with other PHAs to convert their properties through RAD, said this approach works best with smaller agencies.

“We’re doing this with 98 percent of our housing authorities, but it’s only because of the amount needed to borrow,” Riccio said. “If you need to borrow $15 million, you probably can’t get that much [of a loan] on the cash flow you have. [This approach is] much better for smaller housing authorities or larger ones that are doing it in smaller increments.”

Monetizing Losses

About 30 miles east of Madison, the New York City Housing Authority (NYCHA) faced a different issue. After financing its first RAD conversion and using a significant percentage of its annual tax-exempt bond cap, NYCHA sought a developer who could use RAD without tax credits on its second deal, a scattered-site development of more than 1,000 apartments called the Betances cluster.

Rooney’s team came up with an alternative after speaking with his father, company founder Michael Rooney, and both Rhuda and Matt Lockhart. Lockhart is a principal in the Novogradac New York office.

“The thing that stood out is that NYCHA can’t utilize the tax losses,” said Rooney. “In a tax credit transaction, the investor takes that, but [we thought] what if we found a way to monetize that?”

Rhuda said there were hurdles.

“There wouldn’t be LIHTCs used in it,” Rhuda said. “When the LIHTC is used, there’s an exception for a profit motive. That was one of the big challenges, because this needed a true cash-on-cash return.”

The option? MDG Design + Construction took the losses from the property in exchange for providing the equity for the deal. MDG handled the construction and its partner, Wavecrest Management, handled the property management. They met the requisite profit motive through standard after-debt cash flow, fully at risk.

“They figured out how, with us as general contractor and our partner Wavecrest Management as the management agent, we got [profit] out of the deal outside of a potential developer fee,” Rooney said. “It’s a large upfront construction contract and a large management contract that renews every year, so we don’t need the developer fee. As real estate professionals, we have an exemption that allows us to apply losses to all income.”

It wasn’t simple.

“We came up with a structure that follows the rules for ownership and NYCHA feels comfortable,” Rooney said. “In 30 years, there are a put and call options as exit points for MDG. They can buy us out or remove us. They’re ultimately the landlord.”

Like the conventional financing option in Madison, the equity-for-losses strategy doesn’t work everywhere.

“It’s a unique situation,” Rhuda said. “The Rooneys are in a situation where in addition to taking the losses, they are also a construction company. The partners are making money on the management contract.”

Rooney said smaller PHAs might have a rough time following this blueprint.

“The tricky thing [for smaller PHAs] would be investors,” Rooney said. “It’s easier for larger investors, where it may be worth it to take the losses. For a small PHA in a rural area, tax credits are preferable and you get more bang for the buck.”

Rooney also said the monetize-the-losses strategy works best if there is also a mission-driven motivation.

“People have to be ready to trim down a bit,” Rooney said. “It’s tighter for any developer. No one would do this purely to make a profit, but for a mission-driven for-profit … this works.”

He acknowledges a curious problem.

“One of the interesting caveats is that our ability to continue to do this diminishes as we do it,” Rooney said. “There’s only so much in losses we can take.”

Other Possibilities

Patton says many PHAs have chosen a fourth path, beyond tax credits, conventional financing and monetizing the losses: focusing on modest renovations, initially reducing the upfront sources needed to undertake a RAD conversion.

“HUD looks not only at the first year rehabilitation needs, but also the following 20 years for what you have to repair and replace,” Patton said. “I’ve worked with many agencies that provide a limited amount of money up front and then had a much larger per-year reserve for replacements deposit of $500 per unit or more (compared to the requisite $250-$350 per unit per year in most states).”

The result may be less dramatic than other RAD transformations, but just as effective.

“It all depends on the status of the existing properties,” Patton said. “In Georgia, we have a lot of PHAs that have stable properties that aren’t going to win any beauty contests compared to new LIHTC properties, based on their exteriors. However, they fulfill an important need in the community for quality, safe affordable housing.”

With selective use of funds, options are available.

“I worked on a few properties where they direct all of the upfront funding to the interior and kept the exterior as it was,” Patton said. “You can do a lot if you replace the kitchen, bathroom, HVAC and other things. In addition, there’s still a lot you can do with a limited amount of  money to help improve the curb appeal of properties, such as landscaping. There are things that seem like they won’t make a huge difference, but they do.”

All of those options require putting away money for future repairs, funds that come from RAD rents. Those include PHAs’ existing operating subsidy and capital funding amounts permanently attached to the property.

Patton also said PHAs should consider the use of Federal Housing Administration Section 223(f) mortgages without LIHTCs and said she hopes to work with Community Development Financial Institutions to show how a RAD investment makes sense for them.

“I haven’t seen many [CDFIs active in RAD], but they can provide smaller loans than agency lenders are willing to offer, which is a true need on many RAD projects,” Patton said. “There’s a 20-year Section 8 contract one can loan against. That space is underutilized.”

The Federal Home Loan Banks’ Affordable Housing program, which has awarded nearly $6 billion for assistance in affordable housing since 1990, is another option, Patton said.

Rhuda said that whether it’s conventional lending, monetizing losses, Section 223(f) mortgages, Federal Home Loan Banks or something else, RAD provides an opportunity for innovation.

“Public housing has been around a long time and it’s been done one way,” Rhuda said. “RAD is unleashing a new way of thinking. Real estate is local and if you look at the real estate, look at your resources and come up with creative circumstances. There are new ways to do this, new ways to make public housing work.”