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Questions on Development Budget and Pro Forma

Replacement Reserve Funding

Is it acceptable to fund some or all of the required 20 year Replacement Reserve funding in the form of an initial Replacement Reserve deposit , with only a small annual Replacement Reserve deposit or with no annual Replcacement Reserve deposit?

Attachment 1A-1 specifies that the initial and annual reserve deposits must be sufficient to cover all capital needs arising during the first 20 years. HUD recognizes that this requirement can be met through a relatively high initial deposit and a relatively low annual deposit. Please note, however, that an approach that utilizes a high initial deposit and low or zero on-going deposit will result in the Replacement Reserve funding being inadequate after year 20, which may present underwriting concerns for your lender and other funding partners. In a financing involving LIHTCs, the investor will likely want all anticipated rehabilitation completed in the initial financing which should result in a relatively low need for ongoing replacement reserve funding. Contact your lender (and LIHTC investor, if applicable) to determine whether this approach will be acceptable (for FHA financing, your Replacement Reserve approach must meet all FHA requirements as well as RAD requirements). HUD is open to considering this approach as part of your Financing Plan if your funding partners are agreeable.

PHAs and Real Estate Tax Exemptions

Why wouldn’t the PHA be tax exempt from the real estate taxes?

Real estate tax exemption is governed by state and local law. In most cases, HUD believes PHAs will be able to retain their PILOT agreement. You should consult local counsel to make such a determination. Additionally, In some jurisdictions, nonprofits that provide affordable rental housing are exempt from real estate taxes, and such an exemption might be available to your PHA.

RAD Underwriting with High Expense Ratios

In RAD deals with high expense ratios, at 2% & 3% rent/expense trending, NOI trends downward. This makes the debt sizing difficult if you need to keep the DSCR positive for 15 years. You have a very high DSCR in year 1 to get to a 1.05 or 1.10 in year 15. Has HUD considered any measures to mitigate this risk?

The RAD program does not have any requirements regarding how a lender or investor underwrites the transaction or what level of debt service coverage be maintained over time. You may use any trending assumptions that you think are reasonable. Please note though that because rents will increase each year by the OCAF, which incorporates market expense factors, that rents and expenses may trend at the same rate.

Underwriting Standards for No Debt Deals

My PHA is converting a project using no debt. What standard should be used in reviewing the financing plan with respect to cash flow coverage?

Generally, the same standards as used in FHA, e.g., 1.11 if New Construction/Sub Rehab and 1.15 if there are modest or no repairs. Similarly, like FHA, there is no need to make assumptions about income and expense trending when examining long-term cash flow coverage.

Operating Pro Forma Feasibility Requirements for DSCR

Attachment 1A of the RAD Notice Rev-2 states, "For leveraged transactions, the debt-coverage ratio should not be less than 1.11 over a ten year period using 2% growth in revenue and 3% growth in expenses." Will HUD be only reviewing the DCR for the first 10 years of a property? In effect, do we only need to submit a proforma with cash flow projections for 10 years? If so, is that also true for non-leveraged transactions?

HUD requires an operating pro forma that projects out for the length of the initial HAP contract (either 15 or 20 years) for both leveraged and non-leveraged projects. Although we require that you submit a pro-forma for the 15 or 20 year period of the HAP, for purposes of analyzing the project’s feasibility, if it’s a self-financed deal (no debt), then we only test the first 10 years for DSCR and net cash flow. Please note that in the revised Notice, HUD has instructions that say that the Financing Plan will be reviewed and evaluated as a whole.

Replacement Reserve Custodian

Is there a requirement for who holds the Replacement Reserves?

Yes. If there is FHA-insured financing, the insured lender will hold the Replacement Reserve. Otherwise, typically a non-FHA-insured lender or a LIHTC investor holds the Replacement Reserve. In RAD transactions without debt and without LIHTCs, HUD can agree to allow the PHA to hold the Replacement Reserve as a separate account with a banking institution with the account covered by a General Depository Agreement (form HUD-51999). Please note that a GDA may also be required in other circumstances, such as when public housing funds are being used to fund the reserve. Please contact your RAD Closing Coordinator for additional information.

Requirement to Make Monthly Replacement Reserve Deposits Following Conversion

Suppose that the PHA's operating expenses increase following conversion and the project doesn't have the cash to make the deposit into the R4R as required under RAD- what would be the likely consequences of a failure to make required replacement reserve deposits? Does it make a difference whether it's PBV or PBRA?

Failure to make required deposits to the replacement reserve is a violation of both the RAD Conversion Commitment (which survives the closing) and the PBRA or PBV HAP Contract and HUD may take enforcement action in such an event. If a property experiences an unexpected and substantial increase in operating expenses, the owner should contact HUD to determine options that will not result in HUD initiating an enforcement action.