Developer Capacity for SMMF Preservation

Introduction

Adequate organizational capacity is a key factor for entities new to small to medium multifamily (SMMF) preservation and experienced developers who seek to grow their SMMF preservation portfolio. Given the competition within identifying and securing properties, the challenges in securing financing, the complexities of navigating rehabilitation, and the inefficiencies of operating SMMF affordable properties, one must thoroughly prepare before embarking down the path of owning and operating SMMF properties.

Capacity is defined as the measure of an organization or entity’s ability to deliver a service or product. This includes having the adequate level of staff, skills, financial resources, knowledge within an organization and supportive policies, procedures, and efficiencies within an industry.

Understanding your organization’s readiness to preserve and operate SMMF will help your organization determine what steps are needed to either start or sustainably continue SMMF preservation. This can help:

• Develop a long-term business plan that provides strategic direction and financial analysis regarding your organization’s ability to sustain the development and operations of a real estate portfolio.

• Inform acquisition decisions that align with your organization’s mission, preservation goals and portfolio.

• Proactively solve the varied challenges that SMMF properties may face during acquisition, rehabilitation, and long-term property and asset management.

• Determine your organization’s staffing model for SMMF development, including determining which real estate development and asset management functions exist in-house or in partnership with another development entity and/or bench of consultants.

The Challenge of Small to Medium Multifamily Preservation Development

When considering the spectrum of affordable housing development opportunities, preservation projects are often perceived to be the most difficult. For developers, preservation development can be both costly and time intensive for an organization to take on with limited financial yield. In fact, without a significant upfront balance sheet, subsidy, or grant funding, it can take a newer organization several years before preservation development becomes a self-sustaining business line on its own. Further, the projects themselves are difficult for several reasons, including limited availability of financial products and subsidy, unexpected levels of rehabilitation needs, the logistical complications of conducting occupied rehabilitation, challenges addressing older property conditions and deferred maintenance, and the operational challenges that lack economies of scale.

Lastly, these smaller properties operate on thin margins often without operating subsidies to support existing low-income tenants, making them difficult from both a property management and a long-term asset management perspective. Developers must also grapple with the fact that unlike large tax credit projects, without a significant pipeline of projects, SMMF preservation deals alone often do not generate enough developer fees or cash flow to hire development and site-specific property management staff. Finally, developers must also grapple with the long-term financial plan for these projects when they need additional rehabilitation 7, 10, 20, and 30 years down the road.

Key Organizational Considerations for Small to Medium Multifamily Preservation

Organizations undertaking SMMF preservation should take these components of organizational capacity into account.

• Developing a preservation business plan – Aligning mission and business model

• Market analysis and identifying and evaluating properties

• Balance sheet to secure financing and compete with other buyers

• Managing the rehabilitation process

• Property and asset management

Developing a Preservation Business Plan – Aligning Mission and Business Model

Before embarking on your first SMMF preservation deal, it is critical to identify your organizational priorities and assess your capacity to deliver on these priorities. Both mission alignment and capacity to deliver are critical in terms of SMMF preservation, as taking on these tough properties could put organizational sustainability at risk if not fully prepared. In addition, looking at your full portfolio in terms of risk, income, opportunity and overall mission alignment is necessary, following a review of the market and property acquisition opportunities against this framework. See this framework from Mission Economic Development Agency as an example.

Mission alignment is an important aspect that is often taken for granted in affordable housing development. It is often assumed that developers in the affordable housing arena are automatically mission driven. However, given the particularly challenging nature of SMMF preservation, an entity must be clear on how its values and goals align with affordable preservation. For example, if you are a mission-based developer whose goal is to preserve the social capital of a culturally diverse neighborhood through affordable housing, that shapes the amount of risk you are willing to take. Conversely, a private commercial developer may have a goal to stabilize the building and produce a return on investment (ROI) in a certain number of years. As highlighted earlier, profitability is especially tenuous in SMMF preservation, therefore, understanding mission alignment and goals for the property must be clear before the project starts. Developers should ensure there is a clear action plan that incorporates their approach to preservation and an understanding of its realities and preparation.

Market Analysis and Property Identification

A key input to scoping out the capacity to sustainably grow a portfolio of preservation projects is the consideration of the broader market conditions for the geographic area your organization wishes to serve, including the housing stock, average rents and incomes, housing tenure, and comparables for similar rental buildings. Secondly, assessing SMMF properties against your organizational priorities, capacity, risk tolerance, and alignment with funding and financial tools are critical to the success of a project. See the Identifying Properties brief for more information.

In addition, simply identifying opportunities, finding and engaging owners, and vetting deals is quite time consuming and requires staff or consultant time. Due to changing markets within some neighborhoods, increased competition is often with market rate or institutional buyers who seek to either rehabilitate properties and raise rents, or even demolish them for another use. They often have staff capacity to vet properties combined with cash offers, making it very difficult to compete. Engaging with local owners and operators is critical to access SMMF properties.

Balance Sheet and Securing Financing

Once a property is identified, closing the deal is another area that is extremely complicated. Many traditional affordable housing financing sources are not viable for smaller deals (see the Funding Sources Inventory for a list of sources that are viable for SMMF preservation). Given the low rents and small number of units, the deal’s ability to handle significant debt is limited. With SMMF deals in particular, there can also be tight timelines due to the needs of the seller, which is exacerbated by the increased pressure in the market. Securing financing requires a sufficient balance sheet for your organization to be underwritten, as well as often an equity contribution; given the risk tolerance of financing entities, you may find increased requirements for guarantees as well.

Managing Small to Medium Multifamily Rehabilitation

Balancing the needs of existing residents and contractors while avoiding cost overruns is a key challenge during SMMF rehabilitation. SMMF properties are often occupied, and when rehabilitation renders units uninhabitable, a temporary relocation plan can be very costly, disruptive, and requires ample communication with residents. If the project includes subsidies that require relocation procedures, it is important to have a development team or partners with relocation expertise. You can learn more about engaging with residents through the Community and Resident Engagement brief.

The typical SMMF property is older and likely has deferred maintenance needs – these properties may require skilled contractors who understand the realities of these buildings and construction managers who are willing to take on smaller projects. Organizations and entities undertaking SMMF rehabilitation will need to understand how zoning and building code requirements and approval processes impact your rehabilitation scope of work, including the existence of nonconforming structures, accessibility and health and safety requirements, parking requirements and permitted density. You can learn more about rehabilitating SMMF properties and guidance you can implement in the Rehabilitation brief.

Property Management and Asset Management

Once acquired, a strong property management capacity is required to manage the ongoing operations of the property, as well as to build relationships with existing residents. Key criteria requiring special capacities include scattered site management, building relationships with current residents, managing ongoing physical needs of the properties given age and limited resources for significant rehab, and incorporating new compliance requirements if taking on a new public subsidy. More details of these factors can be found in the Property Management and Engaging Stakeholders sections of the toolkit.