1. Cash Flow per Unit
Affordable housing developments are typically not designed to generate rich cash flows by nature, due primarily to rent restrictions. The standard cash-flow metric is defined as total net operating income net of operating expenses, required replacement reserve contributions, and mandatory debt services on the so-called hard debt.
“Per studies produced by CohnReznick based on a survey of approximately 20,000 low-income housing tax credit (LIHTC) projects, the median per-unit per-annum cash flow reported on the national LIHTC portfolio was $597 in 2014, which represented a steady increase from prior years,” says Cindy Fang, senior manager at CohnReznick. “The upward trend was attributable to a very strong occupancy rate driven by pent-up demand for affordable housing; more-sophisticated operating-expense underwriting practices compared to years ago; and refinancing opportunities captured by some projects.
“An average LIHTC project has about 75 apartments, which means the average cash flow per property is under $40,000, most of which is applied toward deferred developer and asset management fees,” Fang says.
2. Operating Costs per Unit
Affordable housing is typically underwritten with a small operating margin due to the rent restrictions and therefore has less of a cushion to weather unforeseen fluctuations in expenses, explains Fang.
A recent CohnReznick study reported that the national median operating expenses (gross expenses, not including replacement reserve contributions) were $5,336 per unit in 2014. Statewide medians ranged widely from as low as $3,634 per unit in Alabama to as high as $8,453 per unit in Massachusetts. Besides location, project type and age were found to be the most influential factors. With affordable housing traditionally lagging in terms of access to operating-expense data, the industry used to witness large variances between underwritten and actual operating expenses.
The industry has come a long way at improving its underwriting practices and benefiting from access to solid industry data, which ultimately contributed to a stronger track record reported on the affordable housing portfolio, says Jeff Dowd, partner at CohnReznick.
3. Cash Available for Distribution
How much cash is the property going to distribute to its stakeholders every year? “That’s the question owners, investors, regulators, and subordinate lenders increasingly want to know,” says Jenny Netzer, CEO of TCAM, a firm that provides asset management and advisory services to affordable housing owners and funders. “It’s what they need to know for budgeting, for monitoring performance, targeting improvements, and determining the value of the property. For subordinate lenders, cash available for distribution helps repay their debt and provides resources for new loans.
“The term ‘cash flow’ has multiple meanings in the industry,” adds Netzer. “What we find matters to our clients is what is actually available for distribution once all required debt has been paid, cash set aside for short-term payables, all reserves funded, and all releases of reserves taken into consideration. It’s not a simple matter, but well-run organizations have become proficient at measuring and projecting bottom-line cash—and using those measurements to drive performance.”
4. Budget Variances
Managing performance means comparing it with a standard. While some of the other measures discussed are useful for underwriting and portfolio analysis, they’re too generic for evaluating the actual performance of properties, property managers, and sponsors. The gold standard for managing actual performance is a realistic but aspirational budget, according to Netzer.
The best operators establish annual operating budgets based on historical performance, research, and specific capital, leasing, and maintenance plans for the property. “Monthly and quarterly variances from budget for key line items of revenue, expense, and capital replacements can then be used to change property performance for the better, not just measure it,” says Netzer.
5. Collections/Economic Vacancy
“Affordable housing across the country has occupancy rates in the high 90s, but is all the rent that should be collected actually being collected?” asks Netzer, an affordable housing industry veteran. “Too many properties are losing revenue to concessions and/or bad debt.”
Economic vacancy, which measures rent earned net of concessions and bad debt as a percentage of the rent being charged, is the most useful measure here. High economic vacancy combined with low physical vacancy points to a need to look at rent levels, leasing practices, and/or collection practices.
Effective operators diligently work to set rents at levels residents can actually pay, verify the ability of prospective residents to pay the asking rents, and assiduously follow up on delinquent rent. These practices go a long way to help owners produce low physical and economic vacancy at their properties, says Netzer.