Neighborhood Transformation
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Neighborhood Transformation
NSP - Can There Be More Effective Implementation of Local
Neighborhood Stabilization Programs?

BACKGROUND - Local governments and some nonprofit consortia have received funding from HUD's Neighborhood Stabilization Program (NSP). The funds can be used to acquire foreclosed upon residential properties and vacant land for the purpose of creating affordable housing opportunities.Under the program it is very difficult to make funds directly available to individuals wishing to purchase homes because the NSP requirements are so daunting. With regard to acquiring foreclosed multifamily apartments it is difficult to find developers willing to participate because of the inherent economic constraints (rents are required to be kept low) and the complicated NSP regulatory requirements. Unfortunately, the local government NSP administrators who design these programs typically have never been developers and, therefore, lack the developer's perspective. Some administrators have an aversion to partnering with experienced nonprofits and therefore end up designing their programs in isolation. For these reasons local NSP programs can end up being needlessly bureaucratic and not developer friendly. The results have been predictable -


Contents


Part One:  Homeownership

Overview - the need to build in market based incentives:  Local NSP programs should work collaboratively with nonprofit developers. To the extent feasible, market based incentives should be built into the single family homeownership program.  The program should be designed to mimic as much as possible the way normal market driven deals are done (while fully complying with all NSP regulatory requirements).

Refresher - How a Bank Might Provide an Unsubsidized Line of Credit (for acquisition, rehabilitation and resale of single family homes).  Here is an outline of how it is typically done. Later in this paper we will explore how such concepts can be applied to NSP.
  • The developer submits a loan application (with all required supporting documentation).
  • The bank issues a commitment letter
  • The loan is closed
  • Disbursements are periodically made for acquisition and rehabilitation
  • To obtain a disbursement the borrower submits a packet with the required documentation.
  • The lender takes a mortgage on each property.
  • The mortgage is released upon the resale of each house (provided ALL of the lender's requirements have been satisfied).

Blueprint for an NSP Single Family Program

Summary: Provide an NSP funded line of credit to nonprofit developers to acquire and rehabilitate properties.  The program would be modeled to the extent possible on how a private sector lender might make an unsubsidized line of credit available (factoring in full compliance with all NSP regulations).  When needed to make the unit affordable, a portion of the funding might be "rolled over" to provide soft second purchase loans.

Overview of the Key Concept: Prior to negotiating any purchase contracts the developer applies for revolving line of credit loan with the NSP funder. A loan agreement is entered into and the developers then begins to seek out properties. Upon execution of a puruchase contract the developer submits a disbursement request to the NSP funder accompanied by all required documentation. The request is then expeditiously approved (or dissapproved) followed by a closing on the acquisition

Loan Application Process.  Through an RFQ of RFP nonprofit developers would be invited to submit applications for the line of credit. The application procedure would require the developer to submit specified documentation. Thus, the NSP lender gets to select a pool of pre-qualified developers with which it will do business. At this stage, no documentation would be required about particular properties (that information would be submitted later as part of a disbursement request).

Loan Agreements would be executed with the nonprofit developers selected during the application process.  The Agreements would specify all of the requirements that had to be met in order for NSP funds to be disbursed.

Disbursements for Acquisition and Rehabilitation. The developer, after executing the Loan Commitment Agreement, would seek out eligible properties for purchase. A disbursement request for a particular property would be submitted to the NSP lender.  The disbursement request would contain all of the documentation required by the Loan Commitment Agreement including:
    • title insurance commitment
    • executed purchase contract
    • appraisal (showing that the purchase price meets NSP requirements)
    • rehabilitation budget
    • environmental compliance documentation
    • proof that property is in an NSP qualified neighborhood
    • other documents reasonably required
"Closing Documents" for Acquisition Disbursements:

1.  Loan Agreement
2.  Promissory Note
3.  Environmental Compliance Agreement
4.  Mortgage
      • The mortgage would be released upon resale only if the buyer had first been approved by the NSP lender. The following documentation would need to be submitted for such approval:
        • Satisfactory proof of the buyer's income
        • Certificate of Completion from approved home buyer education program
        • Other documentation reasonably required by the NSP lender
These would be standardized closing documents that could be quickly adapted for each acquisition.  Provided that all of the lender's requirements had been met, the closing would take place within 14 days after a disbursement package had been submitted.

Meeting the Affordability Requirements

"Recapture" vs "Resale": The regulations governing NSP require compliance with the HOME affordability guidelines. The regulations governing the HOME program allow (but do not require) heavy handed "resale" restrictions, imposed by a recorded covenant, wherein buyers are restricted as to who they can re-sell their homes to and the price that they could ask.  An alternative (and less intrusive) "recapture" method is also authorized wherein the subsidy, under specified circumstances, is recaptured when the property is resold or improperly leased.

Local NSP programs should comply by using "recapture" mechanisms and not "resale" restrictions.  The primary objective of NSP, after all, is to stabilize neighborhoods that are in a downward spiral. It makes little sense to impose low resale prices in areas where prices are already in steep decline.

Below is an outline of how the recapture mechanism could work:

      • In cases where a buyer can obtain affordable conventional financing there is no need for a formal recapture mechanism. The reason? At closing the subsidy is naturally "recaptured" when the buyer pays the purchase price and the developer returns the full amount of the subsidy to the NSP lender in return for a release of the acquisition/rehab Mortgage
  • Purchase Loans for Buyers: In cases where the buyer can not obtain affordable conventional financing, a portion of the developer's NSP acquisition/rehab loan could be "rolled over" and made available to the buyer for a portion of the purchase price. This would be accomplished by a means of "soft second" Promissory Note (secured by a Mortgage) payable to the NSP lender. The Note could be made forgivable at the conclusion of the specified affordability period. This mechanism is expressly authorized by the HOME affordability regulations.
        • Technically speaking, the NSP lender is making a purchase loan to the buyer but there would be no cash transferred at the closing.  As the buyer signs the soft second Note and Mortgage with the NSP lender the developer is given a credit by that same lender against the amount owed on the acquisition/rehab loan.
        • The "soft second" Note would not require amortization (no monthly payments). Payment would be due only if the house were re-sold or improperly leased during a prescribed affordability period.
        • The closing documents for the "soft second" loan for the buyer are as follows:
  • Lender-borrower-agreement
  • Soft Second Note
  • Soft Second Mortgage

Part Two:  Rental - (back to the top)

Background:  The NSP regulations require that 25% of the funds be used to serve families with incomes below 50% of the area median.  Because it is so difficult to provide homeownership opportunities for such persons most local NSP programs earmark a portion of their funds for rental housing.

Recommendation - Use A Portion of NSP Funds Designated for Rental House to Work with Single Family Structures .  Because the federal regulations are so difficult to comply with and because of basic issues of economic feasibility, it is very difficult to use NSP funds to acquire and rehabilitate foreclosed multifamily apartment buildings.  For this reason, it is recommended that local NSP programs look to use a portion of their NSP funds to acquire and rehabilitate foreclosed single family structures as a component of their rental housing strategies. (Doing this would not rule out the use of NSP funds for multifamily buildings where such use was objectively feasible).

The Difficulty of Using NSP for Multifamily Buildings
  • The high cost of rehabilitation
Such buildings are typically old and deteriorated.  There may not be sufficient funds to pay for the cost.  Rehabilitation is expensive and the available NSP funds probably will not be sufficient in and of themselves. 
  • Low amounts of net cash flow
Rents are required to be kept low due to the NSP requirements for serving people with incomes at less than 50% of the area's median income.  Because of this, there is little income to service debt on loans needed to pay for the rehabilitation work.  Beyond that, even if the cash flow was sufficient banks may still be reluctant to make loans for such ventures
  • Uniform Relocation Act compliance
Generally, this statute requires developers to pay the cost of relocating persons displaced in projects that use federal funds.  The developer acquiring the property must be able to document that all tenants in occupancy as of the date that the purchase contract was signed received the notice that is required by the statute. Learning the identity of those tenants can be tricking in a building that has undergone foreclosure. The budget for a project (already tight due to the limited amount of rental income that will be generated) must include relocation expenses necessitated by this law. Feasible acquisitions might be limited to those that are already vacant or those having enough vacant units available so that tenants could be moved around during the rehab process.
  • Tenants in Foreclosure Act compliance
This recent law gives tenants living in foreclosed properties new rights. Locally administered NSP programs, in approving an acquisition of a foreclosed multifamily building, will prudently require documentation showing the identity of the tenants in occupancy as of the date of the foreclosure sale and proof that the required notices had been given to them
  • Davis Bacon Act compliance
Because NSP is federal money, labors costs for the rehabilitation of projects involving more than 11 units will be increased (wages must be paid at the "prevailing" rate pursuant to the requirements of the Davis Bacon Act)
  • Required installation of "Green" Components,
Though not necessarily required by the federal NSP regulations or the relevant building codes, local NSP programs will sometimes add cost to a project's budget by requiring the inclusion of mandatory "green" energy saving features.  This puts an additional strain on already tight rehab budgets (given the limited amount NSP funds available and the limited amount of cash flow available to pay debt service)
  • Environmental compliance. 
Under federal regulations, if the rehab costs exceed 75% of the acquisition costs the project is considered "new construction" requiring costly and time consuming environmental clearance procedures involving United States HUD.  Note: these federal regulations offer a disincentive to developers to try and bargain for a low acquisition price.
  • Compliance with "Section 3" of the Federal Housing Act
Because federal funds are involved, contractors doing the rehab are required to hire local residents (click here for more information). The requirement is typically enforced by requiring the contractors to sign a "First Source Hiring Agreement".

The Bottom Line:  Most developers will find it very difficult (if not impossible) to successfully use NSP funds to acquire and rehabilitate foreclosed multifamily apartment buildings.

Advantages to Using Single Family Structures
  • Acquiring and rehabilitating a single family structure involves much less money than would be needed for large multifamily structures.
  • The rehabilitation work required for a single family structure is on a much smaller scale than the work needed for a large multifamily building. Accordingly, the work would be completed much more quickly and with fewer headaches.
  • Such a strategy would increase the housing options available for larger families.  Most apartment buildings don't offer units with enough bedrooms for larger families. Because of this local Section 8 programs have a hard time placing larger families. The obvious solution is to make single family structures available for rent.  Because of the high likelihood that voucher holders would be attracted as tenants these types of ventures would enjoy a greater degree of economic viability.
  • Such projects would be exempt from the Davis Bacon Act (thus lowering the cost of the rehabilitation work)
  • In most cases there would be no need to comply with the Uniform Relocation Act.
  • Compliance with the Tenants in Foreclosure Act would be much simpler.

Implementation of a Single Family Rental Program
  • To pay for the cost of acquisition and rehabilitation it is proposed that the local NSP program  provide developers with a line of credit similar to that proposed for the homeownership program (see above).
  • NSP disbursements to the developer would be secured by mortgages on the properties acquired.
  • Repayment requirements would be geared to the amount of net rental income to be generated by each property taking into account operating expenses (such as insurance, management fees, reserves, etc.) and a reasonable economic return for the developer.  Provision should be made for periodic adjustments to the repayment schedule in the event of unusual increases in expenses.