Affordable housing owners are facing an unprecedented set of current challenges as a result of the declining economy and frozen financial markets. In the midst of this, we at National Housing & Rehabilitation Association (NH&RA) believe that 2009 presents unique opportunities to improve operations and realize additional value from existing affordable multifamily housing properties. New leadership in the White House and Congress are committed to substantive public policy solutions to our national housing and energy infrastructure, and NH&RA and the affordable housing community are uniquely positioned to capitalize on this opportunity.
Formed in October 2008 as an independent council within the National Housing & Rehabilitation Association, the Council for Energy Friendly Affordable Housing (CEFAH) was formed to promote public policy solutions to improve the energy performance of existing and new multifamily housing developments. With market forces and Obama Administration priorities making greater energy efficiency a high priority, multifamily property owners stand — to better realize increased value from energy cost savings in their developments. CEFAH was formed to help owners and managers identify and implement effective energy savings strategies, and to make sure that the regulatory system for properties assisted by the U.S. Department of Housing and Urban Development (HUD) supports this objective to the maximum extent possible. CEFAH is working to remove regulatory barriers as well as create new funding sources to help owners improve the performance of multifamily projects through low-cost, high-impact energy and utility improvements.
This is a large task. However, CEFAH already has already identified a number of immediate public policy solutions that can be significant catalysts to:
1.) Improve the energy performance and capital situation of stressed multifamily real estate assets;
2.) Immediately create thousands of green construction jobs in a range of fields, including construction, financial analysis, energy auditing, engineering, and more; and;
3.) Reduce the nation’s long-term dependence on foreign energy sources.
If these policy objectives are adopted and implemented quickly and effectively, there will be an immediate and positive impact on both the operations and bottom line of affordable multifamily properties — and help sustain the long-term viability of the nation’s assisted housing portfolio. It is essential that the viewpoint of owners, managers, and investors be considered by public policy makers during 2009 to avoid policy decisions that may create more burden than benefit for the industry, and less incentive than mandate.
CEFAH’s work to date has identified at least five areas where we can take immediate action to benefit owners, investors, tenants, and the federal government. These include to:
1. Decrease energy costs by increasing cash flow to owners
For privately owned HUD-assisted properties, for-profit owners’ annual distributions from project net cash flow generally are limited to 10 percent of the owner’s equity value established at the beginning of the project (and only 6 percent for elderly projects.) This limitation on distributions presents a major obstacle. Owners who might otherwise wish to fund improvements to reduce energy consumption have virtually no economic incentive to do so if they have already reached the maximum limited dividend distribution at the property. In other words, the limited dividend provisions prohibit owners from realizing any benefit from decreased energy costs. The limitation on distribution of profits, which is embedded in regulatory, administrative, and contractual policies and practices, does not generally provide exceptions where cost-savings are generated due to a green retrofit. To overcome this obstacle, CEFAH endorses the authorization of a “green dividend.” payable to owners. This would require HUD to develop a standardized measure of baseline energy usage prior to green renovations, and a means of tracking savings, as a way to compute the size of the allowed green dividend. This proposal may require Congressional action. CEFAH believes both for-profit and non-profit owners should be eligible for such a green dividend.
2. Allow drawdowns of capital for renovations from existing reserves
Energy conservation improvements must now be paid for with up-front capital. In a mature HUD-assisted property, sources of capital for renovations beyond normal maintenance and capital replacements are limited. Green retrofits often involve work that would not be done in the normal course of traditional property maintenance or in the replacement of worn out structural items such as roofs. Case in point: Insulation installed not long ago and still within its “useful life” might be upgraded with modern materials and techniques to achieve a higher degree of heat loss reduction, if not for current HUD policies. HUD’s guidance, outlined in one Handbook, states:
“The main purpose of having a recommended minimum threshold is to have funds available for an emergency or unforeseen contingency, such as a major roof failure or a water or sewer main break, so that funds could be drawn below the customary threshold. Assuming that a project is in very good physical condition and that no major replacements are needed in the near future (e.g., five years), HUD strongly recommends, but does not mandate, that owners target a minimum amount to be held in the Reserve Fund that would equal or exceed the greater of the following two amounts: The initially established monthly deposit times 144 (12 years); or at least $1,000 per unit.”
The upshot: HUD does not impose overt statutory or regulatory restrictions on the use of normal project reserves for green retrofits, but in practice the Department does not encourage the use of reserves for these purposes where it might temporarily depress reserves.
Several broad changes in approach appear necessary to foster green retrofits. First, HUD needs to provide clearer guidance encouraging the use of Reserves for Replacement for green retrofits, in situations where the projected cost savings would permit replenishment of the Reserves over a reasonable period of time. A second area for change is in the use of Residual Receipts. Residual Receipts are a potentially large source of idle, virtually costless capital for greening privately owned affordable housing.
Even Reserves for Replacements and Residual Receipts, however, may be insufficient for a large-scale retrofitting program. CEFAH anticipates working with HUD and Congress to seek approval of a low-cost, easy-to-access loan program to fund green retrofits.
3. Advance additional private capital for improvements
More ambitious green retrofits, involving larger capital outlays (such as for new boilers, photovoltaic cells, geothermal heating, and other capital-intensive improvements) may require policies that attract private capital. HUD rules and regulations need to be revised to encourage the repayment of private financing or owner-loan advances for green capital repairs, to be made out of project income as an allowable line item in the rent formula.
Additionally, HUD requires that its loans be senior, or in a first lien position, to all other debts in any privately owned housing project. HUD approval is also required before the conveyance of the ownership of any project to which HUD is a lender or provides mortgage insurance. HUD therefore approves any encumbrance of the property with new loans, or transfers of interests to investors. In short, any third-party financing or owner-financing would have to be subordinate to the HUD financing and approved by HUD.
HUD’s traditionally tight controls on any additional project debt is designed to discourage owners from over-leveraging properties, as well as to prevent owners from evading dividend limitations through increased borrowing. Yet these rules also create barriers to capital-intensive energy renovations and improvements. An effective green retrofitting program requires a systematic overhaul of HUD debt limitations.
4. Permit installation of improvements owned by third parties
Larger capital outlays for some energy projects, such as photovoltaic installations, should be able to take advantage of the growing market for the syndication of federal energy tax credits. Syndicators—aggregators of capital for projects are creating a growing market for this product among private investors who want to utilize these tax credits and promote renewable energy production. These credits were recently extended under the Energy Improvement and Extension Act of 2008 signed on October 3, 2008.
The model that has to date developed in the solar tax credit industry is for new investors to install solar power equipment on the roof of existing buildings, under either a perpetual easement property right, or through a potentially time limited lease. Either way, the solar equipment owner also enters into an energy supply agreement with the apartment building owner.
HUD rules, however, generally restrict such arrangements. This is because real estate lending rules limit such encumbrances running to third parties out of concern about abusive third-party supply arrangements. HUD as a lender also has a general concern that a project be unencumbered so that in the event the owner goes into default, HUD can foreclose and dispose of the asset easily. Even so, HUD needs to develop standards to encourage the expansion of energy-savings improvements to ensure that the standards are fair and reasonable and so that projects can be approved easily and quickly across the country rather than on a slow, case-by-case basis. CEFAH anticipates working with HUD to help shape the details of how a program that would f be beneficial to owners.
5. Allow energy agreements with third parties
Because of the limited access to new capital for such buildings due to HUD rules, some owners have turned to so called “energy performance contracting,” which HUD now encourages in public housing authority owned affordable housing units. As HUD describes it:
“Energy Performance Contracting (EPC) is an innovative financing technique that uses cost savings from reduced energy consumption to repay the cost of installing energy conservation measures. Normally offered by energy service companies, this innovative financing technique allows building users to achieve energy savings without up-front capital expenses. The costs of the energy improvements are borne by the performance contractor and paid back out of the energy savings. Other advantages include the ability to use a single contractor to do necessary energy audits and retrofit and to guarantee the energy savings from a selected series of conservation measures.”
While HUD encourages these energy performance contracts for public housing properties, such contracts are less common in privately owned HUD-assisted housing developments. These private properties suffer from the split-incentives problem; owners who finance energy conservation measures themselves often do not benefit from the reduced utility costs.
There is not a clear-cut way to finance energy improvements from energy savings. In cases where the rules for HUD’s assisted housing programs do not permit the benefit from utility cost savings to accrue to the owner, HUD will need to develop subsidy reforms or new subsidies to allow energy conservation benefits to flow in part to the owner. In addition, there are other regulatory and market barriers that impede the ability of owners to enter into and benefit from energy performance contracts, such as the lack of standardized contract forms and terms.
Formed in 1971, NH&RA is a professional association of like-minded, successful and driven individuals who are involved in affordable housing, historic rehabilitation and New Markets Tax Credit development. We meet quarterly for serious discussions of significant issues affecting our business. Designed to foster relationships, our meetings are renowned for its combination of cutting-edge information and opportunities to network and socialize. NH&RA provides its members with a variety of information resources including our e-newsletter HousingOnline Weekly and website www.housingonline.com and is also its is also a leading voice in Washington advocating on behalf its members on a number of housing, tax credit and community development related issues .