INTRODUCTION TO RAD
By 2013, San Francisco’s public housing projects had decayed after decades of federal underfunding. An estimated $270 million was needed for immediate repairs, yet the city housing authority received only $10 million a year. The city and the San Francisco Housing Authority chose Bank of America Merrill Lynch as lender and investor of a $2.2 billion transformation of the public housing portfolio to sell 29 properties to seven developers who would renovate the properties using the Housing and Urban Development Rental Assistance Demonstration (RAD) program.
Known as SF-RAD, it is the largest affordable housing deal in U.S. history. The $2.2 billion project required three years and two phases to convert 3,482 units that shelter more than 10,000 people. Participants included the mayor’s office and housing authority, Freddie Mac, seven primary developers, five participant banks and HUD.
“It would have taken the housing authority 27 years to do those immediate repairs, and the repairs were building up so much that they were never going to be able to do all of them,” said Olson Lee, director of the San Francisco mayor’s office of housing. “Our RAD development is doing between $700 million and $800 million in repairs, over three years. So, it would have taken them 80 years to get to the same place.”
“There’s really been a transformation at many of these properties, from people living in units with leaky pipes, bed bugs and other uninhabitable conditions to updated living environments that are now very well managed,” said Ari Beliak, senior vice president, community development banking for Bank of America Merrill Lynch. “There’s nothing else like SF-RAD. This is a big outlier, in a positive sense, to the RAD program and it’s a testament to the mayor’s vision, the city’s ability to put in financial resources in addition to RAD and Bank of America Merrill Lynch’s willingness to step in and do something complex that most institutions didn’t want to touch.”
The massive 29-in-one deal in San Francisco illustrates how the RAD program is changing the face of public housing across the U.S.
According to HUD, RAD addresses what was in 2010 a quickly escalating $26 billion backlog of deferred maintenance on public housing, the result of inadequate funding.
Due to deferred maintenance, an average of 10,000 of the 1.2 million public housing units in the U.S. are lost annually through demolition or obsolescence, according to HUD. The poor condition of such buildings can inhibit additional investment in those properties and further impact communities with the most need.
HUD created the RAD program to enable public housing authorities to access private capital to improve the housing of its tenants, often the neediest portion of the population. Launched in 2012 with funding for 60,000 unit conversions and expanded by 2015 to 185,000 units, RAD quickly maxed out both caps and became the go-to tool for the preservation and upgrade of units for tenants previously living in public housing.
According to HUD's May 2017 RAD newsletter, RAD had leveraged $19 for every public housing fund dollar and resulted in an average $61,000 per unit transformation of rundown, dilapidated properties. More than 60,000 units in nearly 600 projects had been converted to Section 8.
Projects representing over 80,000 units nationwide, from Portland, Ore., to New York City, were on the waiting list as of December 31, 2017.
The RAD program takes existing operating and capital funds a project receives under the public housing program and converts them to rental assistance payments under a Section 8 Housing Assistance Payment contract. Under this model, the RAD program does not use any additional federal operating funds.
The program helps very low income tenants, typically those tenants currently living in or wait-listed for public housing. Tenants contribute up to 30% of their income toward rent, with HUD funding the difference between what the tenant pays and the HUD-determined maximum rental rates for the project.
RAD provides a voucher or project-based subsidy. This subsidy allows the project to operate much like a typical affordable housing or market rate development. The steady stream of Section 8 payments allows owners to use conventional debt coupled with LIHTC (low income housing tax credits) equity to complete the capital improvement or replace the housing units. A typical ratio of loan-to-cost would be 80% construction debt with the balance in tax credit equity and additional subsidies.
Bank of America Merrill Lynch has been deeply involved in RAD, from helping to shape rule-making that allows the involvement of private enterprise to advising housing authorities and developers. Bank of America Merrill Lynch also has provided equity using tax credits and funded taxable and tax-exempt construction and permanent financing.
WHO IS DEVELOPING RAD PROPERTIES?
The development entity of a RAD transaction can be a public housing agency, a private for-profit developer, a non-profit developer or, as San Francisco showed, a joint venture between all three. RAD transactions can be complex in terms of construction and on-going property management because of the various funding sources, restrictions, requirements and financing structures.
As a result, it is important that the development team be experienced. While many public housing agencies have experience as a developer, they choose to work with an experienced co-developer because they don’t have the capacity to develop a project on their own. In some cases, the public housing agency works with the private developer only during the construction period and in other arrangements the collaboration remains in place through the stabilized period.
Some PHAs (public housing authorities) may not understand the development process or know which lenders and investors to contact and the best builders to hire. They may not have lawyers and accountants who can guide them through the HUD process. This lack of expertise and experience can be addressed by working with experienced or specialized developers or consultants.
“There are more players in RAD transactions than in a normal transaction,” Beliak said. “Working with a financial provider that understands the RAD players and process, and has developed effective and efficient tools helps makes a RAD conversion manageable. In SF-RAD, the Bank was able to dramatically reduce costs and allow for more efficiency due to our human, operational, and financial resources.”
RAD transactions can be structured in many ways, but the key aspect of all RAD transactions is the involvement of both the public and private sectors.
In Virginia, a developer obtained construction and permanent financing commitments from Bank of America Merrill Lynch augmented by LIHTC equity. This structure allowed the developer to demolish a public housing project and develop a new mixed income community with public housing and LIHTC units. Similarly, a development in Georgia combined bond financing with LIHTC to complete a family property under the RAD program.
In addition to private capital directly from lenders and investors, RAD has also attracted significant interest from financial intermediaries representing other institutional investors. In 2015 an affordable housing REIT committed $100 million to the RAD program and has made $20 million in loans so far, providing permanent financing for bank construction loans.
RAD transactions are also a natural fit for FHA-insured loans. With the issuance of the updated Multifamily Accelerated Processing (MAP) Guide that became effective in May of 2016, HUD’s FHA 223(f) program allows RAD developers to maximize proceeds for rehab of PHA units with non-recourse permanent financing for rehabs costing up to $41,350 per unit. In cases where more than 50% of two building systems are being replaced or rehab costs exceed the $41,350 threshold, the loan must be underwritten under HUD’s 221(d)(4) program instead, providing for a construction loan that converts to up to a 40-year fully amortizing permanent loan upon final endorsement. FHA lenders have financed many of the initial RAD conversions. Firms approved as FHA MAP lenders who also have extensive tax-credit experience, such as Bank of America Merrill Lynch, are particularly well-suited to work on RAD transactions, given their expertise in financing projects benefiting from the housing tax credit.
In Baltimore, the city housing authority sold a 191-unit public-housing high-rise to a for-profit developer and retained ownership of the land with a ground lease. At just over $87,000 per unit, residents will get completely remodeled units with new HVAC systems, flooring and energy-saving appliances as well as new management, yet the property will remain affordable with a new 20-year Section 8 contract. Total uses of funds are just over $40 million, including a $16 million FHA loan and more than $11 million in LIHTC provided by Bank of America Merrill Lynch.
“This is a dual-track process, with our 221(d)(4) substantial rehabilitation FHA loan on one track, with us driving, and the RAD piece on the other track, with the housing authority driving,” said Susan Monaco, chief underwriter and senior vice president, FHA multifamily community development banking for Bank of America Merrill Lynch. “There are different milestones that must be met on the RAD side at the same time we are working on FHA financing. The developer assists on both tracks. The tricky part is that RAD and FHA must close at the same time.”
CHALLENGES AND OPPORTUNITIES
The RAD program had generated $4 billion in new investment by May 2017, according to HUD's May 2017 RAD newsletter. It can be well suited for a variety of markets. In low-cost areas, it can work without any additional subsidy. It can work in major urban cities with additional government support.
In those locations with lower land and construction costs, RAD transactions can often be successful using conventional debt financing and LIHTC equity. However, one of the challenges of any voucher system such as RAD is that rents may not be set high enough to ensure the financial viability of the project. The cost of renovations in some areas might seem too high, particularly in the major cities and high-cost areas where labor and materials are at a premium. It is not as much a problem in the South and Southeast. However, FHA financing with the 221(d)(4) programs does require the use of Davis-Bacon wages, which can increase construction costs. Ultimately, if rents don't support the amount of debt required for the renovation or replacement of units, additional soft dollars are needed from the public sector. San Francisco, for example, contributed $53 million to the second phase of SF-RAD. For the Baltimore city project, the housing authority provided a $12 million seller takeback note for the purchase. A small grant may be more cost efficient to support a RAD transaction than it would be for a public housing authority to lose the units or renovate the project using limited capital funds. Typically these issues are addressed during financial negotiations, and an experienced lender could offer recommendations to mitigate this issue.
Initially, providers of private capital for RAD conversions were wary of lending into the program because of a concern over senior property rights. Bank of America Merrill Lynch joined with the National Housing Conference in working with HUD on a loan provision that addressed the problem. The so-called RAD rider that resulted stipulated that restrictions that ensured the housing would remain low-income were senior to lender rights. However, lenders are allowed to take ownership of the property for non-performance, while the apartments remain affordable.
The agreement with HUD allows the property to be transferred or sold, paying the lender at no more than the amount owed, with HUD retaining the ability to approve the new owner. The impact of the rider was to make banks and other lenders more comfortable with the risks of non-performance, thereby opening up the RAD capital market.
ELEMENTS OF FUTURE SUCCESS
The RAD program is changing the way very low-income housing is funded and operated. A preliminary report from HUD issued in 2016 has shown that throughout the country public housing authorities are using the RAD program to leverage private sector resources to enhance the affordable housing rental stock in their communities. By working together, agencies and the private sector are modernizing and even adding to low-income housing supply.
HUD says it will release a final report on the full impact of RAD in fall 2019. In the meantime, a critical piece of this program is the ability to access additional capital by using the low-income housing tax credit, which was preserved in the tax reform bill passed in December 2017. The lower corporate tax rate will; however, result in lower LIHTC equity pricing, generating lower proceeds for transactions and potentially creating funding gaps that will need to be filled with other sources. The Fiscal Year 2017 HUD appropriations act authorized another 40,000 units for RAD conversion, raising the total unit cap to 225,000. As of May 2017, there were 125,000 units (representing about 1,000 projects) that were authorized for conversion and are in the process of securing financing.
Will other cities replicate the scope of SF-RAD?
“I think this project is exceptional; we’re putting in nearly $100 million locally, and not every city can do that,” said San Francisco’s Lee. “But can other cities do their public housing redevelopment based upon the principles we established? Absolutely.”
As of May 2017, 89 public housing authorities, including San Francisco, have converted their entire public housing stock to the Section 8 platform through RAD.
- HUD’s RAD program enables public housing authorities to collaborate with developers and access private capital to make major improvements to a property.
- Capital support by way of tax credits is critical to RAD’s continued success.
- A strong and experienced financial provider can best navigate the complexity and optimize the flexibility of RAD.