Considerations When Undertaking Your First RAD Development

By Carson Hayes, President of Hayes Gibson Property Services

For many years, public housing was considered by many to be an outdated proposition whose day had come and gone. The media portrayed public housing as defunct and crime-ridden with a myriad of social and physical plant issues. In many instances, this was an accurate portrayal at the time. Public housing crime was rampant in some areas of the United States and some of the nation’s public housing looked more like a war zone instead of a place for eligible families to have safe, sanitary, and decent housing at an affordable rent. Other affordable housing was much newer, had more amenities, and featured larger unit sizes. Some public housing was torn down and not replaced – increasing the affordable housing shortage. HUD Public Housing had over $26 billion of estimated critical repairs needed before the Rental Assistance Demonstration (RAD) program nationwide. HUD capital funding was unable to keep up with the physical plant needs of the public housing and often PHA’s had to decide between various critical issues. As this housing crisis continued there was significant discussion on how to best address this issue. The RAD Program by HUD became the solution. This program allows PHA’s to revitalize their housing stock by utilizing funding from Section 42 Low Income Housing Tax Credits.

RAD is a lifesaver for many PHA’s. This program allows units to get the much-needed renovation, and the placement of project-based rental assistance has made the units affordable for all residents. It also allows rents at a level to meet reasonable financial needs of the project as well as to fund strong reserves.

As PHA’s consider the RAD program and if it is a fit for their agency, the following are some important considerations when evaluating a potential RAD development:

  • Who will prepare the various applications needed to complete a tax credit project?
  • Do I need a co-developer?
  • How will the property be managed?
  • How will tax credit compliance requirements be met?
  • Why is a tax credit development the appropriate solution?

Who prepares the funding application?

The applications require the preparation of a comprehensive financial model, and the model must show how the project will remain viable for the initial tax credit period of 15 years as well as the extended use period.   There is the coordination of third-party reports such as Phase I Environmental, PCNA, Market Study, property tax exemption, soft fund applications, and scope of the renovation.  Energy efficiency is a critical component, not only to be funded (state agencies have strict requirements) but also will help the property operate more efficiently during the compliance period. Building a development team is more challenging (though not impossible) than working with a consultant who has extensive tax credit experience.   Two types of tax credit programs exist – 9% and 4%.   More equity is raised in a 9% tax credit transaction, but the 9% awards are very competitive.  The 4% tax credits are non-competitive, but much less tax credit equity is raised.  In many cases, there is a need to acquire soft funds to help finance the project.   All of these considerations are typically outside of the normal expertise of the PHA; therefore, consultants are heavily used to submit the funding package.

Do I need a co-developer?  

While the tax credit program provides a great avenue to much-needed funding, these credits are closely monitored, and experience is a critical component for tax credit investors and lenders who respectively provide the equity and debt.   There are required guarantees and some PHA’s will not have the financial strength to provide these guarantees.  State Agencies who allocate the credits along with tax credit syndicators will have very tight regulations on whether or not a PHA may act as a sole developer or whether they will need to have a co-developer.  Choosing a co-developer is a critical aspect of the RAD transaction.   You will have this partnership for the next 15 years.    Lastly, if a PHA desires to be the sole developer on the next phase, then it is critical to choose both a consultant and developer who will mentor your agency and train and support you to self-sufficiency.  In most cases, if you partner with a co-developer, then you will not need a consultant as the developer will perform both roles.  It is critical to have a clearly defined development agreement establishing the roles of the PHA and your co-developer as well as the split of the developer’s fee.  Lastly, the co-developer will usually be the entity providing the tax credit guarantees which will involve both a net worth component as well as a liquidity requirement.

How will the property be managed?

Most PHA’s are accustomed to self-management of any PHA asset.  However, most PHA’s on their first RAD project do not have previous Section 42 experience.   Neither the syndicator nor state agency will easily approve self-management without demonstrated prior Section 42 management experience.   This management is drastically different than typical PHA Public Housing Management.   The Section 42 regulations rely on guidance from the HUD 4350.3 and many PHA’s are not familiar with this handbook and methodology.   Also, most compliance errors under HUD are more conciliatory in nature (i.e. let’s get it corrected and move forward) than the serious effects of major non-compliance in tax credit transactions.   Ineligibility of residents or significant programmatic errors may result in the issuance of an 8823 and left uncorrected may lead to recapture of the tax credits by the Internal Revenue Service (IRS) and involve thousands of dollars.  For these reasons, most RAD deals involve third-party management for at least the first RAD project the PHA does.  It is important to have a management company to mentor and train PHA staff on all Section 42 Regulations so that experience will be achieved; so, by the next RAD project, the PHA will be able to self-manage.   PHA staff would be used for front-line duties in maintenance and management and supported/trained by the third-party management company.  Staff would also obtain the proper tax credit education such as a Tax Credit Specialist (TCS), Certified Credit Compliance Professional (C3P), or equivalent.

How will tax credit compliance requirements be met?

First-year files establish the eligibility of all residents and the eligibility (right) of the project to receive the tax credits.   First-year files will be double-checked by the Limited Partner and usually through a third-party compliance entity.  The initial eligibility process is one of the first major duties done by management and submitted on behalf of the General Partner on behalf of the partnership.   Again, many PHA’s do not have an in-house compliance department with Section 42 experience.  For this reason, compliance is outsourced for at least the first project, if not for all RAD projects done by the PHA.   The typical arrangement has a set-up fee, a charge for first-year files, and then a per file charge for ongoing compliance.    This is another partner who needs to be carefully chosen especially if you want the compliance entity to train your staff so compliance may be taken over in the future by the PHA.  Not every vendor will want to train your staff to take their place over time!  Agencies should look for compliance vendors who have an extensive and verifiable track record of compliance within the state you operate and no outstanding, unresolved 8823’s.

Why is a tax credit development the appropriate solution?

Why the RAD program is something your PHA should consider has many different reasons:

  • Access to rehabilitation or new construction funds which will revitalize your housing stock
  • Earned Developer’s Fee for your PHA
  • Continuance or expansion of your housing operations

Each PHA should develop a long-term strategy for participating in the RAD program.   In some cases, it may make sense to combine multiple properties into one tax credit transaction.   Consult with other PHA’s you may know of that has done RAD projects to get their feedback on what they have learned through the RAD process.   Though it can be a challenging process, the revitalization that the RAD program brings to your PHA may be well worth the effort.

Carson Hayes is President of Hayes Gibson Property Services and a former Senior Associate with The National Center for Housing Management of Washington DC and one of the developers of the Tax Credit Certification (TCS).