Estimates and Financial Feasibility

In the pre-development stage, you will not know for certain how much things will cost or how much funding you will be able to secure. As a result, this analysis will be based on a series of estimates and assumptions about your development model, information from your Project Team, plus data collected for the market analysis.

Types of estimates you will need to analyze financial feasibility:

Cost of land, labor, and materials for acquisition, site work, and construction (AKA “hard costs”).
Other costs not related to labor and materials, like fees and insurance (AKA “soft costs”).
Anticipated income from the project (residential and commercial rents collected; income from parking, laundry, or service fees; rental assistance) on an annual basis.
Anticipated vacancy rate.
Operating expenses (taxes, insurance costs, utilities that are not paid by tenants, repair and maintenance costs, and other administrative or management costs).
Operating and replacement reserve budgets, in case there are shortfalls or larger items (like HVAC) need replacement during your building’s lifespan.
Debt service or other financing costs.

There are four primary ways we use this information to analyze and summarize the project’s financial needs:

A Development Budget, where you detail the costs of building your project and getting it ready for people to live in.
A Sources and Uses statement, where you summarize the funding you have relative to the development costs they will cover.
Operating Income and Expenses, which helps calculate rental income and debt service.
A pro forma schedule of income and expenses, where you estimate how your project costs and revenues will accrue over time.

Many refer to all these components as a “pro forma” together because they are typically found within the same workbook and the pro forma forecasting spreadsheet is typically populated with values from the other sheets and can be useful in doing base calculations. We have a sample pro-forma in the tools for you to use.

Key definitions

Debt is money you borrow from lenders and pay back at regular intervals; equity is money paid by investors in exchange for partial ownership of the project; and grants are money you do not pay back but are awarded because your project meets the goals of the grantees.

In the pre-development stage, you will not know for certain how much things will cost or how much funding you will be able to secure. As a result, this analysis will be based on a series of estimates and assumptions about your development model, information from your Project Team, plus data collected for the market analysis. As you gather more information about costs and funding, you should revisit your feasibility analysis and adjust for accuracy. A pro-forma should be continually refined and returned throughout the development process.

Many affordable housing projects need to engage a consultant or technical assistance provider to perform a full financial analysis to demonstrate that a project is a sound investment. Engaging an expert to perform a financial analysis is another opportunity to learn from an experienced partner and build capacity for financial analysis in-house. All development partners should also be involved in the financial feasibility assessment process to ensure they understand and are able to communicate the results.

DEVELOPMENT BUDGET

A development budget captures all costs required to build your project and place it in service (or have it generally ready for occupancy). The development budget includes the following costs:

Land and site work costs
Construction or rehabilitation costs
Professional fees, including consulting costs
Interim construction costs
Permanent financing costs
Developer fee
Project reserves

Soft costs, which are costs not directly related to construction labor and building materials. This includes costs such as architecture, engineering, permitting, and legal fees. Some soft costs such as insurance may continue after construction is completed.
Predevelopment costs (Development costs that are incurred prior to construction, such as those described in the predevelopment section of this guide. This consists mainly of soft costs but will not be the only part of the process where soft costs are incurred.)

The sum of costs across each category represents your total development cost (TDC), or Development budget.

As you are working on your Development Budget, keep in mind that funding sources may cap the maximum cost per unit. For example, in order to apply for Tax Credits in Nevada, projects are subject to the maximum cost per unit, excluding land costs as outlined in the QAP. Per unit limits are also part of the HOME program.

SOURCES AND USES STATEMENT AND PERMANENT FINANCING

A sources and uses of funds statement is used to summarize your project’s financing and how that compares to your Development Budget. In other words, do you have sufficient funding to cover the costs of building your project?

This statement should capture all sources of financing, their amounts, and what costs they will cover. You have already calculated your “uses” in your development budget. These are your costs within each category mentioned above. You may want or be required to include additional details about each source of financing, such as the type (loan, grant, tax credit, in-kind support, equity investment, etc.) and whether the funding is private or public (federal, state, or local).

Have this statement prepared before you seek funding from a lender or additional funder and include documentation to demonstrate that the funding listed in the statement has been secured. This may include award and commitment letters or partnership agreements.

What is the difference between construction financing and permanent financing?

Construction loans are shorter-term financing, only intended to cover project costs during the construction phase. After construction is completed, this debt is converted to a permanent loan to be paid back (or amortized) over a longer period. This period can range from 5 to 40 years.

A sources and uses of funds statement does not include the details of when your costs and revenues will accrue over your project’s lifetime. Those details are included on your pro forma schedule of income and expenses (or cash flow analysis). See the Financial Modeling Tool and Guidance for more specific guidance and a template you can use for your own analysis. There are two sheets that help you analyze the short term and long-term revenue and costs of the project in the Financial Modeling Tool.

You can use the pro forma workbook to test the impact of different components of your development model or different funding sources on your project’s financial feasibility. Ultimately, you will use the pro forma to demonstrate to funders that you need their investment and, if applicable, will be able to pay them back. When preparing your pro forma for funders to review, you may need to provide additional documentation to back up the information included (e.g., if you say you have a certain amount of funding already secured, provide documentation that confirms this).

OPERATING INCOME AND EXPENSES

The Operating Pro-forma helps to assess the amount of square footage developed relative to the amount of revenue it will generate. Do your best to get accurate data, as inaccurate assumptions can lead to dramatic swings in actual property performance. There are several factors that need to be considered to derive an accurate Operating Pro-Forma:

Costs to Operate:
- Salaries: do you need to pay a full-time or part-time property manager, is there a way to spread this time over a few properties?
- Utilities
- Trash
- Snow removal/grounds maintenance
- Property insurance
- Reserves
Type of units (number of bedrooms and baths per units)
Number of each type of unit
Projected rents: You need to assess Fair Market Rents in your area. Make sure projected rents are reflective of current market conditions for comparable properties in your area. If you have project-based vouchers, you can assume full rent for residents at varying incomes, if not, rents should be scaled to remain affordable to the target income brackets you are setting out to serve. See calculating affordability.

15-YEAR FINANCING PRO-FORMA

The 15-year financing pro-forma will help you assess some key financial metrics for your development. The most common metrics lenders and funders will use to determine whether and how much debt they will offer to a project are the Debt Service Coverage Ratio (DCR, DSC, or DSCR) and loan-to-value ratio (LTV or LVR). Lenders use these metrics to evaluate how likely they are to be repaid for a loan. Recognizing financial analyses are built on assumptions, lenders look for additional cushion between your NOI and the amount of debt they will authorize for your project.

The DCR, which is a ratio of your cash flow to debt payment, reflects the amount of this cushion a lender is looking for. Lenders often seek a 1.25 minimum DCR, meaning that your project cash flow must be equal to or greater than 1.25 times your required debt service. Some lenders will use lower DCR (e.g., 1.15) based on their risk tolerance or perception of risk.

DETERMINING YOUR FUNDING NEEDS

With your pro-forma package estimates, you will be able to project how much of a gap you have between income and expenses (i.e., your “Net Operating Income” or NOI) and how much cash you may have on-hand after paying your debt service (i.e., your “cash flow”). If either of these figures are negative, you will need to find additional funding to close that gap and/or adjust your development model (number of units, square footage, design features) to reduce costs. If you utilize the Financial Modeling Tool, the up- front gap will be evident on the permanent financing tab.