Guidance for Habitat for Humanity Affiliates January 12, 2011

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1 January 12, 2011 Community Planning and Development NSP Policy Alert! Guidance for Habitat for Humanity Affiliates January 12, 2011 Overview Habitat for Humanity utilizes a unique development model to create homeownership opportunities for low- and very-low income families. As Habitat has emerged as a major implementer of NSP programs nationwide, its interaction with HUD s has increased significantly. Many Habitat for Humanity affiliates are administering CDBG/NSP funds for the first time. This guidance seeks to address some of the most common concerns that Habitat for Humanity Affiliates have expressed regarding compliance with Neighborhood Stabilization Program rules and requirements. Unless otherwise specified, this guidance applies generally to NSP subrecipients and developers from other organizations. Designation of entities carrying out NSP-eligible activities NSP and CDBG regulations establish definitions of developers and subrecipients which may differ from the usage of these terms amongst Habitat affiliates in the field. Habitat affiliates must be aware of the differences between developers and subrecipients, as defined by HUD, since different sets of HUD and OMB regulations apply to each entity type. This section clarifies these definitions for Habitat affiliates, as well as the implications of each designation. The designation of a Habitat Affiliate as either a developer or a subrecipient has important implications for: The types of NSP-eligible activities the entity may carry out, Procurement procedures, The eligibility of certain costs, How program and administrative costs are charged, The allowability of developer fees, and The treatment of revenue generated by NSP activities. The full range of implications are discussed in the NSP Policy Alert: Guidance on Developers, Subrecipients, and Contractors, released August 27, This guidance is available on the Resource Exchange website at: U.S. Department of Housing and Urban Development 1

2 Subrecipient: A nonprofit or public agency that assists a grantee or another subrecipient to administer all or a portion of the NSP program. As provided in the NSP Bridge Notice, published on June 19, 2009, Subrecipient shall have the same meaning as at the first sentence of 24 CFR (c). This includes any nonprofit organization (including a unit of general local government) awarded funds by a state. The term also includes any land bank receiving NSP funds from a grantee or another subrecipient. Section (c) reads as follows: Subrecipient means a public or private nonprofit agency, authority, or organization, or a for-profit entity authorized under (o), receiving CDBG funds from the recipient or another subrecipient to undertake activities eligible for such assistance under subpart C of this part. Habitat affiliates which are members of NSP2 consortia may only be designated as subrecipients. NSP2 nonprofit consortium members may not be designated as developers. Developer: A for-profit or private nonprofit individual or entity that the grantee provides NSP assistance to for the purpose of (1) acquiring homes and residential properties to rehabilitate for use or resale for residential purposes and (2) constructing new housing in connection with the redevelopment of demolished or vacant properties. Developers are program beneficiaries and thus distinct from subrecipients, grantee employees, and contractors. Developers may receive NSP funds from either the grantee or a subrecipient. Developer-led rehabilitation is undertaken pursuant to 24 CFR (b)(1). New housing construction is undertaken pursuant to 24 CFR , or the NSP notice published on October 6, 2008, as amended. Both grantees and subrecipients can engage developers. However, to be treated as a developer, the entity must demonstrate ownership or control of the property to be rehabilitated or redeveloped. That is, a grantee or a subrecipient cannot designate an entity as a developer if it is simply providing construction services on a property owned by the grantee or subrecipient; such an entity would be classified as a contractor. Revenue Implications Habitat affiliates must also be aware that NSP grantees and subrecipients are required to treat revenues generated by an assisted activity as program income that may only be used for NSP-eligible activities. Note that costs incidental to the generation of income from real property acquired or improved with NSP funds may be deducted from gross revenues for the purpose of determining the amount of program income. Unless otherwise negotiated in its agreement with the grantee, a Habitat affiliate designated as a subrecipient is required to return any program income to the grantee. This requirement does not apply to affiliates designated as developers, though a grantee may require a developer to return all or a portion of any such income. A significant implication of this policy is that a portion of the mortgage loan payments received by a Habitat affiliate designated as a subrecipient will constitute program income. The portion that constitutes program income is based on the percentage of NSP participation in the total development cost. An NSP grantee and Habitat affiliate that anticipate program income from the affiliate s NSP activities must include terms in their subrecipient agreement which clearly specify how much of any program income generated by the project will be kept by the subrecipient and how it will be used. This will avoid problems at the time of audit or close-out. U.S. Department of Housing and Urban Development 2

3 Habitat affiliates designated as subrecipients: Must follow federal procurement rules May not charge developer fees Must follow cost principles at 24 CFR Part 84 and OMB Circular A-122 Must treat revenues as Program Income and return to grantee. However, if the grantee wishes, subrecipients may keep program income to implement other NSP eligible activities. Habitat affiliates designated as developers: Do not have to follow federal procurement rules May charge developer fees. Do not have to follow OMB Circulars. Are not required to treat revenues as program income. Homeownership Assistance Habitat affiliates frequently request guidance on the use of various forms of homeownership assistance. Within NSP, homeownership assistance encompasses many approaches to closing the gap between the sale price of a home and what a prospective homebuyer can afford to pay. The Housing and Community Development Act, in Section 105(a), recognizes 5 ways in which NSP funds may be used to provide homeownership assistance (i.e. close the affordability gap) for prospective low and moderate income homeowners: 1) Subsidizing interest rates and mortgage principal amounts (including payment of private mortgage insurance) (generally secured by a second mortgage, which may be forgiven) 2) Financing the acquisition by low- and moderate-income homebuyers of housing that is occupied by the homebuyers 3) Paying initial mortgage insurance premiums 4) Downpayment assistance up to 50 percent of the amount required by the mortgage lender. 5) Payment of reasonable closing costs. How can a Habitat affiliate provide homeownership assistance? A key consideration for Habitat affiliates is that entities designated as developers may not provide direct homeownership assistance. However, developers may use secondary financing as a form of homeownership assistance. So while a developer could not provide a buyer with downpayment assistance, assistance could be provided through interest rate or principal buy-down secured through a second mortgage. Alternately, a direct NSP grantee could provide homeownership assistance that a developer may not; this would be more likely when the Habitat affiliate serves as a developer for a direct NSP grantee that is a unit of government. U.S. Department of Housing and Urban Development 3

4 Sales Price Valuation The Habitat development model relies extensively on gifts-in-kind, donations, and volunteer skilled and unskilled labor. Many Habitat affiliates have expressed concern about how to properly value such contributions when setting the sales price of a NSP-assisted unit. Section 2301(d)(2) of HERA directs that, if an abandoned or foreclosed-upon home or residential property is purchased, redeveloped, or otherwise sold to an individual as a primary residence, then such sale shall be in an amount equal to or less than the cost to acquire and redevelop or rehabilitate such home or property up to a decent, safe, and habitable condition. Sales and closing costs are eligible NSP redevelopment or rehabilitation costs. Note that the maximum sales price for a property is determined by aggregating all costs of acquisition, rehabilitation, and redevelopment (including related activity delivery costs, which generally may include, among other items, costs related to the sale of the property). The cost of donated materials and professional services may also be included in the base for determining the maximum sales price under section 2301(d)(3) of HERA. The cost of the donated materials must be based on their fair market value at time of donation. Estimates of the value of unskilled or sweat-equity labor may not be included in the total development cost. Moreover, the costs of donated professional services and materials may not be reimbursed by the NSP grant. On a related topic, when Habitat acts as a lender and forecloses on a loan secured by real property and takes title to the property, the property is then valued on the lender s books at fair market value less the cost to sell the property. For example, if the defaulted loan balance is $100,000 and the mortgaged property s fair market value at the time of foreclosure is $75,000, the new cost basis for the property is $75,000 less the estimated cost to sell the property. (In other words, the amount of the loan has no bearing on the current market value.) If the estimated cost to sell the property is $4,000, then Habitat s cost basis in the property is $71,000 ($75,000 less $4,000). If Habitat makes improves the property following its taking title, the cost of those improvements is added to the cost basis. The property cannot be sold for more than its cost basis (or market value, if lower.) Thus, if Habitat spends $40,000 in NSP funds on the rehabilitation of the property described above, Habitat can sell the property for no more than $111,000 ($71,000 plus $40,000). Development Subsidy In some instances, the total development cost of rehabbed and/or newly constructed NSP units will be greater than the current market value of the unit. This is particularly prevalent in markets where housing values have declined substantially. In such situations, NSP funds can be used to fill the appraisal gap, and will be considered a development subsidy. Grantees may not apply affordability instruments to NSP funds used as a development subsidy. This subsidy will be considered a sunk cost and is considered an eligible use of NSP funds. In this case, the lender (Habitat) should not impose liens in amounts above the value, and may only do so if the lien is made without recourse to the borrower. A non-recourse requires no future payment by the borrower. U.S. Department of Housing and Urban Development 4

5 Affordability Requirements This section discusses affordability requirements and the related compliance issues Habitat affiliates face when utilizing NSP funds to achieve affordability goals. After providing homeownership assistance to a homebuyer whether in the form of a mortgage buy-down, downpayment assistance, closing cost assistance, etc. an NSP participant must ensure that the unit remains affordable for the minimum period of affordability (5, 10, 15, or 20 years, depending on the level of subsidy.) NSP participants may choose one of the following two approaches to ensure continued affordability: Resale: Habitat affiliates may ensure continued affordability of an NSP-assisted unit by placing a lien or deed restriction on a property when it is sold to an income eligible homebuyer at resale. The resale option requires that the borrower sell the property to a buyer who meets income eligibility requirements for the program (low, moderate, or middle income.) This method allows the borrower to earn a fair return on the property, but ensures that it remains in use as affordable housing. It is especially effective in markets with rising prices, where loan proceeds from the sale would be insufficient for the community to acquire a similar unit. When the costs exceed the selling price, as discussed above, the excess cost is a development subsidy and the resale method must be used. This is because there is no direct subsidy to the borrower and thus nothing on which to place a lien. Recapture: Alternatively, Habitat affiliates may utilize the Habitat Soft-Second mortgage as an instrument for the recapture of NSP funds. If using a soft second, the Habitat affiliate may not also use a resale mechanism. The Recapture method is used when there is a Direct subsidy to the borrower, usually secured by a non-amortizing second mortgage. Such loans often have forgiveness provisions, typically tied to the affordability period. If an affiliate is classified as a subrecipient, any income received from interest on a soft second mortgage is considered program income. This does not apply to affiliates designated as developers. The key issue for Habitat affiliates is to determine in advance whether a resale or recapture mechanism will be used, and to explicitly detail whichever mechanism is chosen to HUD. Another Policy Alert, on Accounting for Real Estate Development Costs in NSP, has more detailed information on what is allowable and how to record it correctly. U.S. Department of Housing and Urban Development 5