02publicprivatepartnerships.pdf

Public-Private Partnerships

for

Increasing

Investment

in

Preservation

DeWayne

H.

Anderson

The

purpose of

this paper is to describe the

motivations

of

investors,the obstaclesto

attract-inginvestmenttopreservationventures,pub!ic

devel-opment

needs

addressed

by

preservation, financing

toolsavailable for

housing

rehabilitation,

and

the

ben-efits

of

public-private partnerships for increasing

in-vestment

in such ventures.

A

case study provides a

successful

example

of

how

housing

preservation

and

neighborhood

revitalization can be

accomplished

through

theuse

of

a public-private partnership.

Motivations

of Investors

in

Preservation

The amount

of

capital

which

can be attracted to

preserve a historic building isdirectly related tothe benefits that the project will produce.

The

cardinal principal

governing

bothdebt

and

equityinvestmentin

commercial

real estate ventures is that a project's

"value"

must

exceed

its"cost." Investors evaluatea

venture

based

solely

on

itsabilityto

produce

afuture

stream

of

cash or tax benefits; a property's value is

determined

by

dividingitsprojectedannualbenefits

by

the

market

rate

of

return.

Realestate investors

may

receive

any of

fourtypes

of

benefits:

income,

taxshelter,appreciation,and/or amortization.Typically, lenders" returns arerestricted

to

income

in the

form

of loan origination fees

and

interest

payments.

Real estate equity investors

pur-chaselimitedpartnershipstoreceivecash

income

and/ ortax benefits. Protlts

from

the saleofaproperty

and

DeWayne

Anderson

organized

Landmark

AssetSenicesin

199i whichspecializes in public-privatepartnershipsto rehabilitate historic properties

and

provides property

management

sennces.

He

holdsa Master'sdegreein

Urban

Planning

and

a Bachelor'sDegree inArchitecture.

amortization

of

debtaretypicallydiscounted

by

equity

investors since these benefits will be realized at an

unknown

timeinthefuture.Equityinvestors'

primary

objective

from

apropertyresaleistoobtainthe return

oftheir original capital investment plus an

amount

needed

to

pay any

taxliabil ity

which

may

arise

from

the

sale.

The

developer ofrehabiIitationventuresistypically

not a lender oran equityinvestor.

The

developer'srole is to act as a fiduciary for the equity investor.

The

investor pays fees to the developer to

manage

the

planning,construction,

and

operational phases

of

the project

and

to

assume

the rehabilitation costoverrun

and

operatingrisks.

Obstacles

to

Investment

in

Preservation

Characteristics ofhistoric rehabilitation ventures

thatfrequentlyinhibitinvestmentinclude the following.

1.

The

costofsubstantiallyrehabilitatingexisting

struc-tures for a

new

use typically

exceeds

the cost of

new

construction.

Some

of

the

major

factors

which

contributetothe relativelyhighcostofrehabilitation projectsare:

•

Upgrading

older buildings to current safety

and

handicapped

accessibilitycodes,

• Additional architectural

and

engineering services

needed

to

document

existingconditionsinstructures

and

todescribethescope

of

rehabilitation

work,

• Insurance

premiums

toprotect

owners and

VOLUME

20

NUMBER

be incurred priorto placingabuildinginservice,

•

_{Environmental}

engineeringservices

needed

to

iden-tify

environmental

hazardsinbuildings

and

toplan

and

supervisethe

removal

or

containment

of

envi-ronmentally

hazardous

materials,

and

•

_Rehabi

1itation

work

needed

to

meet

theSecretaryof

theU.S.

Department of

the Interior'sstandardsfor historicpreservationprojects.

2.

Much

ofthe historicallydesignated buildingstockis located in

downtown

areas,agingneighborhoods, and/orrural

communities.

The

demand

for

commer-cial space

and

the rents

which

tenantscan

pay

for

space in these

economically

distressed

markets

restrictsthefinancial viabilityofpreservationprojects.

3.

Many

buildings

which

are eligible for National Registerstatus are typicallyovervalued

by

public

and

privateowners,

have

titleproblems,arelocated

on

inadequatelysized parcels, orinvolve othersite

problems

which

increase

development

costs.

Many

property

owners

are reluctanttotakeaproperty off

the

market

fora

two

tothreeyearperiod,

which

is

needed

toplan

and

financea rehabilitation project.

4.

The

rehabi litationofhistoric buildingsinvolveshigh

development and

constructionrisks

due

tothe

com-plexities

of

theplanning process

and

thedifficulties

of predicting

and

controlling the costs of such

projects.

These

factors

combined

with the relatively

poor

profitabilityexperience

of

priorpreservation projects

makes

itdifficult toobtainprivatefinancing

commit-ments. Since the inception of the Federal Historic

Preservation

Tax

tax incentive

program

in 1976,over

25,000

rehabilitationprojects

have been

undertaken.

Most

of

theseprojects

have

involvedadaptinghistoric

structures located in inner city areas for specialty

retail,office,

high-income

housing,andhospitality uses.

A

highpercentage

of

these

commercial

rehabilitation tax creditventuresdid notgeneratesufficient

income

to

meet

operating expenses,

and

many

defaulted

on

loans.

Information in the National Park Service's 1992

Annual

Report

on

the tax incentive

program

indicates that the

number

of

rehabilitation projects has

been

declininginrecent years.In 1992,about

700

taxcredit

projects

were

initiated nationwide; this represents a

decline

of

more

than 75 percent

from

the

number

of

projects started in 1984.

Over

the pastdecade, about

halfofthe buildings rehabilitated

under

the historic rehabilitation taxcredit

program have been

adaptedfor

housinguse. In 1992,eighty-eightpercent

of

thetotal

number

of housingunits

produced

inhistoricbuildings

combined

the rehabilitation

and

low-income housing

taxcredits.

Public

Needs Addressed by

Preservation

Sincethe rehabilitation

of

landmark

structures

im-pactslocal

community

development

needs, public

lend-ers

have

incentives to provide financial support for these projects. Public benefits that

may

result

from

preservation projects include;

1.

The

preservation of historic cultural landmarks,

which

helpstostrengthencitizens'sense

of

commu-nity

and

toreducetheincidenceof

crime and

other

socialproblems;

2.

The

expansion

ofthe supply

of

affordable rental

housing;

3.

The

development of

necessary publicfacilities;

4.

The

revitalizationof declining businessdistrictsor

deterioratinginnercityneighborhoods;

5.

The

recycling

of former

schools, hospitals,or other

publicly-owned

surplusbuildings

fornew

uses;

6.

The

preservation of

open

space

and farm

land

and

theutilization

of

existingpublicinfrastructure;

7.

The

expansion of local

and

state

governments'

revenues

and

thecreationof

new

jobs;

and

8.

The

reductionintheadverse

environmental impact

ofbuildingdebris

on

landfills

and

theelimination

of

theexistingenvironmental hazardsinbuildings.

In

economically

distressed

market

areas,affordable multi-familyrental

housing

istypically theonly

adap-tive use

which

can attract public

and

private

invest-ment

to rehabilitation ventures. Federal, state,

and

local

government

low-interestrate loan

programs

are available to finance

housing

preservation projects.

Tax-benefit-oriented limitedpartnershipsyndications can

combine

rehabilitationand

low-income

housingtax credits togenerateattractive investor yields.

Itis

aparadox

thatin

many

communities

housingisthe

onlyviableadaptiveuseforrehabilitating historic

CAROLINA

PLANNING

use

by

local interests. This opposition to

low-income

rentalhousingisbasedonsubjective publicattitudesabout

the prospective tenantsofrentalhousing.

Public-Private

Partnerships

for

Increasing

Investment

in

Preservation

Public-private partnershipsprovideaflexible

mecha-nism

for attracting publicinvestmentb\ assuringthat

local

development

prioritiesareconsideredinplanning preservationprojects.Joint-venturepartnerships also

combine

theexpertise

and

financialcapacityofprivate

developers

and

local

governments.

The

appropriate partnership structure for a given

projectis

determined

by

the role

and

leveloffinancial

risk

assumed

by

each partner. Typically the public

partner is

expected

to:

1

.

Define

the local

community

development

agenda,

2. Select the privatedeveloperpartner.

3.Contribute apublicly-ownedsurplushistoricbuilding

orassistthe

developer

in obtainingsite controlof

privately

owned

property,

4. Participate in thedesign ofthe project,

5.

Package

applications

and

administer Federal

and

Stateloans

and

grants.

6.Assistinobtainingapproval

of

localfmancial

sup-port,

7.

Monitor

theoperationofthe project,

and

8.

Accept and

administerhistoric

easement

donations.

The

private partner in a public joint venture is

generallyexpectedto:

1

.

Coordinate

the project'splanningprocess.

2.Obtainprivatedebt

and

equit\capital

commitments.

3.

Manage

the rehabilitationoftheproject,

4.

Assume

management

responsibilitiesforthe

prop-erty

and

thepartnership,

and

5

.

Assume

the

development,

construction,syndication

and

operatingrisks.

Although

public-private partnerships

have

potential

to

expand

investment inpreservationprojects

and

to assist localitiesinaddressingother

development

priori-ties,the

approach

has not

been

\^idely used.Obstacles

that inhibit the broader use

of

public-private joint

venturesarise

from

thefollowingfacts:

1

.

Historicallyadversarial relationships

have

existed

between

private developers

and

local public offi-cials.Local

governments'

rolehastraditionally

been

confined tothe regulation

of

private

development

activitiesthrough zoning, sub-divisionregulations,

and

building codes.

2.

Most

local officials

do

not

have

the

mortgage

banking

training or experience

needed

to under-stand real estate underwriting or to evaluate the

risks

assumed

by

thedeveloper.

These

risksexistin

theplanning, construction,

and

operationalphases of

a rehabilitation project. Public staff

and

elected officialshavelittleincentivetoassumethefinancial

and

politicalrisksinvolvedinapreservation venture.

Bureaucratic

and

political

agendas

delay

and

com-plicatetheprocessof planningpreservationprojects:

these

problems

increaseexponentially withthe size

ofthelocality.

3.

Many

privatedevelopers

do

notunderstand public policyissues

and

areinexperiencedinparticipating

in the

open

political process

which

is inherent in

planninga

community

development

project.

Tools

for

Financing

Housing

Preservation

The two

basic

problems

inunderwriting an afford-ablehousingrehabilitationventureareobtainingpublic andprivatedebt

and

equit>

comm

itments

and

eliminat-ingprojectoperatingdeficits.Currently,there are

two

alternative sources available to finance affordable

housing

preservation.

These

are the Rural Rental

Housing

Loan Program

(S.515)

and

layered public financing.

The

S.515

program,

which

is administered

by

the

Farmers

Home

Administration

(FmHA),

provides a

first

mortgage permanent

loan forninetyfivepercent

of

a project'sappraised valueat

one

percent interest

with a fifty year amortization.

Sponsors of

S.515

complexes must

obtain interim financingtofundthe

completion

of

the project. Construction loans are typically provided

by

commercial banks

at

market

rates.

These

loans are targeted to distressed rural

VOLUME

20,

NUMBER

2

The

competitionfor S.515loansisintense.

A

minimum

of

three years isrequiredto obtain a

commitment

of

these funds,

and

thereispoliticaloppositionto

extend-ingfundingfortheprogram.

FmHA

regulationsrestrict

the

maximum

cost

of housing

units in rehabilitation

projectsto

no

more

that

one hundred and

fivepercent

of

the cost

of

units in

newly

constructed structures.

This cost

containment

requirementtypicallycreates the

need

toobtainadditional sources

of

tlnancing in

S.515rehabilitation deals.

Layered

financingisa

second

method

of financing

rehabilitationhousingprojects.Thisapproachinvolves the layering

of

private loans, federal, state,

and

local

loans or grants,

and

private equity in a variety of combinations.

Sources

of

layered public financingfor

housing

include federal

HOME

and

CDBG

funds,

state

housing

finance,

agency

loanprograms,

and

local

government

funds.

The

terms

of

thepublic loans are

generally

determined

by

the local

market

conditions

affecting

each

project,

and

each loan

program

has its

own

underwritingcriteria,

program

regulations, appli-cation

and

deadline requirements.

Most

public lenders

have

no

formalizedproceduresforlinking

programs

administered

by

other publicagencies.

Generally,thepublic lendersprovide both interim

and permanent

loans.

The

terms

of

public financing

programs

include

below-market

interest rates, loan

amortization periods

of

fifteen tofiftyyears,

and

loan

terms witha

minimum

of

fifteenyears.

Housing

loan

debtservice

payments

may

beallorpartiallyaccrued withadeferred balloon

payment,

due

a

minimum

of

fifteen years

from

the date a building is placed in

service.

The

publiclenders' cultural

environment

is

signifi-cantly different in each state.

Many

state housing financeagencies

have

apreferenceforinvestmentfor

owner

ratherthanrentalhousing,for

new

construction ratherthanrehabilitatedhousing,

and

forpublic rather

than private borrowers.

Some

public lenders tendto

avoidprivately

sponsored

rehabilitationventures

due

totheunderwriting complexities

and

risksinvolvedin

such deals.

The

second

underwriting

problem

which must

be

addressedinthedesign

of

affordablehousing rehabili-tationventuresistheeliminationofprojectoperating

deficits.

These

deficits result

from

the limited rent

payingabiIitiesofeIigibletenants.

Inorderfora

housing

unit toqualify forlow-

income

housing

taxcredits,tenants"

income must

not

exceed

sixtypercent

of

the

median income

forthe county in

which

theprojectis located,

and

tenants" shelter rent

cannot

exceed

thirty percent of the county"s sixty

percent

median

income

limit.This

compliance

period

extendsforfifteenyears

from

thedatethebuildingis

placed in service.

Preservation projects typically involve multistory

structures

which

are

most

suitable for

occupancy by

elderlyand/or smallfamily households,

which have

restrictedincomes.Innon-metropolitan markets,

low-income

eligible tenants"

maximum

average shelter

rents,basedonthirtypercentof income,willgenerally range

from

$1

00

to

$275

per

month.

Afterdeduction

of

tenantpaidelectric utilitiesof about

$75

per

month,

tenants" contribution to project rent generally range

from $25

to

$200

per

month.

A

multi-family

housing

complex"s

operating

and replacement

reserve

ex-penseswilltypically

amountto $200

per

month

perunit.

Thus,an operatingdeficitof upto$175a

month

perunit

may

existbeforedebt serviceisconsidered.

A

number

of techniques

may

be usedtoeliminate

housing

operatingdeficits, includingtheprovision

of

public or privaterentalassistance for tenants,

reduc-tion in localpropertytaxes,water,

sewer

and/ortrash collectionfees,and/orthe useofnon-residential project

income

to subsidize

housing

operating deficits.

The

operatingdeficit

problem

generally

does

not exist in

S.515 financed projects

due

to the fact that

FmHA

provides project-basedrentalassistancetotenants. In

layered financing projects, rental assistance

may

be provided

by

the sponsor, the local

government,

or through Section 8 rental assistance.

The

lack

of

a viableproject-basedtenantrentalassistance

program

Iinkedtopublicfinancingiscurrently a

major

obstacle

todevelopingaffordablehousinginrural

market

areas.

After a project has received loan

and

operating subsidy

commitments,

private equity

commitments

can beobtained. Attracting privateequityto

housing

rehabilitation projects is not a

problem due

to the attractive yieldsthatarecreatedthroughthe

combina-tionofthe rehabilitation

and low-income

taxcredits.

The

historicrehabcreditisaone-time

twenty

percent

credit

claimed

in theyearthatabuildingis placedin

service.

The

Low

Income Housing

Credit is either a fourpercentcreditovera tenyear periodfor federally

subsidized projects or a nine percent credit for

non-federally

funded

new

construction or rehabilitation

projects.

Public-Private

Partnership

Preservation

Case Study

The

RHS

Apartment and

Old

Towne

Neighborhood

Revitalization project in Reidsville,

North

Carolina, providesasuccessful

example

oftheuseofa public-privatepartnershiptorehabilitatea historic structure

CAROLINA

PLANNING

OldeTowneCriticalAreas.Reidsville.NorthCarolina.

government

can use preservationofa

landmark

bui

Id-ing as a catalyst to trigger the revitalization of a deteriorating residentialneighborhood.

In1990,theCity

of

Reidsvilleadopted

acomprehen-sive

development

plan

which

calledfor

development

of

specific

neighborhood

planstoguidefuture

develop-mentand

revitalization activitiesinneighborhoods.

The

Old Tovvne

Neighborhood

plan,

developed

in 1993,

was

thefirstsuchplan.

The

planning process involved extensiveparticipation

by

area residents.

The

Old

Towne

area contains 2.093 persons or fifteen percent of the city"s population.

The

area's

population includesaconcentrationof minority

per-sons with

median

incomes

of about 70 percentthatof

the

average

of

the total city population.

The

neighborhood's housing

stock

was

deteriorated

and

affected

by

the blighting influence

of

two

vacant

deteriorated school buildings

which

historically

had

been

cultural

and

physical focal points ofthe area.

Three

problem

areas

were

identifiedtobethefocusof

neighborhood

revitalization activities: FranklinStreet,

Barber

Street,

and

West End

Plaza.

The

former

Reidsville

High

School,

which

islocated

intheFranklinStreetarea,

was

constructedin 1

922 on

asite

which had

previously

been occupied

by

a school.

Additionswere added

tothebuildingin

1930and

1941,

and

in 1953a

gymnasium/cafeteria

building

was

con-structed tothe north. In 1980, the school

was

aban-doned and

the

gymnasium/cafeteria

was

convertedto

aCityRecreation

and

Senior Center.In 1990,thehigh

school property

was

donated

toaprivatepartnership through the Reidsville

Main

Street Association. In

1992,thepartnershipobtaineda

commitment

from

the

Farmers

Home

Administration foraS.515RuralRental

Housing

loan to rehabilitate the property. After the

FmHA

loan

commitment was

obtained,thecity

initi-ated theplanning processforthe revitalization

of

the

FranklinStreet area,

and

the

developer

began

work

on

design

development

plansforthehighschool.

Both

the public

and

private

components

of

the

program were

developed

withclosecooperation

between

the city

and

thedeveloper.

After

completion

of

the

Old

Towne

plan, thecity

obtained a

Community

Development

Block Grant

(CDBG),

which

includedfunding foractivitiesin all

threecriticalareas

of

the

neighborhood.

The

Franklin

Streetactivitiesincluded

$39,000

for

development

of

VOLUME

20,

NUMBER

and

residential lots

which

are located

on

the

former

schoolplayground.

The

1.29acre

playground

property

was

donated

to Habitat for

Humanity

by

the high

school developer. Habitat is

developing

four afford-abledwellings

on

theproperty.

The

city also

amended

its

zoning

ordinance to

amortize a

mobile

home

park

which

represented a blighting influence

on

the school property

and

the

surrounding

neighborhood.

A

church acquired

and

occupied

the

second

vacant school in thearea.

The

city obtained a

second

CDBG

grant in the

amount

of

$250,000

for

abatement

of environmental

problems

in the school building, for infrastructure

improvements on

streetssurroundingtheschool,

and

for landscape

improvements

to Pine Street,

which

separates the school

from

the SeniorCenter.

These

fundswillbe repaidtothecity

by

thedeveloper.

The

RHS

Limited

Partnershipwill

expend

a total

of

$3.5milliontorehabilitatetheschoolfor53elderly

and

handicapped apartment

units in

accordance

with the

Secretary

of

the Interior's Standards. Sources of fundsincludetheS.515loanof$2.3million,

theCDBG

loan

of

$250,

000 and

$1 millionin equityinvestment

raised

from

the saleoftax credits.

In 1994,theCity

of

Reidsviliereceived an

award

for the

Old

Towne

Neighborhood

Plan

from

the

North Carolina Chapter of

the

American

Planning

Association.

This

award

recognizes

thesignificant potential

of

thepublic-privatepartnership

approach

forincreasing

investment

in

housing

rehabilitation

projects

and

for revitalizing inner city

neighbor-hoods.

However,

the reader is

cautioned

that

no

two

preservation projects

happen

twice

in exactly

the

same

fashion.

Each

localsituation possessesits